Tax problems for those who renounce US citizenship

Are you a covered expatriate? Learn why that matters more than you know…

This is Week Sixteen of the 26 week series #MyEconomicCitizenship. Each week I give you a glimpse into my life as I share the ups and downs experienced in pursuit of a second passport through economic citizenship. Each feature includes my weekly journal walking you through the process of obtaining economic citizenship, followed by an in-depth look at some of the most important topics people considering economic citizenship should understand. The series is presented by Nomad Capitalist in partnership with Peter Macfarlane & Associates, whom I worked with to obtain my passport. To read the entire series, just click here.

Dateline: Pnomh Penh, Cambodia

Just the other day I saw an interesting story in the New York Post that was, unsurprisingly, about Trump. Unlike all the other news stories covering everything Trump is doing, this one highlighted one of Trump’s campaign promises that is currently on the back burner: tax reform.

Surprise. Surprise.

During the election campaign, Trump garnered a lot of popularity by promising a 15% corporate tax rate. My email box was overflowing with people asking if the US was going to become the place where they would be treated best. Everyone was speculating based on Trump’s promise and wondering if we should all just come back to the United States. I remained skeptical.

Now, I don’t love saying this, but there are some reasons why it makes sense to plant flags in the United States. For instance, in a recent article I explained how the US may not be a bad option for business banking in some cases.

But here’s the deal — and I’ve said this from day one — tax reform in the United States is a joke. Politicians are a joke. And you can look at Trump, a guy who’s running around at the speed of a tornado getting so many things done (whether you like what he’s doing or not) and guess what’s the one thing on his list that doesn’t get priority? It’s taxes. Why? Because it’s not as flashy or exciting. Who wants to give small business owners tax cuts?

It’s not a top priority.

So now they’re saying that some of these tax cuts that Trump talked about may not even come through. We’ll have to see what happens. In the meantime, here’s what I do know: I know that George W. Bush promised tax reform and was applauded when me managed to lower the top tax rate from 39.6% to 35%. This is not exactly the kind of tax reform we see in the big safe havens that I talk about all around the world. That’s not Georgia that went from 21 taxes to 6 several years ago and is simplifying the system on an ongoing basis, even recently adopting the Estonia tax model. That’s not what you’re going to get in the US — Trump or not.

I just don’t foresee it.

When it comes to US presidential campaigns, it’s in every candidate’s interest to come up with an appealing tax plan — whether they’ll be able to implement it or not. In 2012, Herman Cain talked about his 9-9-9 plan that would eliminate the current tax system altogether and replace it with a 9% personal income tax, 9% corporate income tax and 9% percent national sales tax. It just so happened that Trump decided to propose a plan with a 15% corporate tax. But I don’t see it happening. It would be interesting. I’m not rooting against it. It’s just a very difficult thing to get tax reform through, especially in a big country like the US that has 20 trillion dollars in debt.

But what does this have to do with you?

And what does this have to do at all with economic citizenship?

The most likely candidate

For starters, some folks see economic citizenship as a way to set themselves up to renounce their US citizenship in the future or to do so right now. They’re tired of living in a system that is so incapable of positive change. They want to go where they’re treated best. And when someone as forceful and action-oriented as Trump puts taxes on the back burner, it’s a clear sign that the US tax system is too sluggish to achieve reform of any consequence.

But who exactly would benefit from obtaining economic citizenship and renouncing their US citizenship? From my experience, the guys who are renouncing right now are the ones who are both Canadian and American.

There are, of course, other groups who are resigning. For instance, one of the tax advisors I work with helps Dutch citizens who were born in the United States, for whatever reason (i.e. their parents were vacationing there), and by virtue of being born in the US they are American citizens. Some of them managed to get into their 20s, 30s and even 40s without understanding that they’re US citizens, only to find out that they are “accidental Americans” and need to file six years of back tax returns. The good news for these folks is that they can file those returns, say that they didn’t mean to do any harm and then renounce and just be Dutch. So that’s easy.

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The group that I personally work with are the guys who are Canadians and one of their parents is American. By virtue of their parentage they became US citizens either because their birth was registered in Canada at the US Embassy or because they were born in the US and then moved or went back to Canada. For these individuals, it just doesn’t make sense to keep both citizenships. That is why Canadian-Americans are the most likely candidates for renouncing US citizenship.

