Important part

At a news conference this morning, Sens. Schumer and Bob Casey, D-Pa., will unveil the “Ex-PATRIOT” – “Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy” – Act to respond directly to Saverin’s move, which they dub a “scheme” that would “help him duck up to $67 million in taxes.”

Full article

http://abcnews.go.com/blogs/politics/2012/05/senators-to-unveil-the-ex-patriot-act-to-respond-to-facebooks-saverins-tax-scheme/

Thoughts

• - I’m surprised it took them this long to introduce this.

• - Once we’ve managed to insulate ourselves from the rest of the world and its capital, THEN our economy will take off!

• - Perhaps if our system wasn’t such a nightmare, people wouldn’t want to leave.

Yes, John. It is a full-blown Moronathon on Capitol Hill.  (PS:  Senator Schumer is also a “D”.  Not to say that the “R” people are sane.  Not at all.  I just need to point out that Sen. Schumer is a “D”.  Also from New York.  Wasn’t that the site of a world-famous stock market once upon a time?)

By curious coincidence, the last few years of tax law and tax enforcement are propelling the United States to a position where currency restrictions will be easy to implement.

If you can’t send your money abroad, at least you can jump on a plane and leave the country, right?  Well, funny you should mention that.  

OK.  Time to take off the tin foil hat, Phil.  Red pill or blue pill?

Now here is the economic reason he gave up his U.S. citizenship last September, pre-IPO.

How he was taxed when he gave up citizenship

When you give up your citizenship, the IRS pretends that you sold everything the day before.  Let’s pretend Eduardo Saverin cancelled his citizenship on September 30, 2011.  That means the IRS pretended he sold everything he had on September 29, 2011.

Among other things he owned was a giant stack of Facebook stock.  Eduardo’s tax lawyer (if smart) went and bought a really expensive valuation opinion on what the stock was worth on that date.  Eduardo acquired the stock at as close to zero as you can be.  So the entire amount was capital gain.

Example.  Eduardo owned 100 shares of Facebook stock that he bought for $100 at founding.  On the day before he expatriated his stock was worth $1,000.  He has a really well-documented valuation opinion to prove it.  (Remember, at this point Facebook is pre-IPO.  There was a secondary market for this stuff so it’s reasonably easy to get reasonably close to what the stock was worth).

Eduardo has capital gain of $900.  He happily pays tax to the U.S. government on that $900 capital gain.

How he’s taxed after he gives up citizenship

Now Facebook goes all IPO ‘n stuff.  His 100 shares are suddenly worth $2,000.  Remember.  Eduardo is a nonresident alien — a noncitizen of the United States who also happens to not be living in the United States.  He sells the stock for $2,000.  He pays U.S. capital gain tax of ZERO.

Whaaaaaa?

Or as Reddit would say, ffffffffuuuuuuuuuuuuu!

Yep.  True story.  Zero tax in the USA.

A nonresident alien does not pay capital gain tax on stock sales of U.S. companies.  Not just Facebook.  It could be Google, Apple, anything.  Nonresident investors do not pay capital gain tax on their stock sales.  (Usual disclaimer – exceptions to the rule exist everywhere but for the well advised investor this is the result).

Example:  Eduardo owned 100 shares of Facebook stock that he bought for $100 at founding.  He cancels his citizenship and pays his $900 tax as described above.  The company goes IPO.  Now the stock is worth $500 per share.  His holdings are worth $50,000.  He sells.  Pays no capital gain tax.

This means that the total capital gain tax that he paid, as a founder of Facebook, was $900.

And if the price per share goes to $1,000, he has $100,000 in his pocket, on which he paid $900 of tax.

Etc.

I don’t know the true numbers

I don’t know the true numbers that apply to him.  But that’s the tax game he played.  He only gets taxed on the capital gain up to the value of the stock on the day before he expatriated.  All future appreciation in value is forever tax-free to him.

I approve.

EDIT:  I’m quoted in an article on abc.com about this situation.

Eduardo Saverin, a Facebook co-founder, renounced his U.S. citizenship last year.

Only an elected official would fail to predict such events.

(There are other utterly predictable events from Federal tax policy that somehow fail to register on the Congressional Richter Scale).

It is also utterly predictable that some politician somewhere will rant about this.  And it is also utterly predictable that the recommended remedy is more regulation, higher penalties, and higher taxes.

The beatings will continue until morale improves, apparently.

EDIT:  Bloomberg reports on the same story.

Atlas Shrugged, apparently.

Here is a simple explanation of how it works.  If you’re just starting to think about giving up your U.S. citizenship or green card, this is the place to start.

Disclaimer, warning shot, weasel-words, pre-emptive strike

Sorry.  Have to do it . . .

- This is not legal advice to you.

- This explanation is like giving me a map of Europe when I ask you to recommend a good Thai restaurant in Zurich.  It is extremely simplified.  There are exceptions and special rules all over the place.

- In other words, if blog posts were art, this is a doodle on a napkin, not the Mona Lisa.

With that out of the way, here is the explanation.

