Renouncing your US citizenship: Is divorcing Uncle Sam right for you?

INTRODUCTION

The billionaire co-founder of Facebook, the only American member of Monty Python, a civil rights leader with a PhD from Harvard, the founder of Carnival Cruise Lines and owner of the Miami Heat NBA franchise, and arguably the best chess mind to ever live have more in common than you might think. So what do Eduardo Saverin, Terry Gilliam,[1] W.E.B. Du Bois, Ted Arison, Bobby Fischer have in common? The answer is that all five have renounced their US citizenship. These individuals are not alone! Record numbers of US citizens living in Canada and across the world are in the process of renouncing. Why would a country like the United States, with a seven to ten year wait list to acquire citizenship have so many citizens headed for the exit? The reason is that three-letter word no one likes to hear: TAX.

The United States is the only major country in the world that taxes the income of its citizens and permanent resident status holders regardless of where they live.[2] With the US tax filing deadline seemingly always right around the corner, US citizens living in Canada and across the globe are annually faced with the burden and cost of meeting their IRS filing and reporting obligations.[3] As such, the recurring nightmares of 1040s, FBARs, and other information returns are causing increased blood pressure and stress to US citizens who don’t call America home. In addition to the filing and reporting obligations, US citizens living abroad must also deal with the consequences of the US estate and gift tax regime during life and at death.[4] To make things even more stressful, the Foreign Account Tax Compliance Act (“FATCA”)[5] went into full effect on July 1, 2014. This dragnet, enacted to catch non-compliant US taxpayers with funds located abroad, is causing many US citizen expats sleepless nights in anticipation of a notice from the IRS asking why they have not been filing US tax returns or reporting all their non-US assets.

But wait my fellow US expats living abroad – don’t lose hope quite yet. There is a silver lining in this doom and gloom story and it comes in the form of renouncing your US citizenship. However, hold your applause until the end because when things appear too good to be true, they usually are. Renouncing one’s US citizenship is riddled with potential pitfalls along the way. While renouncing may work for a Facebook co-founding billionaire, any individual US citizen considering this action must decide if it is right for him or her and be properly advised along the way.

The million dollar question US citizens living abroad must ask themselves is whether their US citizenship “juice” is “worth the squeeze.” In other words, “do I need my US citizenship and, if so, what are its benefits?” Clients are often emotionally and financially drained after becoming US tax-compliant through a voluntary disclosure program, staying US tax-compliant, and continuously planning for cross-border tax issues. Not only can the filing and reporting costs seem ludicrously expensive and intrusive, but the penalty regime for noncompliance can be catastrophic if not dealt with properly. Add those factors to FATCA’s arrival to the cross-border compliance party in 2014, and more and more US citizens living abroad are looking for a way out. Who could blame them?

It is important to remember that renouncing your US citizenship is permanent and there are a number of US immigration and US tax landmines along the way. There are no mulligans once a Certificate of Loss of Nationality (“COLN”)[6] is issued and the only way to regain your US citizenship is through the long and difficult process of naturalization under current US immigration law. If you manage to avoid these landmines, renouncing your US citizenship will relieve you of your yearly filing and reporting obligations,[7] as well as worldwide estate and gift tax exposure.[8] Even so, renouncing is not for everyone.

BENEFITS OF US CITIZENSHIP

A US citizen living abroad who is considering renouncing his or her US citizenship should first ask a very important and logical question: “What am I giving up by renouncing my US citizenship?” Or, put more selfishly, “What is my US citizenship doing for me?” If the benefits of your US citizenship outweigh the compliance and potential tax costs that come with it, then renouncing may not be best for you.

