The main reason people renounce their U.S. citizenship is to take advantage of lower tax burdens abroad, but the growing unease with U.S. politics might also be contributing to a record number of Americans who are renouncing their citizenship and surrendering their passports. While we don’t recommend this to our clients, we have received questions about the financial pros and cons of leaving behind one’s U.S. citizenship. In the interest of keeping you fully informed, we sat down with Raoul Rodriguez, Director of Pinnacle Advisory Group International and an expert on expatriate issues, to discuss the question.
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Pinnacle: First, can this be done? Can a U.S. citizen give up his or her status?
Raoul Rodríguez: Yes, U.S. law allows citizens to give up their citizenship if they no longer wish to be citizens. They do so by performing any one of several expatriating acts with the intent of giving up citizenship. One of those expatriating acts is to appear at a diplomatic or consular office abroad to express a desire to renounce citizenship.
Ok, can it be undone?
No. Expatriation is permanent and irrevocable.
Why are so many renouncing their citizenship? Is it because of the election?
That’s part of it, I’m sure. But there are many reasons—probably as many as there are expatiates—and some are neither financial nor political. However, one major driver is that other countries in the world have lower taxes and have significantly easier compliance burdens on business. By giving up their U.S. citizenship, expats may save taxes and increase wealth long-term.
Can I expatriate and remain in the U.S.?
No, you must expatriate while abroad. After you lose your U.S. citizenship, you would need to apply as any foreign national would for entry back into the U.S.
If I expatriate can I keep my assets in the U.S.?
What about my social security benefits?
You can keep them. You are able to receive your social security payments and have access to Medicare if you come to the U.S. for medical care.
Do I need to have another nationality before I expatriate?
While not a requirement from the U.S. perspective, it is recommended that you have another nationality that (among other advantages) would allow you to legally reside in your new home country and to travel.
How many U.S. citizens are expatriating?
In 2015 nearly 4,300 people expatriated and the trend continues to accelerate.
Are there any tax consequences in the U.S. to giving up citizenship?
Yes. Under current provisions established by the 2008 Heroes Earnings Assistance and Relief Tax Act (HEROES), three new taxes potentially apply to those who expatriate:
- Deemed disposition tax
- New gift taxes
- Estate and Inheritances
After expatriation you will be taxed, with some exceptions, as a non-resident alien.
Are there any other consequences to giving up citizenship?
There are travel restrictions to consider. Taxpayers who expatriated prior to June 18, 2008 cannot spend more than 30 days a year back in the U.S. without facing other tax consequences.
Are there any people exempt from the new taxes when expatriating?
Yes, taxpayers who do not have a net worth of $2 million or more or an average annual net tax liability for the preceding five years of $160,000 will not be subject to these new taxes. In addition, certain dual nationals born abroad and green card holders may also be exempt, regardless of their net worth and prior average tax liabilities.
Taxpayers who are not exempt are known as “covered expatriates.”
What is a deemed disposition tax?
The value of all property owned by the taxpayer on a worldwide basis is assumed to be sold on the day prior to expatriation and capital gains taxes paid on the putative income. The taxes are real, however!
What about assets in my IRA and 401(K)?
Assets in IRAs do not need to be withdrawn, but for tax purposes, the IRA will be treated as if the assets had been distributed on the day prior to expatriation. An early withdrawal penalty will not apply.
Assets in 401(k)s can remain in the same and will not be subject to the deemed disposition taxes, but will be taxed at a 30% rate when eventually withdrawn.
What are the new gift, estate and inheritance taxes that “covered expatriates” need to be aware of?
First, gift or estate taxes are to be paid by the donor or estate on any amounts so transferred above exemption amounts ($14,000 for gifts and $60,000 for estates). Compare that to U.S. persons who can take advantage of the $5.45 million exemption per person in 2016.
Separately, the beneficiaries of such gifts and estates must pay an additional “inheritance tax” if the corresponding gift or estate tax returns are not filed in a timely manner.
Are there any U.S. tax advantages to be being treated as a non-resident alien?
Yes. Some advantages include the fact that non-resident aliens pay no capital gains taxes on the sale of securities, do not pay tax on interest payments, and often pay low taxes on dividend payments when treaty rates are available.
Do Non-Resident Aliens pay U.S. estate taxes?
Yes. Taxable estates (consisting of only U.S. assets) over $60,000 are subject to regular U.S. estate taxes. However, this is dealt with either by holding assets in the name of a foreign entity (that will avoid the U.S. estate tax) and/or by purchasing life insurance.
Any financial advice for those making the leap?
Yes, there are several points to keep in mind:
- Plan for expatriation several years beforehand.
- Choose your new home jurisdiction carefully and keep in mind that the new home country may l have their own taxes.
- Avoid being classified as a covered expatriate by the U.S. tax authorities. There are several ways to plan for this, including gifting, setting up trusts, playing around with valuations, etc.
- Gift all assets up to $5.45 million per person in order to take advantage of the exclusion amounts that will disappear upon expatriation, lower your U.S. taxable estate, and possibly help you avoid being considered a “covered expatriate” in the first place.
- Consider the pros and cons of actually selling U.S. assets and removing to a foreign jurisdiction.
- Transfer IRA balances to a 401(K) if allowed since the 401(K) is not subject to the deemed disposition rules.
- Sell your principal residence if you qualify for the homestead exemption ($250,000 in gains if single, $500,000 if filing married and filing joint) since it is not clear that you will be able to take advantage of this provision after you expatriate.
- Consider purchasing U.S. life insurance if you will need it since purchasing life insurance abroad may be more expensive.
- Carefully draft new estate planning documents both in the U.S. and abroad.
- Consider putting together a team of qualified professionals to guide you through the process.
If you should have any questions about this or want further information, please contact your financial advisor.
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