Dateline: Tbilisi, Georgia December 20, 2017. I was sitting in my living room in Tbilisi, talking with my CFO, and making a number of calculations. What was I doing? I was preparing for the next day when I would go to the US Embassy to renounce my US citizenship. Why so many calculations? I was arranging my financial affairs for my final tax obligations as a US citizen. You see, there are certain tax consequences that you will subject yourself to if you choose to renounce your US citizenship. While I had taken all of those consequences into account long before the eve of my renunciation, I had to make the final calculations that night because the US government literally taxes you until the very last second of your last full day as a US citizen. Your final tax liabilities are determined by the value of your assets the day before you expatriate as if you died that day and now had to pay a death tax to the US government before they allowed you to move on to your next life as a citizen of another country. So, the night before the impending “death” of my US citizenship, I was going over the numbers over and over again to ensure that I had an accurate picture of the value of my assets. When most people consider renunciation, they don’t think about this final scenario and the many tax consequences attached to their decision to renounce. But that is exactly why we need to talk about it. And that is why I have dedicated an entire article to discussing the in-depth tax consequences of renouncing US citizenship. If you want to learn more specifics about how to renounce US citizenship and how the process works, read this article. And, if you want to read about my personal experience renouncing US citizenship, read here. Otherwise, let’s stay the course and examine the six tax consequences you will incur by making the decision to renounce your US citizenship.
1. Cost Consideration
For many people, even being able to renounce their US citizenship is a costly endeavor. For one, giving up one citizenship requires having a second… and second citizenships are not usually cheap things to come by. Obtaining citizenship by descent can take a lot of time, headache and fees; citizenship by naturalization can take even more time and could create additional tax obligations; and citizenship by investment naturally requires an investment, usually on the magnitude of six or seven figures. But even if you were gifted with dual citizenship from birth and enjoy the benefits of having a second passport at no cost to you, there is another cost that prohibits many people from renouncing: The renunciation fee. Based on claims that the surge in renunciations following the introduction of FATCA increased paperwork and other operational costs for the US State Department, the US government felt justified in introducing a fee for anyone who wished to renounce their citizenship. To understand the absurdity of the fee, it’s important to note that most countries do not charge you anything if you choose to claim your right to renounce your citizenship. And, in the countries that do charge a fee, it is rarely more than $100. Up until a few years ago, the US did not charge a fee either. However, in 2010 (yes, right after the introduction of FATCA), the US government began charging a $450 fee. While that was not an astronomical number, it was about five times the average of other western countries that do charge a fee. Then, just four years later, they raised the fee by an astounding 422% to a grand total of $2,350 – the highest fee of its kind in the world and more than 20 times what any other high-income country charges. They also increased the fee for relinquishing citizenship from $0 to the same $2,350. Apparently, the taxes you’ve been paying into the system for years are not enough to cover a little paperwork to officially let you leave. Instead, you must pay in cash at the time of your renunciation (although different embassies do it differently). And, for some people, the fee can be prohibitive. There are literally some people who cannot afford to renounce. That, in and of itself, is a tax.
2. The Exit Tax
Apart from the fee, there is also a possibility that you will be subject to a mark-to-market exit tax on all of your assets. This was the tax that had me working late into the night on the eve of my renunciation. As I’ve discussed before on my YouTube channel, not everyone who renounces has to pay the exit tax. You are only subject to the exit tax if you are considered a covered expatriate. There are three situations that will deem you a covered expatriate and trigger the exit tax: 1. Your net worth is at least $2 million or more; 2. You have had an average federal tax liability (liability, not salary) of roughly $160,000 per year over the five years prior to renouncing; or 3. You cannot certify tax compliance. If you meet any one of these tests, you are considered a covered expatriate and must pay the exit tax. If you do not meet them, you are free from all exit tax obligations. However, you will still need to do the paperwork to prove that you do not meet any of the three tests. While the first test depends on the value of your assets as if you sold them the day before you renounced, it is important to know whether or not you are a covered expatriate long before you renounce so that you can take measures to potentially remediate the situation. Let’s examine each test in more detail to know exactly how you might trigger the tax and how you can avoid doing so, if possible:
Test #1: Net Worth of $2 Million+