Philosophical and patriotic reasons aside, there are a number of general benefits afforded to every US citizen no matter where they are located in the world. The following are some of the main benefits of retaining US citizenship that should be considered by anyone thinking of renouncing:

  1. Protection of US Citizens Abroad: Protection abroad may be an issue for US citizens who find themselves in politically unstable parts of the world. Generally for US citizens living in Canada, this is not a determinative factor when considering retaining US citizenship. Outside of a natural disaster or health epidemic in Canada, US citizens will rarely need the US armed forces to keep them safe in a sticky situation abroad (though if they do, it would be difficult to discount the comfort of knowing the United States, with its 11 active aircraft carriers and SEAL Team Six, is on call).[9]
  2. Consular Services Offered to US Citizens Abroad: Consular services are available to US citizens living abroad and include assistance in situations of detainment by foreign governments, with passport issues, and with cross-border legal affairs.
  3. The Right to Vote in US Elections: Many individuals holding US citizenship feel strongly about exercising their right to vote and with US citizenship comes a constitutionally-granted privilege to participate in US elections. Renouncing citizenship eliminates this privilege.
  4. Access to the US Job Market: This may be the most important factor to consider when renouncing US citizenship, especially for younger individuals. US citizens are legally able to live and work anywhere in the United States. Giving up citizenship closes off the US employment market without going through the proper immigration channels to obtain visas and work permits.
  5. Travel to the United States.: US citizens are able to travel into and out of the United States at their leisure. More details in reference to potential travel restrictions after renouncing are discussed below.

These benefits of retaining US citizenship should be taken into consideration when deciding if renouncing is right for you.

BENEFITS AND CONSEQUENCES OF RENOUNCING US CITIZENSHIP

Having covered some of the main benefits of US citizenship, it is only logical to cover some of the main benefits of renouncing your US citizenship, as well as the consequences that accompany that decision. Some of the main benefits and consequences of renouncing are:

  1. S. Tax Filing and Reporting Obligations (Benefit): Once you have renounced your US citizenship, you will be issued a COLN effective on the date that you appeared at the US Embassy or Consulate General, took the oath of renunciation, and conducted the exit interview. A timely-filed US tax return is still due for the year in which you renounced, though it is a partial year return that reflects from January 1 to the date the oath of renunciation was taken. Once you have been issued a COLN, you will generally no longer have US reporting and filing obligations past the day of your renunciation.[10]
  2. Eliminated Exposure to Future US Tax Law Changes (Benefit): Despite pleas from US expat groups, Congress declined to create a residence-based tax system for individuals in its December 2017 tax reforms. In fact, though the Tax Cuts and Jobs Act[11] represented the most comprehensive overhaul of the US tax code in over three decades, for many US expats the situation got worse. Congress imposed a one-time “transition tax” on controlling US owners of non-US corporations, taxing “earnings and profits” of these corporations at 15.5 percent or 8 percent.[12] Congress also created the ongoing concept of “global intangible low-tax income” (“GILTI”), a type of income which is both immediately includible in the income of certain US shareholders who control non-US corporations and broadly defined.[13] Both the transition tax and GILTI regime may prove very expensive for certain US shareholders of non-US corporations. The particulars of those taxes are beyond the scope of this article, but the changes underscore the continued possibility of unfavorable and sudden shifts in US tax law as well as a trend of US lawmakers (from both major political parties) remaining unwilling to provide tax relief to US citizens abroad.
  3. Reduced or Eliminated US Estate and Gift Tax Exposure (Benefit): US citizens and certain residents are subject to estate tax on their worldwide incomes and are afforded the full unified credit available.[14] Assuming an individual who successfully renounces his or her US citizenship is not considered a resident for US estate and gift tax purposes,[15] he or she will not be subject to US estate tax on his or her worldwide assets at death, but only on any US situs property.[16]
  4. End to Risk of Double Taxation on Common Canadian Transactions (Benefit): While most US citizens resident in Canada do not end up owing US tax because they can claim credit for Canadian taxes paid, this is not true in all cases. There are a number of differences between Canadian and US tax law that can result in double tax to a US citizen even after accounting for the US foreign tax credit system and relief available under the Canada-United States Tax Treaty.[17] Notably, for example, Canada does not tax capital gains on the sale of a principal residence while the United States only allows a $250,000 USD exclusion on this gain.[18] Likewise, Canada allows an inflation-indexed lifetime capital gains exemption ($848,252 CAD for qualified property in 2018) while the United States does not.[19] Other common situations in which a Canadian-resident US citizen can owe US tax because he or she paid reduced or no Canadian tax include estate freezes, receipt of stock options, gambling or lottery winnings, contributions to a non-group RRSP, receipt of capital dividends, and certain charitable contributions.[20]  
  5. Travel to the United States (Consequence): After successfully renouncing US citizenship, traveling into or through the United States may become difficult.[21] Individuals who suffer from certain communicable diseases or who have committed crimes of moral turpitude in the past may be denied entry into the United States if they do not obtain permission before traveling.[22] If flagged for these reasons, the renounced individual can be denied boarding of a plane en route to the United States or physically detained (and even arrested) if the individual attempts to cross a US ground border.
  6. Statelessness (Consequence): Persons intending to renounce US citizenship should be aware that, unless they already possess another nationality, they may be rendered stateless and, thus, lack the protection of any government. This may create enormous problems regarding travel, employment, and housing.
  7. Name and Shame Game (Consequence): Every quarter the names of individuals who lose US citizenship are published in the Federal Register.[23] This includes individuals who renounce US citizenship. Over the last four years, the number of individuals losing their US citizenship has increased dramatically with 742 recorded in 2009, 1534 in 2010, 1781 in 2011, 932 in 2012, 2999 in 2013, 3415 in 2014, 4279 in 2015, and 5,411 in 2016 (numbers for 2017 were not finalized at the time of writing).[24]