Two tasks when you expatriate

There are two things you need to accomplish when you give up your U.S. citizenship.  You need to convince the Department of State that you are no longer a citizen, and you need to convince the IRS that you are no longer a U.S. taxpayer.

Log out of the citizenship system

The first (and easier) part is to terminate citizenship. You do some paperwork (look for Form DS-4079 on the internet; there is other stuff too that the Embassy will want). You show up at the Embassy or Consulate for an interview.

Your citizenship is terminated effective that day but it typically takes about 4 months to get the confirmation paperwork. I recently had two different clients (on opposite sides of the world) get their paperwork back in a matter of days, however.  I blame global warming for that astonishing efficiency.

Log out of the tax system

The harder job is to log out of the tax system.

This job is either paperwork only (if you are “poor”) or it is paperwork plus pay some tax (if you are “rich”).

“Rich” for exit tax purposes

You are “rich” and therefore have to pay tax when you leave if you satisfy one of two financial tests.

The first test is a simple balance sheet test. Is your net worth (assets minus liabilities) $2 million or more?

The second test is based on the amount of Federal income tax paid over five years before you terminate citizenship. Is the average Federal tax liability over those five years $151,000 or more? For someone who terminates citizenship in 2012, that means we look at 2007-2011, and calculate the average based on those years.  The $151,000 amount is indexed for inflation so next year it will be higher.

If you satisfy EITHER of these tests, you are “rich” and therefore you will pay tax when you leave the United States. Plus you do the paperwork, of course.

If you satisfy NEITHER of these tests, you only have some paperwork ahead of you but you do not have to pay any tax.

Income calculation for someone who is “rich”

For a rich person who terminates citizenship, there is a “mark-to-market” event in the person’s life. Pretend that all assets are sold on the day before you went to the Embassy to cancel your citizenship, at market prices. The first $651,000 of profit is tax free. Everything above that is taxable, at the normal tax rates that would apply.

There are special rules if you are a beneficiary of a trust, or if you have a pension.  There are a few other odds and ends that can cause taxation.

But the most important thing is this “pretend that you sold everything and pay real money taxes on the pretend profits.”

This is done for all assets worldwide.

The exit tax paperwork

The tax paperwork filed is a complex income return for the year you terminate your citizenship.  You file it according to the normal filing deadlines.  For someone who terminates citizenship in 2012, you will be filing your tax return in 2013.

The tax return has a component that is part-year reporting as a citizen of the United States, another component which is part-year reporting as a nonresident of the United States, and (this is the important one) Form 8854, which is the form the government wants to see to log you out of the tax system.

Prior five years are clean

In order to do this right, your U.S. tax paperwork and tax payments must be up to date for the prior five years. For someone who will terminate citizenship in 2012, that means the 2007-2011 tax returns must be filed, and must be correct.

“Thar be dragons!”

Can I tell you again that there is a lot of other stuff that is important, tax-wise?  Get smart before you make that appointment to terminate your citizenship. 

Shameless self-promotion

We do a lot of this stuff.  

We will walk you through the early stages so you can make a well-informed decision:  how to do it, how long it takes, what the estimated tax hit (if any) will be, what can be done to reduce or eliminate taxes.  

Then if you hire us, we do everything.  In our experience the “get out of the citizenship” part is straightforward but the tax stuff is not.  We do the pre-expatriation tax planning.  We do the exit year tax returns for you and the following year as well because there is usually some strange stuff going on in the year after you leave the United States.  It is rare that people can get their financial affairs arranged so that their U.S. finances are completely wrapped up by the time they leave.

I travel frequently (the upcoming trip is Switzerland from 20-27 May, Beirut from 27-30 May, and Dubai from 30 May to 03 June) so we can meet outside the USA.  Or we can meet in my office or talk via phone or Skype.

But leave aside the tax stuff for the moment.  If you are thinking about canceling your U.S. passport in order to live abroad, there are nontax problems to think about.  

Today’s HackerNews brought me the story of John McAfee, the founder of the company that created McAfee Antivirus.  He is wealthy (!) and living in Belize.  I have no reason to believe he terminated his U.S. citizenship.  He probably thought he had found a great place to retire.

According to news reports from Belize, the local Gang Suppression Unit has been called out on Mr. McAfee.  From the article:

McAfee lives in Belize and he says that he has become a target of the Gang Suppression Unit. He says the GSU came busting into his research facility in Orange Walk, killed his dog, took his passport, handcuffed him and arrested him on a bogus weapons charge. McAfee says he’s a victim because he didn’t donate money to a known U.D.P. Orange Walk politician.

Yes, I guess it is theoretically possible that Mr. McAfee is a criminal.  Unlikely, though.  Occam’s Razor suggests that his version of the story is vastly more plausible.

My point? Do not rely on getting citizenship in another country just because it is easy.  If you must get a questionable passport, use it as a stepping stone towards a second (third?) citizenship in a stable (economically and politically) country. Do not assume that you and your money can necessarily live anywhere you want.  You are a guest in someone else’s house.  You might be asked to leave at any time, in a polite or not-so-polite way.

