Each year, we see more and more people “expatriating” from the United States. Indeed, in 2015, almost 4,300 individuals expatriated, and in 2016 more than 5,400 individuals expatriated. 2017 may be on pace to be the highest year for expatriations, with more than 4,400 individuals expatriating through the first three quarters of the year.1 Although each case is unique, this overarching trend may be due in large part to the increased reporting and compliance obligations that the United States imposes on U.S. taxpayers with foreign assets.2 With expatriation numbers on the rise, it is a good time to review the tax implications of an individual cutting ties with the United States. This article will discuss the U.S. tax rules governing expatriations, highlighting some traps for the unwary and offering planning techniques that can be implemented to avoid, or at least mitigate, the potentially harmful economic effects of expatriation. It will also demonstrate that for some wealthy or soon-to-be-wealthy individuals, expatriation can be an extremely prudent financial decision for tax purposes.
1 Fourth-quarter data was not yet available at the time of publication of this article.
2 A discussion of the Foreign Account Tax Compliance Act (commonly referred to as “FATCA”) and the various other reporting obligations imposed on U.S. taxpayers with respect to their foreign assets is beyond the scope of this article.
Expatriations are governed by the rules enacted as part of the Heroes Earnings Assistance and Relief Tax Act of 2008 (the “HEART Act”).3 These rules apply to individuals expatriating on or after June 17, 2008, and are found mainly in §877A and §2801.4 Under these rules, a mark-to-market “exit tax” is imposed on an individual classified as a “covered expatriate.”5 Additionally, a special transfer tax can be imposed on the U.S. recipient of a gift or bequest received from a covered expatriate.6 For individuals expatriating before June 17, 2008, a different set of rules applied; however, with the passage of time, these rules become less relevant.7
3Pub. L. No. 110-245 (June 17, 2008).
4 All section (“§”) references are to the Internal Revenue Code of 1986, as amended (the “Code”), or the Treasury regulations thereunder, unless otherwise specified.
5See generally §877A; Notice 2009-85, 2009-45 I.R.B. 598.
6See generally§2801; Prop. Reg. §28.2801-1 through §28.2801-7.
7 For a good discussion of these rules and their dwindling relevance, see Thomas S. Bissell, How to Calculate the 10-Year Period for Expatriates Under ‘Old’ §877 , 46 Tax Mgmt. Int’l J. 458 (Aug. 11, 2017).
In assessing the potential U.S. tax consequences of expatriating, one must determine whether an individual is considered an “expatriate.” An expatriate is defined as any U.S. citizen who relinquishes citizenship, and any long-term resident of the United States who ceases to be a lawful permanent resident of the United States.8 This definition is easy to understand in the case of a U.S. citizen. Even those non-tax practitioners can identify U.S. citizens with relative ease, and relinquishing citizenship is commonly done pursuant to a renunciation before a diplomatic or consular officer. A little more investigation is necessary, however, in the case of a long-term resident who ceases to be a lawful permanent resident of the United States.
A “long-term resident” is any individual (other than a U.S. citizen) who was a “lawful permanent resident” of the United States in at least eight of the last 15 years leading up to the expatriation.9 In common terms, this refers to individuals who have possessed a green card in eight out of 15 years before they expatriate. To cease being a lawful permanent resident of the United States, the individual’s status must have been revoked or administratively or judicially determined to have been abandoned.10 As discussed in more detail, below, residency status can also cease through the use of an income tax treaty.
An individual’s “expatriation date” is defined under the current expatriation regime. In the case of a U.S. citizen, the expatriation date is the date an individual relinquishes U.S. citizenship.11 In the case of a long-term resident, the expatriation date is the date on which the individual ceases to be a lawful permanent resident of the United States.12
A few traps exist that can catch those who are unfamiliar with some of the nuances of the current expatriation regime. The first is the misperception that an individual must hold a green card for eight full years to be considered a long-term resident. For U.S. income tax purposes, however, an individual is considered a resident alien with respect to a calendar year if such individual is a lawful permanent resident at any time during the calendar year.13 Accordingly, holding a green card for any portion of a year counts as a full year of lawful permanent residence for purposes of the expatriation regime.14
13 Reg. §301.7701(b)-1(b)(1).
14 As a result, an individual could hold a green card for just over six years and be considered a long-term resident. For example, an individual who received a green card on December 31, 2010, and formally abandoned the green card on January 2, 2017, would be considered to have been a lawful permanent resident of the United States for eight years.
Second, when considering abandonment it is important to note that regulations prescribe the process for formally abandoning an individual’s status as a resident. Giving up your green card or letting it expire is not sufficient. In particular, when the individual initiates the process of abandoning resident status, such status is considered to be abandoned only when the individual’s application for abandonment or a letter stating the alien’s intent to abandon his or her resident status, accompanied by the Alien Registration Receipt Card, is filed with U.S. Citizenship and Immigration Services (“USCIS”) or a consular officer.15 Hence, one cannot informally abandon a green card, and unless an individual follows the appropriate procedures, such individual will continue to be classified as a resident for purposes of the expatriation regime. Recent Tax Court cases involving the same taxpayer highlight how costly it can be if an individual does not follow the proper procedure to expatriate.16
15 Reg. §301.7701(b)-1(b)(3).
16Topsnik, 143 T.C. 240 (2014); Topsnik, 146 T.C. 1 (2016).
Another important point is the interaction of U.S. income tax treaties and the effect of such treaties on the expatriation rules.17 These treaties typically contain residency “tie-breaker” provisions under which a green-card holder could claim to be a resident of the treaty partner country, provided certain requirements are met. If an individual claims to be treated as a resident of a foreign country under a tax treaty, does not waive the benefits of the treaty applicable to residents of the foreign country, and properly notifies the IRS of such treatment, such individual ceases to be treated as a lawful permanent resident of the United States.18 This can have one of two effects for expatriation purposes. If an individual has already been a lawful permanent resident of the United States for eight of the last 15 years and claims residency under a treaty, this will trigger an expatriation, bringing with it the attendant income tax consequences.19 If the individual has not yet reached the eight-year threshold, claiming treaty residency effectively tolls the accrual of years, such that a green card holder could avoid reaching the eight-year mark — thereby avoiding classification as a long-term resident — by continually claiming residency under an income tax treaty.20
17 The United States has entered into over 60 income tax treaties with various countries. See https://www.irs.gov/businesses/international-businesses/united-states-income-tax-treaties-a-to-z.
19 IRS Form 8833 is the form that must be filed in order for an individual to claim residence under an income tax treaty. The IRS notes the expatriation implications right in the top section of the form: “If the taxpayer is a dual-resident taxpayer and a long-term resident, by electing to be treated as a resident of a foreign country for purposes of claiming benefits under an applicable income tax treaty, the taxpayer will be deemed to have expatriated pursuant to section 877A.”
