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Giving up US Citizenship or a US Green Card

By Professor Marshall J. Langer52

Chapter Summary

Many US citizens dislike the amount of tax they must pay. This has led to an increase in the number of citizens who consider giving up US citizenship even though punitive exit taxes have been in place since 2008. With the threat of even higher US federal and state taxes in the near future, the interest in leaving permanently continues to rise.

The exit taxes are deliberately punitive, and have been designed specifically to prevent the highest taxpayers from leaving by removing virtually all of the financial benefit gained by doing so.

Giving up US citizenship is a complicated business, and a wide range of factors must be taken into account, including residence, domicile and citizenship, marital status and the status of beneficiaries, sources of income and location of assets, and the timing of any move. You must also acquire another citizenship to replace the one given up.

The exit taxes do not apply to everyone who gives up US citizenship; there are two key tests to determine whether you are caught by it. The first is based on income tax liability over the past five years and the second is based on your net worth. There are exclusions for certain items when calculating your net gain, and gains and allowable losses are taken into account.

Once you have relinquished or renounced US citizenship, and paid exit taxes if necessary, you must still take care not to fall back into the US tax pool by spending too many days there.

Depending on your new passport, you may need to obtain a visa to enter the US again. There is also a significant tax on gifts or bequests that you subsequently give to any other US taxpayer once you have left.

Some wealthy Americans feel that their federal, state and local governments tax about 50% of their income while they are alive and try to take the rest when they die. They are aware that it takes a lot of “other people’s money” to pay for a vast system of political featherbedding, to reward political campaign contributors and to pay for give-away programs designed to assure the loyal vote of grateful recipients.

The debt of the federal government is astronomical. The US is the richest nation on earth and most of its states are essentially bankrupt. The US social security system is a fancy Ponzi scheme. Anyone in the private sector who did what the government does every day would be sitting in jail for the rest of their lives.

The US legal system is also driving some people to take action. The trial lawyers are protected by Members of Congress who rely heavily on the lawyers’ massive political campaign contributions. Many businessmen and professionals live in constant fear that they will be wiped out by lawsuits and huge judgments. It is no wonder then that some US citizens and long-term residents are seeking to protect what they have by moving themselves and their assets abroad.

Taxation is not the only reason why Americans give up US citizenship or terminate long-term US residence, but it is frequently considered by wealthy individuals who are already living abroad or plan to do so permanently. Unlike citizens of France, Germany, Switzerland, the UK and other countries, US citizens remain almost fully subject to US income and death taxes even if they never intend to return to live in America. Despite tax treaties, they are often subject to at least some double taxation.

Thousands of wealthy British residents have already left Britain to avoid the maximum income tax rate which has been as high as 50% and is currently 45%. They have tried to escape British taxes by changing both their residence and their domicile. They can retain their British citizenship and their British passports which are also EU passports. Many wealthy Americans do not yet fully realize that they may now be facing combined federal and state income taxes that exceed the rates that have caused people to leave Britain. In some cases, the combined corporate and individual income taxes on dividends received from US corporations may exceed 60%.

The US applies all eight tentacles of the “tax octopus.” To escape US income, gift and death taxes, you must consider each of the eight tax tentacles:

• Residence: you cannot have a green card, and you must avoid meeting the substantial presence test by spending too many days in the US

• Domicile: you must terminate your domicile in any US state or territory

• Citizenship: you cannot be a US citizen since the US taxes its citizens on a worldwide basis

• Marital Status: you must take steps to eliminate the application of any “community property” rules under which each spouse is entitled to a half interest in most income and property acquired by the other spouse during the marriage

• Source of Income: you must eliminate or minimize any taxable income from US sources

• Location of Assets: you must eliminate or minimize holding any assets that would be subject to federal or state gift or death taxes

• Timing: the timing of various acts must be carefully considered (for example, you might sell your family home before you leave but try to postpone receipt of foreign-source income until after you go)

• Status of Beneficiaries: several special factors must be considered if your spouse or any of your other intended beneficiaries will remain US citizens or residents

More than a million US residents become US citizens each year but, at least until recently, fewer than 1,000 Americans per year have given up US citizenship. Many of those who have done so were returning to a country in which they were born (such as South Korea) that does not permit them to retain another citizenship. Many countries permit dual citizenship, but some do not.

