September 14, 2016 - Phil Hodgen
Hello again from Phil and welcome to the biweekly Expatriation Only newsletter. Subscribe to our other newsletters at hodgen.com/newsletters.
This Week: Planning For the Exit
This week’s topic was triggered by an email from reader J., received a few weeks ago. She wanted to know how a 20+ year green card holder should plan for giving up permanent resident visa status and leaving the United States.
Here is a high-level view of our S.O.P. for helping people exit the United States. Bear in mind that each situation is slightly different, so just treat this as a high-level map of the terrain.
1. Are You an Expatriate?
The first question is whether the individual will be an expatriate when the exit from the United States is complete. If the person is a U.S. citizen or has held a green card for long enough to be a “long-term resident”, then the answer is yes.
“Expatriates” must worry about the exit tax rules (IRC §§877A and 2801). People who are not “expatriates” just leave the United States in the regular, ordinary way.
Plan. For green card holders, try to get rid of the visa before becoming a “long-term resident”. For U.S. citizens, is there a possibility of claiming relinquishment of citizenship long ago?
2. Are You a Covered Expatriate?
Once you have decided that the individual is an expatriate, you need to decide whether he or she is a covered expatriate. This is an expatriate who has extra stuff going on:
- Net worth above $2,000,000; or
- Net tax liability over the previous five years exceeding the threshold (whatever it is for the year of exit); or
- Tax returns and tax payments for the previous five years are somehow defective.
Each of these items has its own checklist, of course.
Plan. Try to defeat all three of the tests:
- If your net worth is above $2,000,000, can you do something that will bring it below the threshold? Or, can you use the “expatriate before age 18.5” or “expatriate free because you are a dual citizen” exceptions?
- Ask the same question for your average tax liability for the previous five years: if you postpone expatriation can you bring your average down? Or, can you use the “expatriate before age 18.5” or “expatriate free because you are a dual citizen” exceptions?
- Review your tax returns for the prior five years and fix any problems. (Really. If you screw this up, I have no sympathy. This is boring but easy to fix.) Or, start being scrupulously honest 🙂 and filing tax returns every year until you have five clean tax returns on file.
3. Timing Your Exit: Income, Deductions
Look at upcoming income items. Are there events that will occur where it is better to be a U.S. resident? Are there events coming up where it would be better to be a nonresident? (This includes stuff like bonuses, pension distributions, stock sales, real estate sales.)
Look at upcoming tax deductible expenses. Are there items where it would be better to be a U.S. resident taxpayer? (E.g., mortgage interest expense on a house, carry-over losses from rental properties, etc.)
Plan. You are going to expatriate anyway. Use this information to time your expatriation date.
- E.g., if you expect to get a big bonus at work, would it make sense to be outside the grasp of the IRS when the bonus hits your bank account?
- If you are a green card holder, you can use this information to help you decide whether to be a full-year tax resident for the last year of holding a green card, or to claim part-year tax resident status.
- Especially for covered expatriates, sometimes it makes sense to be taxed on an income item (or force a sale before the expatriation date). The exit tax is a “pretend” sale. A real sale — with tax paid — reduces your net worth and leaves you with cash. Cash generates no “pretend” capital gain when you expatriate (this is the mark-to-market tax rules of IRC §877A(a)).
- Finally, we look at the “out of the frying pan, into the fire” scenario. Take an individual with a U.S. citizen spouse. What if the individual expatriates but then makes an election to file a joint U.S. income tax return with the U.S. citizen spouse? I.e., remain a U.S. taxpayer? Is there a good reason to do this? Is there a good reason to not do this?
If none of these things amount to much money — so we don’t really care because it doesn’t cost anything extra in taxes — then the decision is all about paperwork and life. This is particularly true for people who are not covered expatriates.
How can we make the individual’s final year tax return return as simple as possible, and avoid filing extra and avoidable tax returns?
- In general that would mean expatriating in the current year and not waiting to next year. Why file an extra tax return if it is not necessary?
- In general, it means we prefer full-year resident tax returns as the final income tax return for an individual. Why? Because they are easier, therefore cheaper to prepare. And for people who can use a foreign tax credit, the full-year tax status probably will not cost them extra money. For citizens, that means timing a renunciation date very early or very late in the year. For green card holders, the same is true, but they also have treaty elections and the default rule (“if you have a green card for a single day in a year, you are a full-year tax resident unless you do special things”) to help them achieve full-year tax returns.
4. Estate Planning: Do What? And When?
Look at gift planning and estate planning. What are the rules before and after expatriation?
- Interspousal transfers. Asset transfers between spouses tend to be easy and tax-free in almost every country. Things get a bit weird in the Internal Revenue Code for noncitizen spouses who are the recipients of transfers. Should you be moving things around before expatriation?
- If the individual will be a covered expatriate and will have U.S. heirs, the dreaded tax on the recipient at gift tax rates (40%) will apply. What can the covered expatriate do now, while still a U.S. taxpayer, that will side-step IRC §2801?
- On the other hand, a green card holder domiciled abroad arguably can make gifts without caring much at all about the U.S. gift tax laws. How will you use this to your advantage?
- If the individual will have U.S. assets after expatriation, what estate planning is needed to shelter the assets from U.S. estate tax? Should these moves be made before or after leaving the U.S. system? (Hint: the unified credit is useless after you leave the U.S. tax system.)
5. Create Your Plan
Based on the answers to these questions, it will usually become apparent that there are some things that should be done while the individual is still a U.S. taxpayer — before expatriation. And it is obvious that there are some things that should be done after expatriation.
Make your action list. Somewhere in the middle of that list is a milestone labeled “Renounce Citizenship” or “File Form I-407”. But there will be plenty of other things to do both before and after.
6. Into Action
With this pre-planning you will be ready to expatriate, in control of your (tax) destiny.
It sounds like a lot, but for most people the work can be done quickly. (Your life is probably not that complicated.)
Let me put it this way. Wouldn’t you like to make sure there is water in the pool before you jump off the diving board?
Behold the mighty power of the checklist. 🙂
That’s it for this week. Don’t take this as actual legal advice, because it isn’t. Go hire someone, get things done right, renounce your citizenship, and move freely about the planet. Vaya con Dios.
See you in a couple of weeks.