‘COVERED EXPATRIATE’ STATUS
Having established who qualifies as an expatriate, the next step is to determine if the individual is a “covered expatriate.” Covered expatriate status is defined by three tests, and an individual need meet only one of the tests to be considered a covered expatriate.21 Under the first test, commonly referred to as the “Tax Liability Test,” an individual is a covered expatriate if his average annual net income tax liability for the five (5) years preceding expatriation exceeds a specified threshold (the base amount is $124,000), indexed annually for inflation ($162,000 for 2017, $165,000 for 2018).22 Under the second test, commonly referred to as the “Net Worth Test,” an individual is a covered expatriate if his or her net worth as of expatriation is $2,000,000 or more.23 Under the third test, commonly referred to as the “Certification Test,” an individual is a covered expatriate if he or she fails to certify under penalty of perjury that he or she has complied with all federal tax obligations for the five (5) years preceding the expatriation.24 This certification must be made on Form 8854 and is filed with the covered expatriate’s U.S. income tax return for the year of expatriation.25
23§877(a)(2)(B). The $2 million threshold is not indexed for inflation.
25Notice 2009-85, §2A.
Exceptions to the foregoing definition exist for certain dual citizens and minors. For example, an individual may avoid being classified as a covered expatriate if, at birth, he or she became a citizen of the United States and a citizen of another country and, as of the expatriation, he or she continues to be a citizen of, and is taxed as a resident of, such other country.26 An individual may also avoid covered expatriate status if he or she relinquishes U.S. citizenship before he or she attains 18.5 years of age.27 For each exception to apply, however, the individual must not have spent too much time in the United States prior to the expatriation. In the case of the dual citizen exception, the individual must not have been a resident under the “substantial presence test” for more than 10 years out of the 15 years leading up to the expatriation.28 In the case of minors, the individual must not have been a resident under the substantial presence test for more than 10 years before the expatriation.29 The substantial presence test will be discussed in more detail later in this article.
Another potential trap should be noted here. Although the foregoing exceptions may seem tantamount to a “get out of jail free card,” these exceptions only protect an individual from covered expatriate status under the Tax Liability and Net Worth Tests. No exception exists for the Certification Test. Hence, failure to comply with the Certification Test results in automatic covered expatriate status. Given the burdensome reporting requirements that can apply in the case of a U.S. taxpayer with foreign holdings, individuals considering expatriating are advised to review their U.S. tax filings for the previous five (5) years to determine whether they have complied with all federal tax obligations.
THE EXIT TAX
Having determined that an individual is a covered expatriate, the next step is assessing the potential effect of the exit tax. If an individual is a covered expatriate, the individual is deemed to have sold all of his or her property on the day before the expatriation date for fair market value.30 Individuals pay tax on the net gain on the deemed sale at generally applicable U.S. tax rates based on the character and holding period of the asset. The amount of gain required to be recognized is reduced, however, by an exclusion amount, indexed annually for inflation (with a base amount set at $600,000 and increased to $699,000 for 2017; $713,000 for 2018).31 Special rules apply for allocating the exclusion amount among the covered expatriate’s assets.
While this gain exclusion amount can serve as a shield against the exit tax, it is important to note that it does not apply outside of the expatriation regime. Of particular note — and especially to those in the estate planning field — is the interaction with §684. Under §684, gain is generally imposed on transfers by a U.S. person to a foreign trust. Although an exception is provided for transfers to foreign grantor trusts, if a foreign grantor trust becomes a nongrantor trust, the U.S. person is generally treated as having transferred the assets to a foreign trust immediately prior to the cessation of grantor trust status, triggering a deemed sale under §684.32 Many times as a result of an expatriation, a trust which was previously classified as a domestic grantor trust as to the covered expatriate can become a foreign nongrantor trust, resulting in gain recognition under §684. The expatriation rules specifically provide that §684 applies before the expatriation rules.33 Accordingly, the gain exclusion amount provided under §877A is not available to shelter gain required to be recognized under §684. Guidance issued by the IRS confirms the application of such treatment: “A covered expatriate’s expatriation may cause a domestic trust of which the covered expatriate was treated as the owner on the day before the expatriation date to become a foreign trust … If a covered expatriate’s expatriation also causes the covered expatriate to cease to be treated as the owner of the trust, appreciated property held by the trust will generally be subject to the gain recognition rules of section 684.”34
32 Reg. §1.684-2(e).
34Notice 2009-85, §4.
Certain types of property are specifically excluded from mark-to-market tax treatment, including certain deferred compensation items, specified tax-deferred accounts, and interests in nongrantor trusts.35 For these assets, the covered expatriate is either subject to a 30% withholding tax on distributions when received, or is treated as having received a distribution of his or her entire interest the day before he or she expatriates.36 A covered expatriate with these types of assets must comply with certain reporting requirements, including filing Form W-8CE with the relevant payor.37
36§877A(d), §877A(e), and §877A(f).
37Notice 2009-85, §8D.
Deferred compensation items include most work-related tax-qualified retirement plans, including 401(k) plans.38 Deferred compensation items are classified as either “eligible deferred compensation items” or “ineligible deferred compensation items.” An eligible deferred compensation item is any deferred compensation item with respect to which: (i) the payor is a U.S. person (or if not, such payor has elected to be treated as a U.S. person for purposes of the expatriation rules); and (ii) the covered expatriate notifies the payor of his or her status as a covered expatriate (on Form W-8CE) and irrevocably waives any right to claim any withholding reduction under any treaty with the United States.39 If the foregoing conditions are satisfied, the payor must deduct and withhold 30% of the “taxable payment” made to the covered expatriate.40 A taxable payment is defined as any payment to the extent it would be includible in the gross income of the covered expatriate if such expatriate continued to be subject to tax as a citizen or resident of the United States.41 Ineligible deferred compensation items are those deferred compensation items not treated as eligible deferred compensation items.42 For these ineligible items, the covered expatriate is treated as having received an amount equal to the present value of the covered expatriate’s accrued benefit on the day before the expatriation date as a distribution under the plan.43 No early distribution tax will be imposed as a result of the foregoing treatment.44
38Notice 2009-85, §5B.
42Notice 2009-85, §5B.
Specified tax-deferred accounts include items such as individual retirement accounts, 529 accounts, and Coverdell savings accounts, among others.45 If a covered expatriate holds an interest in a specified tax-deferred account, such person is treated as having received a distribution of his or her entire interest in such account on the day before the expatriation date.46 No early distribution tax will apply as a result of the deemed distribution.47 A covered expatriate must provide Form W-8CE to the payor of the account (generally within thirty (30) days of expatriating), and within sixty (60) days of receiving the Form W-8CE, the payor must provide a written statement to the covered expatriate setting forth the amount of the covered expatriate’s account balance on the day before the expatriation date.48
46Notice 2009-85, §6.
48Notice 2009-85, §8D.
In identifying property subject to the exit tax, U.S. estate tax principles are used. For purposes of computing the tax liability under the mark-to-market regime, a covered expatriate is considered to own any interest in property that would be taxable as part of his or her gross estate for U.S. estate tax purposes as if he or she had died on the day before the expatriation date as a U.S. citizen or resident.49 This raises an interesting question for those covered expatriates who are deemed to be the owner of a trust’s assets under the grantor trust rules, found generally in subpart E of Part I of subchapter J of the Code.50 While the income of such a trust is taxable to the deemed owner of the trust’s assets (i.e., the grantor), these trusts are often drafted such that the trust’s assets are not includible in the gross estate of the grantor upon his or her death. Thus, an argument might be made that such assets should not be subject to the exit tax in the case of a covered expatriate. This argument is aggressive, however, as the Joint Committee on Taxation stated in the legislative history of §877A that “[i]n the case of the portion of any trust for which the covered expatriate is treated as the owner under the grantor trust provisions of the Code, as determined immediately before the expatriation date, the assets held by that portion of the trust are subject to the mark-to-market tax.”51 In its own guidance, the IRS states: “If the covered expatriate is treated as the owner of any portion of a trust under the grantor trust rules (sections 671 through 679) on the day before the expatriation date, the assets held by that portion of the trust are subject to the mark-to-market regime.”52
49Notice 2009-85, §3A.