In fact, I’m currently helping somebody who is renouncing their US citizenship because they are both Canadian and American and they simply felt more Canadian. Plus, it’s going to make their tax planning when they go to live overseas a heck of a lot easier because they’re making about half a million dollars a year. Reasons as simple as logic and identity make Canadian-Americans the most likely group to be renouncing.

Most other people I work with are people who think they might renounce later. In general, having a second passport is great for the opportunity to renounce. And, as I shared with my email subscribers this week, it’s one of those situations where, when you have the second passport, all of these opportunities suddenly present themselves in a more meaningful way. It’s not just theory anymore. Now you could really go and renounce.

For that reason, I do talk about getting the best second passport that you can afford with both your time and money. And that’s why economic citizenships are great because, unlike an EU citizenship where you have to wait around for five years and jump through a lot of hoops and spend good money, with economic citizenship you can bypass all that.

The cost of renouncing

So what does it take if you actually want to get an economic citizenship and then go through the process of renouncing your US citizenship? More specifically, what are the tax ramifications? Again, I’m not a tax advisor. I work with tax advisors and I’ve talked with them about this, so I’m just going to tell you the basics. We’re not going to go into every situation — if you want a specific situation, that’s why I help my clients create plans with the help of tax advisors.

In general, I work with younger guys who have achieved great success, but know that they’re greatest growth is still ahead of them. For example, the guy who is Canadian-American has been making $500,000 for a couple of years now. He’s obviously not saving and pocketing all of the money, but he’s potentially got a company that has value. Before he made the decision to renounce, he had to take into consideration several different tax factors. For instance, how would the IRS value his company? And what about all the money he has saved in the bank? Here’s a guy who’s young and successful, but he’s approaching the financial limit where being too successful can cost you if you choose to renounce.

So what exactly is that limit? How do you know if you’ve reached it? And what are the costs of renouncing US citizenship if you are past the limit? Let’s take each question one by one.

The Covered Expatriate

First, what most people don’t know is that there are two different costs involved with renouncing US citizenship. Number one is the standard fee of $2,350. This fee is up from $0 five years ago and $450 two years ago. So they’re really taking advantage. But so be it. The second fee involves paying taxes on your assets. This second fee does not apply to every renunciant — only those who qualify as covered expatriates — and there are three ways to trigger it:

    1. You have two million dollars or more in assets

    2. You have had an average federal tax liability (not salary) over the last five years of $160,000 per year ($800,000 or more combined in the five years prior to renouncing).

    3. If you can’t certify tax compliance. (Side note: This means that anyone who wants to renounce should be tax compliant before doing so. If someone who was not tax compliant were to come to me and they were planning on renouncing, I would get their tax compliance streamlined while we were completing the passport process. So this should never be an issue.)

If you meet any of these three tests, then you’re what’s called a covered expatriate. If you are a covered expatriate, you’ll receive a $650,000 exemption and then after that you pay capital gains tax. Let’s take a look at each test in a little more detail.

Test One: $2 million in assets

When the IRS is determining whether or not you are a covered expatriate, they act as if you were to sell all of your assets on the day that you’re leaving the country. In a sense, it’s like you died and they are subjecting you to the estate tax. If you own a house that’s worth a million dollars, but you paid $500,000 for it, they’re going to act as if you sold it for the million dollars that it’s worth.

And, obviously, the valuations are determined by the IRS. Upfront, you may say that you have a house that’s worth a million dollars, but if they audit you and say that it’s worth 1.2 million, then you’ll have to provide evidence to prove that it’s worth just the one. (Side note: you do get an exemption if it is your personal residence).

The point is that the IRS will basically consider that you’ve sold all your assets the day that you renounce. So that rental house you own, depending on how long you’ve owned it, you’ll pay either short term or long term capital gains. And you’d pay that immediately. So if you’ve owned the rental house for a period of time that it qualifies as a long term capital gain, then you’d pay the long term capital gains rates — a little less than $100,000. And you pay that because it’s as if you sold it.

This applies to stock, real estate, companies, anything. If you own a company, they can do it. And this is where I think some people may get into trouble because, what’s a company worth? If you own an internet business, what’s an internet business worth? If you own a consulting company, does that have any value? Some companies may have zero value or next-to-zero value because it’s just your time and your effort and you could always quit. So there’s a whole process involved in figuring out if you have two million dollars or more.

Help me get my economic citizenship!

But, again, you have to pay capital gains tax. You may not have to pay that much capital gains tax if you have two million dollars in cash already. Cash is cash. The problem is when people build up assets and then have to sell those things. And with the people I work with, the biggest asset is their company.

