We get questions. Some of them are answered on the weekly Expatriation Only email list (subscribe!). Here is one that I’ll just answer here as a blog post. It is a followup to an earlier question from reader N.
This is for parents of wealthy children–how do you ensure that your children can give up their U.S. passports without paying a massive exit tax? Here is one method.
If you are a “covered expatriate” when you renounce your U.S. citizenship, then the possibility of a massive tax bill exists. You are treated as if you sold all of your assets. Special tax rules apply to beneficial interests in trusts and other things. Other Bad Stuff Happens.
For the purpose of this blog post, just assume that “massive tax liability” is the result.
You want to avoid covered expatriate status if you can.
Let’s consider the expatriation choices for minor children with wealth. It is difficult for a minor to renounce U.S. citizenship. Our usual recommendation is to not bother. Wait until the child turns age 18.
When a minor child has wealth it is almost always because he or she is a beneficiary of a trust. Let’s assume that the value of a child’s beneficial interest in a trust exceeds the $2,000,000 threshold, making the child a potential covered expatriate when he/she renounces U.S. citizenship.
If the child renounces citizenship between age 18 and 18 1/2, the amount of wealth held by the child (directly or in a trust) is irrelevant–he or she will not be a covered expatriate. [Warning: some conditions apply.]
The rules are in Internal Revenue Code Section 877A(g)(1)(B)(ii), which says that an individual is not a covered expatriate if both of these conditions are true:
(I) the individual’s relinquishment of United States citizenship occurs before such individual attains age 18 1/2, and
(II) the individual has been a resident of the United States (as so defined) for not more than 10 taxable years before the date of relinquishment.
The first requirement is easy to understand–just make sure the renunciation date is before age 18 1/2. If you are successful in having a renunciation before age 18 (I applaud your tenacity) you’ve met the test. If you wait until age 18 (now the State Department cannot reject your application because you are a minor), you are OK too.
The second requirement is a bit non-obvious. What you do is look at the “substantial presence test”, which is the day-counting rule that applies to determine whether a nonresident is a resident of the United States. Find this stuff at Internal Revenue Code Section 7701(b)(1)(A)(ii) and Section 7701(b)(3).
If you can show that the child was not in the United States for a sufficient number of days to qualify as a resident under the substantial presence test, then that is a taxable year that is NOT counted toward your 10 years before the renunciation date.
For a child who has lived outside the United States for most of his or her life, this is easy. It is likely that the child has spent only holiday-style quantities of days in the United States.
If the child has spent up to and including 10 years of his or her life in the United States as a resident under the “too many days” test, then it is possible at any time to exit the United States without covered expatriate status.
Yes, tax law always comes with conditions. The child who renounces citizenship with substantial wealth will not be a covered expatriate–as long as the renunciation occurs before age 18 1/2.
However, the child must still satisfy the certification test–on Form 8854 he or she must certify that the previous five years of U.S. tax obligations are neatly squared away. All forms filed, all tax bills paid. And the child must file correctly and on time for the year of renunciation. This means the final tax return and Form 8854.
In other words, don’t ^@!$!#@& up the paperwork. 🙂