51 Joint Comm. on Taxation, Technical Explanation of H.R. 6081, the “Heroes Earnings Assistance and Relief Tax Act of 2008,” As Scheduled for Consideration by the House of Representatives on May 20, 2008 (JCX-44-08), at 43 (May 20, 2008).
52Notice 2009-85, §1.
Staying on the topic of trusts, for all other income tax purposes, a nongrantor trust is a trust of which the grantor (or some other person) is not deemed to be the owner of the trust’s assets under the Code’s grantor trust rules. For expatriation purposes, however, a nongrantor trust means the portion of any trust (whether domestic or foreign) of which the expatriate is not considered to be the owner under the grantor trust rules.53 Accordingly, an expatriate could be the beneficiary of a trust that is classified as a wholly owned grantor trust as to somebody other than the expatriate but still as a nongrantor trust for purposes of applying the expatriation rules.
53§877A(f)(3); Notice 2009-85, §7.
The effect of this definition may ultimately benefit the covered expatriate. As previously mentioned, interests in nongrantor trusts are not subject to the general mark-to-market rules of §877A(a). Rather, the trustee of a nongrantor trust of which the covered expatriate is a beneficiary is generally required to deduct and withhold 30% of the “taxable portion” of any direct or indirect distribution to the covered expatriate.54 The taxable portion of such a distribution is defined as the portion of the distribution that would have been includible in the covered expatriate’s gross income if the covered expatriate had continued to be subject to tax as a citizen or resident of the United States.55 Distributions from grantor trusts, however, are not taxable to beneficiaries under U.S. income tax principles. Accordingly, the covered expatriate should be able to avoid the 30% withholding tax when receiving distributions from a trust treated as a grantor trust as to a third party for general income tax purposes but treated as a nongrantor trust for expatriation purposes.
DEFERRING THE TAX
An individual may elect to defer payment of the exit tax. The election is irrevocable and is made on an asset-by-asset basis.56 If the covered expatriate makes the election, payment of tax attributable to a particular asset is deferred until the year in which the property is disposed.57 To make the election, however, the individual must provide adequate security with respect to such property and must waive any right under any U.S. treaty that would preclude assessment or collection of any tax imposed by reason of §877A.58 The covered expatriate must also enter into a tax deferral agreement with the IRS.59 Additionally, interest on the deferred tax amount accrues at the rate generally applicable to interest on underpayments (currently 4%).60
58Notice 2009-85, §3E.
A simplified example based on guidance issued by the IRS illustrates how the deferral election works.61 Assume that a covered expatriate (“CE” for purposes of this example) relinquishes citizenship on October 1, 2017 (and is therefore deemed to have sold all of his assets on September 30, 2017). CE has taxable income without regard to the deemed sale (compensation for services rendered), on which CE owes $300,000 of U.S. income tax. CE owns two assets subject to the exit tax rules (Asset “A” and Asset “B”), each of which has $500,000 of built-in gain that will be includible in CE’s gross income as a result of the deemed sale under §877A (taking into account the gain exclusion amount). CE’s total tax liability in the year of expatriation is $500,000. Accordingly, $200,000 is the amount of tax allocated among the assets deemed sold pursuant to §877A and, in this example, is attributable equally to Asset A and Asset B.62 CE elects to defer the tax liability attributable to each of the assets subject to the exit tax rules (i.e., CE elects to defer the $100,000 tax liability attributable to Asset A and the $100,000 tax liability attributable to Asset B). Accordingly, of the $500,000 total U.S. income tax owed, CE will only pay $300,000 in 2017 due to the deferral election. If, instead, CE had made a deferral election with respect to Asset A only, CE would owe $400,000 in U.S. income tax in 2017 with the remaining $100,000 owed in the year CE actually disposes of Asset A.
62 The tax attributable to a particular asset is the tax imposed by reason of §877A (in this example $200,000) multiplied by a fraction, the numerator of which is the gain on the deemed sale of the particular asset ($500,000 in this example), the denominator of which is the total gain with respect to all built-in gain assets ($1,000,000 in this example). §877A(b)(2).
INCOME TAX FILING REQUIREMENTS
The covered expatriate must also be aware of the numerous tax filings required by expatriating, particularly in the year of expatriation. A U.S. income tax return will be required in the year of expatriation, and a covered expatriate must file a “dual-status return” if he or she was a U.S. citizen or long-term resident for only part of the taxable year that includes the day before the expatriation date (likely to be the case in the year of expatriation, unless the individual expatriates on January 1).63 To file a dual-status return, the covered expatriate files a U.S. Nonresident Alien Income Tax Return (Form 1040NR) and attaches to it as a schedule a U.S. Individual Income Tax Return (Form 1040).64 The Form 1040 should be marked “Statement” across the top and show the income tax computation for the part of the taxable year during which the individual was a U.S. citizen or resident.65 The covered expatriate should keep in mind that even in the years following expatriation, he or she may be required to file a Form 1040NR to report certain U.S.-source income earned as a nonresident alien.66
63Notice 2009-85, §8B.
64 Reg. §1.6012-1(b)(2)(ii)(b).
66Notice 2009-85, §8B; Reg. §1.6012-1(b)(1).
The covered expatriate must also file Form 8854 to certify that he or she has complied with all federal tax obligations for the five (5) years preceding the expatriation.67 Form 8854 is required under the Certification Test and is necessary to, among other things, waive treaty benefits when needed, such as in the case of eligible deferred compensation items.68 The Form 8854 must be attached to the covered expatriate’s U.S. income tax return for the year of expatriation, and the covered expatriate is considered to have timely filed the form it if is filed by the due date of the tax return (including extensions).69
67Notice 2009-85, §8C.
Form W-8CE may also be required for a number of reasons. A covered expatriate who owns a deferred compensation item, a specified tax deferred account, or an interest in a nongrantor trust must file Form W-8CE with the relevant payor on the earlier of: (i) the day prior to the first distribution on or after the expatriation date; or (ii) 30 days after the covered expatriate’s expatriation date.70 The Form W-8CE notifies the payor that the individual is a covered expatriate. Failure to provide this form can have significant consequences, such as converting what would have been an eligible deferred compensation item to an ineligible deferred compensation item, resulting in deemed distribution treatment instead of a 30% withholding tax.
70Notice 2009-85, §8D.
TRANSFER TAX CONSEQUENCES
Covered expatriates, or perhaps more accurately their U.S. family members, must also deal with a special transfer tax. The tax is imposed under §2801, and the Treasury issued proposed regulations in 2015 providing further guidance on the tax.71 Under these rules, U.S. recipients pay tax at the highest gift or estate tax rate (currently 40%) on the receipt of a so-called covered gift or bequest.72 A “covered gift” means any property acquired by gift directly or indirectly from an individual who is a covered expatriate at the time the property is received.73 As used in the definition of covered gift, the term “gift” has the same meaning as it does under normal U.S. gift tax principles, but without regard to various exceptions.74 A “covered bequest” means any property acquired directly or indirectly by reason of the death of a covered expatriate.75 Property acquired “by reason of the death of a covered expatriate” includes property that would have been includible in the gross estate of the covered expatriate under normal U.S. estate tax rules had the covered expatriate been a U.S. citizen at the time of death.76
71REG-112997-10, 80 Fed. Reg. 54,447 (Sept. 10, 2015).
