The US Exit Tax, also known as the Expatriation Tax, applies to individuals who decide to renounce their US citizenship or give up their green card. Established under IRC Section 877A, this tax primarily targets high-net-worth individuals to ensure that any taxes owed on their worldwide income and assets are settled before they permanently exit the US tax system. If you’re considering severing your ties with the US, understanding this tax is crucial. Here’s a breakdown of the essential information.
Key Points to Remember:
- The exit tax ensures that former citizens or residents pay any remaining taxes on their income and assets before leaving the US tax system.
- US citizens and long-term residents classified as “covered expatriates” by the IRS are required to pay this tax.
What Is the Exit Tax?
When US citizens or long-term residents decide to relinquish their citizenship or green card, they may face an exit tax. The exit tax is not a penalty for leaving the US but a mechanism to ensure that all outstanding tax obligations are met before exiting the US tax system. It can include:
- Unfiled tax returns
- Untaxed assets, such as future capital gains on stocks or retirement accounts
In short, the exit tax enables former citizens and residents to fulfill their final tax obligations before leaving the reach of the US tax jurisdiction.
Who Is Subject to the Exit Tax?
Not everyone leaving the US must pay an exit tax. Only US citizens and long-term residents whom the IRS classifies as “covered expatriates” are required to do so. The exit tax applies to all your worldwide assets at the time of renunciation, including personal property like cars and jewelry. However, there are exceptions, such as certain foreign pensions earned before becoming a US taxpayer.
Covered vs. Non-Covered Expatriates
The distinction between covered and non-covered expatriates is critical in determining whether you owe an exit tax.
- US Citizens: US citizens who renounce their citizenship and meet the “covered expatriate” criteria are subject to the exit tax. The IRS evaluates whether you qualify as a covered expatriate based on the following factors:
- Net Worth: If your net worth exceeds $2 million on the date of renunciation, you are considered a covered expatriate. This includes the value of all your assets, such as unrealized capital gains, calculated at fair market value.
- Annual Net Income Tax: If your average net income tax liability over the past five years exceeds a specific threshold, you will be categorized as a covered expatriate. For 2023, the threshold is $190,000.
- Tax Filing Compliance: You must have filed all tax returns for the past five years. Failure to do so results in classification as a covered expatriate.
- Long-Term Residents: Green card holders who have lived in the US for at least eight of the past fifteen years may also be subject to the exit tax. However, some exceptions, such as treaty elections, may help avoid this status. However, caution is advised when making treaty elections, as they can unintentionally trigger expatriation and make you liable for the exit tax.
How Is the Exit Tax Calculated?
The exit tax is calculated based on any remaining tax liabilities you have when renouncing your citizenship or residency. This includes taxes on income, capital gains, and untaxed assets. Fortunately, the exit tax only covers unpaid taxes, so if you have already paid taxes on certain income or assets, they won’t be taxed again.
Given the complexities of calculating exit tax liabilities, it’s highly recommended to consult a tax expert to avoid costly mistakes.
Can You Avoid Paying the Exit Tax?
Even if you qualify as a covered expatriate, there are ways to reduce or potentially avoid paying the exit tax. For instance, you can strategically distribute assets between yourself and your spouse since the $2 million net worth threshold only applies to individual assets.
However, be mindful of legal restrictions. Attempting to evade taxes can result in severe penalties. If the exit tax is more than you’re willing to pay, reconsidering renunciation may be a viable option. While staying a US citizen means you must continue filing annual tax returns, most expats do not end up owing taxes due to credits like the Foreign Earned Income Exclusion.
What Happens After Paying the Exit Tax?
Your tax obligations don’t necessarily end after renunciation. If you have accounts or assets remaining in the US, you may need to continue filing Form 8854 annually or a 1040NR (Non-Resident) tax return, potentially paying a flat 30% tax on income earned within the US. In some cases, early withdrawals from retirement accounts could also incur a 10% penalty. Proper planning before expatriation is crucial to avoid unnecessary complications.
Falling Behind on Your US Tax Returns?
All US citizens, regardless of where they reside, are required to file annual tax returns. If you’re behind on this obligation, the IRS offers the Streamlined Filing Compliance Procedures, an amnesty program that can help you avoid penalties. To qualify:
- Certify that your failure to file was unintentional.
- File the last three years’ income tax returns and pay any outstanding taxes.
- Submit FBARs (Foreign Bank Account Reports) for the past six years.
Completing these steps can bring you back into compliance, although additional filings may be required to avoid the exit tax.
Pro Tip:
Act promptly if you need to come into compliance. The IRS is more lenient if you reach out first. Waiting for the IRS to contact you could lead to penalties and the loss of amnesty opportunities.
Final Thoughts
The US Exit Tax is a complex process that requires careful planning. For anyone considering renouncing their US citizenship or green card, consulting an experienced tax professional is vital to ensure that you meet your obligations and avoid unexpected consequences.