THE PROCESS OF RENOUNCING YOUR US CITIZENSHIP AND § 877A: TAX ISSUES

If you decide to proceed with renouncing your US citizenship, the proper precautions must be taken to avoid the imposition of the US exit tax.[25] Section 877A of the Internal Revenue Code was enacted in 2008 under the Heroes Earnings Assistance and Relief Act. It established a more stringent exit tax regime applicable to the “covered expatriate.”[26] Section 877A classifies an expatriate as a “covered expatriate” when the individual meets any portion of a three-part test (discussed below) and renounces his or her US citizenship or loses US residency[27] after June 17, 2008. A covered expatriate subject to the exit tax under § 877A will face a “mark-to-market” exit tax regime, which treats the covered expatriate as having sold all of his or her property for its fair market value the day before the “expatriation date.”[28] The “expatriation date” is the date that the taxpayer renounces citizenship or ceases to be a lawful permanent US resident.[29] The mark to market exit tax regime applies to unrealized net gains in excess of $713,000 USD.[30] The mark-to-market rules deviate in application to any deferred compensation items,[31] specified tax-deferred accounts,[32] and interests in non-grantor trusts.[33] The three-part test of the statute will classify an individual as a “covered expatriate” if any of the following statements are true:

  1. the individual had a net worth of $2 million USD or more at the time of renunciation (Net Worth Test); or
  2. the individual had an average annual net income tax liability of more than $165,000 USD in the five years ending before the date of expatriation (Tax Liability Test); or
  3. the individual failed to certify on Form 8854 that he or she had complied with all US Federal tax obligations for the five years preceding the date of expatriation (Compliance Test). [34]

There are two main exceptions to the exit tax regime for expatriates looking to renounce. The first exception is largely limited to dual citizens who were born in and continue to live in the country of their other nationality. The second is even narrower and is limited to citizens who did not live in the United States for more than ten years before the age of eighteen and a half. As minors are generally not allowed to renounce their US citizenship, this exception effectively allows only a six-month window for such individuals to avoid the imposition of § 877A’s exit tax regime.