If you expatriate, the new US exit tax law enacted in 2008 aims to make you promptly pay an exit tax on most of your previously untaxed worldwide gains and deferred income. In those cases where this tax is permitted to be postponed, the IRS (Internal Revenue Service) makes sure that you cannot escape the exit tax or reduce it by using tax treaties. Finally, a nasty new special income tax is imposed on any US citizens or residents who receive gifts or bequests from you exceeding US$14,000 a year at any time in the future. The bottom line: the new rules are designed to remove most or all of the tax benefits you might derive by leaving. The government wants to encourage you to stay and pay.

The US Congress didn’t enact the first constitutional income tax on individuals until 1913. The US income tax rates in early years were generally quite low. The US Supreme Court decided in 1924 that it was OK to apply the income tax to US citizens living abroad as well as to everyone residing in the US. Despite the fact that the case involved less than US$1,000 and the result was questionable, it is almost inconceivable that either Congress or the courts will ever change it. Today, the US is the only developed country in the world that taxes not only its residents but also its citizens, even those who have never lived in the US or who have lived abroad for many years.

Having or acquiring another citizenship is a practical necessity for anyone seeking to reduce or eliminate US federal, state and local taxes that are becoming more confiscatory each year. Some Americans acquire a second citizenship through ancestry or by marriage; others do so through an economic citizenship program such as that of St. Kitts and Nevis. Dual citizenship does not eliminate US taxes if one of these is US citizenship.

Are you a US citizen? For many of those reading this the answer is obvious. They were born in the US or have been naturalized, and they have never done anything to lose their American citizenship. However, US citizenship is also acquired by birth abroad if at least one of your parents was a US citizen and has met minimum US residence requirements. These rules have been changed several times and your actual citizenship will normally depend on the law in effect at the time you were born.

A child born in the US to a mother who is an alien simply visiting the US at that time is a US citizen. A child born in the US whose parents are illegal aliens is also a US citizen. Anyone born in the US and “subject to its jurisdiction” is a US citizen by birth even if neither of his or her parents were US citizens or US residents. The only children born in the US who are not subject to its jurisdiction are the children of ambassadors or other representatives of foreign countries.

A child born abroad is a US citizen at birth if both parents are US citizens when the child was born and at least one of them had resided in the US sometime before the child’s birth. If only one of the parents is a US citizen, the child born abroad is a US citizen if the citizen parent was physically present in the US for at least five years and at least two of those years were after he or she was 14 years old.

In the US 2010 Census, the government made every possible effort to count all individuals in the country, including illegal aliens. It did not count any US citizens who live abroad. Geneva-based American Citizens Abroad has estimated that there may be as many as seven million US citizens living abroad. No one, including the government, really knows. US citizens are not required to obtain identity papers nor are they required to have US passports. Most Americans living abroad do not register with a US Embassy; they are not required to do so.

A single (not married) US resident or citizen (including one living abroad) is not required to file an annual income tax return if he or she has less than US$9,750 of gross income per year. The amount is less than US$3,800 if he or she is married and filing separately.

A US citizen must relinquish (or renounce) his or her US citizenship in order to leave. If you do leave the US, you must also take into account the income and capital transfer taxes imposed by the US state and community in which you last lived or in which you own any property.

Until 1966, the US made no serious effort to keep Americans from giving up citizenship for tax reasons. The first US anti-expatriation rules enacted in 1966 were generally unenforceable, but they have been beefed up several times during the next four decades. Since 1995, most anti-expatriation rules have also applied to long-term resident aliens, those who have held green cards in eight of the last 15 years. The rules have never been applied to those who do not hold green cards, even those who have been fully subject to US income taxes for many years because they were deemed to be US residents under the substantial presence test (because they spent an average of more than four months a year in the US).