This first test is not about assets alone but your assets minus your liabilities – your net worth. There are, of course, various different components that factor into your net worth and calculating each one can vary in complexity. A business, for example, is often the biggest asset of the people I work with. It also happens to be one of the more complicated assets to calculate in terms of knowing the value of the company as if it were sold the day before the owner renounced. There are so many different considerations that go into valuing a business that some people can get into trouble here. What is a company worth? What is an internet company worth? If you own a consulting company, does that have any value? Some businesses may have zero value or next-to-zero value because they are entirely based on your time and effort and you could always quit. There’s a whole process to figuring out the worth of your business and how it counts toward your assets. It is not just the value of the business itself, either. For instance, your company could be a cash cow that produces a lot of cash that you park in your company overseas. Or, your company could have an inherent enterprise value. One guy I spoke to is part of a startup that is raising money in Silicon Valley. Whatever the latest round of funding is, that’s the value of the company. If he owns 10% of the company and the last round of funding was $20 million, there’s his $2 million right off the bat and anything else he has puts him over. While you can save a lot of money by renouncing your US citizenship and going overseas, if your business is worth a lot, it may also cost you a considerable amount just to leave. You’re the one who has to determine whether renouncing will save you more money in the end. However, if you have a company that could reach that $2 million limit sometime in the near future, it may be better to buy an economic citizenship and renounce now than risk going over and triggering the exit tax. Cash is another asset that is factored into your net worth. Unlike a business, cash is pretty easy to value. It is also very unlikely that you will owe much if any capital gains tax on your cash holdings since cash is cash. Cryptocurrencies are also relatively easy to value. Some people would argue that cryptocurrencies should not factor into this calculation, but I wouldn’t risk the assumption. It’s better to be transparent and report everything upfront to make a clean break than to live with the worry hanging over your head that the IRS will come back and nail you later for failing to disclose your crypto holdings. Real estate in the United States and other developed countries is pretty easy to value as well, while getting a valuation for real estate in emerging economies may be a bit more difficult. The bigger challenge with real estate is that the IRS determines the valuation of the property. If you paid $500,000 for a home that is now worth $1 million but the IRS says it’s worth $1.2 million, you’ll either have to go along with their calculation or provide evidence that it’s worth just $1 million. And, even if you do not sell the home before you leave, you will have to pay as if you did. So, while you invested $500,000, the IRS will treat you as if you have $1.2 million in your pocket and a total of $700,000 in capital gains. (It should be noted that you do get an exemption if it is your personal residence.) Stock is another easy asset to calculate. Basically, everything you own is thrown into the exit tax. Some things may be easier to calculate than others and you will need professional help to crunch the final numbers. Just be sure to calculate your net worth well in advance of your renunciation date or you may be caught by surprise and end up paying a large exit tax bill.
Test #2: High Average Tax Liability
It is much less common to meet this second test than the other two. You would have to make a considerable amount of money to pay an average of $160,000 in taxes each year, especially if you’re an 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. For most entrepreneurs, the bigger test to worry about is Test #1 and knowing whether or not you have $2 million in assets. However, if you are an employee with a high salary, I can see this test becoming much more problematic. Whatever your situation may be, if you are paying an average of $160,000 or more a year in taxes – or have paid $800,000 or more combined in the five years prior to renouncing – you will be considered a covered expatriate and trigger the exit tax. With that kind of tax burden, you may not care about the exit tax and may simply want to renounce and move overseas right away. However, before you jump ship, I have just one suggestion: if you have never lived overseas before, give it a try before you decide to renounce. Try as many offshore strategies available to you to legally reduce your tax, if not eliminate it before considering renunciation. If those solutions do not work, you can go from there, but travel first to see if you enjoy the lifestyle, then make your decision.
Test #3: Tax Compliance
Very possibly, the principal way people trigger the exit tax is by failing to be in compliance with US tax laws. This isn’t necessarily because they are trying to evade taxes, but because they have never called the US home and were not aware that they had to file and pay taxes there because they never viewed themselves as American. Well, lo and behold, they do. And, if you can’t prove tax compliance for the past five years, you will be considered a covered expatriate and will be subject to the exit tax. One of the tax advisors I work with helps Dutch citizens who were born in the United States, for whatever reason (perhaps their parents were vacationing there or living in the US temporarily), and by virtue of being born in the US, they are American citizens. Some of these folks managed to get into their 20s, 30s and even 40s before they found out that they were “accidental Americans” and needed to file years of back tax returns. The good news 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. 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. They too may have been unaware of their US citizenship responsibilities (read, tax obligations) and must come into compliance before renouncing or become subject to the exit tax. Then, there are the people who have been living overseas assuming that they didn’t need to pay taxes. If this was you, you can use the streamlined filing compliance procedures to get back on track and avoid triggering the exit tax. Don’t think you can get away with anything less than compliance. Seriously, don’t be an idiot. I had one guy tell me, “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. If you’re living overseas, 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. If you don’t file your taxes, it’s going to come back to bite you in one way or another. If you never want to deal with US taxes again, you have to face them now and certify your tax compliance in the past, whether you’ve been living overseas or in the US. And if you’re living overseas, don’t think you’re above the law or assume that you’ll never 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.
