Exit tax is a one-time tax


Posted by:
Phil Hodgen

Written on:
September 13, 2011

Posted in:
Expatriation

I received this question from reader M:

I hate to ask a stupid question but IRS Notice 2009-85 gave me brain freeze. If your assets consist of property in the US and you sell all the property and pay the proper tax to the IRS before leaving the US, is there another tax or “exit fee” on the net amount received for the property on top of this or on any money removed from US banks upon leaving the US? Thanks.

Section 877A

We are in the land of Section 877A — the law that applies to U.S. citizens and green card holders who give up their citizenship or permanent residence visas.

  • Not every person who gives up a passport or green card is going to file some paperwork with the IRS to log out of the U.S. tax system.
  • And not everyone who gives up a passport or green card is going to pay tax because of this tax law.

Let’s assume M is in the unfortunate position where she must do the paperwork and she will have to pay a tax when she gives up her citizenship or green card.

Simple Example of the “Exit Tax”

The phrase “exit tax” is sloppy, informal tax lawyer slang. So it is easy to get confused if you don’t know what those teenage delinquents — that would include me, international tax lawyer extraordinaire :-) — are talking about.

The “exit tax” is the regular income tax applied to special people, but at an earlier date than would otherwise be the case. The special people are those who give up their U.S. citizenship or green cards.

Example

You bought Google stock for $300/share and now it is worth $400/share. If you remained a U.S. citizen or green card holder, you would only have to pay tax when you actually sold the stock.

On the other hand, if you give up your U.S. citizenship or green card, you have to pay tax on your $100 profit as if you sold your stock the day before your “expatriation date.” (“Expatriation date” means the the day on which you gave up your citizenship or green card. Another piece of jargon!)

It is the same tax amount that you would pay if you had chosen to sell the stock voluntarily. It is just a question of timing and the event that triggered the tax.

Paying the tax on your Google stock because you gave up citizenship or green card status — this is part of what we refer to as the “exit tax.”

Once you have paid the “exit tax” (either in a giant lump sum up front, or because of the 30% withholding made on payments as you receive them) you have cash in your pocket. The IRS will not tax you a second time. You are free to move about the planet.

“Exit Tax” Consists of Several Things

The phrase “exit tax” that we use consists of four different ways in which you pay tax when you give up U.S. citizenship or green card status:

  • Mark-to-market. The example I gave above is technically–and correctly–defined as capital gain tax (the regular kind) on mark-to-market gain. Simply put, the IRS pretends that you sold everything you own on the day before you gave up your citizenship or green card. You did your “pretend” sale at market price. (Hence the phrase “mark-to-market”). You pay tax on the capital gain on “pretend” capital gain you received.
  • IRAs and other specified tax-deferred accounts. There is a whole zoo of little accounts like IRAs in the Internal Revenue Code. Political boondoggles all. Well-meaning, bleeding-heart, social-engineering boondoggles, but boondoggles nonetheless. The IRS pretends that all of these accounts were completely distributed to you on the day before you gave up your citizenship or green card. Pay income tax at regular tax rates.
  • Deferred compensation accounts. These are normal and normal-ish pension plans. If they are “good” deferred compensation plans, the IRS will take 30% of your monthly pension payment as tax, as the distributions are received by you, for the rest of your life. If they are “bad” deferred compensation plans, pretend they dumped the whole amount in your wallet on the day before you gave up your citizenship or green card, and do some complex math. Pay tax.
  • Trust distributions. Weirdness. Not important for our purposes here. I will write more about this in some other blog post.
  • UPDATE. Gifts/bequests. The sins of someone subjected to the exit tax in all of its glory (a “covered expatriate” is the technical description of that person) are visited upon his/her children. Someone who gives money or leaves property at death to a U.S. heir will also leave that heir with a whacking great big tax bill. (Because why would the U.S. government want capital to come into the USA? It’s not like we need business investment or jobs or anything. . . . Oh, wait. . . . ) (Update to blog post jogged by the comment below; thanks.)

Exit tax — (mostly) a one-time thing

Four very different items, with different tax rules for each. The teenage delinquents international tax practitioners refer to all four collectively as “exit tax.” That’s confusing.

