Covered Expatriates May Still Have to Pay U.S. Taxes

The number of people leaving the United States for good is on the rise. However, just because ex-pats turn in their passports doesn't mean they can throw away their U.S. tax forms. Find out whether you could be considered a "covered expatriate" and what that means for your IRS filing obligations.

Why Taxpayers May Renounce U.S. Citizenship

There are many reasons why taxpayers may choose to to renounce their U.S. citizenship or permanent resident status. While expatriates are not required to disclose their reasoning, many cite the pressures of American global tax reporting requirements.

U.S. taxpayers living overseas may be required to file annual Reports of Foreign Bank and Financial Accounts (FBARs), now FinCEN Form 114, if their assets reach certain threshold requirements. This is in addition to international income disclosures on their annual federal tax returns. In addition, the Foreign Account Tax Compliance Act (FATCA) also requires international banks and other financial institutions to disclose assets controlled by U.S. taxpayers. This can sometimes make it difficult for American citizens overseas to open bank accounts or get loans.

Because of this (and other reasons), an increasing number of overseas residents are choosing to renounce their U.S. citizenship or permanent resident status. In 2016, a total of 5,411 renounced their citizenship, including 2,365 in the last quarter alone. This is 26% more than in 2015 and 58% higher than 2014, and many more leave without formally renouncing their status.

What It Costs to Become an Expatriate

The decision to renounce U.S. citizenship is not easy, or inexpensive. The United States charges $2,350 to hand in a passport and requires the taxpayer to file Form 8854 with the IRS. This fee is more than 20 times the average for other high-income countries. For some "covered expatriates", even that fee is minimal compared to the Exit Tax charged by the IRS.

What is a Covered Expatriate?

Three financial conditions trigger an IRS Exit Tax and the corresponding designation of a "covered expatriate":

• A worldwide aggregate net worth of over $2 million.
• An average net annual income tax liability over $162,000 during the past 5 years
• An inability to certify 5 years of U.S. tax compliance

Taxpayers within the covered expatriate category are liable to pay an Exit Tax as high as 23.8% on the net value of all their assets above $699,000 for 2017 (adjusted annually). This amount is calculated as though the taxpayers sold all of their assets for fair market value the day before expatriation. It can sometimes be deferred on certain assets, including 401(k) plans, but then must be paid as distributions are made out of the account at 30%, rather than the lower rate many expatriates receive through treaty benefits.

Even if a U.S. taxpayer's assets do not meet the $699,000 threshold, being deemed a "covered expatriate" can still be a problem. For example, later gifts to friends and family in the U.S. could result in additional tax consequences for the recipients.

The up-front cost and ongoing negative consequences mean that U.S. taxpayers considering renouncing citizenship or relinquishing permanent resident status are well advised to include an accountant and an experienced tax lawyer in the process. Through strategic gifts and a thorough review of the taxpayer's history, a foreign resident may be able to sever ties with the United States without bearing the label "covered expatriate" or the Exit Tax that comes with it.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding expatriation or the Exit Tax, contact Joe Viola to schedule a consultation.