Renunciation of U.S. Citizenship
Renouncing U.S. citizenship is a significant decision with wide-ranging implications. Renunciation may have adverse U.S. tax implications. This blog will break down the tax complexities surrounding the renunciation process and provide you with an essential understanding without getting lost in the jargon.
Who is a Covered Expatriate?
A covered expatriate includes individuals who renounce their U.S. citizenship or abandon their green-card and are classified as long-term residents if they meet one of the following tests:
- Average annual U.S. tax over 5 years exceeds US$190,000
- Net worth exceeds US$2 million
- Fail to certify five years of complete U.S. federal tax returns.
The following exceptions to covered expatriate status may apply:
- Dual Citizens at Birth: Individuals who were both a U.S. citizen and a citizens of another country at birth
- Minors Renouncing Before Age 18½: Generally, individuals who renounce their US citizenship before reaching the age of 18½ and were residents of the U.S. for 10 years or less
U.S. Exit Tax
Covered expatriates are subject to U.S. Exit Tax as detailed below:
Deemed Sale of Worldwide Assets
This tax is imposed on the net gain of the deemed sale of worldwide assets at the fair market value on the day before renunciation of U.S. citizenship. An exemption of US$821,000 (2023) may reduce or eliminate the taxable gain. The gain after exemption is taxed at rates up to 20%. Exemptions, such as on the sale of a principal residence, are not available to reduce this tax This tax may be deferred, but it is subject to an interest charge. Individuals abandoning their green-card may reduce their taxable gain by using the fair market value of their assets at the date they obtained that status.
Pension, retirement plans and other deferred compensation plans are subject to U.S. Exit Tax. An individual is deemed to receive all deferred compensation on the day before renunciation of U.S. citizenship. There is a 30% U.S. withholding tax, though tax treaty relief may apply. Eligible deferred compensation is taxed when it is received.
Individual retirement plans and other “specified tax deferred accounts” under U.S. tax law are treated similar to deferred compensation.
Covered expatriates who are beneficiaries of non-grantor trusts are subject to a 30% U.S. withholding tax on distributions, less if provided by a tax treaty and pursuant to IRS agreement, and the deemed disposition rules noted above where the fair market value of the trust’s assets exceeds its U.S. tax basis. A beneficiary of a discretionary non-grantor trust may be subject to this provision even where he or she cannot compel payments to them.
U.S. Tax on Covered Gifts or Bequests
Covered expatriates who gift or bequest property to a U.S. citizen or resident subjects the recipient to a 40% U.S. tax. This provision applies to both direct and indirect gifts to U.S. recipients, U.S. trusts, and distributions from non-U.S. trusts to U.S. persons.
IRS FORM 8854
IRS Form 8854, Initial and Annual Expatriation Statement must be filed by renouncing individuals who renounce their U.S. citizenship and long-term residents abandoning their green card. Only covered expatriates are subject to a tax from this form. It is informational only for other filers. This form is generally due with the individual’s final U.S. tax return in the year that they either renounce U.S. citizenship or abandon their green-card where they are also a long-term resident.
Renouncing U.S. citizenship carries profound implications for your U.S. tax obligations. Similarly, abandonment of a green-card, either voluntarily or involuntarily may have the same U.S. tax obligations. Navigating the intricate world of taxes, exit taxes, deferred compensation, and reporting forms is complex. This guide provides an overview. When considering this path, seeking professional advice is essential to ensure a full understanding of the tax and non-tax consequences to make an informed decision.
For more information, please see our webinar on Renunciation of U.S. Citizenship: Tax 101.