Last minute gut check before expatriation

Hello again from Phil Hodgen. This is your every-other-Tuesday newsletter about expatriation — the tax consequences of giving up U.S. citizenship or green card status. If you want to stop getting this, just click the Unsubscribe link at the bottom of this email. We have other email newsletters that you can subscribe to; go to hodgen.com/lists to sign up.

Last minute gut check for a reluctant renunciant

I get emails from people. Lots of them. This one is from a gentleman (let’s call him M) who lives abroad and intends to give up his U.S. citizenship. Here’s the story. He goes in for his second appointment at the Embassy in early January. He is doing one last double-check to make sure if he doing the right thing. Maybe you are going through the same thought process.

[On January xx] day I will have a second “counseling” at the US Embassy in [City] about renouncing my U.S. citizenship. The paperwork then goes to Washington for approval and confirmation. I want to be absolutely sure it is the right course to take for practical reasons. I have personal feelings to resolve as well of course. Let me give you a brief background.

He is a dual U.S./U.K. citizen. He and his wife live in Asia and after nearly two decades of traveling back and forth, they decided to remain there permanently — no plans to return to the United States to live.

As the years passed, however, my wife and I gradually came to the conclusion that living in two countries on opposite sides of the Pacific was too inconvenient and costly. Because of her family and other ties, we decided to make [Country] our only home, sold our house and car . . . and in 2013 moved definitively to [Country] where I have long held permanent resident status. My wife formally “abandoned” her US resident status in 2014.

Well, M, I hope your wife jumped through all of the tax hoops correctly for when she gave up her green card: she was not a covered expatriate, and she filed her 2014 Form 1040 and Form 8854 on time. 🙂

I kept only one practical link — a small balance in Bank of America to pay my Visa card (and CPA). All my tax returns have been filed and taxes paid every year. We have been scrupulously correct in obeying all immigration and other U.S. laws and regulations. My 2015 tax return shows “an open balance for the 2014 returns and other services in 2015.” All our taxes are fully paid in [Country]. I am [age] and well, and will now certainly live out my years here.

M is giving up his U.S. citizenship purely because of the hassle of dealing with the U.S. tax system. No other reason. If he could keep his U.S. citizenship without the tax hoo-hah, I’m sure he would.

I want to simplify my life as much as possible, and our wise CPA is the first to understand that I want to be absolved of any further relationship with the IRS (even though I will no longer need to send him checks).

IMHO the United States government has a pretty silly system when it drives citizens away with bureaucracy and paperwork. M is not the only one who reports this as his primary motivator — just the latest one. Here are his questions:

Please advise me what if anything remains to be done to cut the last formal link with the States, though I will always have the same basic feelings for the country that I had when I applied for dual citizenship — more now, because of the friends I made and the precious memories I have of living there. Finally, assuming I have gone through all those hoops, will I have any recurring cost or formality if I keep my US passport and do not renounce my citizenship on January 12th?

What to do when your tax filings are clean

If you, like M, are up-to-date with your U.S. tax paperwork and have paid all your taxes for the previous five years, the process is relatively clear:

1. Figure out whether you are a covered expatriate or not.
   1. What was your average tax liability for the previous five years?
   2. What was your net worth on the day you renounced your U.S. citizenship?
2. If you are a covered expatriate, figure out if there is a way you can reconfigure your financial life to NOT be a covered expatriate.
3. After analysis (and financial reconfiguration if possible), you either are or are not a covered expatriate.
   1. If you have successfully reconfigured your life to NOT be a covered expatriate, proceed with the second appointment at the Embassy and formally renounce your U.S. citizenship. Your tax problems are purely of the paperwork variety. You do not have any special extra tax to pay for the privilege of giving up your U.S. citizenship.
   2. If you decide (after analysis and all attempts at reconfiguring your financial life) that you are a covered expatriate, put that appointment on January xx, 2016 on hold until you fully understand the tax costs of renouncing your citizenship. There are some unpleasant “gotcha” situations where you can face double taxation (e.g., on pensions). After you have solved those problems, then proceed with your renunciation process.
4. You will have 2015 U.S. tax filing responsibilities, because you were a U.S. citizen for all of 2015. File those tax returns in the normal course of business sometime during 2016. Your current CPA can handle these with ease, as he has done for all of your prior years.
5. You will have 2016 U.S. tax filing responsibilities and (maybe) some tax to pay. If you have tax to pay, make the estimated payments for the short year of 2016 (from January 1 until your renunciation date). Your CPA can help you calculate that. You will file your 2016 tax returns sometime in 2017, in the normal course of business.

The tax problem of being a covered expatriate

This newsletter is already long enough but I want to give you a hint of why you need to be ultra careful that you are not a covered expatriate. Everyone focuses on the immediate tax cost of renouncing citizenship as a covered expatriate. This is, indeed, a problem. There can be a large lump sum “settle your bill before your check out of the hotel” payment due to the IRS when you renounce your U.S. citizenship. But there is a more pernicious problem: the problem of potential double taxation later on. Any asset that you own as a covered expatriate will have its built-in capital gain taxed when you renounce your citizenship and are treated as a covered expatriate. You will pay U.S. tax on that built-in capital gain. But if you still own the asset after renunciation, you face a second tax on the capital gain in [Country] when you sell the asset later.

You own real estate in [Country]. You bought it for $250,000 and now it is worth $500,000. You are a covered expatriate, so when you renounce your U.S. citizenship you pay U.S. tax on the $250,000 of capital gain. Five years after renunciation, the property is still worth $500,000. You sell the property in 2022, and [Country] taxes your capital gain of $250,000. There is no practical way (at this time, anyway) for you to get credit in [Country] in 2022 for the U.S. exit tax you paid in 2016. This means you will pay capital gains tax twice on your $250,000 profit.

There is no current method to solve that problem. It will take bilateral agreements between the other countries and the United States to solve this problem for former U.S. citizens. And, as you might guess, the Federal government’s interest in treating former citizens fairly . . . is probably close to nil. Don’t hold your breath.

What if he keeps his U.S. passport?

M asks what his consequences will be if he decides, on January xx, 2016, to keep his U.S. passport rather than renounce his U.S. citizenship. He has eliminated all U.S. assets and all U.S. sources of income. He is retired, and living in [Country], paying income tax and filing tax returns. The only (!) price he pays for keeping the U.S. passport will probably be the cost of paying the price demanded by the U.S. tax system:

• Annual U.S. Form 1040 income tax returns (no State tax returns, since he is not a resident of any State);
• The current and future financial colonoscopy paperwork (FBARs, FATCA, etc.) that the U.S. government requires.
• Exposure to the U.S. estate tax system at the time of death, which is a problem only if his net worth exceeds the “no tax due” amount (currently $5.43 million of assets); and
• The added complexity of the U.S. gift tax rules if he wants to give assets to his non-U.S. wife.

In other words, the price to pay for a U.S. passport is added complexity, which is usually solved by spending more than you want to spend on tax professionals. 🙂

In summary, here is your customized disclaimer

Don’t take my word for it. This means you, M, and also anyone else who is going through the thinking process for renunciation. Hire someone smart to think methodically about the situation and give you concrete advice. Then take that dive off the 10 meter board and swim away, a free man (or woman). Talk to you in a couple of weeks. Phil.