The general idea is that the IRS wants to tax you as you are leaving. The reason they want to do this is because they are afraid that once you are gone you won’t every come back and voluntarily pay tax to the United States government if they can’t force you to do it. That’s why all of your tax is due immediately. The only exceptions are for things like pensions, where there is a pension plan in the United States who can be forced to do tax withholding for the IRS.

Finally, here is M’s answer

In direct answer to M’s question — you will pay tax once and once only when you exit the United States. In most cases it will be in one giant lump in the year that you give up your U.S. citizenship or green card. In a few cases the tax will be imposed by 30% withholdings on payments to you, forever and ever into the future until you don’t receive any more payments (this is for things like pension payments).

And when you have paid that exit tax, there is no further tax imposed when you want to move your cash out of the United States.

No hope for future guidance, I think

This area is fiendishly complex, not because it needs to be, but because of the peculiar way in which Congress conceived (in the “let’s be fruitful and multiply” sense of the word) this law.

Congress wrote a skanky piece of legislation — stupidly conceived (in the thinking sense, not the “let’s make a baby” sense), poorly written, and full of entirely predictable consequences that are damaging economically and diplomatically to the United States. (Can you guess that I have an opinion about this?)

Congress left next to no legislative history. (Legislative history is the stuff that Congress says so you can figure out what their intentions were, so if you find an ambiguity in the law they wrote you can try to reverse engineer the law to achieve the intent of Congress). You can’t look there for help if you’re puzzled.

Notice 2009-85 is, in my estimation, all you’re going to get in this area of tax law in terms of guidance. There may be a few odds and ends of Notices and Announcements from the Service in the future. But not much.

I don’t think you will get Treasury Regulations issued during our lifetimes. The law is messy (so it is a hard job) and the number of taxpayers to whom it will apply is small (relative to the total population of taxpayers). I don’t think the Commissioner will carve off a bunch of brainpower to throw at this problem.

How will you know what the rules are? You won’t.

Exit tax is a one-time tax by
  • Anon345

    Thanks for the detail, but one last unanswered question, what happens to one’s social security payments, assuming you had reached the magical age and qualified for them? Are they too forfeited as the price of giving up your Citizenship?

    • http://hodgen.com/ Phil

      Another blog post inspiration! Yay. (Short answer – you still get social security).

  • Anonymous

    There’s an item missing from the “… different ways in which you pay tax when you give up U.S. citizenship or green card status”, perhaps because it’s applied to gift and bequest recipients rather than the person departing.

    Section 2801 imposes a transfer tax on U.S. persons who, directly or indirectly, receive gifts or bequests from covered expatriates. It’s imposed at the highest gift or estate tax rate in effect, so around 45%. Of course, it seems quite impossible that the IRS could track or enforce this, but then practicality and common sense are not threads that run through any part of the crass stupidity (and that’s me being polite; I too have an opinion here) that is the “exit tax” law.

    • http://hodgen.com/ Phil

      True. I left out Section 2801. I was trying to keep the post as focused as possible. No one-time exclusion, no “who is a covered expatriate?” etc.

      But yeah.

      I’ll throw in an EDIT/UPDATE to flag the readers. Thanks.

    • Wada

      It is theoretically possible to track this, since US persons are supposed to file form 709s on receiving foreign gifts (> 100K from persons, 13K from trusts).

    • http://hodgen.com/ Phil

      Well actually Form 3520. :-) We have a small cottage industry in remedial Form 3520 filings.

    • Anonymous

      Theoretically possible, but in practice I’d say not a chance. Split gifts into small parcels. Or transfer via one or more non-US persons. Or have the US recipient expatriate themselves before they receive the gift. Or don’t reveal the initial source of the gift to the recipient (“it’s your non-US uncle Jose’s money, and not, and never was, your covered expatriate aunt Agatha’s”) who can then fill out whatever forms the US demands with a clear conscience.

      Only an idiot would fess up to owing Section 2801 tax. I’d love to see the statistics on how much the exit tax has actually raised since it was introduced, but I doubt we ever will. And we’ll never see an accounting of the damage it’s caused because that can’t readily be measured. It’s a damaging law passed by a ignorant congress.

