Should I stay or should I go?: tax considerations in U.S. expatriation.

• Author: Bowman, Scott Andrew
• Position: Tax Law

As most recently highlighted by the controversy surrounding the expatriation of Facebook co-founder Eduardo Saverin, a misconception appears to be that U.S. expatriates somehow magically escape U.S. taxation by surrendering their U.S. passports. (1) The reality is that certain U.S. expatriates, known as "covered expatriates," are subject to tax under a complex tax regime. These expatriates are forced to navigate a mark-to-market "exit tax" upon expatriation, and any U.S. person who receives a gift or bequest from a covered expatriate is subject to a special succession tax. These tax ramifications require careful consideration as they may cause significant obstacles for the potential U.S. expatriate.

This article examines the tax considerations facing potential U.S. expatriates. Although tax benefits may await an expatriate who relocates to a no- or low-tax jurisdiction, such tax benefits are not a foregone conclusion. Instead, the decision requires sensitivity to the special income and transfer tax regimes applicable to certain U.S. expatriates and the planning opportunities that can mitigate these tax consequences.

In addition, potential expatriates face a host of nontax issues, which often include selecting a new country of citizenship, deciding which family members will expatriate, managing the formal expatriation process, and determining whether the expatriate will (or will be able to) come back into the United States. Although beyond the scope of this article, caution should be exercised in navigating these nontax issues as well. Notable among these are a provision of immigration law known as the "Reed Amendment" (2) and the recently proposed "Ex-PATRIOT Act." (3) Invocation of the Reed Amendment would render a former U.S. citizen ineligible for admission to the United States if the U.S. Attorney General determined that the former U.S. citizen surrendered citizenship for tax avoidance purposes. Although the Reed Amendment appears never to have been enforced, rumors of enforcement and of threatened enforcement have begun to circulate recently. The Ex-PATRIOT Act, should it become law, would bar certain expatriates, including covered expatriates, from ever re-entering the United States, subject to a rebuttable presumption that the expatriation produced a substantial reduction in taxation. What these provisions make clear is that any individuals considering expatriating should retain immigration counsel in addition to (or prior to) their tax counsel.

Definition of "Covered Expatriate"

The current regime governing the taxation of U.S. expatriates was introduced in 2008 under the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act). (4) The HEART Act created a category of expatriates dubbed "covered expatriates" who are subject to a tax regime provided by [section][section] 877A and 2801. (5) As such, it is critical first to determine whether a potential expatriate will be a covered expatriate in order to determine the tax implications for the expatriate and the potential beneficiaries under his or her estate plan.

* Definition of "Expatriate"--For purposes of the U.S. expatriation regime, an "expatriate" generally means an individual who relinquishes U.S. citizenship. Relinquishing U.S. citizenship is typically done by renouncing U.S. nationality before a U.S. diplomatic or consular officer. Other acts of expatriation may include obtaining naturalization in another country upon application after reaching age 18, formally pledging allegiance to another country after reaching age 18, serving in the armed forces of another country in combat against the United States or as a commissioned or noncommissioned officer, or holding certain non-U.S. government positions. (6)

Additionally, and somewhat surprisingly, long-term green card holders may fall within the definition of an "expatriate." If a non-U.S. citizen held a green card in eight or more of the last 15 tax years and ceases to be a U.S. resident, the green card holder will be treated as an expatriate for U.S. tax purposes. (7) As the statute implies, holding a green card in any portion of a calendar year counts as a full year for purposes of this test. Termination of U.S. residency for a green card holder is most often achieved through abandonment of the green card; notably, the mere expiration of the green card does not terminate U.S. residency for income tax purposes. A green card holder also is deemed to cease being a U.S. resident if the green card holder establishes residency in another country and fails to waive the benefits under any tax treaty between that country and the U.S. (8)

Because the exit tax is tied to the date the expatriate surrendered U.S. citizenship or ceased to be a U.S. resident, as the case may be, the statute defines an expatriate's "expatriation date." (9) In the case of a U.S. citizen, the expatriation date is the date the U.S. citizen relinquishes U.S. citizenship. In most circumstances, this will be the date the expatriate renounces U.S. nationality before a U.S. diplomatic or consular officer. In the case of a green card holder, the expatriation date is generally the date the green card holder abandons the green card; however, in the case of a green card holder invoking the residency tiebreaker provision of a U.S. tax treaty, the date may be retroactive to the date the green card holder's non-U.S. residency commences under the treaty.

* Definition of "Covered"--Being an expatriate alone is not sufficient to subject an individual to the U.S. expatriation regime. In addition, the individual must be "covered." A covered expatriate is an expatriate who meets one or both of the "tax liability test" and the "net worth test," or who fails the "tax certification test." (10)

The tax liability test is satisfied if the expatriate's average annual net income tax liability for the five taxable years preceding the expatriation date is greater than $151,000 (for calendar year 2012, adjusted annually for inflation). This includes the total income tax liability shown on the individual's return, even if filing jointly.

The net worth test is satisfied if the expatriate's net...