73§2801(e)(1)(A); Prop. Reg. §28.2801-2(g).
74 Prop. Reg. §28.2801-3(a). For example, the exclusion of direct payments for certain educational and medical expenses under §2503(e) does not apply. Id.
75§2801(e)(1)(B); Prop. Reg. §28.2801-2(f).
76 Prop. Reg. §28.2801-3(b).
Unlike general U.S. transfer tax rules where tax is imposed on the donor (in the case of a gift) or the estate of the decedent (in the case of a bequest), the transfer tax imposed under the expatriation regime must be paid by the person who receives the property.77 Accordingly, a U.S. recipient who acquires property from someone who has expatriated must determine whether such person was a covered expatriate, and whether the receipt of the property triggers transfer tax consequences.78 The proposed regulations even create presumptions in certain circumstances. For example, in the case of gifts, unless the living donor makes certain information available to the U.S. recipient, “there is a rebuttable presumption that the donor is a covered expatriate and that the gift is a covered gift.”79
78 Prop. Reg. §28.2801-7(a).
79 Prop. Reg. §28.2801-7(b)(2).
The tax applies to property regardless of where the property is located, and regardless of whether the covered expatriate acquired the property before or after expatriating.80 Further, whereas donors can typically gift up to $14,000 free of gift on a per-donee basis (increasing to $15,000 in 2018), U.S. recipients receive only one annual exclusion amount, such that all covered gifts or bequests are subject to the tax once the total in any calendar year exceeds the annual exclusion amount.81
80 Prop. Reg. §28.2801-2(f), §28.2801-2(g).
Note also that the residency status of the recipient of the property is determined under U.S. transfer tax principles, meaning that in the case of a non-U.S. citizen, such person will be subject to the tax if he or she is domiciled in the United States.82 “Domicile” requires physical presence in a particular location coupled with the intent to remain there indefinitely.83 Domicile is based on a number of factors, and determining whether a person is a U.S. domiciliary is a subjective analysis (unlike in the case of determining residency for U.S. income tax purposes, which is based on objective tests).
82 Prop. Reg. §28.2801-2(b). As the preamble to the proposed regulations states: “The proposed regulations define the term ‘citizen or resident of the United States’ as an individual who is a citizen or resident of the United States under the estate and gift tax rules of chapter 11 and chapter 12, respectively, in subtitle B of the Code. Accordingly, whether an individual is a ‘resident’ is based on domicile in the United States, notwithstanding that section 877A adopts the income tax definition of that term. The Treasury Department and the IRS believe that, because section 2801 imposes a tax subject to subtitle B, the tax definition of resident under subtitle B generally should apply for purposes of section 2801.”
83See Reg. §20.0-1(b)(1), §25.2501-1(b).
Certain transfers are excepted from the imposition of the transfer tax. For example, property subject to U.S. gift or estate tax and properly reported on a timely filed U.S. gift or estate tax return is not subject to tax under the expatriation regime.84 To qualify for the foregoing exception, however, the covered expatriate (or his or her estate) must also timely pay the U.S. gift or estate tax due.85 Additionally, transfers that would have otherwise qualified for the charitable or marital deduction are not subject to tax.86 Gifts to spouses who are not U.S. citizens do not qualify for the unlimited marital deduction; however, such transfers are entitled to an increased annual exclusion amount (a base of $100,000, indexed annually for inflation) on which U.S. gift tax will not be imposed ($149,000 for 2017, $152,000 for 2018).87 The proposed regulations confirm that to the extent a transfer qualifies for this increased annual exclusion amount, such transfer will not be considered a covered gift subject to the §2801 tax.88
85 Prop. Reg. §28.2801-3(c).
88See Prop. Reg. §28.2801-3(f)Ex. (1).
Specials rules also apply to transfers in trust. In the case of a covered gift or bequest made to a domestic trust, the §2801 tax applies as if the trust were a U.S. citizen, and the trust is required to pay the tax.89 In the case of a transfer to a foreign trust, however, the trust itself is not subject to tax under the default rule.90 Rather, the U.S. recipient pays the tax on distributions received from the trust to the extent such distributions are attributable to covered gifts or bequests.91 To determine the portion of a distribution attributable to a covered gift or bequest, the proposed regulations provide a method under which the trustee must calculate the “§2801 ratio.”92 The §2801 ratio must be redetermined after each contribution to the foreign trust and is crucial in determining the tax liability that will be imposed on U.S. recipients.93 To avoid the foregoing default tax treatment, a foreign trust may elect to be treated as a domestic trust solely for purposes of applying the §2801 tax (i.e., the foreign trust can elect to pay the §2801 tax immediately upon the receipt of a covered gift or bequest).94
89§2801(e)(4)(A). A “domestic trust” means a trust defined in §7701(a)(30)(E) (i.e., a trust that satisfies both the “court test” and the “control test”). Prop. Reg. §28.2801-2(c).
91 Prop. Reg. §28.2801-5(a).
92 Prop. Reg. §28.2801-5(c).
94§2801(e)(4)(B)(iii); Prop. Reg. §28.2801-5(d).
TRANSFER TAX FILING REQUIREMENTS
Although it has not yet been released, Form 708 will eventually be required to report the receipt of covered gifts and bequests and compute the §2801 tax.95 The form would generally be due on the 15th day of the 18th month following the close of the calendar year in which the covered gift or bequest was received.96 Special rules would likely apply in the year the proposed regulations are finalized.97
95 Prop. Reg. §28.6011-1(a).
96 Prop. Reg. §28.6071-1(a).
97See Announcement 2009-57, 2009-29 I.R.B. 158; Prop. Reg. §28.6071-1(d).
Covered expatriates can do advanced planning to avoid or mitigate the potentially harsh tax consequences that apply before and after expatriation. The most effective strategy, at least in the case of a non-U.S. citizen, is to avoid being classified as an expatriate altogether, i.e., expatriate before holding a green card for eight years. Being aware of the years in which one holds a green card is crucial, and if the green card holder has the ability to claim residence under an income tax treaty, such a position can be used to prevent years from accruing. Remember, however, if the individual has already reached the eight-year threshold, claiming such a position will trigger an expatriation.
For those who have already reached the eight-year threshold, and for U.S. citizens not qualifying for one of the two available exceptions, other planning options must be considered. Pre-expatriation gifts can be used to bring an individual under the $2 million threshold of the Net Worth Test. For example, the lifetime annual exclusion amount against gift and estate tax in 2017 was $5.49 million (with a base amount of $5,000,000, indexed annually for inflation).98 A U.S. citizen or long-term resident can utilize this exemption amount to make gifts free of U.S. transfer tax to reduce his or her net worth. Additionally, where only one spouse is expatriating in the case of a married couple, gifts of an unlimited amount could be made to the spouse who will retain his or her U.S. citizenship. As mentioned earlier, however, the unlimited marital deduction is not available for gifts to a non-citizen spouse.99
98 As discussed further, below, this year the base amount doubled to $10,000,000 (with inflation adjustments), although it will return to previous levels in 2026.