  • Anonymous

    I’m a real life example of economic damage done by the exit tax to the US. I’m from the EU, but lived and worked in the US for over ten years up to early 2008. I left before the exit tax law passed, and in specific response to it, to avoid losing tens of thousands of dollars in unrecoverable double-taxation from my US based retirement accounts built up over many years. I cashed in all my other investments, paying full US tax on them, and departed along with my cash.

    Today I still do the same job for the same multinational employer, only now I live back in the EU and no longer have a green card. I pay around the same annually in tax as I used to when living in the US, so I haven’t gained anything there. But I avoided (effectively retroactive) destruction of my retirement savings by the exit tax. And while I haven’t personally saved in tax, not one penny of what I pay each year, a not inconsiderable amount, now goes to the US treasury. It all goes to another country instead. Cumulatively this is already greater than the amount the US sought (and failed) to confiscate with the exit tax, and the differential grows larger each year.

    Outrageously stupid law. It baffles me that the American public, generally well known as folk unwilling to take crap from anyone, permit congress to get away with such travesties without even a whimper of complaint.

    • Anon345

      It is not really surprising when you think about it. The US tax code is the most complicated special interest legislation in the world. Congress can not help itself, but to be constantly changing it or adding new provisions or exclusions. Look what is happening right now with the latest Job Creation legislation. More tax rule changes and more pages added to the 1,000s already written. Few Americans know much about the many obscure rules, exceptions, and new Statutes coming out of Congress regularly. Me included.

      Look how many didn’t even know what a FBAR was, and got caught in the recent IRS witch hunt to collect revenues, so the likely hood of them knowing what an Exit Tax is is infinitesimally small. That is unless you spend your life reading blogs like this now, which sad to say, I find myself doing just to stay out of any non compliance issues… GBA!! :)

      I would say you have made a smart move. It is one I consider all the time, especially with the coming of FATCA!

  • M

    To take Phil’s intelligent explanation one step further & stick with the property issue. It sounds like there might be an advantage to expatriation BEFORE selling property tax-wise. Won’t the IRS have to value the property in order to assess the “pretend sale” tax liability? And if they do this in such a depressed market, couldn’t the pretend sale assessment end up being much lower than what the property eventually sells for. But you’ve already paid tax on the pretend sale assessment. It sounds like they won’t come after you as an expatriate for the difference?

    • http://hodgen.com/ Phil

      Hi, M.

      There are some situations where you want to sell before you expatriate. E.g., for reasons to strange to explain here, you should sell your primary residence and claim the Section 121 $250,000 capital gain exclusion ($500,000 per couple) before you expatriate.

      For situations where the “pretend” sale price is hard to figure out, you will have a battle of the appraisers with the IRS. These are good battles to have.

      For situations where the “pretend” sale price upon expatriation is easy to figure (e.g., publicly traded stock), you don’t want to sell before you expatriate because there is a one-time exclusion at the time of expatriation: you get $636,000 (for 2011) of “pretend” profit tax-free at the time of expatriation.

      So as usual, the answer to “What’s the correct strategy?” is “It depends . . . .” :-)

      Phil.

    • Wada

      Phil

      It seems to me that if one has assets in a tax deferred retirement account such as Roth IRA, one could sell them when still a US citizen and stash in money market funds, then expatriate. Is that correct ? There should be no capital gains on the money market funds.

      For other retirement accounts (regular IRAs, 401ks), the solution might be to convert some portion to Roth IRAs over a period of time, taking a hit each year, then use the Roth IRA strategy mentioned above.

      For regular assets, one could sell some to reset their basis, taking advantage of tax losses to avoid paying too much tax, making use of lower capital gains rates, using Section 1031 exchanges or one time exclusions such as that on US home property and so on.

      This is not likely to help someone with a lot of assets (say in the $10M range), but for someone just over $2M or so, this might be used to minimize exit tax.

    • M

      For clarification purposes, will the IRS come after you for the difference if you sell your property post-expatriation for more than they assessed it for in the “pretend sale.” And, conversely, can you get anything back as an expatriate if you sell property for less? Thanks.

