April 8, 2020 - Phil Hodgen

What goes on your balance sheet when you expatriate?

When you expatriate, you are required to declare all of your assets and liabilities and compute your net worth. If your net worth is above $2 million, you are a “covered expatriate” and hilarity ensues.

What goes on your balance sheet?

Let’s talk about what goes on your Form 8854 balance sheet.  What, specifically, is an asset you own?

This is how you figure it out:

  1. Assume you are a U.S. citizen or a resident of the United States (as “resident” is defined for estate/gift tax purposes).
  2. There is an asset that you are wondering about. Should you include it on your balance sheet or not?
  3. Pretend you gave it away.
  4. Ask yourself: in my “pretend” status as a U.S. citizen or (estate/gift tax) resident, would I hypothetically owe U.S. gift tax on that transfer?

The law

The relevant authority is at Notice 97-19, Section III:

Determination of net worth. For purposes of the net worth test, an individual is considered to own any interest in property that would be taxable as a gift under Chapter 12 of Subtitle B of the Code if the individual were a citizen or resident of the United States who transferred the interest immediately prior to expatriation. For this purpose, the determination of whether a transfer by gift would be taxable under Chapter 12 of Subtitle B of the Code must be determined without regard to sections 2503(b) through (g), 2513, 2522, 2523, and 2524.

An interest in property includes money or other property, regardless of whether it produces any income or gain. In addition, an interest in the right to use property will be treated as an interest in such property. Thus, a nonexclusive license to use property is treated as an interest in the underlying property attributable to the value of the use of such property.

Notice 97-19 guided people who expatriated under the pre-2008 exit tax rules.  Yet we still use those rules today.  We are told to use these ideas for 2008 and later expatriations by Notice 2009-85, Section 2.B.

Gift tax rules for green card holders domiciled abroad

This is sometimes tricky to understand for green card holders living abroad.

Green card holders living permanently outside the United States are usually treated as residents of the United States for income tax purposes, but nonresidents of the United States for estate and gift tax purposes.

Nonresidents of the United States (the estate/gift tax definition) have the ability to make gifts without U.S. gift tax.

  • Residents (the estate/gift tax definition) pay gift tax on gifts of everything, no matter where that thing is.
  • Nonresidents (the estate/gift definition) pay gift tax only on gifts of U.S. real estate and gifts of “tangible personal property” that is located in the United States.

It’s tempting to want to use the liberal gift tax rules for nonresidents (the estate/gift tax definition) when doing your pre-expatriation tax planning.

Apply the rules for expatriation

A green card holder (U.S. resident for income tax) who is a U.S. nonresident (using the estate/gift tax definition) might own real estate in a foreign country.

The green card holder intends to file Form I-407 to terminate green card status — thereby expatriating.  

The green card holder and would-be expatriate wants to avoid covered expatriate status — by keeping net worth below $2 million.

It is tempting to apply the general principle of “U.S. green card holders who are domiciled abroad are not taxed on gifts” of, for instance, foreign real estate.  If you don’t have a gift tax if you give it away, don’t include it on your balance sheet for exit tax purposes.

Unfortunately that’s not how it works.  We replace reality (the normal gift tax rules applied to non-U.S. domiciled green card holders) with fantasy:  “pretend you are domiciled in the United States”.

How to think about the problem

For green card holders living abroad, it is usually easy — from the U.S. gift tax perspective — to avoid gift tax.  With a bit of pre-thinking, of course.  Look before you leap. If you are on the diving board, check to see that there is water in the swimming pool before you jump.

The real problem will be found in the other country: what are the transaction costs and tax costs imposed on that gift? That’s where you put your attention.

If you are a green card holder permanently living abroad (“domiciled” outside the United States, to use tax jargon) and you want to give up your green card and stop filing U.S. income tax returns, here’s what you need to do for net worth test planning:

  1. Identify the assets you need to give away in order to reduce your net worth below $2 million.
  2. Confirm that you can do so without triggering U.S. gift tax liability. You might do that by proving that the gift is not a “taxable gift” under U.S. tax law, or it might be a taxable gift and you will use the unified credit to eliminate the gift tax liabliity.
  3. Look at the local country tax costs. Is this a taxable gift in the other country? Look at the transaction costs. Does it cost a metric ton of money, for example, to transfer ownership of real estate from one person to another?
  4. Do the math: is it cheaper/better to be a covered expatriate or is it cheaper/better to be give away the assets and not be a covered expatriate?