Trusts can also be utilized in connection with pre-expatriation gifts; however, care must be taken to ensure that the trust is appropriately structured. For example, to accomplish the objective of reducing an individual’s net worth, the transfer to the trust would need to be a completed gift for U.S. gift tax purposes. Thus, the covered expatriate would need to part with sufficient dominion and control over the assets being contributed to the trust. Consideration should also be given to whether the trust will be a domestic trust or a foreign trust. Use of a domestic trust may be beneficial to avoid the potentially harmful “throwback tax” rules that can apply to distributions to U.S. beneficiaries of foreign trusts. Finally, thought should be given to whether the trust should be classified as a grantor trust or a nongrantor trust for U.S. income tax purposes. Given the IRS’s position that the assets of a grantor trust are subject to the exit tax, use of a nongrantor trust may produce better results. A domestic nongrantor trust may also prove beneficial because it will avoid application of the §684 rules that can be triggered by expatriating.
Compliance may also be an issue, as there are no exceptions to the Certification Test. For those individuals with past compliance failures, formally entering one of the disclosure programs offered by the IRS may serve as an appropriate method to bring an individual into compliance.100
100 The IRS offers numerous programs for these individuals, including its Offshore Voluntary Disclosure Program, Streamlined Procedures, and Delinquent Return Procedures.
Timing can also play a role in planning. Expatriating would make more sense when an individual owns high-basis assets or, conversely, at a time when the fair market value of the individual’s assets is low. Paying the exit tax may also make financial sense if the individual anticipates making substantial income in future years.
If all else fails, covered expatriates do receive a significant exclusion amount against the income tax that would otherwise be imposed on the net gain from the deemed sale of their assets. Utilization of this exclusion amount, coupled with strategic sales of assets prior to the expatriation, may serve to minimize, or eliminate altogether, the income tax liability that would be created by the expatriation.
Remember, however, that a covered expatriate’s U.S. family members, and any other U.S. person who receives property from a covered expatriate, will still have to contend with the transfer tax imposed under the expatriation regime. In the case of non-U.S. citizen family members, avoiding the §2801 tax may be possible by waiting for the individual to no longer be domiciled in the United States, as the tax applies only to those U.S. recipients who are considered U.S. residents for gift and estate tax purposes. For those family members who are U.S. citizens, expatriating prior to receiving the gift or bequest may be a viable planning strategy (especially if the individual qualifies for one of the exceptions relating to dual citizens and minors). Pre-expatriation gifts, discussed above in the income tax planning context, also play a role in transfer tax planning. Because the §2801 tax applies only to property acquired from a person who is a covered expatriate at the time of such acquisition, gifts made before the expatriation date are not subject to the transfer tax under the expatriation rules.101
101§2801(e)(1); Prop. Reg. §28.2801-5(e)Ex. 2.
THE POTENTIAL TAX SAVINGS
While the thought of paying an immediate mark-to-market exit tax can seem financially daunting, one need look no further than the expatriation of Facebook co-founder Eduardo Saverin to understand the economic effect of expatriating and the tax savings that can be achieved. Saverin expatriated before Facebook’s May 18, 2012, initial public offering.102 Facebook’s IPO price was $38 per share, and although the exact amount of Saverin’s ownership is unknown (it was at one point 5% according to the website whoownsfacebook.com), his stake in the company made him a billionaire. While Saverin most likely was a covered expatriate subject to the exit tax, reports suggest that he achieved significant tax savings by expatriating. According to an article from The Wall Street Journal, his stake in the company was worth approximately $2 billion based on Facebook’s IPO price.103 By expatriating, Saverin may have saved at least $80 million in income taxes, and potentially as much as $700 million in estate taxes (had he died a U.S. citizen).104 The reason for the income tax savings is that by expatriating, Saverin was able to limit his tax exposure to the appreciation in the stock until the expatriation. Appreciation in the stock thereafter is not subject to U.S. income tax. While likely the case that Saverin’s expatriation tax liability was by no means negligible (reports estimate it could have been anywhere from $365 million up to $461 million),105 the income and estate tax savings achieved may have been well worth the hit. At a share price around $185,106 if Saverin does still own any stock, it is difficult to imagine that he is regretting his decision to expatriate.
102See 77 Fed. Reg. 25,543 (Apr. 30, 2012) (listing Saverin in the Treasury’s required quarterly report of individuals who have chosen to expatriate).
103 Laura Saunders, So How Much Did He Really Save? Wall St. J. (May 18, 2012), https://www.wsj.com/articles/SB10001424052702303360504577410571011995562.
105See Tim Worstall, Eduardo Saverin’s Current Tax Saving: $67 Million. And It Could Be a Tax Loss in the End, Forbes (May 17, 2012), https://www.forbes.com/sites/timworstall/2012/05/17/eduardo-saverins-current-tax-saving-67-million-and-it-could-be-a-tax-loss-in-the-end/#5fba9e555e02; Chris O’Brien, Did Eduardo Saverin’s Bid to Save Taxes on His Facebook Windfall by Renouncing His Citizenship Backfire? Silicon Beat (June 4, 2012), http://www.siliconbeat.com/2012/06/04/did-eduardo-saverins-bid-to-save-taxes-on-facebook-windfall-by-renouncing-his-citizenship-backfire/. In his own statement just before the IPO, Saverin was quoted as saying: “I am obligated to and will pay hundreds of millions of dollars in taxes to the United States government.” Saverin Says He Will Pay ‘Hundreds of Millions’ in Taxes, N.Y. Times Bits (May 17, 2012), https://bits.blogs.nytimes.com/2012/05/17/saverin-says-citizenship-move-not-made-for-tax-reasons/.
106 As of the time of publication of this article.
The decision to leave the United States represents but one side of the equation in the expatriation process. Where to take up residency after expatriation represents the other side.107 The covered expatriate will ideally seek to take up residence in a jurisdiction that has a lower tax rate (both income tax and transfer tax) than the United States, but a similar commitment to freedom and the rule of law, as well as a comparable — if not better — lifestyle offering. Requirements for obtaining citizenship or permanent residence status in the new jurisdiction will also need to be considered, as the expatriate will need to be able to live there legally.
107 For a discussion of this and other considerations that factor into the decision to expatriate, see Leigh-Alexandra Basha, Victoria Burk, and Abigail E. O’Connor, Is the Toll Charge for the U.S. Exit Tax Worth the Price Tag for Getting on the Road Out of the United States? 116 Daily Tax Rep. (BNA) J-1 (June 17, 2013).
Mr. Saverin renounced his U.S. citizenship in 2011 and chose Singapore as his new home. Singapore is one of a handful of jurisdictions that offers a route to citizenship by the making of an investment in the country’s economy. The move appears to have been a financially prudent one for Saverin, as Singapore taxes individuals at a top rate of 20% and does not impose a capital gains tax or an inheritance tax.108 In general, individuals are also only taxed on Singaporean-sourced income.109 Whether the move was also a practical one for Mr. Saverin is more debatable. Widely viewed as one of the most successful nations in Asia (if not the world) Singapore is highly protective of its citizenship, and its investment program reflects this by imposing extensive residence requirements on applicants. Singapore is also a single-citizenship nation, generally disallowing dual citizenship. The implications of inheriting Singaporean citizenship, particularly for any male children, are also substantial, and include the obligation to partake in the country’s National Service scheme.