    • http://hodgen.com/ Phil

      M,

      Here’s what I think:

      1. If you properly document the asset value on your expiration date, the IRS can’t really complain if the sale price is higher after you expatriate. The only thing they can do is attack your appraisal. As long as you get a reputable opinion from a reputable appraiser I think you’ll be fine.

      2. If you sell for less later the IRS will not give you any money back. That’s for sure.

      3. If you sell for more money later the IRS has a serious practical problem — how do they know? Unless the asset is in the United States the IRS will be completely in the dark.

  • M

    I’m wondering if you think the constitutionality of the tax exit law will ever be challenged in the courts since it’s still relatively new? And why do we still tax on citizenship rather than residency like other countries? Wouldn’t everyone be better off if we got in line on this one. The loss of tax on US citizen global assets would probably be more than made up with the tax on resident foreigner global assets. And we wouldn’t have to go around blacklisting countries and suing Swiss banks. I like it! Sorry EU!

    • http://hodgen.com/ Phil

      None of the people I have helped to do this have any interest in fighting the U.S. government in its own court system.

      And the people who do have the incentive and desire to fight the constitutionality of this tax would, I’m guessing, just . . . ummm . . . fade away and live a happy life.

      As for changing the tax system to something sane, forget it. You’re talking about politicians, remember? The intelligence that gets them elected does not necessarily extend to competence in any other facet of human existence. “God grant me the serenity to accept the things I cannot change . . . .” Etc.

    • Anonymous

      There is at least one academic paper that concludes that the exit tax is unconstitutional. From http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1628568

      “This article will argue that, as it currently stands, the exit tax is not constitutional because it is not narrowly tailored to achieve a compelling government interest and must be judged at that standard because it infringes on the fundamental right to expatriate and discriminates based on national origin.”

      And on “…loss of tax on US citizen global assets would probably be more than made up with the tax on resident foreigner global assets.”, the US already both has its cake and eats it here. Because the US taxes on both residency (like other countries) and citizenship (unlike practically any other country), resident foreigners are already on the hook to the IRS for their worldwide income. Also their worldwide assets with the US estate tax should they have the poor judgment to die while still resident in the US.

    • Wada

      People have been fighting the constitutionality of the tax system for years (including the estate tax), and losing pretty much all the time.

      In general, the sort of scrutiny mentioned in the excerpt only holds for rights specifically mentioned in the Constitution/Bill of Rights. Congress has very broad authority in writing immigration and naturalization law, so I doubt very much that expatriation would be considered a fundamental right.

    • Poser

      The right to expatriate is recognized by Congress via legislation: i.e., the right of citizens of other countries to expatriate from their own countries to join the United States. This unintentionally gives US citizens the right to expatriate from the US–a right which is recognized by international law and assumed by the Declaration of Independence.

    • Poser

      I might add that a great resource for this question on the web is: http://renunciationguide.com/

    • http://hodgen.com/ Phil

      Thanks for this link. I did not know about that website before. And I do lots of expatriation work. The site is very good.

    • M

      The website rununciationguide.com seems to be taken, in some instances, verbatim from another site at http://www.taxesforexpats.com.

    • http://hodgen.com/ Phil

      Oooh. Plagiarism. Makes me sad. Should make them embarrassed.

    • Anonymous

      “The website rununciationguide.com seems to be taken, in some instances, verbatim from another site at http://www.taxesforexpats.com.”

      I believe it happened the other way around, and TfE… liberated content from renunciationguide.com. Not that they appear to have done anything untoward here — renunciationguide.com specifically notes that all of its content is free and that anyone can do anything they like with it.

    • Poser

      Hi Phil: You’re welcome. I’ve been reading the renunciationguide.com since February 2011. This is the first I’ve seen of the other site. I think renunciationguide.com is the older site.

  • Poser

    I was just simply planning to ignore the IRS from hence forth. I’ve expatriated recently, and my assets are considerably less than 2 million, and so I am not a covered expatriate. But since my assets are all in my new country (and they were earned in my new country too, for the information of those complaining about how the US is losing revenue because of greedy expatriates!!) except some DEBTS owed to me (which won’t be paid back with the US economy having gone down the toilet) and a small remote mosquito infested swamp land parcel, there isn’t anything they can do except arrest me at the border (if I decide despite my current boycott of the US economy to enter the US with my foreign passport) for not filing the expatriating tax forms–to my knowledge, no such arrests are currently happening.