Startup founders who have already had a lot of success may still benefit by renouncing, even if they’ll take a big hit by doing so now. For example, Eduardo Saverin renounced his US citizenship way too late and had to pay a ton of tax. However, he renounced before Facebook totally went public and so he still avoided a lot of other taxes. Just a short time after he renounced, some experts placed his savings at $700 million.

It’s also important to note that your company will count towards your assets for various different reasons. It could be that the company is a cash cow and you just park a lot of cash in your company overseas. It could also be that the company has an inherent enterprise value. One guy I talked to recently is part of a startup and the company is raising money in Silicon Valley. Whatever the latest round of funding is, that’s the value of the company. So if he owns 10% of a company and the last round of funding was 20 million, then there’s his two million and anything else he has puts him over.

So, while the biggest reason you might be considering renouncing is because you have a company that could be valued at a decent amount and want to save money by going overseas, it will also cost you to leave. You’re the one who has to determine whether renouncing will save you more money in the end. And if you have a company that could reach that limit some time in the near future, it’s better to buy an economic citizenship and renounce now than risk going over the limit.

Test Two: The Big Tax Bill

I don’t typically run into the problem of having people who pay $160,000 in tax because you’d have to make a lot of money to be paying that amount each year. Especially if you’re an American entrepreneur living overseas, you’d have to have a pretty big company to be paying yourself such a high salary to qualify for that amount of tax. So, if you’re an entrepreneur, the general issue to deal with is whether or not you have two million dollars in assets. And, again, that can include the enterprise value of your company, stocks, real estate investments, etc.

However, if you are paying an average of $160,000 or more a year in taxes — perhaps as an employee with a high salary — and you just want to renounce and move overseas right away then I just have one suggestion: I don’t necessarily recommend that someone who has never lived overseas just renounce on the first day that they are going to live overseas. You should try and do as many offshore strategies legally to reduce your tax, if not eliminate it, and then go from there. Travel and see if you enjoy the lifestyle first, then make your decision.

Test Three: Tax compliance

Finally, if you’re living overseas and you’ve never filed taxes, don’t be an idiot. I had one guy say, “Well, what if I never go back to the United States?” The guy is 26 years old. Are you really going to do that? Are you never going to go back to the United States for the next 55 years, not even for one day? Don’t be an idiot. File your tax returns overseas. Be in tax compliance.

It’s like a friend of mine who ruined he credit score when he was 19 years old because he didn’t want to pay a $100 charge that wasn’t his. He argued with the credit card company, but when they told him he would have to pay it, he just said “Whatever! I’ll ruin my credit score. I’m not paying.” He eventually got it back up, but it took a lot of work and a number of years to do so.

You don’t want to do the same thing to your taxes.

If you’re living overseas, or even if you just have overseas bank accounts, you need an expat-focused US tax person to do your taxes because, otherwise, you’ll overpay. But you also want to make sure you’re filing all the proper forms. People who have offshore bank accounts need to file the FBAR, and if you’re living overseas you still have to file.

Don’t be an idiot and not file your taxes because it’s going to come back to bite you in one way or another. Even if you ever want to renounce and never have anything to do with the United States again, it’s going to cause you problems because you won’t be able to certify tax compliance. This applies whether you’re in the US or living overseas, but especially if you’re living overseas, don’t think you’re above the law and just won’t ever go back because there may come a time when, even if you don’t want to go back, you’ll want to renounce your citizenship and you’re going to have some problems. So file your taxes. Be legal.

Get your economic citizenship & second passport

My goal in doing this series is to help as many people as possible become global citizens by obtaining second citizenship. I live this stuff, in part, so that I can better help individuals like you reduce taxes, obtain a second passport and experience more freedom.

If you’d like to work with me directly to create a wholistic global citizenship strategy, then click here. We’ll go through an entire deep dive process to determine exactly what you need — from passports to residency to where you’re going to live — all so we can get you to your end goals.

If you’re just interested in getting a passport and already know which passport is the right choice for you, then you can go directly to Peter MacFarlane & Associates’ website and contact them by clicking here.

If you’re still determining which approach you should take, feel free to keep reading this series to garner all the knowledge you need to form a vision and actionable plan for the future.

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Andrew Henderson

Andrew Henderson

Andrew has been internationalizing since 2008, and has learned what works and what doesn't work when it comes to reducing taxes, increasing personal freedom, and creating wealth. Click here to work with him personally.
Andrew Henderson
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