108See Ong and Li, 7340 T.M., Business Operations in Singapore, at IV. and X.
St. Kitts and Nevis is another jurisdiction worth considering. From an economic perspective, St. Kitts and Nevis does not impose income, capital gains, or estate tax. Located in the Caribbean, the nation promises a life of indulgence at home, and a life of excitement abroad, as obtaining a St. Kitts and Nevis passport allows the holder to travel visa-free to over 150 nations, including Russia and the 22 EU member states of the Schengen Area.110
110See Marie Sapirie, Facebook Expat Is Latest Billionaire Without Borders, 135 Tax Notes 925 (May 21, 2012).
Important to the U.S. citizen who wants a trusted option for expatriation, St. Kitts and Nevis can boast the longest-standing citizenship-by-investment program in the world.111 Citizenship by investment, as is intended in the context of St. Kitts and Nevis, means the receipt of citizenship upon the making of an investment to a nation. In this sense, the St. Kitts and Nevis offering is different from that of Singapore, as residence is not a prerequisite to citizenship. Unsurprisingly, it is St. Kitts and Nevis’s pure “citizenship by investment” model that attracts the highest number of applicants today, at the expense of the more time-consuming “residence by investment” options.
111 In 1984, St. Kitts and Nevis passed the Saint Christopher and Nevis Citizenship Act, 1984, entitling a person to “be registered as a citizen of St. Christopher and Nevis […] if the Cabinet is satisfied that such person has invested substantially in St. Christopher and Nevis.”
Applicants considering St. Kitts and Nevis need to make a minimum contribution of $250,000 to the Sugar Industry Diversification Foundation (a specially approved foundation that assists the local government in transitioning to a more diversified economy by researching and providing funding for alternatives to the sugar industry),112 or invest a minimum of $400,000 in approved real estate projects.113 Thus, in addition to being free from any residency or visitation requirements (applicants need never even live on the island),114 St. Kitts and Nevis presents less burdensome monetary requirements than its Singaporean counterpart (Singapore’s program requires a minimum investment of approximately $2,000,000).
113See Shamik Trivedi, For Sale: Foreign Citizenship, Maybe Diplomatic Posts, 138 Tax Notes 1033 (Mar. 4, 2013).
114 For an overview of some of the various “citizenship by investment” programs, see Ramy Inocencio, World’s Overlooked Countries to Buy Second Citizenship, Residency, CNN (July 5, 2013), http://www.cnn.com/2013/06/28/business/world-overlooked-countries-second-citizenship/index.html. See also Kim Gittleson, Where Is the Cheapest Place to Buy Citizenship? BBC News (June 4, 2014), http://www.bbc.com/news/business-27674135.
From September 2017 to March 2018, St. Kitts and Nevis applicants were also given the option to contribute $150,000 to the Hurricane Relief Fund, a temporary fund established to respond to the severe impact of the 2017 hurricane season. An example of the nation’s dynamism and ability to respond to current demands, the Hurricane Relief Fund suggests more citizenship initiatives will be unveiled in 2018.
Other countries in the Caribbean offering citizenship-by-investment programs include the Commonwealth of Dominica, Grenada, Antigua and Barbuda, and St. Lucia. Although only St. Kitts and Nevis enjoys the prestige that comes with running a successful citizenship-by-investment program for over three decades, countries such as the island nation of Dominica have found their own means of attracting applicants with their 20-year-old program.
Entrenched in regulation, Dominica’s 25-year-old citizenship-by-investment program gives applicants certainty and stability, as well as two affordable routes to citizenship: a minimum contribution of $100,000 to the nation’s Economic Diversification Fund, or the purchase of a pre-approved real estate development worth at least $200,000. Dominica is also famed for its welcoming, warm environment — as reflected in the government rejecting the trend to “ban” nationalities from citizenship-by-investment programs, and instead accepting applicants from across the globe.
Grenada is also a noteworthy destination for prospective expatriates. Like St. Kitts and Nevis and Dominica, it affords visa-free travel rights to most of the European Union, and, together with St. Kitts and Nevis, it provides visa-free entry to Russia. Uniquely, Grenadian citizens can also travel to China, a jurisdiction that is normally closed off to foreign travel.
Another unique attribute of Grenadian citizenship is its eligibility under the U.S. E-2 Visa Program. Of little interest to Americans wanting to expatriate from their homeland, but of high interest to those wanting to relocate to the United States, the E-2 Visa allows foreigners to live and work in the country without necessarily becoming taxable “U.S. residents” for U.S. tax law purposes.115 The E-2 Visa is not a route to citizenship but rather is a means for the foreigner to significantly impact, and profit from, the American economy. The E-2 Visa is distinct from the more famous EB-5 Visa, a “Green Card” that is delivered to investors who inject $1 million in the economy ($500,000 in the case of a “targeted employment area”) and create at least 10 full-time permanent jobs. Holding an EB-5 Visa can, in time, qualify an investor for U.S. citizenship, and is, thus, comparable to a Global Investor Program in Singapore.
115 Although not tantamount to holding a green card, aliens present in the United States on an E-2 Visa can still be classified as U.S. tax residents under the “substantial presence test,” discussed more fully, below.
Grenada’s citizenship-by-investment program was launched in 2013, a year that also saw the inauguration of the Antigua and Barbuda Citizenship by Investment Program. Antigua and Barbuda was a copy of the St. Kitts and Nevis Program, allowing applicants to select between a contribution to the National Development Fund (NDF), the purchase of government-approved real estate, or an investment in an approved business.116 Originally priced at $250,000, $400,000, and $1,500,000, respectively, the three routes were each subject to an additional government-processing fee of $50,000 (which increased with the number of applicants).
116 In 2013, the provisions regulating the Antigua and Barbuda Program could be found in the Antigua and Barbuda Citizenship by Investment Act, 2013 and in the Antigua and Barbuda Citizenship by Investment Regulations, 2013.
Antigua and Barbuda stands out from the rest of the Caribbean because it requires applicants to visit the nation for a period of five days within five years of receiving citizenship. Whilst a short residence requirement, failure to fulfill the five-day stay may result in the investor being deprived of his or her citizenship — a risk some investors may not be willing to take.
When St. Lucia unveiled its own citizenship-by-investment program on January 1, 2016, it required applicants to make an oath or affirmation either in an office in St. Lucia, or before a St. Lucian Embassy, High Commission, or Consulate. The requirement was eliminated by regulation later that year,117 together with several other requirements that had limited the St. Lucia program’s accessibility to investors.118 These included a $3,000,000 total net worth requirement and a 500-applicant cap per year. Another key change was the reduction in the investment for applicants, from $200,000 to $100,000 for a single applicant. While presenting an appealing price tag, St. Lucia is the only Caribbean jurisdiction that does not allow economic citizens to pass their citizenship to children born after the completion of the citizenship process. In this regard, St. Lucia fails to appeal to those who wish to see the certainty of their citizenship status being conferred to their offspring.
