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Exiting The USA: Exit & Transfer Taxes
This blog is relevant for anyone who is planning on moving out of the USA as a Green Card holder or surrendering their US citizenship at any time.
It will focus on those leaving on a Green Card (I.e. as a Legal Permanent Resident (LPR)). If you are considering renouncing your US citizenship, much of this still applies.
Abandoning Green Card Status
Please DO NOT think you can just leave and effectively abandon, or even keep, your Green Card / LPR status. Taking this approach can have disastrous consequences.
As a minimum you must submit form I-407 to U.S. Citizenship & Immigration Services (USCIS). If you don’t then you may still be considered a Legal Permanent Resident and subject to US tax, regardless of where you live. The expiry of your Green Card will not sever your status, nor tax obligations.
This approach could jeopardise your future access to the US.
Worse, if you are considered a Covered Expatriate and/or Long-Term LPR (see below), in addition to the USCIS form, you have IRS forms, obligations, and possible taxes.
As per Golding & Golding, “The failure to file the necessary U.S. expatriation forms may result in FBAR penalties, FATCA penalties, PFIC Tax, passport revocation, liens, levies, and examination.”
US citizenship as a non-US resident brings with it significant ongoing challenges and costs. As a result, many expats in the US who don’t plan to stay choose not to take up US citizenship and simply give up their LPR status when they leave.
What can come as a very unpleasant surprise is the Expatriation Tax (aka Exit Tax).
The Exit Tax has the potential to apply to any:
- US citizen renouncing their US citizenship (exceptions may be available to certain dual citizens but require one to have become a US citizen at birth, so I will not delve into this further in this blog).
- Long-Term Legal Permanent Residents (i.e. anyone on a Green Card for any part of 8 of the last 15 years).
This potentially catches any US citizen who has moved out of the US, has no intention of ever returning and belatedly realises what a burden US citizenship is on a US expat and decides to renounce it.
But the person most at risk for the exit tax is the Green Card holder who plans on leaving the US and thinks they can give up their Green Card and walk away consequence free. Maybe they can, but frequently they can’t.
So, what makes a Legal Permanent Resident (LPR) a LONG-TERM Legal Permanent Resident? Being an LPR for any part of 8 out of the last 15 years. A critical detail here is that being an LPR for even one day in a year counts as a full year.
For example, you get your Green Card on 1 December 2020, then 2020 is your first year towards your 8. If you exit the US on 31 January 2027, then you leave as a Long-Term LPR, despite having only held that Green Card for 6 years and 2 months (i.e. way below 8 years).
It’s a trap all Green Card holders need to be aware of.
If you are renouncing US citizenship or you are a Long-Term Legal Permanent Resident, you must file Form 8854 (see website) with the IRS (in addition to filing I-407 with USCIS) the year after your expatriation.
If you are not a Long-Term Legal Permanent Resident then you do not have to do this, so this should be your first planning consideration:
Can you give up your Green Card before becoming a LONG-TERM LEGAL PERMANENT RESIDENT?
Just because someone is required to file 8854 does not automatically mean they will be subject to the Exit Tax. For that, you must determine if you are a Covered Expatriate or not.
If you plan on exiting the US and giving up your Green Card, regardless if you’re a Long-Term LPR and/or a Covered Expatriate, there is important information you should consider about this process. You must not simply walk out of the US and consider the matter closed. Please skip to the end of this blog if you think this applies to you.
You are a Covered Expatriate if you renounce your citizenship or expatriate as a Long-Term LPR after June 16, 2008, and any of the following statements apply:
- Your average annual net income tax liability for the 5 tax years ending before the date of expatriation is more than a certain amount.
- Your net worth was $2 million or more on the date of your expatriation.
- You are unable to certify on Form 8854 that you have complied with all federal tax obligations for the 5 tax years preceding the date of your expatriation.
Many of our clients find themselves caught by the $2m net worth test.
If you are a covered expatriate, you are subject to tax on the net unrealized gain in your worldwide assets and property as if the property had been sold for its fair market value (FMV) on the day before your expatriation date (“mark-to-market tax”). You are eligible to reduce your total capital gain by $725k (but not to below zero).
There are some exceptions to the exit tax, the details of which will not be covered here:
- Eligible Deferred Compensation Items (e.g.. 401ks)
- Ineligible Deferred Compensation Items. (e.g. IRA and foreign pensions, such as SIPPs)
- Specified Tax Deferred Accounts.
- Interests in Non-grantor Trusts.
Liquid investments are easy enough; you’ve made a gain in your investment portfolio and whilst you may not want to, it is usually not a big deal to liquidate some investments to pay the tax.
But what about illiquid investments? What about a property with a significant gain, or a closely held business? You could own a business with a $10m increase in value, but that doesn’t mean you have c.$2.5m cash on hand to pay the Exit Tax associated with this!
But perhaps the biggest, nastiest surprise is associated with ineligible deferred compensation schemes.
