For those of you who are thinking about expatriation in 2016, this is a perfect time to start doing the footwork.
When should you renounce?
There are four major factors that drive the timing of your expatriation:
- Covered expatriate status (you may need some time to re-engineer your life before you renounce your U.S. citizenship);
- Income tax liability (will choosing a “good” date reduce your overall income tax bill?);
- Paperwork (will choosing a “good” date make your U.S. income tax paperwork simpler, therefore cheaper to prepare?); and
- Banking (is your local bank asking you uncomfortable questions about your U.S. connections?).
Covered expatriate status
If at all humanly possible, you should avoid being a covered expatriate. This means that all of the following statements are true:
- Your total net worth when you expatriate is under $2,000,000;
- You did not have (on average) $161,000 of net income tax liability (a not-necessarily-simple concept); and
- Your 2011 – 2015 income tax returns are all filed, completely accurate (with every form attached), and your taxes fully paid up.
Our experience is that the third bullet point is the one that trips many people. Most people have “accurate-ish” tax returns. We find that they may never have heard of Form 8621, Form 8865 or Form 5471. Or they are alarmed to discover that the IRS thinks their retirement plan is a foreign grantor trust. Etc.
Give yourself plenty of time to do a self-audit (at least) or a third-party audit (if you think it is warranted) of your 2011 – 2015 tax returns.
If you have not filed tax returns for some or all of these years, fix that problem pronto.
This whole process can take months. Start early.
Income tax liability
This is not as easy as it seems.
At first blush, we are talking about the notorious “exit tax” that you will pay if you are a covered expatriate. If you are a covered expatriate, your job is to re-engineer your life so that you are not a covered expatriate — if this is possible.
The reason that covered expatriate status is horrific is that it will create double-taxation for you. You will pay a lump of income tax to the United States when you renounce citizenship (the exit tax), but this tax will probably not act as a foreign tax credit in your home country, and is certainly not a taxable event in your home country. This can lead to painful circumstances:
- You renounce your citizenship and are treated as if you sold a rental property that you own in your home country. You pay the exit tax. This is not a taxable event in your home country — you still own the property. Later, you sell it. You pay capital gain tax again on the same capital gain.
- You renounce your citizenship and because you are a covered expatriate you are treated as if you took a distribution of your entire pension. You pay a massive tax now to the IRS. But you didn’t really take a distribution. The money is still in the pension. Later, you retire and start taking distributions from your pension. You will pay tax again in your home country.
Big Income Events
There is also the consideration of expected large income recognition events. Are you expecting a big bonus? Will you be selling a property sometime in 2016?
If so, it might be useful to do this before or after renunciation, but you will not know for sure until you run the numbers.
As a general principle, if you have a property sale and the property is in the United States, you will pay capital gain tax on that sale anyway, so you are indifferent as to timing. But all else equal, for expatriates I would rather load up this type of event into the portion of the year where they are still U.S. taxpayers.
Look carefully at your deductible expenses, net operating losses, passive activity losses, and anything else that can reduce your U.S. income tax liability. Figure out what the timing should be — is it appropriate to harvest these expenses before you renounce?
For instance, if you are a not a covered expatriate and you have a U.S. capital loss carryforward, what happens when you leave the United States and have no further U.S. tax exposure? If you buy and sell U.S. stock on the public markets, you will not be subjected to U.S. capital gain tax.
Your capital loss carryforward will not save you any U.S. tax, because you will never have U.S. capital gain. You are better off selling some stock now to offset capital gains on those sales with capital loss carryforward. You are also better off selling your losing stocks to create a U.S. capital loss, so you can offset it against U.S. capital gain before you expatriate. This is true especially if you are not a covered expatriate.
Here, the objective is to make your U.S. income tax returns and Form 8854 as simple to prepare as possible.
Income tax return
You will be preparing a dual-status income tax return for the year that you expatriate: for part of the year you were a U.S. taxpayer, and for part of the year you were not.
This makes the work a bit complicated, and you pay for that complexity either by hiring someone, or by administering some brain damage to yourself. 🙂
The U.S. tax system operates on the “cash method” meaning that you only report income on your income tax return when you actually receive it in cash. So on a dual status income tax return, if you never receive any income during that time period, you can happily fill in the tax return with a lot of zeros. That’s easy.
Usually, we like to have a renunciation date as early in the year as possible or as late in the year as possible.
- If your renuniciation date is January 5, 2016, it is unlikely that you received any income during January 1 through 4. This means that the portion of the dual status tax return for the time that you were a U.S. citizen is really easy to fill in.
- If your renunciation date is December 30, 2016, it is likely that your non-U.S. income is trivial, and therefore it is easy to fill in the portion of the dual status tax return for which you were a nonresident alien.
This requires you to report all of your assets and liabilities, and has a section where you report income (and trust me, it is confusing).
Are there any things you can do before expatriation that will make your financial affairs simpler to report? E.g., if you have a lot of stocks and bonds and you sell everything and hold cash, your balance sheet on Form 8854 is much simpler. If you cash in an IRA (because, perhaps, you will be taxable on it anyway), you have saved yourself a bit of work as well.
This is not a major area for simplicity, unless your life is very complicated indeed. Still, it is worth a look.
Banking and FATCA
The world is rolling over and playing dead for Uncle Sam. Banks worldwide are demanding that their customers lie or tell the truth about being U.S. citizens or taxpayers.
You would be surprised at the countries that nominally, at least, are cooperating with the USA. Think of the more unattractive places to live on the planet at the moment. Yep. Them too.
So sooner or later you should expect that you will get an inquiry from your bank: are you a U.S. taxpayer? You will get the opportunity to fill in a Form W-9. For many, many banks, telling the truth means that you are an ex-customer of the bank. Now what do you do if you are a permanent resident of that country and need a bank account to hold your walking-around money?
All else equal, you should exit the United States sooner rather than later.
The level of formal — and informal — level of information sharing to the United States seems to vary wildly. There are vastly differing effective dates for when information will be shared. If you get out of the USA sooner rather than later, you will have the opportunity for sleeping dogs to, well, continue to sleep. So to speak.
And when it comes to telling the bank that you are no longer a U.S. taxpayer, you will need that Certificate of Loss of Nationality to prove it. The sooner you get that piece of paperwork in your pocket, the better off you will be.
Save yourself some trouble. This is a factor that militates for sooner rather than later. Your future self will thank you.
For any additional information you may call us NML Consultores 915194392 or email us at email@example.com