117 The changes were introduced by the Saint Lucia Citizenship by Investment (Amendment) Regulations, 2016.
118 Major changes to the Program were made with the Saint Lucia Citizenship by Investment (Amendment) Regulations, 2016.
In Europe, Austria, Malta, and Cyprus also offer citizenship options. Austria notoriously adopted a complex, case-by-case scheme in Article 10, Paragraph 6 of the 1985 Nationality Act. Malta introduced its own scheme when it published the Individual Investor Program of the Republic of Malta Regulations, 2013. These were quickly replaced, however, with the Individual Investor Program of the Republic of Malta Regulations, 2014, following extensive criticism on the part of the European Union. The 2014 Regulations added a new “genuine link” dimension to the Individual Investor Program, resulting in applicants having to demonstrate at least one year of residence in Malta prior to obtaining citizenship.
Unlike Malta, Cyprus has retained its flexible residence and visitation requirements, asking that applicants only visit Cyprus or a Cypriot consulate once (to sign their Naturalization Certificate and to provide biometrics). However, such flexibility comes at a cost: a minimum investment of €2 million, of which €500,000 must be made in real estate to be kept for the entirety of the applicant’s lifetime.119 With its high entry thresholds, Cyprus’s Scheme for Naturalization by Exception is competitive in the European domain — where Malta seeks a €1,150,000 aggregate investment and Austria reportedly seeks around €8 million — but it falls short of successfully competing against the more reasonably priced Caribbean options.
119 The requirements of Cyprus’s Scheme for Naturalization by Exception can be found in a decision of the Council of Ministers passed in September 2016, which amended a previous decision made two years earlier. The decision, issued by the executive branch of the Cypriot government, was based on Section 111A(2) of the Civil Registry Laws of 2002-2015.
Europe is also the seat of longstanding residence programs, including the United Kingdom’s Tier 1 (Investor) Visa Program. This £2 million option presents successful applicants with leave to remain, and, within five years, permanent residence. For applicants in a rush to secure their status, £5 million and £10 million options are also available, speeding up permanent residence eligibility to three and two years respectively. Although highly sought-after due to the U.K.’s fame as a business powerhouse, a provider of outstanding education, and a fair and just implementer of the law, the Tier 1 (Investor) Visa Program is expected to suffer as a result of the finalization of Brexit and the U.K.’s exit from the European Union.
As with any cross-border planning, local counsel in the relevant jurisdiction should be consulted to determine which particular program is most appropriate based on the individual’s facts and circumstances.
RETURNING TO THE UNITED STATES AFTER EXPATRIATING: PERSONA NON GRATA?
While this article focuses on the U.S. tax implications of expatriating, it is important to note that expatriating can also have non-tax implications. While a discussion of such implications is outside the scope of this article, one law is worth noting, as this law may be relevant to the familiar client question: “Can I return to the United States?”
The law is commonly known as the “Reed Amendment.” Passed as part of the Illegal Immigration Reform and Immigrant Responsibility Act of 1996, the Reed Amendment added to the list of individuals ineligible to enter the United States the following category: “Any alien who is a former citizen of the United States who officially renounces United States citizenship and who is determined by the Attorney General to have renounced United States citizenship for the purpose of avoiding taxation by the United States is inadmissible.”120 The constitutionality of the Reed Amendment has been called into question, however, and it appears to be difficult to enforce. As one commentator has noted, the imposition of a penalty upon a person for exercising a constitutional right is itself unconstitutional.121 As other commentators have noted, the statute itself is unclear and raises due process issues. For example, invoking the Reed Amendment requires a factual determination that the individual expatriated for tax avoidance purposes; however, the IRS is bound by certain confidentiality provisions that generally prevent the disclosure of the taxpayer information that would be needed to make such a determination.122 The Joint Committee on Taxation recognized these shortcomings in a 2003 report where, among other things, it studied the enforcement of the Reed Amendment, stating: “The immigration provision requires the Attorney General to determine whether a former citizen renounced his or her U.S. citizenship for tax avoidance purposes. However, the ability of the Attorney General to access tax returns or return information for purposes of making this determination is limited under the Code.”123
1208 U.S.C. §1182(a)(10)(E).
121See Heimos, 837 T.M., Non-Citizens — Estate, Gift and Generation-Skipping Taxation, at V.C. (citing Carter, Note: Giving Taxpatriates the Boot Permanently: The Reed Amendment Unconstitutionally Infringes on the Fundamental Right to Expatriate, 36 Ga. L. Rev. 835 (Spring 2002)). See also Heimos, 806 T.M., Immigration and Expatriation Law for the Estate Planner, at IV.D. (discussing the constitutional right to expatriate).
122See Michael G. Pfeifer, The Current State of Expatriation, ALI CLE Estate Planning Course Materials Journal (Dec. 2014). See also N. Todd Angkatavanich et al., Foreign Affairs: A Primer on International Tax and Estate Planning (Part 2), 42 Tax Mgmt. Est., Gifts & Tr. J. 247 (Sept. 14, 2017).
123 Joint Comm. on Taxation, Review of the Present-Law Tax and Immigration Treatment of Relinquishment of Citizenship and Termination of Long-Term Residency (JCS-2-03), at 72 (Feb. 2003).
While it appears for now that covered expatriates are legally allowed to re-enter the United States after they have expatriated, care should be taken not to inadvertently become a U.S. resident again for income tax purposes. Individuals not holding a green card can still become residents for U.S. income tax purposes if they spend too much time in the United States in any year. Under the “substantial presence test,” an individual is a U.S. income tax resident if he or she meets the following requirements: (i) the individual is present in the United States for at least 31 days during the year; and (ii) the total number of days present in the United States during the current year and the two preceding years, using the weighted formula described below, equals or exceeds 183 days.124 In computing days of presence, the following formula is used:
• All of the days of presence in the current year are counted;
• ⅓ of the days of presence in the immediately preceding year are counted; and
• 16 of the days of presence in the second preceding year are counted.125
125§7701(b)(3)(A)(ii). Certain exclusions apply for purposes of computing days of physical presence; however, such exclusions are outside the scope of this article.
Due to the substantial presence test’s mechanical formula, the following practical observations can be made. An individual who spends 183 days or more in the United States in any given year will be a U.S. income tax resident for that year.126 If, however, an individual never spends more than 121 days in the United States in any given year, he or she will not be a U.S. income tax resident under the substantial presence test. Accordingly, even those individuals who have successfully expatriated need to be aware of how much time they spend in the United States post-expatriation.
126 To avoid such classification, the individual would generally need to claim residency under the “tie-breaker” provisions of a U.S. income tax treaty.
For the covered expatriate who loses track of his or her day count and inadvertently triggers U.S. income tax residency after expatriating, an exception known as the “closer connection exception” may provide relief. The exception is only available to those individuals who have spent 182 days or less in the United States in the current year but who, as a result of the substantial presence test’s three-year look-back formula, are considered to be U.S. income tax residents.127 To qualify for the exception, the individual must maintain a “tax home” in a foreign country during the current year and have a “closer connection” to such foreign country than to the United States.128 An individual’s tax home is considered to be located at the individual’s regular or principal place of business or, if none, then the individual’s tax home is the individual’s regular place of abode in a real and substantial sense.129 In general, the tax home maintained by the individual must be in existence for the entire current year and must be located in the same foreign country for which the individual is claiming to have the closer connection.130
127§7701(b)(3)(B). For example, an individual who was physically present in the United States for 365 days in 2015 and 2016, but only 180 days in 2017, would meet the day count prerequisites for claiming the closer connection exception in 2017.