Strategies to Avoid Being a Covered Expatriate
If you assess your situation well before you renounce, it is possible to remediate it so you no longer qualify as a covered expatriate by the time you renounce. However, it is much easier to fix some situations than others. For instance, it is practically impossible to go back and undo your past earnings and average tax payments. You may be able to reduce the average by waiting longer to renounce while earning less, but you will have to weigh the costs and benefits involved with that decision. It is also rather difficult to undo your net worth, although there are some gifting strategies that people use to reduce their net worth. One option would be to use your money to buy the second passport that allows you to renounce. While I see a second passport as an investment, this does work to reduce your net worth. There are complicated solutions for reducing your net worth, but other strategies could be as simple as giving some money to charity before you renounce. The easiest test to avoid is the last because you can always go back and become tax compliant. If you’re not in tax compliance and you’re thinking of renouncing US citizenship, get tax compliant first. This test should never be an issue in the end.
How Does the Exit Tax Work?
But let’s say you can’t avoid being a covered expatriate – you have a high net worth and there is no way you can avoid paying the exit tax. How does it all work? The day before you expatriate, they look at the value of your assets (which you will declare on a form after you have renounced) and everything is basically deemed as sold in order to calculate your final net worth as a US citizen. Again, figuring out exactly what your net worth is and what your gains are is an issue for much more complicated tax planning. But once you know your net worth, from there you must calculate your capital gains as the exit tax is paid on capital gains. It is also important to note that you do not get to exempt your first $2 million in assets. You trigger the exit tax by having more than $2 million in assets, but once triggered, only $699,000 of your capital gains will be exempt from taxation. You don’t get to exempt the $2 million, plus the $699,000 on top of that. Depending on your asset types, you may not have to pay that much capital gains tax. For instance, if all of your $2 million is in cash, your capital gains will be minimal, if not non-existent. However, even if you have less than $699,000 of capital gain, being a covered expatriate could have negative consequences. For instance, anything you gift family and friends in the year that you expatriate would have a tax bill attached that they would have to pay. Again, if you can avoid being a covered expatriate it will eliminate a lot of complications. The bigger problem is when people build up assets and then have to “sell” them the day before they expatriate. If your money is tied up in your investments, you may not even have the cash on hand to pay the exit tax. The IRS may deem them as “sold” but that doesn’t mean that you really have sold them and can use the money from your investments to pay the tax. Another issue with calculating the exit tax is that the IRS will tax you based on whether or not your capital gain is long-term or short-term. For example, if you bought a home in London for £100,000 twenty years ago and it is now worth half a million pounds, there is now a £400,000 capital gain and you will be taxed at long-term capital gains tax rates of about 20%. On the other hand, if you bought something three months ago and it has gone up in value, that will be a short-term capital gain subject to income tax. You can defer the exit tax on certain assets, notably 401(k) plans, but most everything else will be subject to short- or long-term capital gains tax rates, which can get as high as 23.8% for net capital gains.
It May Be Worth It Anyway
I do think that for a lot of folks – especially those involved in fast-growing businesses and fast-growing investments like cryptocurrencies – it may be better just to pay the exit tax and be done. Rather than wasting your time on a million and one different strategies to avoid becoming a covered expatriate, don’t worry about it, pay the exit tax, and then enjoy the freedom from there on out. Some people look at renunciation and think that if they owe an exit tax, it’s not worth it. But the exit tax could get worse and worse every year. After Eduardo Saverin of Facebook fame renounced to become a citizen of Singapore, Congress considered raising the capital gains tax to 30%. They could change the rules of the exit tax or any of the conditions for renouncing at any point in the future. So, while you may take a hit now, you may still benefit in the long-run by renouncing and paying the exit tax. In Eduardo Saverin’s case, while he still had to pay a ton of tax when he renounced his US citizenship, he renounced before Facebook totally went public and some experts placed his savings at $700 million just a short time after he renounced. So, paying an exit tax may not be the end of the world for you. That is up to you to determine, preferably with some professional help.
3. Past Taxes
During the renunciation process, you will undergo a couple of interviews. At some point in those interviews, the embassy official will directly ask you – under oath – whether or not you are renouncing in order to escape any taxes, military service, etc. As we discussed under the exit tax, there is no way to escape past taxes. While some angry readers chose to speculate about all the potentially nasty reasons I chose to renounce, the truth is that all the nasty stuff doesn’t go away just because you are no longer a US citizen. You can still be charged with crimes, you can still be hauled in by the IRS, you will still need to meet financial responsibilities such as child support payments, and your past tax debts certainly do not go away. You can stop incurring new tax debts once you renounce, but whatever has already happened doesn’t just get wiped away. Whenever someone has come to me in the past looking for help to renounce, the first thing we look at is tax compliance. If they didn’t realize they had to pay or file, it doesn’t matter. Everyone needs to get compliant before they renounce, and that often involves paying past tax debts. While you should pay those past taxes whether or not you are planning to renounce, they are an unavoidable expense that comes with renouncing. There is no way out of the US tax system without paying your past dues. Other people may be in compliance but still have tax debts that they haven’t paid yet. Those need to be cleaned up too. It’s not as if all tax obligations disappear once you renounce. Whatever you owe before you renounce, you still owe once you are no longer a US citizen. Period.
