mhaven.net EXPATRIATION TAX PRESENTED BY MONICA HAVEN, EA, JD, LLM

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1 EXPATRIATION TAX 2016 PRESENTED BY MONICA HAVEN, EA, JD, LLM

2 LEARNING OBJECTIVES Identify covered expatriates & exempt individuals Determine the basis on which the exit tax is computed Apply & correctly allocate the lifetime exclusion Know how to report & when to pay the tax 2

3 FAMOUS FORMER CITIZENS Tina Turner Switzerland (2013); lived 20 years in-country and married to German music executive Denise Rich Austria (2011); moved to father s native country after pardon by President Clinton Jet Li Singapore (2009); school system for daughters but Singapore does not allow dual citizenship Eduardo Savarin Singapore (2009); was Brazilian first but moved to US when targeted for kidnapping Bobby Fisher Iceland (2005); arrested and jailed for 8 months in Japan when US passport revoked for anti-american activities John Templeton Bahamas (1968); to avoid estate tax Yul Brynner Switzerland (1965); renounced when IRS sought to tax dual citizen who over-stayed in US President John Tyler Virginia (1862); to accept a post as representative of the Confederacy

4 AND THE NOT-SO FAMOUS Donna-Lane Nelson Switzerland (2011); Swiss bank threatened to close Americans accounts due to FATCA reporting requirements Laurie Lautman New Zealand (2013); can t afford annual tax prep fee of $3,360 to have US returns prepared Christina Amman Switzerland; burdensome FBAR reporting for joint accounts with Swiss husband Corine Mauch Switzerland; born to Swiss parents and feels at home in Zurich Norman Heinrich-Gale Austria; moved to the Alps when overwhelmed by pace of American life Quincy Davis III Taiwan; joined national basketball team Carol Tapanila Canada; wants to protect retirement savings earned in Canada from US tax

5 AND THE EXODUS CONTINUES

6 WHY LEAVE? High federal (& state) tax rates US taxes on worldwide income Burdensome reporting requirements under Bank Secrecy Act (1970) & Foreign Account Compliance Act (2010) Obtain or retain citizenship in a country that does allow dual citizenship In protest of US politics and policies: Creole entertainer & civil rights activist Josephine Baker angered by racism & discrimination Running for political office abroad: Andreas Papandreou became Prime Minister of Greece To obtain release from detention: Yasser Hamdi captured in Afghanistan & declared an enemy combatant

7 REASONS DON T MATTER The list of reasons is varied and long Some are accidental Americans Inadvertent forfeiture - Green Card holder who works & lives abroad claims Foreign Earned Income Exclusion (subject to residency tests) and does not return to the US to satisfy immigration rules Some are asked to leave Americans wishing to leave need not explain

8 WHATEVER THE REASON US will assess a departure tax to discourage tax avoidance by forfeiting US citizenship or residency Assessed on unrealized gains Known as the Exit or Expatriation Tax

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10 BACKGROUND 1913: 16 th Amendment created a tax regime that was citizenship-based Applied to every citizen of the US, whether residing at home or abroad 1918: Foreign Tax Credit introduced 1926: Foreign Earned Income Exclusion - No income limitations until : maximum exclusion = $101, : maximum exclusion = $102,100

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12 COVERED EXPATRIATES Heroes Earnings Assistance and Relief Tax Act ( HEART ) of 2008 Reason for departure irrelevant presumption of tax avoidance now mute Covered if expatriate satisfies any one of the following three tests Income Tax Liability Net Worth (Non-)compliance

13 INCOME TEST Average annual income tax for 5 most recent years ending before expatriation > $161K [in 2016] Adjusted annually for inflation Effective June 18, 2008

14 NET WORTH TEST Must be > $2 million on date of expatriation No inflation adjustment Effective June 18, 2008

15 COMPLIANCE TEST Must certify compliance with all federal tax obligations for 5 most recent years ending before expatriation Use Form 8854 Initial and Annual Expatriation Statement Effective June 18, 2008

16 EXEMPT INDIVIDUALS Not covered if: Dual citizenship since birth, AND Have not lived in US more than 10 of most recent 15 years Individuals under age 18½ who have not lived in US more than 10 years

17 HOW TO EXPATRIATE Renunciation voluntary forfeiture of citizenship Requires formal process before a US diplomatic or consular officer in a foreign state Relinquishment involuntary forfeiture of citizenship Renounce in time of war with US Attorney General s approval Commit an act of treason [will lose citizenship but not tax status] Pledge an oath of allegiance to a foreign country Join the armed services of another country engaged in war against the US or join another country s army as an officer even if that country is not at war with the US Work for a foreign government while also a citizen of that country Accept employment by a foreign government in a job for which an oath of allegiance is required Abandonment voluntary forfeiture of residency

18 EXPATRIATION: US CITIZENS On the earliest date of: When renunciation before US diplomatic or consular officer is approved & certificate issued by US Dept. of State When person submits signed statement of voluntary relinquishment & certificate issued by US Dept. of State When US Dept. of State issues certificate of loss of nationality When US court cancels certificate of naturalization

19 EXPATRIATION: US RESIDENTS Lawful permanent residency ceases when: Immigration & residency status revoked or administratively determined to have been abandoned, OR Inadvertent abandonment: Individual treated as resident of foreign country as per prevailing tax treaty & does not waive treaty provisions via Form 8333 Treaty-Based Return Position Disclosure and Form 8854 Initial and Annual Expatriation Statement (Part 1, Line 5), OR Formal abandonment: Individual submits Form I-407 Abandonment of Lawful Permanent Resident Status to US consular officer Green Card Holder subject to expatriation rules only if long-term resident (at least 8 of most recent 15 years)