128 Reg. §301.7701(b)-2(a).
129 Reg. §301.7701(b)-2(c)(1).
130 Reg. §301.7701(b)-2(c)(2).
An individual will be considered to have a closer connection to a foreign country than to the United States if the individual establishes that he or she has maintained more significant contacts with the foreign country than with the United States.131 Such a determination is generally a facts-and-circumstances analysis, with the following non-inclusive list of factors taken into account:
• The location of the individual’s permanent home;
• The location of the individual’s family;
• The location of personal belongings, such as automobiles, furniture, clothing and jewelry owned by the individual and his or her family;
• The location of social, political, cultural or religious organizations with which the individual has a current relationship;
• The location where the individual conducts his or her routine personal banking activities;
• The location where the individual conducts business activities (other than those that constitute the individual’s tax home);
• The location of the jurisdiction in which the individual holds a driver’s license;
• The location of the jurisdiction in which the individual votes;
• The country of residence designated by the individual on forms and documents; and
• The types of official forms and documents filed by the individual (e.g., Form W-8or Form W-9).132
131 Reg. §301.7701(b)-2(d)(1).
To claim the exception, the individual must file Form 8840, Closer Connection Exception Statement for Aliens.133 Form 8840 is generally due by the due date (including extensions) of the individual’s U.S. income tax return.134 If an individual does not file Form 8840, he or she will not be eligible for the closer connection exception.135
133 Reg. §301.7701(b)-8(a)(1).
134See Instructions to Form 8840. If an individual does not have to file a U.S. income tax return, he or she must still file a Form 8840.
135 Reg. §301.7701(b)-8(d)(1). Note also that an individual who has personally applied, or taken other affirmative steps, to change his or her status to that of a permanent resident during the current year or has an application pending for adjustment of status during the current year will not be eligible for the closer connection exception. Reg. §301.7701(b)-2(f).
TAX REFORM EFFECTS
On September 27, 2017, the Trump Administration and certain members of Congress released a framework of their proposal for tax reform. Known as the “Unified Framework for Fixing Our Broken Tax Code,” the proposal aimed to simplify the Code and provide tax relief across a broad array of taxpayers, both individuals and corporations. The House and Senate then released their versions of reform legislation, known as the “Tax Cuts and Jobs Act.” The Conference Committee then reconciled the differences between the House and Senate versions of the reform proposals and merged them into a single piece of legislation,136 which President Trump signed into law (Pub. L. No. 115-97) on December 22, 2017.
136 Due to Senate rules, the title of the act was changed to “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.” This article, however, shall refer to the legislation as “the 2017 tax act.”
The 2017 tax act calls for a move to a quasi-territorial taxation model for corporations, under which the foreign earnings of a U.S. corporation would not be subject to U.S. income tax, subject to various exceptions. While not specifically mentioned in the act, lawmakers have at least considered a similar shift in the taxation of individuals, shifting from a citizen-based income tax model to a residency-based model.137 Such a shift would mean that only income earned in the United States would be subject to U.S. income tax.138 To the 8.7 million Americans who currently live and work abroad, this could provide tremendous tax relief.139
137 Demetri Sevastopulo and Barney Jopson, U.S. Expats Given Hope of Lower Tax Bills, Fin. Times (Oct. 25, 2017). American Citizens Abroad, a group who advocates on various issues for U.S. citizens living and working oversees, also recently wrote a memo to the Senate outlining an approach for a territorial tax system for individuals. See Laura Davison et al., Hill Briefs: Territoriality for Individuals; Rand Paul a ‘Yes,’ 227 Daily Tax Rep. (BNA) G-4 (Nov. 28, 2017).
138See Paul Panckhurst, Millions of U.S. Expats May Get Tax Relief, Financial Times Says, Bloomberg (Oct. 25, 2017), https://www.bloomberg.com/news/articles/2017-10-26/millions-of-u-s-expats-may-get-tax-relief-financial-times-says.
139Id. Under current U.S. tax law, U.S. citizens are subject to U.S. income tax on their worldwide income.
While the foregoing shift in the taxation of individuals is merely a consideration at the moment, the significant planning implications, and the related uncertainties, should be observed. For example, a residency-based tax model would presumably eliminate the need for many U.S. citizens living abroad to relinquish their U.S. citizenship, at least for substantive income tax liability reasons. Query, however, whether such U.S. citizens would still be subject to the plethora of compliance and reporting obligations that apply to U.S. taxpayers with assets abroad.
The act leaves the U.S. transfer tax system in place and, beginning after December 31, 2017, the basic exclusion amount is doubled to $10,000,000 (with inflation adjustments).140 This increase will sunset and return to previous levels in 2026. Accordingly, it appears for now that the §2801 tax will remain in place, and individuals who are considered covered expatriates will need to continue to assess the impact of the potential tax consequences thereunder. With a doubled exclusion amount, however, there may be significant planning opportunities for those individuals expatriating before 2026.
140 In 2018, the exemption amount will be approximately $11.2 million for individuals and $22.4 million for married couples. Note, however, that for individuals who are neither U.S. citizens nor U.S. domiciliaries at the time of their death, the exclusion amount for U.S. estate tax purposes remains at $60,000 (which equates to a credit of $13,000 against the U.S. estate tax). §2102(b)(1).
Expatriating can be an arduous process. It may also be a significant event for the individual expatriating. Proper planning (both tax and non-tax) should be undertaken well in advance to assess the potential effects of expatriation, both on the individual expatriating and on the expatriate’s family members. Indeed, individuals considering expatriating would be well-advised to look before they leap. They may be surprised to learn the tax consequences of expatriating.
Jonathan E. Gopman is a partner in Akerman LLP’s Naples office and Chair of the firm’s Trusts & Estates Practice Group. He currently serves as a Co-Chair of the Asset Protection Planning Committee of the Real Property, Trust and Estate Law Section of the ABA (for the 2017–2018 bar year) and is a Fellow of the American College of Tax Counsel. He is a co-author of the revised BNA Tax Management Portfolio on Estate Tax Payments and Liabilities. He has authored and coauthored numerous articles on asset protection and estate planning and chapters in books on asset protection and frequently lectures on these topics throughout the world. He is co-author and co-editor of The Tools & Techniques of Trust Planning, 1st Edition, in 2016 with Stephen R. Leimberg. He received his J.D. from Florida State University College of Law (with High Honors) and his LL.M. (in Estate Planning) from the University of Miami School of Law.
Paul D’Alessandro, Jr., is an associate in Akerman LLP’s Miami office, where he advises clients on matters such as federal income and transfer taxation of nonresident alien individuals, entity classification, pre-immigration issues, inbound and outbound tax planning, and the restructuring and disposition of U.S. real property holdings. He also provides practical analysis regarding federal income, gift, and estate tax consequences.
Micha Emmett is the CEO of CS Global Partners, a leading international advisory firm, and a dual qualified attorney. She travels extensively to provide consultancy services to private clients and governments in Europe and the Caribbean. Micha also operates in Africa, the Middle East, and Asia, where she has been a speaker at a wide array of international events focusing on citizenship by investment (CBI), global citizenship, and foreign direct investment.