The US Exit Tax
As an American, you’re subject to U.S. income taxation on your worldwide income, even if you live abroad. Filing and preparing a U.S. income tax return can be complicated and costly. This has been a reason for Americans to renounce their U.S. citizenship. A last U.S. tax return is required for the year in which you renounce your citizenship. You may be subject to an exit tax.
What is the exit tax?
Once you’ve renounced your U.S. citizenship, you’re no longer subject to U.S. income taxation, unless you receive income from U.S.-sources. Examples are dividends from American companies or the sale of U.S. real estate. Until you renounce your citizenship, you’re taxed on your capital gains when you realize them. In other words, only when you sell an asset, are you subject to tax on the gain. Without the exit tax, the IRS would not be able to tax Americans on their unrealized gains. When you renounce your citizenship, you’re deemed to have sold all your assets. The exit tax is the tax on the deemed sale of your assets upon expatriation.
Who’s subject to the exit tax and how to calculate it?
You’re subject to the exit tax if you’re a “covered expatriate”. You may be a covered expatriate if any of the following applies. Your net wealth exceeds $2 million. Your net wealth is calculated as the total of your assets minus your liabilities. Assets include cash, investments, real estate and pensions. Mortgages and loans are examples of liabilities. If your average income tax liability over the 5 years prior to the year in which you renounce your citizenship exceeds a certain threshold, you’re a covered expatriate. The amount is adjusted for inflation annually.
Finally, you’re a covered expatriate if you haven’t filed a complete and correct U.S. tax return for at least 5 years prior to the year in which you renounce your citizenship. In other words, if you have not filed your tax returns, you’re automatically a covered expatriate.
The tax on the deemed sale of your assets is calculated for each type of asset separately. The gain is calculated as the difference between the fair market value of the asset and your tax basis. Generally, your tax basis is the purchase price. Therefore, even if you’re a covered expatriate and as such subject to the exit tax, you may not actually owe any tax. For example, if you own cash only, the gain on the deemed sale of your assets would be zero. Your tax basis equals the fair market value.
What can I do about the exit tax?
Some relatively simple tax planning may help to reduce your exit tax. However, this entirely depends on your specific facts and circumstances. The exit tax can be a reason for not renouncing your citizenship. We strongly advise consulting one of our experience U.S. tax professionals before renouncing your citizenship.
If you are an American and would like to know more about the exit taxation, please contact us. We specialize in preparing U.S. tax returns for Americans living abroad. We have offices in Denver, as well as the Netherlands, Germany, Switzerland and the United Kingdom.