Expatriation: Relinquishing Your U.S. Citizenship and Green Card

In our recent article: “Planning Considerations for U.S. Persons Country of Residency/Domicile,” we reviewed various planning considerations when a U.S. person wishes to establish domicile in a foreign jurisdiction without relinquishing U.S. citizenship or U.S. green card. Here, we go a step further and review planning considerations when a person wishes to give up their U.S. citizenship or U.S. green card (aka permanent resident card).

While all the planning considerations discussed in the other article apply to what is being discussed here, a myriad of additional federal income tax code (“Code”) provisions must be complied with when domicile change is combined with relinquishing U.S. citizenship or a U.S. green card (‘expatriation”), the most prominent being under IRC Sections 877 and 877A (“Expatiation Provisions”).

We will discuss planning considerations related to expatriation that occurs on or after June 17, 2008. Additional provisions apply to expatriation that occurred before June 17, 2008. The term “expatriation” or “expatriating” for our purposes means relinquishing U.S. citizenship or U.S. green card and not expatriate assignment under which an employee is sent by a U.S. employer to a foreign country, (or a U.S. person chooses to work for an employer located in a foreign country).

Here is the list of things to review as you plan to expatriate. A “yes” or a “no” answer at each stage can mean more planning is needed, or you can move forward and expatriate.

1. Are you a U.S. citizen or a U.S. green card holder? The answer to this question is important because a U.S. green card holder is subject to the Expatriation Provisions only if they are considered a long-term resident of the U.S. An individual is a long-term resident of the U.S. if the person is a lawful permanent resident of the U.S. in at least eight out of the 15 taxable years ending with the taxable year in which such individual ceases to be a lawful permanent resident of the U.S. Additionally, if for any taxable year the individual is treated under an applicable treaty to be a resident of a foreign country and does not waive the benefit of that treaty, the person is not treated as a lawful permanent resident of the U.S. for such tax year.

The first planning consideration before expatriation is therefore to determine if you are a U.S. citizen or a green card holder. If a U.S. citizen, read on for more. If you are a U.S. green card holder, are you a long-term resident of the U.S. and did you apply to be a resident of another country under a treaty? If the answer is yes eight out of 15 years, read on and see what else you may need to investigate.

2. Are you a “covered” expatriate or a “non-covered” expatriate? As one would rightly guess, more planning is needed for a covered expatriate and less so for a non-covered expatriate. A non-covered expatriate is simply a U.S. citizen or a long-term resident of the U.S. who is not a covered expatriate. A covered expatriate is any U.S. citizen or a long-term resident of the U.S. who is an individual where any of these apply:

1. With average annual net income tax for the five years ending before the date of expatriation or termination of residency that is more than a specified amount ($178,000 for tax year 2022 amounts); adjusted for inflation tax liability test.
2. With a net worth of $2 million or more on the expatriation date or termination of residency; net worth test.
3. Who fails to certify on Form 8854 (Initial and Annual Expatriation Statement) that they are compliant with all

U.S. federal tax obligations for the five years preceding the date of expatriation or termination of residency; certification test. A U.S. citizen who otherwise meets the tax liability test or net worth test but does not meet the certification test is not a covered expatriate if that U.S. citizen does not meet either of the following two conditions:

1. A dual citizen (of the U.S. and other country) by birth (i) who as of the expatriation date continues to be a citizen of and taxed as a resident of that other country; and (ii) who was a resident of the U.S. for not more than ten years during the 15 tax-year period ending with the tax year during which the expatriation occurs.
2. A minor who expatriates before such individual attains age 18 1/2 and is a resident of the U.S. for not more than ten years before they expatriate.

The next planning consideration, therefore, is to review tax returns for the five preceding years to see if your tax liability crosses the threshold, review net worth based on all assets owned, and ensure that you can certify compliance on Form 8854 (Initial and Annual Expatriation Statement) with all federal tax obligations.

A consultation with a tax advisor to review each of these tests is imperative because the definition of net worth is quite complicated and, depending on the assets held, detailed valuation rules must be complied with if one claims a net worth of less than $2 million.

