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IRS Heavy Hand Blamed for Increase in Expatriations

“U.S. legislation is resulting in denial of financial services to Americans residing overseas.” This banner headline appears on the website of a U.S. expatriate group, the American Citizens Abroad, and underscores the new numbers from Treasury showing a record number of Americans renouncing their U.S. citizenship. In the first quarter of 2015, 1,336 individuals renounced their citizenship. This is the highest quarterly figure recorded since the Treasury Department started announcing the numbers in 1997.

Treasury is required under a 1996 law to publish a quarterly notice with the names of each person who renounces U.S. citizenship or terminates their long-term U.S. residency. The notice does not indicate the individuals’ reasons for leaving the U.S.

Looking at the annual data shows a clear trend. In 2014, a total of 3,417 gave up citizenship while in 2013, the number was 2,999. Given this upward trend and the first quarter 2015 figure, the number of expatriates could exceed 5,000 in 2015.

Tax Consequences of Leaving

Renouncing citizenship comes with a price tag, the so-called “expatriation tax.” This rule treats all property of a covered expatriate as if it had been sold for its fair market value on the day before the expatriation date. This “mark-to-market” rule requires that any gain or loss from the deemed sale is taken into account for the last tax year of citizenship. There is a mitigating provision, though. For 2014, the first $680,000 of gain is excluded. The exclusion amount is adjusted for inflation each year.

The expatriation rules don’t apply to everyone who gives up U.S. citizenship or residency. There are income and asset limits that exempt some taxpayers. The rules only apply to you if you meet any one of the following criteria:

  • Your average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than $160,000. This amount is adjusted yearly for inflation.
  • YYour net worth is $2 million or more on the date of your expatriation or termination of residency.
  • YYou fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation or termination of residency.

Expatriates must file Form 8854 with the IRS listing their foreign address, giving the date of expatriation, and identifying the property subject to taxation. There are hefty penalties for failing to do so.

Obama Administration Proposes Relief for Dual Citizens

Current law contains an exception from these rules for dual citizens who have had minimal contacts with the U.S. during the 15 years preceding the relinquishment of their U.S. citizenship. These individuals still must complete five years of U.S. tax filings before they can leave tax-free.

The Obama Administration’s latest budget proposal would exempt dual citizens from the expatriation tax and from certain reporting requirements. To qualify, the taxpayer must have become a dual citizen at birth, must have continuously maintained citizenship in another country and must not have been a U.S. resident since attaining age 18 ½. Also, the taxpayer should not have a U.S. passport or can have only used a U.S. passport to leave the country. This proposed relief rule for so-called “accidental citizens” is similar to the current treatment of nonresident aliens. Despite Obama’s support of this change, Congress has shown little interest in changing the taxation of dual citizens.

Reasons for Leaving

While there is a lot of debate over the reasons expatriations are increasing, several recent tax law changes seem to be driving the trend. With the new, complicated foreign financial reporting requirements, U.S. taxpayers living abroad are afraid of the huge penalties for failure to disclose their foreign assets. A related problem is the inability of these citizens to get a foreign bank account. The Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions to disclose their U.S. citizen accounts or face a 30% withholding penalty. Many of these institutions have decided to avoid this headache by refusing U.S. citizen deposits.

The American Citizens Abroad literature makes this observation about the problem: “The enactment of FATCA legislation in 2010 and the increased enforcement of FBAR reporting in the past few years have resulted in problems of financial access for overseas Americans. Because of this legislation, some foreign banks have refused to do business with Americans.”

While the expatriate numbers are relatively small given the total number of U.S. taxpayers, the upward trend is unsettling.

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