Expatriation Tax Planning for US Citizens

In the U.S., a special “expatriation” tax regime exists to deter “wealthy” U.S. citizens from relinquishing their citizenship in order to avoid future U.S. taxes. Under this tax regime, so-called “covered expatriates” are treated for U.S. income tax purposes as having sold all property in which they are considered to own an interest. The sale is considered to occur on the day before their expatriation date and at the then fair market value of their assets in calculating their income tax for their last tax year as a U.S. citizen. (For my Canadian dual citizen clients, this “deemed disposition” of property is similar to that which occurs under the so-called Canadian “departure“ tax. That “departure” tax treats a Canadian income tax resident as having sold certain assets at fair market value at the time they cease to be a Canadian income tax resident.) In calculating the amount of the net gain subject to tax (i.e., the excess of taxable gains over deductible losses), the first US$744,000 of net gains is excluded (for expatriations occurring in 2021).

You are a “covered expatriate” to whom the tax regime applies at the time of relinquishing your citizenship if either:

1. the value of your worldwide assets (as determined for U.S. estate tax purposes) exceeds US$2.0 million;
2. your average U.S. income tax paid during the five years preceding relinquishment exceeds US$172,000 (for expatriations occurring in 2021), including taxes attributable to your spouse’s income if you file a joint return; or
3. you are not current with all of your U.S. tax compliance obligations, including income, employment and gift tax obligations, as well as U.S. information reporting obligations, have not paid all relevant tax liabilities, interest and penalties for such years or are unable to submit evidence of such compliance at the time of relinquishing your citizenship.

There are several US tax consequences of becoming subject to the US “expatriation” tax regime, in addition to the “deemed” sale of your worldwide assets mentioned above. Additionally:

1. previously untaxed income may either be accelerated or subjected to a 30% withholding tax when distributed to you (this applies to certain deferred compensation, as well as to certain tax deferred accounts, including individual retirement accounts, education savings accounts and health savings accounts; it also applies to certain incomplete transactions such as deferred like-kind exchanges and involuntary conversions);
2. subsequent distributions from a trust of which you are a beneficiary may be subject to a U.S. withholding tax of 30%, even if such distributions would not have otherwise been subject to tax to a U.S. nonresident (e.g., because they are considered to be of foreign source income) and if the distribution by the trust is of appreciated property, taxable gain is recognized by the trust as if the property were sold to the expatriate at its fair market value; and
3. a special transfer tax system will follow the covered expatriate for the rest of his or her life to tax any U.S. persons receiving gifts or bequests of foreign (e.g., Canadian) situs property from them.

We advise US citizens concerning planning for the relinquishment of US citizenship, including planning to avoid “covered expatriate” status. In our experience, the most effective expatriation tax planning occurs when a cross-border tax planning attorney is consulted long before the date you wish to relinquish your citizenship. We are also experienced advising those who become subject to the special inheritance tax regime. We welcome any inquiries that you may have concerning your specific tax situation. Feel free to call us at (760) 578-5093, contact us via email at Brent@LanceCrossborder.com or by using our online contact form. We will respond to all relevant inquiries quickly, without any obligation.