Guide to US Expatriation Tax Requirements

It doesn’t matter whether you’re a US expat in Canada, Mexico, China, or any other country on earth: when it comes to compliance with expatriation tax, the rules depend not on which nation you moved to, but on the specific date you expatriated from the United States.  In this tax blog entry,  international CPA Ted Kleinman of US Tax Help will explain some basic US expatriation tax requirements, including which set of rules you must follow, which forms you must file — and the penalties if you don’t.

What is Expatriation Tax (Exit Tax)?

In plain terms, an expatriation tax or “exit tax” is simply a tax on individuals who give up their status as a tax resident in their home country — in this case, the United States.  The laws pertaining to US expatriation tax are supplied by IRC (Internal Revenue Code) Sections 877 and 877A, respectively titled “Expatriation to avoid tax” and “Tax responsibilities of expatriation.”

The provisions of IRC 877 and 877A may potentially apply to you, regardless of whether you are an expatriate living in Switzerland, Singapore, or any other nation, if either of the following statements are true:

  • You have renounced your US citizenship.
  • You are a long-term resident who has terminated your status as a US resident for tax purposes.

However, depending on when you left the United States, additional requirements may be applicable. The IRS filters US expatriates into three broad categories by date of expatriation as follows:

  • On or before June 3, 2004
  • After June 3, 2004, but before June 16, 2008
  • On or after June 16, 2008

Let’s take a closer look at each of these categories one at a time to see which rules and provisions apply to each.

On or Before June 3, 2004

If you fall into this category, expatriation tax applies to you if you meet the citizenship/residency requirements discussed earlier, so long as one of the main reasons for your expatriation was US tax avoidance.  The IRS assumes a motivation of tax avoidance if you either:

  • Had a net worth of or exceeding $622,000 the day you expatriated.
  • Had an average annual net income tax exceeding $124,000 for the five years prior to expatriating.

Expatriation tax lasts for a 10-year period.  You should have filed Form 8854 (Initial and Annual Expatriation Statement).

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After June 3, 2004, Before June 16, 2008

If you fall into this category, you are subject to certain amendments to IRC Section 877 supplied by the American Jobs Creation Act of 2004, or AJCA.  In accordance with the AJCA amendments, you may be subject to expatriation tax if your average income tax liability, for the five years before you expatriated, meets or exceeds the following totals:

  • $124,000 for 2004
  • $127,000 for 2005
  • $131,000 for 2006
  • $136,000 for 2007
  • $139,000 for 2008
  • Net worth of $2,000,000 on the date you expatriated from the US.

You are required to:

  • Formally certify that you were fully compliant with all tax reporting and tax payment requirements dating back five years before you expatriated.  Be forewarned the IRS will carefully scrutinize your certification for accuracy.
  • Pay US tax on your worldwide income for the next 10 years after you expatriate, provided that, during a given year:
    • You were physically present in the United States for over 30 days.
    • You were physically present in the United States for over 60 days, if you were working for an employer in the US.

The IRS will continue to treat you like a US citizen or long-term resident until you have provided notice of your expatriation to both the IRS and either (1) the Secretary of the Department of State (if you were a citizen) or (2) the Department of Homeland Security (if you were a long-term resident). In other words, you are required to file Form 8854.

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On or After June 16, 2008

If you expatriated on or after June 16, 2008, you are considered to be a “covered expatriate” if any of the three following statements are true:

  • On the day you expatriated, your net worth was $2,000,000 or greater.
  • You failed to certify, via Form 8854, that you complied with all tax requirements dating back five years prior to your expatriation.
  • For the five years preceding your expatriation, your annual net income tax, on average, surpassed the following totals:
    • $145,000 for 2009
    • $145,000 for 2010
    • $147,000 for 2011
    • $151,000 for 2012
    • $155,000 for 2013
    • $157,000 for 2014

(Note that, unusually, the total does not change from 2009 to 2010.)

As stated on the IRS’ Instructions for Form 8854, as a covered expatriate, with a few exceptions “you are subject to income tax on the net unrealized gain in your property as if the property had been sold for its fair market value on the day before your expatriation date.”  This is reflected by IRC Section 877A(a)(1), which states, “All property of a covered expatriate shall be treated as sold on the day before the expatriation date for its fair market value.”  This is known as the mark-to-market tax.

As a covered expatriate, you should also be forewarned that any US citizen who receives a gift or inheritance from you may be very heavily taxed — generally at a rate of 40%.

Regardless of which of the above three categories you belong to, the penalties for failure to file Form 8854 can be severe.  Willful failure to file this form constitutes a violation of IRC Section 6039G (“Information on individuals losing United States citizenship”), and accordingly, may be penalized with a hefty fine of up to $10,000.  Of course, a complete failure to file isn’t necessary to trigger massive civil penalties: you can also be fined with the $10,000 penalty for filing the form with inaccurate or incomplete information.

Expatriation taxes are extremely complex — and the penalties for noncompliance can be devastating. As a taxpayer, it is in your best financial interests to work with a knowledgeable CPA who has experience handling international tax matters, like Ted Kleinman.  To start discussing your situation with Ted in a private consultation, call US Tax Help today at (541) 923-0903.