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US Expatriation Tax

The expatriation tax provisions apply to U.S. citizens who have renounced their citizenship and long-term residents who have ended their U.S. resident status for federal tax purposes.

The actual details of the US exit tax are available here: https://www.irs.gov/individuals/international-taxpayers/expatriation-tax 

This article will give a summary of what it is and why.

Why

I didn’t write the laws or rules, but most countries have something called an expatriation tax. In Canada, it is called the Departure Tax. The tax is created to prevent people from fleeing their tax obligations by going to live in a different country making it hard for the original country to tax them. 

The idea of the expatriation tax is that you are considered to have sold certain types of property (even if you have not sold them) at their fair market value (FMV) and to have immediately reacquired them for the same amount. This performs a ‘reset’ of everything you own. Because you have ‘sold’ these properties, you may be subject to taxes (such as capital gains).

Who Pays For It

There are two classes of people that are subject to the US Exit Tax when you leave the US:

  • US Citizens that renounce their citizenship.
  • Long-term US resident leaving the US.

US Citizens

If you are a US Citizen and you are renouncing your US Citizenship.

Long-term Residents

If you are US Resident Alien admitted as Long-Term Resident (ex: Green Card), then you will be subject to the US Exit tax when you leave the US, under the following condition:

  • You must have lived at least 8 years in the US in the last 15 years. 

The number of years is computed as any single day in a calendar year. For example:

Johnny arrives in the US in December 31st 2015 and leaves the US in January 1st 2022.

Johnny has only spent 6 years + 2 days in the US, however, the IRS will consider the following 8 years as being long-term Resident: 2015, 2016, 2017, 2018, 2019, 2020, 2021, 2022. Hence Johnny will be subject to the US expatriation tax.

In other words, you can avoid the US expatriation tax if you don’t spend more than 8 years as a long-term resident in the US. You may also be able to avoid it if you alternate between long-term resident and temporary resident over multiple years, but this may be hard to achieve. 

Criteria

Fortunately, there are other criteria for the US expatriation tax to apply. 

There are 3 criteria, at least one must be met:

  1. Networth more than $2,000,000 OR;
  2. Your last 5 years average net income for tax purpose is above $171,000 (amount from 2020, adjusted with inflation) OR;
  3. You have unsettled tax issues with the IRS.

In other words, the US exit tax will apply if:

  • You are quite rich! – Note, the networth applies to individual.
  • You made a bunch of money in the last 5 years, putting you around the 10th percentile by household income. 

How to file

If you believe you are subject to the US exit tax, you must file form 8854: About Form 8854, Initial and Annual Expatriation Statement 

You can also file this form as it will ask you questions to check if you are subject to the exit tax as there are some exceptions available.

Strategies

Becoming a US Citizen

If you are eligible, you can apply for naturalization.

If you are a long-term resident and are subject to the expatriation tax, one strategy to avoid the tax is to apply to become a US Citizen.. Once you become a US Citizen, you will be able to leave the US without having to pay the expatriation tax. Keep in mind that US Citizens are taxed on the world-wide income; so you will have to declare your income to the IRS for the rest of your life.

Obviously there are a lot more factors to consider when becoming a US Citizen.

Network Strategy

If the networth criterion applies to you, one strategy may be gifting your spouse a large chunk of your networth. This works because the networth limitation applies to each individual.

Income Strategy

Another approach may be to deliberately reduce your income in the years before leaving the US. This may or may not be worth it depending on your personal financial situation.

What about me?

This article was written in 2021; I am sure this will age like milk!

Our family has been holding a Green Card since 2019, so the 8 years rule will apply starting from year 2026. By 2024 we would have spent 5 years in the US as a long-term resident, so we would be eligible for US Citizenship if we wanted to take that route. In any cases, it seems like we have most of our bases covered to avoid the US Expatriation tax no matter what we decide to do in the future.

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