Bottom Line Up Front
If you make a large gift before expatriation and in the same year, you will pay a large gift tax. The unified credit does not apply to you.
Make your big gifts in year 1, and expatriate in year 2.
Objective: Avoid Covered Expatriate Status
A covered expatriate is someone who has a net worth of $2,000,000 or more when relinquishing U.S. citizenship (or giving up a long-held green card).1
If you have a net worth of more than $2,000,000 but less than $7,500,000, it is possible to give away enough assets — with no gift tax — to avoid covered expatriate status. You file a gift tax return, but pay no tax.
You are a U.S. citizen who wishes to renounce but does not want covered expatriate status. Your net worth is $5,000,000.
You give $3,500,000 of assets to your spouse, and file a gift tax return reporting the gift.
Now your net worth is $1,500,000. This is less than the $2,000,000 threshold for covered expatriate status. If you successfully avoid covered expatriate status under the other two tests,2 you will be able to renounce your U.S. citizenship and not be a covered expatriate.
This is why you are making large gifts. Let’s see how you make those large gifts tax-free.
Gifts Before Expatriation Are Taxable
Gifts made by U.S. citizens (and noncitizens who are domiciled in the United States) are taxed.3 The only question will be exactly how much tax you must pay in real money.
There are some ways to avoid paying gift tax:
- Small gifts that are not taxed: you can give up to $14,000 to any person and this will not be a taxable gift.4
- Gifts made to U.S. citizen spouses will be completely tax-free, regardless of amount.5
There are a few other ways to make tax-free gifts that we will not look at. The point of this analysis is for you to keep wealth in the family while you, personally, appear to the U.S. government to have an individual net worth at the moment of renunciation of under $2,000,000.
Taxable Gift But No Tax Payable (Unified Credit)
Once you have exhausted these methods, your gifts will be taxable. But you can make a large amount of tax-free gifts while not paying gift tax.
This is because of the “unified credit” that applies to otherwise taxable gifts.6 This is an amount that can be used to shelter wealth from gift tax (if you give it away) or estate tax (if you leave an inheritance). Or it can be used partly to shelter lifetime gifts and partly to shelter inheritances from tax. The unused credit means that your “expatriation gift tax” may be avoided.
Let’s ignore the estate tax part of the unified credit, and focus exclusively on the gift tax part. You are going to renounce your U.S. citizenship and thereafter you do not care about the U.S. estate tax—you are out of the U.S. tax system and your assets are out of the United States.
You only care about the gift tax part of the unified credit because you want to use it to successfully renounce your U.S. citizenship, tax-free.
Here is how the unified credit works, as applied to the example given above. For the sake of this example, pretend that you have never made taxable gifts before.
- Make a gift of $5,500,000 to your noncitizen spouse.
- Calculate the gift tax due on that gift.
- Use the unified credit amount (it adjusts annually for inflation) as if those are real dollars used to pay real tax.
- If the credit amount is not enough to pay all of the tax due, use real dollars to pay the gift tax.
In other words, the unified credit is like play money you can use to pay real gift tax. But once you have used up all of your play money, you have to use real money to pay the rest of the tax.
Unified Credit: What Are You on December 31?
Only people who are U.S. citizens (or noncitizens domiciled in the United States) on December 31 can claim the unified credit to reduce or eliminate gift tax.
You make a $3,500,000 gift to your noncitizen spouse in September, 2016. You renounce U.S. citizenship in January, 2017.
You can claim the unified credit to eliminate U.S. gift tax on the gift to your noncitizen spouse.
If you make a large taxable gift in the same year that you renounce your U.S. citizenship, you cannot use the unified credit to eliminate the gift tax.
You make a $3,500,000 gift to your noncitizen spouse in September, 2016. You renounce U.S. citizenship in November, 2016.
You cannot claim the unified credit to eliminate gift tax.
Here is why.
Return to the example of a large gift made in the same year (but before) renunciation of U.S. citizenship.
The unified credit that applies against gift tax liability has a value of zero for people who make a gift while they are citizens (or residents) of the United States by renounce citizenship (or give up their green cards) later in the year.
In the case of a citizen or resident of the United States, there shall be allowed as a credit against the tax imposed by section 2501 for each calendar year an amount equal to the applicable credit amount in effect under section 2010(c) which would apply if the donor died as of the end of the calendar year.7
You are a citizen or resident of the United States when you make the gift. This makes you eligible for a credit against the gift tax.
The credit amount is measured by looking at the estate tax credit that would apply if you died on December 31. This credit amount is given in IRC § 2010(c).
We pretend that you died on December 31 of the year in which you expatriate. We look at IRC § 2010(c) to see the size of the credit to which you are entitled.
On December 31 you were a nonresident and noncitizen of the United States, because you expatriated. The value of the unified credit amount under IRC § 2010(c) for a nonresident noncitizen is zero because IRC § 2010 is available only for citizens and residents of the United States.
Therefore, you made a taxable gift while still a U.S. citizen (or resident). You do not have the unified credit to eliminate the gift tax liability created by that gift. You will owe
Your strategy, therefore, is simple. To avoid the net worth test (and covered expatriate status) make your large gifts in the calendar year before you expatriate.
As usual, the disclaimer. Don’t be silly and believe some random email newsletter (like this one). Do your own research and come up with a plan. Getting this wrong will be expensive.
See you in a couple of weeks.
- IRC §§ 877(a)(2)(B), 877A(g)(1)(A). ↩
- Any one of three “tests” can make you a covered expatriate. In addition to the “net worth test” described here, you can be a covered expatriate if your average Federal tax liability for the five years before expatriation exceeds a threshold amount. This is the “net tax liability test”. See IRC §§ 877(a)(2)(A), 877A(g)(1)(A). Alternatively, you can be a covered expatriate if you cannot certify (or prove if challenged) that your Federal tax obligations (payment and paperwork) is fully up to date for the five years before renouncing U.S. citizenship. See IRC §§ 877(a)(2)(C), 877A(g)(1)(A). ↩
- IRC § 2501. ↩
- IRC §2503(b). The amount show is for gifts made in 2017. Rev. Proc. 2016-55, § 3.37(1). Coincidentally, the same $14,000 exclusion amount applies to gifts made in 2016. ↩
- IRC § 2523(a). ↩
- IRC §2505(a). ↩
- IRC § 2505(a)(1). ↩