Introduction:
Expatriation, or the act of relinquishing US citizenship or long-term residency, is a significant decision with potential tax consequences. The United States has a unique tax regime that requires citizens and long-term residents to report and pay taxes on their worldwide income, regardless of their current residence. However, when individuals choose to expatriate, they may trigger specific tax implications. In this article, we will explore the tax consequences associated with expatriation from the United States and the rules that individuals need to consider before making such a life-changing decision.
1. Exit Tax – The Mark-to-Market Regime:
The Exit Tax, also known as the Mark-to-Market regime, is a critical aspect of expatriation tax consequences. It is designed to capture any unrealized gains on an individual’s worldwide assets as if they were sold on the day before expatriation. These gains are then subject to income tax at the individual’s applicable tax rates. The Exit Tax applies to US citizens and long-term residents with average annual net income tax liability of more than a specified threshold for the previous five years before expatriation.
2. Determining Covered Expatriates:
Certain individuals who meet specific criteria may be classified as “covered expatriates.” Covered expatriates are subject to the Exit Tax and face additional tax implications. To be classified as a covered expatriate, one must meet one of the following conditions:
a) Those with average annual net income tax liabilities exceeding a certain threshold (which can change eachyear) for the previous five years before expatriation.
b) Individuals with a net worth of over $2 million on the date of expatriation.
c) Those who fail to certify compliance with all US tax obligations for the five years preceding expatriation.
3. Inheritance and Gift Tax Considerations:
Covered expatriates may also face inheritance and gift tax consequences. Under current tax law, US citizens and long-term residents are generally exempt from inheritance and gift taxes on transfers made to US persons. However, once an individual is classified as a covered expatriate, these tax exemptions no longer apply. Any gifts or bequests to US persons made by a covered expatriate may be subject to US gift or estate tax.
4. Reporting Requirements:
Individuals who expatriate must comply with specific reporting requirements to ensure transparency with the Internal Revenue Service (IRS). Covered expatriates must file Form 8854, Initial and Annual Expatriation Statement, with the IRS. This form discloses information related to the expatriation event, assets, and other necessary details. Non-compliance with reporting requirements can result in severe penalties.
Conclusion:
Expatriating from the United States is a significant decision that can have far-reaching tax consequences. The Exit Tax under the Mark-to-Market regime, the determination of covered expatriates, and the potential impact on inheritance and gift taxes all need to be carefully considered before making the move. It is essential for individuals contemplating expatriation to seek professional advice from tax experts familiar with international tax laws and regulations. Understanding the tax implications of expatriation can help individuals make informed decisions and ensure compliance with US tax requirements during this life-changing process.