4. Estate Tax
There are both costs and benefits to renouncing when it comes to the actual US death tax. The estate tax is a tax on the transfer of your property at death – the final “exit tax” per se. The federal estate tax applies to property owned by a US citizen wherever they may own it, which means that your worldwide assets are subject to estate tax rates of up to 40% at the time of your death. Renouncing shields your non-US assets from this estate tax exposure. That’s the benefit. However, the estate tax also applies to US property owned by non-US citizens. So, if you maintain property in the US – real estate, stocks, etc. – it will still be subject to US estate tax rates at the time of your death. If you renounce, you will lose advantages that only US citizens have to shield that property from the estate tax. Currently, US citizens can shield up to $11.2 million in property from the estate tax while non-US citizens can only shield a measly $60,000. That’s the cost. If you plan to maintain properties in the US, the death tax will deliver a heavy blow at the time of your passing. However, if you renounce, sell your properties in the US, and move to one of the many countries with no estate taxes, you can avoid the burden of a death tax completely. But note that this particular strategy will take high levels of professional planning to pull off successfully.
5. Gift Tax
There are also costs and benefits to renouncing when it comes to US gift tax laws. The good news is that the Trump tax reform doubled the federal gift tax limit to $11.2 million per US citizen, which means that you can gift a large amount of your wealth to significantly reduce your net worth and get under the US exit tax threshold. However, special rules apply when a covered expatriate gifts property. If you make a large gift before you expatriate but in the same year that you renounce, you will pay a significant gift tax because the unified credit will not apply to you. It is better to make your big gifts at least one tax year before you plan to expatriate. Additionally, once you renounce, your gifting strategies may be limited. For instance, as a US citizen, you can make unlimited tax-free gifts to a spouse who is also a US citizen. If one spouse remains a US citizen and wishes to gift money to their non-US spouse, they will only be allowed a small annual exclusion of $152,000 before becoming subject to the 40% gift tax. While this exclusion increased from $149,00 in 2017, it is peanuts compared to the unlimited exclusion that US citizen couples are allowed. And when the gift tax rate is 40%, an exclusion of $152,000 isn’t going to protect you from much.
6. Final Reporting Obligations
After you have taken the oath of renunciation, while you are no longer considered a US citizen, you still have two final reporting obligations. If you fail to file these final reports, you have not fully expatriated for tax purposes.
Dual Status Income Tax Return
First, you must file one final US tax return for the year in which you renounced. Because you will be considered a US citizen for part of the year and a non-US citizen for the other part, this return will be considered a “dual status” return. A dual status return simply means that you will be taxed as a US citizen for the part of the year in which you were still a US citizen and as a non-resident alien for the time following your renunciation. Pretty simple.
With your income tax return, you must also file Form 8854. This is the form where you will declare all of your assets and make any applicable exit tax payments. Until you file this form, you may remain subject to US tax. The exact date when you expatriate (renounce US citizenship or a long-term residence) will determine which parts of the form you must complete. You can learn more about those terms from the IRS. The biggest change since 2017 is that you used to have to file returns for several years following your renunciation. Now, all you have to do is file one final tax return, pay the renunciation fee, and maybe the exit tax and you’re done. Some would argue that you do not need to be in tax compliance before you renounce as long as you put things in order before you file Form 8854, but this isn’t a great strategy. You want your renunciation to be a clean break and it is better to be in tax compliance before you renounce to eliminate any potential issues with your final return.
Renunciation Tax Planning
As simple as the process of renunciation may be, the actual tax consequences can be greater than most people anticipate. If you plan to renounce, you need to ensure that you are in full tax compliance before you move forward. If possible, you should also take measures to avoid becoming a covered expatriate under the other two tests. This can be complicated and will likely require outside help. You can use different strategies depending on whether or not you are single or married. You generally have fewer options if you are single. From the couples I have helped with renunciation, I have found that they have more options that they can work with. What I see the most, however, is that one spouse is more willing to renounce than the other. There are still gifting strategies and asset transfer strategies available in these situations, but the point is that every situation is going to be different. And that means that there is definitely some planning involved. What I don’t want is for anyone to get the wrong idea and try to hide their money under someone else’s name or “hire a friend” and have them pay them back later. Those are never good ideas. And, in some circumstances, you may actually increase your US tax burden by renouncing. You need a real strategy. The tax implications of expatriation can become complicated rather quickly. You need proper guidance from someone who has experience with renunciation. You really do. Your local tax guy from Kansas isn’t going to cut it. You need someone who has experience with the forms, the process, and with the potential tax consequences. So, if you want help, feel free to reach out.