Is renouncing US citizenship the best way to avoid paying taxes?

Eight times more individuals renounced US citizenship in 2011 than in 2008

The US is considered to have the longest arm when it comes to tax collection. US citizens as well as green card holders are expected to pay tax on their worldwide income. This means that even if they migrate and no longer reside in the US, their US tax duties remain and they must pay US tax on their foreign income.

In 2010, the US government issued the Foreign Accounts Tax Compliance Act (Fatca). Under these new rules, foreign financial institutions are obliged to report to the Internal Revenue Services (IRS) about the foreign financial accounts held by US persons (citizens and green card holders). This came in addition to the commitment already in place for US persons to declare their worldwide income.

Currently, the regulatory authorities in UAE are formulating procedures to facilitate compliance with the US Fatca and set clear instructions for financial institutions under their supervision.

Once such framework is place, it will be very difficult for US expats to evade paying tax to US on their “tax-free” UAE income.

The question that many have been increasingly asking themselves is if it perhaps make more financial sense to renounce US citizenship altogether.

“Nowadays, everybody is getting scared and becoming keen to comply. But once they realise what they have to pay, they might start looking into renouncing their US citizenship or giving up their US green cards,” says the Dubai-based American tax specialist Virginia La Torre Jeker, J.D.

“Around the world, various interest groups have become more empathetic to why individuals are renouncing and they are making the IRS take notice,” she writes in one of her ‘Let’s talk about US Tax’ blog entries.

“Cited are serious banking problems with overseas financial institutions refusing to have American clients; the plight of American women married to non-US spouses who refuse to provide information to the IRS regarding jointly owned foreign financial accounts and other foreign assets; the huge administrative and financial burden to comply with all the confusing and complex US tax and information reporting requirements when living overseas.”

According to Virginia, the numbers are increasing, with 8 times more individuals renouncing US citizenship in 2011 than in 2008. “In 2011 close to 1,800 individuals renounced their US citizenship or relinquished their long-term green cards.”

However, it is not as simple as it sounds. Although each US citizen or green card holder (generally one who has held the card for 8 years in the past 15 years) has the right to expatriate, there are harsh consequences if this person fails to comply with the expatriation tax rules. And these tax rules are complex.

Virginia specialises in US taxation and international tax planning. Part of what she does is advise US citizens and green card holders wishing to expatriate on a tax-efficient exit strategy. “There are various factors and conditions one must carefully look at before taking any decision,” she says.

“Under the US tax laws, if the person who is expatriating has a net worth of at least $2 million or has a certain average income tax liability over the past 5 years, he will be treated as a so-called ‘covered expatriate’. Additionally, the person who is expatriating has a duty to notify the IRS of his expatriation and provide the agency with certain detailed tax information. Significantly, he must affirm under penalties of perjury that he has satisfied all of his US tax liabilities for the past five years prior to the year of expatriation. If required by the IRS, he may have to provide evidence of this. If the person fails to comply with any of these conditions, he will be treated as a ‘covered expatriate.’ ”

A covered expatriate will be subjected to the Exit Tax, she continues to explain. “The Exit Tax requires the individual to pay US tax on the unrealised gain of all his worldwide assets as if such property were sold on the day before expatriation.

“Furthermore, certain pensions and deferred compensation will be subject to withholding tax when payments are made to the expatriate in future years amounting to 30 per cent of every such payment.

“In addition, US individuals who receive gifts or bequests (e.g., assets passing to heirs at death) from covered expatriates owe a tax on the gift or bequest.

“The tax is at a flat rate equal to the highest gift / estate tax rate in effect at the time of the gift /death. In 2013 this highest current rate is 45 per cent. So, for example, if an individual qualifies as a “covered expatriate” and leaves his US child assets at death worth $1 million, the child must pay tax to the IRS of $450,000,” Virginia explains.

These rules are a type of “punishment” or “penalty” for expatriating, but the bite of the punishment is felt by the US person receiving the gift or inheritance. Because of these rules, the consequences of expatriation can follow you or your loved ones for the rest of your life.”

According to Virginia it is not very difficult to exceed the dollar thresholds, and there are quite some expatriates who have not satisfied their tax liabilities making expatriation very difficult. However, this does not mean that the option of renouncing citizenship should be excluded, if you ask her.

“Smart tax planning can accomplish a lot. If a person has not been tax compliant, we have to put him back into compliance. With proper planning we can often change a person from potentially being a covered expatriate to not being one at all. If we cannot completely eliminate the covered expatriate status, then we can work to have the Exit Tax reduced as much as possible. Proper tax planning is the key here,” she says.

“In some cases, it is really worth it.”

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