How Can You Avoid Exit Taxes when You Renounce (Examples)

How Can You Avoid Exit Taxes when You Renounce

When a U.S. Taxpayer is considered a U.S. Citizen or Long-Term Lawful Permanent Resident (LTR), then when they formally expatriate from the United States, they may become subject to an exit tax at departure. It will depend on whether the Taxpayer is considered a ‘covered expatriate’ and if the Taxpayer is considered a covered expatriate, whether or not they fall into any of the categories for exit tax. While the mark-to-market exit tax category is the most common, there are other categories, such as specified tax-deferred accounts and ineligible deferred compensation. Unfortunately, many Taxpayers do not realize they may be stuck with an exit tax until they are ready to expatriate. However, if a Taxpayer can prepare in advance, he may be able to minimize the impact of the exit tax. Let’s look at a few examples of ways Taxpayers may be able to prepare to minimize exit taxes.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Do Not Become U.S. Citizen

Since the United States exit tax only impacts U.S. Citizens and Long-Term Lawful Permanent Residents, one of the first ways to avoid becoming subject to the exit tax is to avoid becoming a U.S. citizen. Obviously, for Taxpayers who were born Americans, it is much more difficult to avoid, but for Taxpayers who only become citizens because it is easier for them to travel back and forth to the United States, they should weigh the options and determine whether becoming a U.S. citizen outweighs the benefit of obtaining a terrorist visa or other type of visa.

• • • Example: Adam is a non-U.S. citizen who married a U.S. citizen and therefore has the right to become a lawful permanent resident and subsequently a U.S. citizen. He has a very high net worth and is unsure how long him and his spouse will reside in the United States. Instead of becoming a U.S. citizen, Adam may continue on his L-1 visa and wait until it comes up for renewal to determine whether or not he should pursue a green card and ultimately U.S. citizenship.

    • Example: Adrian is married to a U.S. citizen and currently on a green card. He has held the green card for six years and is deciding whether or not he should pursue citizenship or possibly give up his green card and obtain a B1/B2 tourist visa — since him and his spouse will be doing a significant amount of traveling in the upcoming years. Before obtaining his citizenship, Adrian should consider the pros and cons of maintaining a terrorist visa instead of citizenship.

Avoid Long-Term Resident (LTR) Status

Taxpayers who are approaching Long Term Lawful Permanent Resident status may want to consider giving up their green card before they reach the eight-year mark. Depending on which foreign country they may reside in and how often they want to travel to the United States, sometimes a visa will provide sufficient benefits for the amount of time they want to spend in the United States. Alternatively, green card holders who reside in a treaty country may consider applying for form 8833 treaty benefits to be treated as a non-resident alien for tax purposes because any year that they qualify means that year is not applied toward the 8 out of 15-year threshold. (Beware of 8^th year tax piftall).

• • • Example: Brent has had his lawful permanent residency for seven years. If he becomes a long-term resident, he would be subject to a significant amount of exit tax on his foreign pension and mark-to-market gain. However, if Brent was to give up his green card in the 7th year come, then he will not considered a long-term resident and would not be subject to the exit tax.

    • Example: Barbara has a green card and lives in a foreign country that is a treaty country with the United States. Barbara lives in the foreign country for majority of the time (she was previously on a re-entry permit). Even though Barbara is considering returning to the United States to live for at least six months in the year, she does not want to become subject to the exit tax, so while she is living outside of the United States she may make a treaty election on Form 8833 to be treated as a non-resident alien for U.S. tax purposes.

Gifting to Spouses and in Advance

To avoid the exit tax — or to minimize the exit tax — Taxpayers may be able to integrate certain gifting strategies. It is important to note, that the IRS does enforce the three-year pullback rule for gifts made to non-spouses. For gifts made to spouses who are U.S. citizens, generally, there is an unlimited exception and the Taxpayer can gift the necessary assets to the U.S. citizen (subject to any potential timing rules) and avoid those assets being included in the estate. Alternatively, if the Taxpayer’s spouse is a non-U.S. citizen, then there are some limitations on gifting rules, and then the Taxpayer may have to complete other forms such as IRS Form 709 — in addition to the fact that the timing requirements are more strictly enforced in terms of whether the Taxpayer is a U.S. person on the last day of the year — so proper planning is important.

• • • Example: Charles is a Long Term Resident who has a high net worth. He is married to a U.S. citizen who is not expatriating and has no intent to expatriate. Charles may consider gifting a significant amount of wealth to his spouse in order to bring himself below the $2,000,000 mark and avoid covered expatriate status (he does not qualify as a covered expatriate under the other two tests).

    • Example: Chris is a Long Term Resident who is married to a permanent resident. He is considering giving up his green card but he is a few hundred thousand dollars above the $2,000,000 threshold. Chris does not want to deal with the hassle of filling out a Form 709, so instead for the three years prior, chris gifts his spouse the maximum amount of gift possible and over those years brings his net worth down below the $2,000,000 mark. status (he does not qualify as a covered expatriate under the other two tests).

Avoid Acquiring Certain Assets Before Expatriating

It is important to note, that the exit tax is not a wealth tax. Thus, if a Taxpayer knows they will be a covered expatriate at the time they exit and there is no way to avoid that designation, then they may want to plan which type of assets they own in the years preceding the expatriation. Taxpayers should be aware that there is a certain exclusion amount on the mark-to-market gain as well as certain step-up rules that apply for deemed distributions such as ineligible deferred compensation.

• • • Example: David U.S. citizen who has a large amount of cash that he inherited and is considering expatriating from the United states. He wants to invest the money in various equities. If David believes that the value of the equities will increase significantly, he may consider expatriating before acquiring the assets. That is because if the majority of the assets that David has at the time he patriots is cash, then even if he is a covered expatriate, he is not subject to the exit tax.

    • Example: Dylan is a U.S. citizen with many family members abroad who each have a significant amount of wealth. One of his family members wants to gift dylan 20% in a foreign business because that company is going to go public and that the value of the shares will increase significantly. Subject to possible timing rules, Dylan should consider waiting to receive the gift until after he expatriates, so any potential increase in value would not become subject to the exit tax.

Do any Exceptions Apply?

Some Taxpayers may qualify for an exception to being a covered expatriate even if they otherwise fall into one of the three categories of being a covered expatriate. For example, if the Taxpayer is a dual citizen but has been residing outside of the United States or otherwise qualifies for the minor’s exception they may not be subject to an exit tax even if they would otherwise be considered a covered expatriate.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.  *This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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