Moving to Another Country Can Greatly Impact Your Tax Planning
September 12, 2022
By Ragini Subramanian
There are many things that attract people to relocate to the U.S. and, by the same token, many U.S. citizens are lured to other jurisdictions. What is often forgotten is how the U.S. Treasury taxes U.S. citizens and green card holders who travel outside U.S. borders to live or work—temporarily or permanently—in foreign jurisdictions.
Impact on Income and Estate Taxes
U.S. citizens are subject to income tax in the U.S. on their worldwide income as well as U.S. tax return and foreign information return filing requirements. The country they call home—temporarily or permanently—after they leave the U.S. may also impose income tax on some of the same income that is taxed by the U.S.
A relief from double taxation is available in the U.S. either in the form of a foreign tax credit to offset taxes payable in the U.S., taking advantage of the foreign income exclusion provisions of the U.S. tax code, or availing double-tax relief afforded under a tax treaty between the U.S. and the foreign jurisdiction that is now the home. However, all this may not be as simple as it sounds:
- The availability of a foreign tax credit may be limited (i.e., due to a smaller ratio of foreign source income to the U.S. source income, the foreign country tax rate is higher than that in the U.S., or the foreign tax is not eligible for foreign tax credit).
- One may not meet the strict parameters of the foreign income exclusion rules (i.e., does not have a closer connection to the foreign country, does not meet the parameters of the tax home test, does not meet a continuous period of 330 days presence in a foreign country, or they are not present in the foreign jurisdiction for any period of 12 months).
- No treaty exists between the U.S. and a given foreign country (e.g., U.S. and Hong Kong), or the existing treaty does not provide relief from double taxation for a particular item of income. Contributions to a retirement plan of an employer of a foreign country often fall under this.
What about transfer taxes, such as lifetime gifts and estate taxes upon passing. While there are several avenues to avoid double taxation with respect to income tax, there are not many options regarding gift tax or estate taxes. A U.S. citizen is subject to gift and estate taxes in the U.S. no matter where the U.S. citizen lives, works, gives away property or passes away. The country of residence’s gift, transfer or estate tax rules may also impose a gift or transfer tax. There are a far greater number of income tax treaties than there are gift and estate tax treaties between the U.S. and foreign countries that provide relief from double taxation. By the same token, fewer countries have gift or estate tax laws similar to those in the U.S. In many instances, gifts to close relationships—such as parents, children, brothers and sisters—are not subject to transfer taxes. That, however, does not take away the fact that the U.S. gift and estate tax laws remain applicable.
Therefore, it is very important to evaluate the income, gift and estate tax implications if you and your spouse have chosen to retire to another nation or if you are relocating to another country for a career opportunity.
Does Relinquishing Your U.S. Citizenship or U.S. Residency Make Sense?
You may think, forget it, I will just give up my U.S. citizenship or my green card to get away from the U.S. tax system. However, while this may work in some cases, it will not be the right option in all instances. If you are a U.S. citizen or considered a long-term resident of the U.S. and (1) meet a certain net worth threshold of more than $2 million, not inflation adjusted; (2) meet a tax liability threshold for 2022 average net income tax liability for the five tax years immediately before expatriation of not more than $178,000, inflation adjusted; or (3) simply do not or cannot certify that you are fully compliant with all applicable U.S. tax laws, you are considered a “covered expatriate” under a U.S. tax regime popularly known as the “exit tax.” With respect to certain assets, a covered expatriate is taxed in the U.S. before leaving the U.S. on the gain—after excluding up to $767,000 for 2022 plus inflation adjusted—as if the assets were sold at fair market value as of the date of expatriation. Other assets (e.g., pension plan, education savings plan) are taxed at the election and subject to a complex set of rules as of the date of expatriation or when income is received after a person leaves the U.S. In the latter case, the person may remain subject to tax in the U.S. and specific tax return filing requirements only on that income source and any other income source that may be considered U.S. source. The mistake many people make is returning to the U.S. after relinquishing their U.S. citizenship or green card and reestablishing U.S. tax residency, which places them back at square one.
The exit tax may not be that bad, but in the absence of proper planning, relinquishing your U.S. citizenship or green card can have other tax implications. The gift and estate tax exemption is lost if you forsake your citizenship. The exemption is $10 million, inflation-indexed ($12.06 million in 2022) for the years 2018 through 2025. Instead, you're limited to a nonresident exemption of just $60,000. A 40% gift tax after only a $15,000 annual exclusion on gratuitous transfers of tangible property (e.g., cash, U.S. real property) located in the U.S. can make gift giving more expensive. The sale of U.S. real property located in the U.S. requires additional compliance under the U.S. Foreign Investment in Real Property Tax Act of 1980. A partnership interest in the U.S. partnership or foreign partnership deriving income in the U.S. may subject a nonresident to a multitude of tax withholding regimes depending on whether the partnership is engaged in passive activity or in an active trade or business in the U.S. It may also generate tax return filing requirement in the U.S.
Make Informed Decision
Your assets and estate plan can be subject to a significant impact immediately and as you plan for the future if you move abroad. Before going overseas, consult with your tax professional about your plans and the tax implications.