In recent years there has been a large increase in the number of US citizens handing in their passports and renouncing their US citizenship. Many of these are people that we call “Accidental Americans” who were either born in the US and left very young or born outside of the US and were eligible for US citizenship via one or both of their parents. A few are bona fide Americans who have decided they have no desire to ever return to the US and do not want to continue with the ongoing US tax obligations.
There are two distinct but related aspects to the renunciation of citizenship and getting out of the US tax system:
- The actual renunciation of the citizenship in relation to the immigration laws which is handled by the State Department
- Dealing with the tax laws relating to renunciation with the IRS
For US citizens in the UK at least, there is a prescribed process on the US Embassy in London website. Essentially this involves downloading the relevant forms from the site, gathering the required documents, and then sending them to the embassy to book a renunciation appointment. This is normally booked for about four to eight weeks ahead.
We are told by former clients that the appointment involves sitting in a room with five or six other US citizens doing the same thing and waiting to be called to a window where your documents are reviewed, you pay the embassy fee of $2,350 and various questions are asked. You are then told that you will receive a Certificate of Loss of Nationality which will declare that you presented yourself at the London embassy on that date and as of that date you were no longer a US citizen. Jaffe & Co does not advise on the immigration side and you may want to engage appropriate counsel.
On the tax side, as one may understand, Congress does not want US citizens to renounce their citizenship and walk away from the US tax system so easily. Certain expatriates will be subject to the “Exit Tax” upon renunciation; these are called Covered Expatriates. An expatriate, generally, is a Covered Expatriate if they meet one or more of the following criteria:
- They have not complied with all US federal tax obligations for the five years preceding the year of expatriation;
- Their annual net income tax liability (actually paid to the IRS, after all credits) has been more than $190,000 on average over the above five tax years (Tax Liability Test); or
- Their net assets are worth $2.0m or more on the date of renunciation (Net Worth Test).
If one is a Covered Expatriate then they are subject to the Section 877A “Mark-to-market” Exit Tax regime whereby the taxpayer is deemed to have sold all of their assets on the day of renunciation and received any and all deferred compensation accrued on that date. The Covered Expatriate is allowed a certain amount of “gain” to be excluded before the amounts become taxable ($821,000 in 2023). There is no set rate of the Exit Tax: the taxable amounts are entered as income on the taxpayer’s final tax return and the net tax liability calculated by the return.
For the final year of citizenship the taxpayer files a Form 1040NR “Dual Status” return along with the Form 8854 Expatriation Statement. The former is a special type of tax return where the taxpayer reports their worldwide income as a normal US taxpayer up to the day of renunciation, and then only US-source income for the rest of the year per ordinary non-residents. A Form 1040-NR return is actually filed, with a “Form 1040 attachment” reporting income for the first part of the year. The Form 8854 Expatriation Statement is the form used to tell the IRS that the taxpayer has renounced their citizenship and declares whether or not they are a Covered Expatriate, and works out the amount of deemed taxable income subject to the exit tax.
A noteworthy aspect of the renunciation rules is a specific exemption allowed when determining Covered Expatriate status. If a taxpayer was born both a US citizen and citizen of another country and continues to be a citizen of that other country and be taxed as a resident of that country, then they are exempt from the Net Asset and Net Tax Liability tests as long as they have not been tax resident of the US for more than ten out of the last 15 years. This in turn raises the question of whether the taxpayer is considered born a citizen of both countries…
The above process has many, many nuances and complications and we strongly recommend that any US person considering renunciation obtains professional advice before presenting themselves at the embassy for renunciation. The rules regarding the valuation of assets for the Net Assets test can be extremely complicated, especially when deferred compensation, annuities or trusts are involved. A taxpayer could be worth $100m upon renunciation and be able to walk away with no Exit Tax; or be worth $2,000,001 and be liable for hundreds of thousands of dollars of Exit Tax.
The above is a very brief overview. Seek professional advice before going to the embassy.