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23 BASIS FOR TAX Asset-based tax uses a mark-to-market regime Assessed on unrealized gains as if all assets sold 1 day before expatriation date Applied to all of expatriate s worldwide assets & future gifts/bequests Phantom gains (& losses) are subject to income tax Subject to capital gains & ordinary income tax rates Gifts & bequests taxed at highest estate tax rate Reported on Form 8854

24 EXEMPT ASSETS Certain deferred compensation plans & retirement accounts Non-grantor trusts (expatriate is not the owner on day before expatriation) Subject to automatic 30% withholding upon distribution Example Company granted restricted stock units to employee in 2015, receivable in 2017 if he continues to work for company. Taxpayer quits job and expatriates in 2016 units will be treated as vested on day before expatriation & subject to exit tax If instead taxpayer continues to work & notifies company of status as covered expatriate no exit tax inclusion but distributions subject to 30% withholding

25 EXCLUSION AMOUNT Tax basis may be reduced by applicable exclusion amount (indexed for inflation) $693,000 [in 2016] Each individual eligible for one lifetime exclusion amount Must be allocated on pro-rata basis to all gain properties Gains & losses actually realized upon later disposition may be adjusted for phantom gains and losses which were subject to exit tax

26 ALLOCATION OF EXCLUSION AMT. Covered Expatriate relinquished gain in He owned the following: Step 1: Step 2: Step 3: Asset FMV on date of expatriation ($) Basis = FMV at Purchase ($) Multiply total exclusion amount [$693K in 2016] by ratio of individual gain over aggregate gain on all assets. NOTE: Exclusion amount is not allocated to asset with built-in loss. Asset X: (1.8 million 2 million) X 693,000 = $623,700 Asset Y: (200,000 2 million) X 693,000 = $69,300 Subtract allocated exclusion amount from deemed gain Asset X: 1.8 million 623,700 = $1,176,300 reportable gain Asset Y: 200,000 62,600 = $130,700 reportable gain Built-in Gain or Loss ($) X 2,000, ,000 1,800,000 Y 1,000, , ,000 Z 500, ,000 (300,000) Aggregate Gain = $2 million Report includible gains of Assets X and Y, as well as loss of Asset Z on Form 1040 for the portion of the taxable year that includes day before expatriation. File Form 1040NR for the remainder of taxable year.

27 GIFTS & BEQUESTS Expatriates are forever subject to gift and estate taxes on property transferred to US citizen or resident beneficiaries NOTE: Transfers to citizen spouse & non-citizen beneficiaries are exempt Property is valued at FMV on date of gift (death) Expat is entitled to annual gift exclusion [$14K in 2016] but not lifetime exclusion [$5.45 million in 2016] Example US citizen has only cash assets on date of expatriation no exit tax Expat later bequeaths net worth to his citizen children entire net worth subject to estate tax Same rules apply to expat s foreign trust if beneficiary is US citizen or resident

28 WHO IS LIABLE? Gifts and estates from expats are taxed at highest marginal rate in effect [40% in 2016] Tax becomes liability of US citizen or resident donee Forever taint can live on for multiple generations if beneficiaries include grandchildren & great-grandchildren Example High net worth taxpayer renounces citizenship & bequests $10 million to each of her US citizen children Each beneficiary will owe $4 million of federal tax in lieu of the estate taxes that expat will not pay

29 REPORTING THE TAX Gain or loss from deemed sales are included on Form 1040 (Forms 8949 & 4797, and Schedule D) Character of gain is preserved as capital or ordinary, short- or long-term Due 90 days after expatriation May make irrevocable election to defer payment until gain is realized on individual assets [must submit bond to guarantee payment of tax]

30 PAYING THE TAX Exit tax is due 90 days after expatriation Taxpayer may make irrevocable election to defer payment on asset by asset basis Must file Form 8854, Schedule C Must submit bond to Secretary of the Treasury to guarantee payment of tax If deferral agreement accepted by IRS, payment must be made by the earlier of: Due date of return for year in which asset is actually sold, OR Due date of the return for the year of expat s death, OR Date that posted bond is considered insufficient IRS will provide 30-day notice to taxpayer to increase bond or pay tax

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32 FILING REQUIREMENTS Form 8854 must be filed with US consulate or federal court at time of expatriation NOTE: Failure to file penalty = $10,000 Expatriates must file even if no exit tax due Taxpayer must certify that he has complied with all federal tax filing requirements for most recent 5- year period before expatriation Must file Form 8854 annually for 10 years due April 15 th Must also file Form 1040NR for 10 years

33 FORM 8854 PART I GENERAL TAXPAYER INFO & GUIDANCE WHICH PARTS TO COMPLETE BASED ON DATE OF EXPATRIATI ON

34 FORM 8854 PART III PROVIDE MARK-TO- MARKET VALUATIO NS OF ALL ASSETS

35 FORM 8854 PART IV VERIFY THAT TAX RETURNS FOR 5 PRIOR YEARS HAVE BEEN FILED & THAT TAXPAYER IS NOT AN EXEMPT INDIVIDUA L

36 FORM 8854 PART IV USE TO ELECT DEFERRA L OF TAX PAYMENT

37 FORM 8854 PART V TAXPAYER MUST PROVIDE BALANCE SHEET & INCOME STATEMENT

38 PAY TO LEAVE

39 Monica Haven, E.A., J.D., L.L.M. PHONE: (310) FAX: (310) WEBSITE: www. Student Text to accompany this presentation is available on the Publications page of my website. The information contained herein is for educational use only and should not be construed as tax, financial, or legal advice. Each individual s situation is unique and may require specialized treatment. It is, therefore, imperative that you consult with tax and legal professionals prior to implementation of any strategies discussed.