Eligible deferred compensation schemes such as 401ks can be excluded from the mark-to-model calculation because you are able to elect to have it subject to US withholding at source (i.e. upon distribution). There are further details/consequences to this, but they are outside the scope of this blog.
To be clear, a 401k balance contributes towards your net worth test, but it is excluded from the exit tax calculation, because the US knows it will get to tax it later.
Ineligible Deferred Compensation Items
IRAs and SIPPs do not benefit from this treatment. They are not included in the mark-to-market calculation described above, but they are treated as receiving the present value of your accrued benefit as of the day before the expatriation date. You should include this amount on your Form 1040 or 1040-SR for the year that includes your expatriation date.
What this means is that the entire balance of your IRA and/or SIPP (or other foreign pension scheme) will be added to your income for the year and taxed at your highest margin rate.
At best, this is likely to be tax inefficient for you (taxed at a higher rate than you would drawing it out piecemeal in retirement). At worst, it leaves you with a dry tax bill – e.g. the entire balance of your SIPP becomes taxable upon exit, but if you are under 55 years of age you cannot access your SIPP to pay the tax.
There are ways to defer the tax, but they will be costly (interest will be added), and you’ll need to post a bond.
Furthermore, care must be taken to avoid double tax. The Exit Tax is a Phantom Tax. If your IRA and/or SIPP are taxed by the US upon exit, but you leave the funds in your IRA and/or SIPP (either intentionally because you are unaware of the consequences or because you have no choice – e.g. you are under 55) and you return to the UK where you later retire, your SIPP will be taxed again with, as far as we are aware, no relief for the US tax you have already paid on it upon exit.
Similarly, it is easy to imagine a scenario where a closely held company is taxed twice – once upon your exit from the US and again upon sale – with no double tax relief available.
Illiquid assets – property, business etc – and foreign pensions are the main reasons why someone may be “forced” to take US citizenship even if they have no intention of ever moving back to the US. This subjects them to a future of US tax returns, some double taxation and many other difficulties, but it can be infinitely preferable to suffering a catastrophic dry exit tax.
Lifelong Repercussions – The Transfer Tax
As if all that wasn’t bad enough, wait for this kicker…
If you expatriate from the US as a Covered Expatriate, any future gifts you make to any US citizens (your kids, perhaps?) may be subject to an immediate “inheritance-type transfer tax” at “the highest estate tax rate in effect on the date of receipt” i.e. 40%.
It is the responsibility of the recipient to declare the gift to the IRS and pay the tax.
You exit the US as a Covered Expatriate and 10 years later you gift your US citizen daughter $500,000 to help her buy a home or start a business. You daughter is likely required to report this gift to the IRS and pay them 40% of it, after making allowance for the annual exclusion amount (currently $17,000 in 2023) – i.e. $193,200 in tax ($500k less $17k @ 40%)
A Word on Giving Up Your Green Card
As discussed at the start of this blog, you cannot just leave the US and consider your permanent residence status severed. There is a formal process you must go through, including filing a form (I-407) with USCIS to properly give up your permanent residence.
If you do not do this, you could find that your permanent resident status is revoked (as it likely will be if you live outside the US for a prolonged period of 6 months) and/or simply lapses (e.g. your Green Card expires) BUT this will not sever your status as a LPR and US taxpayer. The IRS will still be anticipating tax returns and possibly taxes from you and not providing them could get you into significant trouble (not simply financial trouble – you could be barred from entering the US).
You could find that your permanent residence status is revoked AND, as a Covered Expatriate, having failed to file the relevant forms with the IRS, you are hit with a devastating concoction of taxes, penalties and other adverse consequences.
We speak to too many expats who think they can leave the US but keep their Green Card, just in case they want to come back, but it does not work like that and the repercussions that can result from this can be devastating.
At a minimum we think you should consult an immigration lawyer prior to giving up your Green Card / LPR. If you think you will be Covered Expatriate, or even just a Long-Term LPR you should seek cross-border tax advice also.
The threat of Exit Tax is serious and we find it catches people unaware. In my experience, it most often catches Green Card holders. On the other hand, expats who take US citizenship before leaving are often shocked by unanticipated future difficulties and costs this entails. I think very few consider renouncing (although the stats suggest this is rising), but Long-Term LPRs probably do not want US citizenship and for years have planned on simply walking away.
Only now they find they have to deal with the exit tax which, depending on their asset mix, could be substantial and difficult, or take citizenship begrudgingly and accept the ongoing consequences. The best option for these people may simply be to get out before triggering long term LPRs (i.e. crossing the 8 year threshold) or, if it’s too late, investigating planning options with a suitable cross-border adviser who understands it from both a US perspective, and from your future country of residence perspective.
As always, the single most important piece of advice I can give you is not to tackle this alone. You need good advice from cross-border tax advisers. Preferably attorneys.
The stakes are high!
Further Reading / Useful Links:
Plan First Wealth is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.