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Green Card Holders, No Gift Tax, and Expatriation

Portrait of Phil Hodgen

Phil Hodgen

Attorney, Principal

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Hello again from Phil Hodgen. You signed up for the every-other-Tuesday newsletter about expatriation topics, and (surprise, surprise, surprise) here it is. (You get bonus points for knowing the '60s TV reference). If you want to stop getting these emails, just click the Unsubscribe link at the bottom of the email.

Green Card Holders Abroad and Gifts

This week's episode is about the net worth test and green card holders.Specifically, let's talk about someone who is a green card holder living abroad who has a net worth of $7,000,000.1 Our green card holder wishes to file Form I-407 and stop being a permanent resident of the United States. How can we be sure that our green card holder will have less than $2,000,000 of net worth, and be able to pull the plug on U.S. tax status cleanly?

Avoid Covered Expatriate Status

Fans of 26 U.S.C. § 877A will no doubt be keenly aware of what it means to be a “covered expatriate”.2 In brief, as a covered expatriate our hypothetical green card holder will:
  • Experience a “let's pretend” sale of all assets and pay capital gain tax on the pretend net capital gain3 after an allowance for some tax-free pretend net capital gain.4 This is the Mark-To-Market rule.
  • Be treated as having all “specified tax deferred account” be immediately taxable.5 (IRAs are the classic example).
  • Have some pensions and other deferred compensation be immediately taxable.6
  • Have some special tax rules apply to distributions received from trusts.7
  • Inflict a grievous tax burden on U.S. persons who receive gifts or inheritances from him.8
You do not want to be a covered expatriate.

Avoid Being a Covered Expatriate By Being Poor

There are three things that make you a covered expatriate. One of these is being rich. “Rich” means a net worth of $2 million or more.9Remember how I arbitrarily assumed our green card holder had a net worth of $7 million? There was a reason for that. Let's show how the green card holder can quickly become poor enough to avoid being a covered expatriate – in full view of the IRS.

Become Poor By Giving It Away

If you don't own it, you don't count it as part of your assets. So our green card holder should give away enough assets so that his net worth is below $2,000,000.There are a host of practical questions to surmount. Does our green card holder have people who can receive the gifts? (What if the green card holder is unmarried, without children?) What if some of the assets are real estate? (Some countries will impose a transfer tax on real estate – called a “stamp duty” – that may make this strategy costly.)But let us assume away all of those problems.There is another, even larger impediment to very large gifts: the gift tax. The United States imposes a gift tax on all gifts. (As usual, certain exceptions apply to make some gifts nontaxable.) The gift tax rate is 40%.I am proposing that our intrepid green card holder should give away $8 million of assets. By any measure, such a gift should trigger a gift tax.Yet there will be no gift tax imposed. Our green card holder – soon to expatriate – can make this gift without worrying about the U.S. gift tax.10Why?

“Who Is A Resident?” Definition Mismatch

The reason is that the Internal Revenue Code has two different definitions of a “U.S. resident” for tax purposes.
  • Our green card holder living abroad is definitely a U.S. resident fully liable for paying U.S. income tax.
  • But our green card holder is probably NOT a U.S. resident who is required to pay U.S. gift tax.
The gift tax11 is not applied to gifts by nonresidents who are not citizens of the United States.12 A “resident” is an individual who has his domicile in the United States at the time of the gift.13 A nonresident, then, has his domicile outside the United States at the time of the gift.“Domicile” simply means that you live in a place with no intention to leave. The concept of “domicile” is not defined in the Internal Revenue Code, but for estate tax the Regulations give us a brief and somewhat circular definition:14
A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal.
Estate tax and gift tax definitions are to be applied interchangeably, unless there is a good reason to not do so.15For our green card holder living abroad and intending to abandon his permanent resident visa status, it is probably a pretty good bet that his domicile is not in the United States. In our experience, we find many green card holders who have lived outside the United States for years – sometimes decades. They have no intention of living in the United States. Their true domicile is outside the United States.Such a person is not a citizen of the USA (obviously – otherwise why would you get a green card?) and is not a “resident” of the United States for U.S. gift tax purposes. This means that our green card holder can make gifts without incurring gift tax, and can make his net worth under $2 million without too much effort. He avoids “covered expatriate” status.

Failsafe: Unified Credit

There is a fallback – the unified credit. If our green card holder is treated as domiciled in the United States, then he is entitled to give away up to $5.45 million of assets (for gifts in 2016), as long as he has not used some of that amount in the past.This means that our green card holder is protected both ways. He claims he is not domiciled in the United States, so is not subjected to the gift tax at all. If the IRS disagrees, then he can claim that the first $5.45 million of assets he gave away is tax-free because of the unified credit.Either way, our green card holder can give away enough assets to end up with a net worth under $2 million, avoiding covered expatriate status.

Disclaimer

Hoo, boy. This week's disclaimer had better be airtight. There are so many fact-based questions here that it is impossible to give a definitive answer without knowing exactly who you are, where you live, what you are giving away, etc. I don't know you (whoever you are) and I don't know any of that stuff. Therefore, this is not legal advice to you. Go get yourself some of that legal advice stuff before you make gifts.In addition, I wildly simplified a lot of stuff here. I can see veins popping as tax professionals read this: “You forgot to talk about transfers during life or at death for the unified credit, Phil!” Yeah I know. All subtlety is lost when writing an email newsletter, and tax law is nothing if not subtle. Consider all of the law (rules, exceptions, exceptions to the exceptions, etc.) before making a move.See you in a couple of weeks.Phil
  1. This is a purely arbitrary amount, designed to demonstrate how a green card holder living abroad can achieve noncovered expatriate status despite having significant wealth. Camel, eye of the needle, and all that stuff. ↩
  2. 26 U.S.C. § 877A(g)(1)(A). ↩
  3. 26 U.S.C. § 877A(a)(1). ↩
  4. 26 U.S.C. § 877A(a)(3). ↩
  5. 26 U.S.C. § 877A(e). ↩
  6. 26 U.S.C. § 877A(d). ↩
  7. 26 U.S.C. § 877A(f). ↩
  8. 26 U.S.C § 2801. ↩
  9. 26 U.S.C. § 877A(g)(1); 26 U.S.C. § 877(a)(2)(B). ↩
  10. As usual, certain exceptions apply: for gifts of U.S. real estate, and gifts of some personal property located in the United States. ↩
  11. 26 U.S.C. § 2501. ↩
  12. 26 U.S.C. § 2511(a). ↩
  13. 26 C.F.R. § 25.2501-1(b). ↩
  14. 26 C.F.R. § 20.0-1(b)(1). ↩
  15. Merrill v. Fahs, 324 U.S. 308 (1945). ↩