The following are the two exceptions to § 877A’s exit tax regime:

  1. An individual is exempt from the exit tax regime if he or she:
    1. files Form 8854;
    2. became a dual citizen at birth and continued to be a citizen and tax resident of the other country (i.e., Canada) at the time of renunciation of citizenship; and
    3. was a resident of the United States for no more than ten of the fifteen tax years ending with the tax year during which the renunciation of citizenship occurred.[35]
  2. An individual is exempt from the exit tax regime if he or she:
    1. files Form 8854;
    2. renounces his or her US citizenship before the age of 18 and a half; and
    3. was a resident of the United States for no more than ten years before the age of 18 and a half.[36]

In the practical application of these two exceptions, a renouncing individual who qualifies under either will not be subject to the Net Worth Test or the Tax Liability Test. Every renouncing individual, whether qualifying under the exceptions or not, will always be subject to the Compliance Test. Form 8854 is filed with a renounced individual’s final year return. On Form 8854 the renouncing individual must affirm, under penalties of perjury, that he or she is compliant with US tax and filing obligations for the period of five years preceding expatriation. Thus, taking the proper steps to avoid the exit tax regime of § 877A requires that the renouncing individual be US tax-compliant in all circumstances.

Another common question regarding the renunciation of US citizenship is whether a minor child, parent of a minor child, or guardian of a minor child is capable of renouncing. To renounce one’s US citizenship, the renouncing individual “must voluntarily and with intent to relinquish US citizenship:

  1. appear in person before a US consular or diplomatic officer;
  2. in a foreign country; and
  3. sign an oath of renunciation.”[37]

The US Department of State then reviews the renunciation, and, upon its approval, a COLN will be issued.[38] The position of the US Department of State is that citizenship is a status that is personal to the individual US citizen. Therefore, a parent may not renounce the citizenship of his or her minor child.[39] Similarly, parents and legal guardians may generally not renounce the citizenship of individuals who are mentally incompetent. Minors seeking to renounce their own US citizenships must demonstrate to a consular officer that they are acting voluntarily and that they fully understand the implications and consequences that accompany the renunciation.[40] The renouncing minor will have to convince the officer that he or she is not subject to duress or undue influence and that he or she voluntarily wants to renounce.[41]

THE PROCESS OF RENOUNCING US CITIZENSHIP: IMMIGRATION ISSUES

Assuming that the proper tax compliance steps have been or will be taken to avoid the imposition of the exit tax under § 877A, the actual process of renouncing one’s US citizenship also creates immigration issues of which to be wary. Congress amended the US Immigration and Nationality Act[42] with provisions to deny re-entry into the United States if the US Attorney General determines that a former citizen renounced his or her US citizenship for the purpose of avoiding US tax.[43] This provision became known as the “Reed Amendment” because of its introduction by then-US Representative Jack Reed of Rhode Island. Although it appears that this law is seldom enforced, there is no guarantee that it will continue to be in the future. Under this provision, an individual who is found to have renounced for US tax avoidance purposes will be denied access into the United States and will be considered “inadmissible” for immigration purposes.

The Reed Amendment is intended to prevent a tax-motivated expatriate from returning to the United States. Representative Reed, in proposing the amendment stated:

In an instrumental way, I would hope in the future if those very slick and smart tax lawyers advising their clients about how to avoid their taxes suggest expatriation they should also indicate very clearly that the consequences are you cannot return at will to the United States.[44]

What is important to remember is that the burden to prove that there was a tax avoidance purpose in renouncing lies with the US government. Consequently, what is said at the exit tax interview is critically important. Other categories of individuals on this same “inadmissible list” include known terrorists, members of the Nazi party, and international child abductors.[45]

Avoiding this determination and classification is vital for those individuals who still desire to visit and travel through the United States after renouncing. The process of renouncing US citizenship is a multi-layered procedure of immigration filings and tax compliance submissions that come to a crescendo with an interview administered at a US Embassy or Consulate General. During this interview the renouncing individual will:

  1. be asked to confirm his or her desire to renounce;
  2. be given a statement of understanding concerning the consequences and ramifications of renunciation or relinquishment of US citizenship;
  3. affirm or swear that this decision is voluntary with no outside influence;
  4. be instructed as to the irrevocability of renouncing US citizenship;
  5. be asked to read the oath or affirmation of renunciation of nationality of the United States; and
  6. be individually questioned regarding the purpose and intent of the decision to renounce.