After more than a decade of unsuccessful attempts, Congress finally passed an exit tax in 2008. Anyone who gave up US citizenship or long-term residence before 17 June 2008 is covered by old rules. Most of these old rules have been replaced for persons covered by the new rules. Those who have expatriated after that date are covered by the new rules. They do not generally face continued US taxation or tax returns for ten years after expatriation. The new rules apply to US citizens who give up US citizenship and to departing aliens who have held a green card for eight of the last 15 years. Anyone who leaves after holding a green card even one day more than seven years risks becoming a covered expatriate subject to the exit tax and a new punitive death and gift tax regime.

The new US exit tax law is quite complex, and it contains numerous cross-references to other sections of the US tax law. This explanation is necessarily over-simplified. Anyone seriously interested in exploring possibly giving up US citizenship or a green card should obtain competent professional advice.

The new exit tax does not apply to everyone who expatriates. It applies to you if you meet either of two monetary tests one of which can change each year because it is indexed for inflation. You must also certify to the IRS under penalties of perjury (on IRS Form 8854) that you have complied with all of your US tax obligations for the last five years. If you meet either an income tax test or a net worth test, or if you do not make the required certification, you are a covered expatriate and you are subject to all of the negative aspects of the new exit tax law.

If you expatriate during 2013, the income tax test will be based on the average of your US federal income tax liability after foreign tax credits for the five years 2008-2012. If your average net income tax liability during these years was more than US$155,000 a year, you are a covered expatriate. This amount is indexed for inflation annually and will probably be increased in future years.

The other test is based on your net worth on the day immediately before your expatriation date. If your net worth is at least US$2 million on that date you are a covered expatriate. That amount is not indexed for inflation.

If you don’t meet either monetary test and you make the required certification, you are not a covered expatriate and you are not subject to the exit tax. If you are a covered expatriate, the next step is to calculate the amount of your exit tax.

Certain assets are excluded when you determine your net gain subject to the exit tax. These include your interests in non-grantor trusts and in eligible deferred compensation items such as qualified pension plans, profit sharing plans or qualified annuity plans. An alternative tax system applies to these properties. You will be required to send the payers of these items new IRS Form W-8CE (Notice of Expatriation and Waiver of Treaty Benefits). The trustees or other payers must withhold 30% US income tax on any amounts they subsequently pay you that would have been taxable had you remained a US citizen or resident. You cannot reduce this tax under any tax treaty.

US real estate is covered by the exit tax. After you expatriate, each US real property interest will be covered by FIRPTA (the Foreign Investment in Real Property Tax Act), but its basis will be adjusted by the amount of gain to which the asset has been subjected to the exit tax.

If you have an IRA (individual retirement account) or some other specified tax-deferred account you will be treated as receiving your entire interest in that account on the day preceding your expatriation date. You must pay tax thereon, but you will not be subject to a penalty for early withdrawal.

With respect to all of your other worldwide assets, you must determine the fair market value and the adjusted cost basis of each asset. Each of these assets must be marked-to-market as though you had sold it the day before your expatriation date.

Gains and allowable losses are taken into account. Tax is imposed on your net gain exceeding US$668,000 if you expatriate in 2013. The federal tax rate on long-term capital gains (those on most assets held more than a year) may now be as high as 23.8%. Most state and local governments impose additional taxes. One observation: many US taxpayers who sustained large capital losses during 2008 still have large capital loss carryovers and these can be taken into account in calculating their exit tax.

You can elect to defer paying the exit tax on some or all of your assets by making an irrevocable asset-by-asset election to do so until you die or dispose of the asset. You must provide adequate security to the IRS and maintain such security in force.

In a typical case, a US citizen’s expatriation date is the date on which he or she signs a statement voluntarily relinquishing US nationality or an oath of renunciation before a US consular officer somewhere outside the US even though expatriation is not confirmed until some months later when he or she receives a CLN (Certificate of Loss of Nationality).

