With the birth of the Duchess of Sussex’s new baby, Archie Harrison Mountbatten-Windsor, some attention has been given to the tax consequences of becoming a U.S. citizen, as the new royal baby automatically acquired citizenship by virtue of being born to a U.S. citizen mother. In light of this, related conversation concerning the consequences of expatriation has come to the forefront. As you may know, the United States’ complex tax filing regimen, coupled with other family reasons, provides great incentive for individuals to renounce their citizenship. Those who renounce their citizenship are subject to an exit tax. However, many people are unaware that this exit tax also applies to foreign individuals renouncing their green cards as well.
The exit tax requires individuals leaving the U.S. tax system—i.e. “expatriates”— to pay a U.S. tax on their income and worldwide assets, one last time. According to this tax, all assets are treated as if they are sold on the day before the citizenship or resident status is terminated. As a result, if the imaginary sale produces any profits, the expatriate must pay tax on those profits. The idea is that when an individual expatriates, the U.S. gets to tax that individual on items that may be out of its reach after the expatriation. Since U.S. citizens are taxed on worldwide income and assets, the government wants to be able to collect tax on the wealth that a U.S. citizen has accumulated.
This exit tax is also applicable to certain foreign individuals. While the exit tax is applicable to all citizens renouncing citizenship, it applies to only those foreign individuals who have maintained a U.S. permanent residency for a certain amount of time and are now relinquishing their green cards. However, note that foreign individuals who are residents of the U.S. under a different type of visa have no risk of being subject to the exit tax when they become nonresidents.
Further, before the exit tax is applied, an event must occur that terminates the individual’s citizenship or long-term resident status. A U.S. citizen who relinquishes U.S. citizenship will always be an expatriate. However, a green card holder who terminates his green card will be an expatriate only if he is a “long-term resident” under a count-the-years test—meaning a lawful permanent resident in eight of the 15 years ending with the year of expatriation.
Additionally, the individual must become a “covered” expatriate. There are three tests to become a “covered” expatriate: (1) the expatriate’s net worth was $2 million or more when he expatriated; (2) the expatriate’s average U.S. tax bill for the five years before expatriation was above a certain threshold ($168,000 for 2019); or (3) the expatriate did not file his tax returns correctly or pay all his tax for the five years before expatriation. Although a covered expatriate must file the same tax return paperwork as non-covered expatriates, he will be subject to the exit tax.
Recall that an expatriate will be deemed to have sold all his worldwide assets on the day before expatriation and will pay U.S. tax on the gains from the pretend sale. However, the impact of expatriation does not end there. U.S. persons receiving gifts or an inheritance from a covered expatriate must pay tax on what they receive from a covered expatriate.
If you think this may be your situation, seek advice from a professional that can give you advice that is relevant to your situation.
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