Ever thought about packing it all up and starting that romantic, expatriate life abroad? Ever felt like these parts were just so wild, it was time to find yourself a new passport? Expatriation, where a US citizen renounces citizenship, or where a legal permanent resident (LPR) renounces and terminates their status, is a very real option for some individuals in today’s global economy and structure. What many often don’t realize is this (big) decision can trigger very big tax consequences as well.
Expatriation triggers something commonly referred to as the “exit tax.” It essentially allows the IRS one final stab at a tax on all assets owned by the individual, by forcing a mark-to-market valuation and imposing a tax on any gain. I.R.C. 877A took effect for most individuals that expatriated on or after June 17, 2008. There are three basic prongs for applicability of the mark-to-market regime (assets deemed sold for fair market value the day before the expatriation date) to be met:
- Your average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a set amount, adjusted for inflation annually ($178,000 for 2022)
- Your net worth is $2 million or more on the date of your expatriation or termination of residency, OR
- You 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.
Only one of the above three factors is needed to become a “covered expatriate.” And if you are one, well, the tangle begins. Your assets will be marked to market, and any gain arising from the deemed sale and any loss are taken into account for that tax year, except that wash sale rules of I.R.C. 1091 will not apply. A special exclusion amount will apply for 877A calculations, as well as specific means of calculating the amount of payment and elections possible for deferral of the taxes due.
For the initial expatriation year (and subsequent years thereafter if applicable), the covered expatriate must file a Form 8854 to stay compliant. Like with most other provisions of the tax code, violations of 877A come with penalties, and the penalties can be steep. Failing to file a Form 8854 alone can cost you a $10,000 penalty. So you will still owe taxes and you may still have tax forms to complete, whether you stay or go. Considering expatriation? Don’t neglect the exit tax. With proper tax planning, tax advice, and time, it is possible to greatly reduce the impact of the mark-to-market regime and allow certain funds or assets to retain as much value as possible, such as by gifting or various transfers and other techniques, prior to expatriating. Before you head for the exit, a taxpayer should consult a tax advisor familiar with Form 8854 and discuss consequences and options to avoid an unwanted tax surprise.