    Yet my new government won’t recognize my tax liability in the US–once I become a new citizen–despite the tax treaty with the US, and the only way the IRS is going to collect from me another red penny is if they invade and occupy my new country and impose US law here.

    All this to say, I don’t see any compelling reason to fill out the stupid expatriating tax forms. The only thing that could happen from my point of view is that it would give them enough information to charge me with criminal FBAR violation–for in looking over the form, I see that even if you have less than 2 million in assets, you are required to list all of the assets in detail. So on the basis of my Fifth Amendment rights, I refuse to cooperate.

  • Poser

    http://www.bloomberg.com/news/2011-09-15/thousands-come-clean-to-irs-in-offshore-tax-disclosure-program.html

    Bloomberg carries the IRS water. Not one statement about people who are expatriating, or millions of Americans living overseas who can’t sleep at night, or the foreigners who have emigrated to the US who now regret doing so. Typical of the media to only tell the statist government side of the story.

    • Just Me

      Thanks for the alert that the story was there. I had missed it.

      Don’t you just love that headline.

      Please consider emailing the authors with some feedback. I did. Their email address is at the end of the story.

      I have taken it upon myself, to email every reporter and/or editor for every story like this I come across. Those of us who have “come clean” as this story likes to characterize us in the headline, need to be willing to at least give reporters some feedback as the the realities of the unintended consequences of these IRS actions. They may not read it, or think the story is too boring, but again maybe there is one reporter somewhere who is willing to push back on IRS press releases and question the narrative.

    • Just Me

      Just saw that AP has even a better characterization in their Headline. These guys certainly have no knowledge of which they write..

      http://news.yahoo.com/12-000-tax-cheats-come-clean-under-irs-181341503.html

    • Just Me

      and also a WSJ story…

      http://online.wsj.com/article/SB10001424053111903927204576573032432839022.html#articleTabs%3Darticle

      Reading the comments, there is only one from a practitioner that understands the unintended consequences of this program. The majority of people see this just like the IRS wants them to. Cheats and evaders getting caught. The press sure does a good job carrying the IRS narrative, without a question of substance.

    • Just Me
    • Poser

      The federal government spends over 10 billion per day. So the IRS is congratulating themselves for extorting 2.9 billion. This is enough money to run the government for roughly eight hours. Is it really worth it?

      From the conclusion of The journal article that anonymous quoted above:

      This method of taxation goes to heart of what it means to be a citizen. Is a citizen simply an individual receiving benefits from the legitimate monopolizer of violence or is the citizen a member of a common endeavor to create and sustain a government among equals? If the people are the former, existing in a separated and adversarial relationship with the government, then perhaps the government should be empowered to tax all who it can reach for its own enrichment. If, on the other hand, the citizens are engaged in a collective relationship, with the government merely acting as their representative and agent, then when a citizen elects to leave the community and no longer receive the rights of the community, then the individual should not have lingering obligations upon leaving the state.

      Interesting thoughts, no?

      http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1628568

    • Just Me

      Interesting thoughts yes..

      Btw, I did receive an email response of interest from Bloomberg this morning, and have replied to it in a comprehensive way. I must admit, that a lot of emails I send to reporters just seem to get swallowed up in the ether with no response. However, in these days of cut and paste, it isn’t that hard to form a new one from previous ones, so the effort isn’t that that great to send out responses directly to reporters, if you can find their email. And… maybe, just maybe, it stirs a question or two in their minds about the IRS narrative. Hope springs eternal. :)

  • Canadian

    I am so glad I stumbled on to this site. Aug. 22 was the first I had ever heard about an FBAR. I moved to Canada when I was a child and I have citizenship in Canada, so I never knew about any of this. After reading about the FBAR and FATCA, I decided to hire a tax lawyer to get my taxes straight so I could expatriate. So far it has cost me $5000 just to get 4 years done (taxes and FBARS). I have never owed any US tax and I have no US source income. The problem I have is that my Canadian husband thought it would be a very good idea to make me 50% owner of his company when we got married. While this was sweet at the time, I have no idea how this will be evaluated when it comes time to expatriate and I fear it will it put me over the 2 million dollar limit. I am sick to death worrying about FBAR penalties and my husband is furious that his financial privacy has been breached.