While the Code does not specify what will constitute a failure to comply with tax return filing requirements, the tax compliance includes not only personal tax returns but entity tax returns, employment tax returns and such other tax returns required to be filed by the person who is expatriating. If a taxpayer otherwise does not meet the parameters of the net worth and tax liability test and is not compliant with their tax filing obligation, it is a good idea to become compliant before expatriating. Depending on the level of noncompliance, an expatriating individual may need to follow special IRS procedures (e.g., streamlined filing compliance procedures, relief procedures for certain former citizens). If prior noncompliance is involved, following proper procedures in consultation with a knowledgeable tax advisor to become compliant can save penalties and possibly subsequent audits by the IRS.

Why is being or not being a covered expatriate so important? A non-covered expatriate can leave the U.S. after filing Form 8854 (Initial and Annual Expatriation Statement) and the necessary tax return for the year of expatriation after applying normal tax rules applicable to that tax year. A covered expatriate, on the other hand, is subject to a more complex tax regime in the year of expatriation:

1. Depending on the type of asset held, a covered expatriate is subject to tax under a mark-to-market tax regime or an alternative tax regime.

1. 1. The types of assets subject to an alternative tax regime, for example, include interest in a non-grantor trust, deferred compensation items and specified tax deferred accounts. Examples of deferred accounts include 401(k) plans, 529 plans, certain employee pension plans, certain retirement accounts and health savings accounts.
      An expatriating individual may generally make an election to defer tax on income from deferred compensation items or specified tax deferred accounts to the time of actual distribution (even if after the expatriation date) and be subject to tax at 30% at such time. If the election is not made, the account is deemed distributed as of the expatriation date and taxed at the applicable marginal tax rate as of such date.
      One planning consideration is to conduct a detailed analysis to decide if these accounts should be taxed as of the date of expatriation taxation at the marginal tax rate on the entire account value or post-expatriation distribution date taxation at 30% (along with meeting other compliance requirements). Various factors should be reviewed to make this determination including value of the asset as of the expatriation date, applicable tax rate in the year of expatriation, the amount of possible distribution and the impact of current marginal rate versus at-distribution 30% rate.
   2. All other assets, including an interest in a grantor trust, that are not subject to an alternative tax regime are subject to a mark-to-market rule. Simply put, an asset that is not subject to an alternative tax regime and considered held by the expatriating individual is deemed sold on the day before the expatriation. The income from such deemed sale is taxable on the day before expatriation after excluding $767,000 (calendar year 2022 inflation-adjusted amount) at the applicable marginal tax rate of the expatriating individual. If the expatriating individual is a long-term resident of the U.S., additional in-bound step-up in-basis rules are applied to determine the income subject to a mark-to-market tax regime.
      The determination of what property is considered held by an expatriating individual is quite complex. It includes interest in any property that would be taxable as part of the gross estate of the expatriating individual for federal estate tax purpose if that person were to die a day before the expatriation date. Because of the many variables and complexities involved, planning considerations should include consulting with at tax advisor who is well-versed with all these rules.

In summary, planning considerations before expatriating include:

• Determine if you are a U.S. citizen or long-term U.S. resident.
• Review whether you are compliant with all tax filings in the U.S. before expatriating.
• If necessary, consult a tax advisor to take steps necessary to become compliant with all U.S. tax filings.
• Determine whether you are a covered expatriate or a non-covered expatriate.
• If a covered expatriate, review all the assets held as well as the value of these assets, and obtain valuation reports to support the net worth test.
• Determine what assets are subject to a mark-to-market tax regime and what assets are subject to an alternative tax regime.
• Review assets subject to an alternative tax regime and decide the timing of taxation of these assets: date of expatriation or at distribution.
• Review assets subject to a mark-to-market tax regime and the tax impact.
• For a long-term U.S. resident who is a covered expatriate, not only review assets subject to mark-to-market tax regime but also the application of in-bound step-up in-basis rules to reduce income subject to tax upon a deemed sale.
• Review possible steps that may be taken well before expatriation to ensure that the asset is excluded from the estate as of the date of expatriation.
• Determine what is your date of expatriation. This is important because, broadly put, it is the date when the immigration authorities consider you as no longer a U.S. citizen or a long-term U.S. resident.
• File all required tax returns in the U.S., including Form 8854 (Initial and Annual Expatriation Statement).

Expatriation is not for the faint of heart. Many issues need to be reviewed, and many steps must be followed to make the process as smooth as possible. Engaging an advisor well-versed in this matter is one of the major planning considerations before undertaking successful expatriation.