Plan ahead.

(4) Deferred compensation item. For purposes of this subsection, the term “deferred compensation item” means—

(A) any interest in a plan or arrangement described in section 219(g)(5),

(B) any interest in a foreign pension plan or similar retirement arrangement or program,

(C) any item of deferred compensation, and

(D) any property, or right to property, which the individual is entitled to receive in connection with the performance of services to the extent not previously taken into account under section 83 or in accordance with section 83.

Emphasis added.

How’s that for a circular definition?  I think it takes the cake.  A “deferred compensation item” means, among other things, an “item of deferred compensation.”

Gee thanks.

Fortunately, Lara Banjamin and the now-retired Bill Yates of the Office of Associate Chief Counsel (International) gave us an exit from that infinite loop in Notice 2009-85, at Section 5.B.4:

Item of deferred compensation means any amount of compensation if, under the terms of the plan, contract, or other arrangement providing for such compensation (compensation arrangement), the covered expatriate has a legally binding right as of the expatriation date to such compensation, the compensation has not been actually or constructively received on or before the expatriation date, and pursuant to the compensation arrangement the compensation is payable to (or on behalf of) the covered expatriate on or after the expatriation date, but such term does not include any deferred compensation item that is described in section 5.B (1) a, 5.B (1) b, or 5.B (1) d of this notice. An item of deferred compensation generally includes an amount (other than a deferred compensation item described in sections 5.B (1) a, 5.B (1) b, or 5.B (1) d of this notice), whether or not substantially vested, that constitutes nonqualified deferred compensation for purposes of section 404 (a)(5) (determined without regard to § 1.404 (b)-1T, Q&A 2), including a cash-settled stock appreciation right, a phantom stock arrangement, a cash-settled restricted stock unit, an unfunded and unsecured promise to pay money or other compensation in the future (other than such a promise to transfer property in the future), and an interest in a trust described in section 402 (b)(1) or (4) (commonly referred to as a secular trust).

Now THAT makes sense.  (Seriously meant, with no sarcasm, irony, etc.)

The list is discussed on the Isaac Brock site, including some omissions.

I think the explanation for the omissions is in the careful wording at the top of the list:

This notice is provided in accordance with IRC section 6039G of the Health Insurance Portability and Accountability Act (HIPPA) of 1996, as amended. This listing contains the name of each individual losing United States citizenship (within the meaning of section 877(a) or 877A) with respect to whom the Secretary received information during the quarter ending March 31, 2012. For purposes of this listing, long-term residents, as defined in section 877(e)(2), are treated as if they were citizens of the United States who lost citizenship.

The emphasized text tells it all. This is the list people that the Secretary (of the Treasury) heard about in January, February, and March of 2012. It is not the list of people who actually terminated their citizenship or green cards in the first quarter.

I happen to know several people who pulled the plug in Q1 of 2012. They are our clients. They won’t file their final tax returns–with Form 8854 attached–until sometime in 2013. Filing tax returns is the way you notify the Secretary of the Treasury of anything tax-related.

So even though our clients are former citizens at this time, the much-maligned Treasury Secretary legitimately has no clue about these people. And he won’t know until next year. Therefore they are not on this list.

Just in case you get the impression that the United States is a hellhole and you should get out as fast as you can, please read Yasmine Mustafa’s story about becoming a naturalized U.S. citizen and what it means to her.

There are some real-world people making real-world decisions.  For those who reflexively think “Traitor!” when they hear of someone canceling U.S. citizenship, this article might be eye-opening.

In short, the cost of U.S. citizenship has gone up.  It is no surprise that an increasing number of people are choosing to drop the passport.  Price up?  Fewer buyers.  Simple.

Our firm does a lot of this type of work.  We log people out of the citizenship system, then log them out of the tax system.  It’s one of the reasons I am on a plane every 7 or 8 weeks to somewhere or another.  (I will be in Switzerland May 20-25, Beirut May 27-29, and Dubai May 30-June 3.  Meet me.  Text or email me to set something up.)

A word for those who are considering this major life step.  I do not think it is smart to let tax considerations drive major life decisions.  You are on the planet once.  Then you die.  Don’t be rash.  Go.  Live there (wherever “there” is for you) for a couple of years and hang on to your U.S. passport.  See if you like it.  Simplify your life so you can simplify your taxes.  Cross your fingers and hope you can open a bank account.  :-)

In my experience, this is not a step for everyone.  But for many, it is a staggeringly obvious choice to make.  As the IRS — through increased regulations, obtuse paperwork, and not-so-smart tax policing — continues to bull its way through the great china shop of life, I expect to see the number of expatriates continue to climb. 

(Oh, by the way, in the shameless self-pimping department, let me just point out that Atossa was kind enough to give me a shout-out in the article.  Thanks Atossa).

And one more thing.  Let’s abuse one more bias commonly held about expatriation.  (A bias especially prevalent among politicians, it seems).  Did you notice in the article that the people interviewed are living in high-tax countries, both for income tax and death taxes?  Isn’t that interesting . . . .