A typical long-term resident’s expatriation date is the date on which he or she files Department of Homeland Security Form I-407 with a US consular officer. You can’t just cut up your green card.

If you pay any required exit tax (or you are not a covered expatriate) and you live overseas, you will be taxed as a nonresident alien individual provided you do not become a US resident under the substantial presence test by spending too many days in the US. That test generally permits you to spend an average of up to about 120 days a year in the US without being treated as a resident for US tax purposes. Since that test is based on a moving average of days (including partial days) you have spent in the US over a three-year period, you should obtain professional advice on how that test will apply to you.

You will also have to escape the other tentacles of the “tax octopus” and comply with all US immigration law requirements if you wish to visit the US. You must obtain a visa to enter the US unless your passport is issued by a country that is covered by the US visa waiver program.

If you are a covered expatriate, the nastiest part of the new law imposes a special new income tax or transfer tax on all covered gifts or bequests exceeding US$14,000 per year that any US citizen, resident or trust receives from you either directly or indirectly at any time after you expatriate. The tax rate will be the highest rate of gift or estate tax imposed at the time of the gift or your death. For those dying after 2012, that rate is 40%. Exemptions apply for gifts or bequests received by your spouse (if he or she is a US citizen) or a qualifying charity. We are still awaiting regulations or other guidance from the IRS as to how this new tax on gifts or inheritances will work. The IRS has deferred the reporting and tax obligations with respect to this tax pending the issuance of guidance. The IRS has also stated that it will provide a reasonable period of time between the issuance of such guidance and the date it prescribes for filing the required reports and paying the tax.

The new law does not contain any immigration penalty. It is not a ground for denying you a visa or entry into the US. The 1996 Reed Amendment remains in effect but it has never been applied to bar any former US citizen who had expatriated from visiting the US.

You may still be subject to US Foreign Bank Account Reporting (FBAR) requirements even after you expatriate since these rules may apply to some non-Americans. The FBAR definitions and rules are different from the tax rules.

One of the unintended consequences of these rules is that some foreigners who might normally consider moving to the US to take long-term employment or start a business are having second thoughts and may decide to move elsewhere instead. A well-advised wealthy foreigner who does move to the US may now be advised to avoid trying to obtain a green card or becoming a US citizen and, if possible, to live in a tax-friendly state with a nonimmigrant visa such as those available to a treaty investor or treaty trader.

Seven US states do not impose any state or local income taxes; they are Alaska, Florida, Nevada, South Dakota, Texas, Washington (the state, not DC), and Wyoming. The other 43 US states and many of their local governments do impose income taxes on top of those imposed by the federal government. The extra income taxes in at least 10 of these states can now exceed 10% and those imposed on residents of New York City can be as high as about 13%. Many states apply these high tax rates to both ordinary income and capital gains. About half of the states do not impose any extra death tax on top of the federal estate tax; the other half do.

Prior versions of US anti-expatriation legislation have been unsuccessful in raising meaningful amounts of revenue. The revenue estimates for this legislation are probably grossly overstated. Why then does the US Congress waste so much time and effort trying to pass these types of rules? The real aim of the exercise is apparently not to collect taxes from those who expatriate but to discourage you and others from leaving. Like most governments, the US wants to retain its best-paying “customers.”

When a US exit tax was first proposed by President Clinton in 1995, the US Treasury Department issued a press release stating that the Clinton Administration aimed at “stopping US multimillionaires from escaping taxes by abandoning their citizenship.” It added that a few dozen of the 850 people who had relinquished their citizenship the previous year did so to avoid paying tax on the appreciation in value that their assets accumulated while they “enjoyed the benefits of US citizenship.”

Later that year, the staff of Congress’ Joint Committee on Taxation issued a report that ran several hundred pages including eight lengthy appendices. I may be the only person outside of government that read the whole thing. I was fascinated by the following language excerpted from a lengthy letter near the end of Appendix G from Leslie B. Samuels, then Treasury’s Assistant Secretary for Tax Policy, to Kenneth J. Kies, who was then Chief of Staff for Congress’ Joint Committee on Taxation: