Calculating the Tax Cost of Expatriation

Recent changes in US tax law have significantly impacted expatriates, particularly those with extensive international connections. This guide explores the complexities of expatriation, the consequences of being a covered expatriate, and the evolving tax strategies necessary to navigate this challenging landscape. With national division, uncertainty in new wealth taxation, and the memory of COVID-19 restrictions fresh in people’s minds, expatriation has become an even more attractive option for many.

How the TCJA of 2017 Influences Expatriation Decisions for Americans Abroad

The Tax Cuts and Jobs Act (TCJA) of 2017 has reshaped many aspects of the US tax system, but it left the expatriation rules under Sections 877A and 2801 unchanged. Despite this, the new tax provisions indirectly impact expatriates by altering the economic incentives surrounding US citizenship and long-term residency. For many Americans living abroad, particularly entrepreneurs and investors, the increased tax burdens have made expatriation a more attractive option.

Who Qualifies as a Covered Expatriate?

A “covered expatriate” faces specific tax consequences upon renouncing US citizenship or terminating long-term resident status. You are classified as a covered expatriate if you meet any of the following criteria:

1. Your average annual net income tax liability for the five years preceding expatriation exceeds $165,000 (as of 2018).
2. Your net worth is $2 million or more on the date of expatriation.
3. You fail to certify full compliance with US federal tax obligations for the five years preceding expatriation.

Being a covered expatriate triggers two primary tax outcomes: the Exit Tax and the Special Transfer Tax. The Exit Tax treats all global assets as sold the day before expatriation, making them subject to US income tax. The Special Transfer Tax applies to gifts or inheritances given to US persons by a covered expatriate, taxed at the highest US estate or gift tax rate.

Reporting Worldwide Income as a Dual-Status Taxpayer

When expatriating, you must file a tax return for the entire calendar year. Depending on your circumstances, you may need to file:

1. Form 1040 as a full-year resident.
2. Form 1040NR as a full-year nonresident.
3. Form 1040 and Form 1040NR as a dual-status taxpayer (part-year resident and part-year nonresident).

For dual-status taxpayers, all income worldwide must be reported for the part of the year you were a resident. After renunciation, only US source income is reported. This process can be complex, and professional guidance is often necessary to ensure compliance and optimize tax outcomes.

Strategies for Minimizing Exit Tax Liability

Effective tax planning can significantly reduce the impact of expatriation taxes. Here are some strategies:

1. Asset Reallocation: Before expatriation, reallocate assets to minimize net worth and avoid covered expatriate status.
2. Utilize Exclusions: The TCJA doubled the estate and gift tax exclusion, allowing for larger lifetime gifts that reduce taxable estate size.
3. Pre-Expats’ Gift Planning: Gifts of non-US real estate or other non-US tangible property can reduce net worth without triggering US gift tax.

Specified Tax Deferred Accounts and the Exit Tax

Certain tax-deferred accounts, such as IRAs, 401(k)s, and health savings accounts, have specific rules under the exit tax. Covered expatriates must treat these accounts as distributed on the day before expatriation, paying tax on the deemed distribution without early withdrawal penalties. Properly filing Form W-8CE with account custodians and reporting on Form 8854 is essential to comply with these rules.

Estate Tax After Expatriation

Even after expatriation, the US estate tax can apply to nonresident noncitizens on US-situs assets, like US real estate or shares in US corporations. The estate tax exemption for nonresidents is much lower ($60,000) compared to US citizens, making estate planning crucial for expatriates. One strategy is to convert US situs assets to foreign situs assets to avoid US estate tax.

The Impact of New Tax Provisions on International Business Owners

The TCJA introduced new taxes on foreign earnings, such as the repatriation tax and the Global Intangible Low-Taxed Income (GILTI) tax. These changes disproportionately affect US individuals with foreign businesses, making expatriation a more viable option for reducing overall tax liability. For instance, creating a US parent corporation for a foreign business or restructuring ownership can mitigate some tax impacts but often involves high legal and accounting costs.

Strategic Expatriation for Global Financial Planning

The evolving US tax landscape presents new challenges and opportunities for expatriates. With the heightened focus on international tax compliance and the changes introduced by the TCJA, expatriation might be a strategic option for US citizens and long-term residents abroad. Understanding the rules and implications of expatriation, utilizing effective tax planning strategies, and seeking expert advice are crucial steps in navigating this complex process.

Expatriation isn’t merely about departing from the US; it’s about reimagining your financial future on a global scale. With evolving tax laws, staying informed and proactive is crucial for making optimal decisions tailored to your unique circumstances. For professional advice on overseas tax strategies and business structures, consult Helm Advisers.