    • http://hodgen.com/ Phil

      Consider making a gift back to your husband of your half of all assets. Formm 709 is your friend. Then expatriate well under the $2,000,000 threshold.

      Get some help. You can do this in a relatively painfree way. :-)

    • Canadian

      Thank you for your help. I will investigate further. Do you have any idea how long this whole process takes? I am hoping to have everything done in a year, but I hear that it can take up to 6 months to get a consulate appointment. I really appreciate your website and all of the comments posted. It is very difficult to find accurate, objective advice on expatriation.

    • M

      This is really a kicker. I thought I had seen it all but then came across estate transfers to NRA spouses that are no longer eligible for the unlimited marital deduction without gifting to the NRA prior to death or a complicated QDOT. This makes no sense at all since any citizen spouse can take & spend all their assets abroad anyway. I honestly don’t understand the point of it.

  • Dawn Dearborn

    Phil, great site. More on it than I had originally realized. I would be interested in knowing whether a covered expatriate retiree has to pay 30% of the monthly payments of a defined benefit pension based on years worked in the “foreign” country – as well as 30% of any U.S. pension payments. Not sure how the tax on the foreign pension would be collected. Does anybody have experience of this?

    • phil

      @Dawn,

      Thanks for the comment and the question.

      Your question is worthy of a blog post or an FAQ. (We are working on an FAQ page for the site right now). I don’t have the time to write this up because of an impending mosquito-filled vacation.

      But here is my off-the-cuff, totally nonbinding, your mileage may vary, no warranty express or implied, etc. etc. answer.

      A pension is going to be either “eligible” or “ineligible.” For people working in a foreign country and for whom pension contributions are made to a foreign pension, I’m going to guess it is an “ineligible” plan. (“Eligible” means the IRS could reach out and grab the pension plan administrator by its corporate neck and “encourage” full tax compliance via strangling. A foreign pension plan with an administrator abroad is beyond the reach of the IRS’s long arms. For now.)

      The basic idea for “ineligible” pension plan is generally that a covered expatriate takes the present value of the plan on the day before expatriation as a giant taxable lump of income.

      But . . . and here is the “Open the pod bay door, Hal” escape for you. If the pension contributions are attributable to services performed outside the United States, then you don’t include the value of the pension plan that is attributable to those contributions.

      The place to look is Section 5 of Notice 2009-85. You can ask Mr. Google to find this for you. At some point as the website rolls out I will get this online for you. But not now.

      (UNWANTED TRIVIA: “HAL” as the computer in the movie. Roll each letter forward one. H becomes I. A becomes B. L becomes M. Stanley Kubrick cunningly hid the epitome of corporate evil (1960’s edition) — IBM — in the movie.) (Well, other multinationals competed for “King of Evil” in the ’60s, but I digress).

      (I digress a lot).

  • Faraway

    What if someone exits not satisfying condition 3 i.e, not filing taxes for the past five years properly and they dont have any tax liabilities and net worth is a little over million in cash assett overseas with no properties elsewhere. Would they also have to have mark to market taxes on that cash asset? Anyone care to comment? Been in that situation?

  • Faraway

    I like that story about federal govt spending 10 million dollars a day and then only collecting 2.9 million dollars. Is it really worth their time. Poser, you really outdone yourself. Congrats

  • Faraway

    Condition 3 stated above was not willful but lack of awareness.

  • Dawn Dearborn

    Thanks, Phil. I’m very glad to know that a pension based on contributions in relation to work overseas would not be included in the valued assets for expatriation. (Recognizing that this is “non-binding advice”) Look forward to the blog post and FAQ when you escape the swamp! Presumably if an American abroad did not have a pension but a pension “account”, the value of that would be included as a taxable asset even if accumulated during work abroad.