If you’re a U.S. citizen or permanent resident, the U.S. government has assigned itself the right to tax your income, no matter where you live.
I sometimes tell U.S. clients that even if they jumped in the Starship Enterprise and traveled to the Delta Quadrant (30,000 light years away from earth at its closest point), they would still be subject to U.S. tax!
In response to the ridiculous — but unfortunately very real — presumption that U.S. citizens must pay income tax wherever they live, an increasing number of U.S. citizens are giving up their U.S. nationality.
Today I’d like to share with you some of the myths and truths you should consider before you start to take steps to make a permanent move offshore.
Giving up your citizenship is a big step, and it means you no longer have the legal rights and privileges of a U.S. citizen. You can’t vote, for instance, and you no longer have the automatic right to live in the United States. But this process of expatriation is the only way U.S. citizens can permanently sever the obligation to pay tax on non-U.S. income.
However, there are also a number of myths — many of them propagated over the Internet — about expatriation. Here’s a brief summary:
Myth #1: “Only a tiny number of people expatriate each year.”
It’s true: the “official” number of people who take this admittedly radical step is tiny—only a few hundred annually. The Treasury Department is supposed to publish their names in the Federal Register each quarter. But the real numbers are much higher.
One especially busy U.S. consulate in Switzerland expatriates three people daily with appointments booked a year in advance. That comes to close to 1,000 expatriations annually — just from a single consulate.
Another reason the official numbers are so low may be that the law mandating Federal Register reporting by the Treasury Department applies only to “covered expatriates.”
These are individuals who have a net worth over $2 million, or who meet other criteria making them potentially subject to an exit tax.
However, only a handful of the covered expatriates my firm has helped expatriate have had their names published in the Federal Register.
I think the government doesn’t want you to know that the number of people expatriating is exploding. And it’s willing to “cook the books” to make sure the information doesn’t get out.
Myth #2: “You have to pay an exit tax on your net worth when you expatriate.”
I was at a dinner meeting where I was introduced to an elderly gentleman who insisted that anyone who expatriated would automatically forfeit 15% of his or her net worth.
When I asked him for a legal citation to this “fact,” he simply repeated his assertion. He also mentioned that he was a major contributor to the organization sponsoring the event we were attending. That no doubt earned him some brownie points at this organization, but it doesn’t make his assertion correct.
The fact is that the exit tax now imposed on U.S. expatriates only applies if you’re a covered expatriate. And even if you are, the exit tax only applies to unrealized gains that exceed $627,000 (2010 threshold, adjusted annually for inflation).
There’s no exit tax on your net worth simply because you’ve expatriated. Of course, that may change in the years ahead if Congress decides to put the screws to expatriates in some future law.
Myth #3: “You can only spend 30 days/year in the USA.”
Another misconception is that if you expatriate you can only spend 30 days each year in the United States without becoming subject to U.S. tax on your worldwide income.
This myth actually has some basis in fact, because it was true under an old law that was abolished in 2008. And it still may apply if you are a covered expatriate who gave up U.S. citizenship between 2004 and 2008. But no longer.
Myth #4: “If you expatriate you can’t come back.”
There’s another rumor that once you expatriate you can never return to the United States. That’s hogwash, although again there’s a small basis in fact to the rumor.
In 1996, Congress enacted the so-called Reed amendment to the Immigration and Nationality Act. The amendment gives the Attorney General the discretion to deny entry into the United States to a former U.S. citizen who renounced U.S. citizenship in order to avoid U.S. taxation.
Other categories of “excluded persons” are those with communicable diseases or other health conditions; those convicted of crimes involving moral turpitude or illegal drugs or with multiple criminal convictions; prostitutes; spies; terrorists; and draft evaders.
After Congress enacted the Reed Amendment, commentators criticized it for violating U.S. treaties and possibly the U.S. Constitution as well. And nearly 15 years after its original enactment, regulations under this provision have not been issued, and its power has never officially been invoked.
“Tax motivation” is no longer a factor in determining the status of a covered expatriate. For this reason, the Reed Amendment may no longer be relevant, particularly since it has been so long since its enactment, with no regulations in place to enforce it.
Given this history, it may be safe to assume that one can safely give up U.S. citizenship with no fear of future exclusion, particularly if you choose an expatriation option other than formal renunciation.
Myth #5: “Expatriates lose Social Security benefits.”
Again … not true! No restrictions exist on Social Security payments sent to non-citizens in most cases. The only significant restrictions are if you live in a country upon which the U.S. government has imposed trade or financial restrictions; e.g., Cuba, North Korea, or Iran. In a handful of other countries (e.g., New Zealand), a non-U.S. citizen may not receive U.S. Social Security payments more than six months after leaving the United States.
However, if you’re not a U.S. citizen, depending on where you live, there may be a withholding tax of as much as 30% on the first 85% of your monthly payment. This percentage may be reduced or eliminated if there’s a tax treaty between the United States and your residence country.
Myth #6: “Expatriates are automatically targeted for reprisals by the IRS.”
Thank goodness this myth is false. There is no IRS vendetta against expatriates. Quite the opposite! The IRS has much easier pickings going after people still living in the United States, with substantial U.S. assets. It can use its resources more efficiently than to harass former U.S. citizens not living in the United States and with minimal or no U.S. assets or activities.
Indeed the act of expatriation stops the clock on all future IRS obligations. You still have obligations to pay past taxes, but the statute of limitations for collections eventually runs out assuming you’ve filed all relevant returns for tax years prior to expatriation.
Is expatriation for you? The decision to give up U.S. citizenship is a serious one. It’s a step you should take only after consulting with your family and professional advisers. But it’s the only way that U.S. citizens and long-term residents can eliminate U.S. tax liability on their non-U.S. income, wherever they live. And it’s a tax avoidance option that Congress may eventually make much more onerous.
Best,
Mark