Answering these questions honestly and in one’s best interests is critically important.[46] The answers to particular questions can have far-reaching consequences for both the renouncing individual and his or her family. As a result, many individuals pursuing the renunciation process request that a US-trained and licensed attorney accompany them for the interview. If properly admitted and approved by the particular Embassy or Consulate, US legal counsel may accompany the renouncing individual to the hearing. The presence of competent and qualified legal counsel can provide a great deal of comfort to what can be an intense, emotional event.

CONCLUSION: FINAL THOUGHTS

In the end, renouncing your US citizenship is a decision that comes with a number of variables that must be carefully considered. With US immigration and tax pitfalls scattered throughout the process, understanding the repercussions of renouncing and proceeding carefully is imperative to a smooth departure from the US club and all its membership fees.

For questions or inquiries please contact Alexander Marino via email at [email protected] or by phone at 403-693-5114.

 

If you’re interested in more information on renouncing your US citizenship, new US tax reforms, or renunciation as a US citizen or green card holder living abroad, attend one of our free seminars. Check our Knowledge Portal on Learning Tax to get dates and times on upcoming US Renunciation seminars.

 

[1] When asked why he renounced in 2006, Mr. Gilliam replied, “The reality is, when I kick the bucket, American tax authorities assess everything I own in the world—everything I own is outside of America—and then tax me on it, and that would mean my wife would probably have to sell our house to pay the taxes. I didn’t think that was fair on my wife and children.”

[2]  I.R.C. § 7701(b)(6). Lawful permanent resident, otherwise known as “green card” holders.

[3] June 15 for filers abroad. You may be allowed an automatic two month extension of time to file your return and pay any federal income tax that is due. You will be allowed the extension if you are a US citizen or resident alien and on the regular due date of your return you are living outside of the United States and Puerto Rico and your main place of business or post of duty is outside the United States and Puerto Rico, or you are in military or naval service on duty outside the United States and Puerto Rico.

[4] I.R.C. § 2033 and Treas. Reg. § 20.01(b)(1).

[5] Foreign Account Tax Compliance Act, Pub. L. No. 111-147, 124 Stat. 71, 97 (2010).

[6] A COLN is issued by the Bureau of Consular Affairs of the US Department of State.

[7] It is important to note that an individual who successfully renounces US citizenship could still have filing and reporting obligations moving forward under the I.R.C. § 7701(b) definition of resident. Even though not a US citizen, an individual whose days spent in the United States for the tax year at issue exceed the allotted days under the substantial presence test, then that individual has  the  same  reporting  and  filing  obligations  as  a  US citizen.

[8] I.R.C. § 2033 provides that the gross estate of a decedent who was a citizen or resident of the US at the time of their death, shall include all of their assets no matter where situated. Residency for estate tax purposes is different than residency for income tax purposes. Residency for estate tax purpose is a domicile test (see Treas. Reg. §20.0-1(b)(1)). Thus, a renounced individual could still face estate tax exposure if considered domiciled in the US.

[9] Charles P. Rettig, “Evaluation of an IRS Undisclosed Offshore Account IDR”, Tax Notes, November 2011. Tip of the hat to Chuck for this illustrative reason for retaining one’s US citizenship.

[10] Contingent on not being classified as a US resident for income tax purposes. See substantial presence test referenced, supra note

[11] Pub. L. No. 115-97, 131 Stat. 2054 (2017).

[12] I.R.C. § 965 (2018).

[13] I.R.C. § 951A (2018).

[14] $11,200,000 USD in 2018 (indexed for inflation). Estate tax rate is 40 percent.

[15] Residency for estate and gift tax purposes is a domicile test. Residency for income tax purposes is a separate test. Referenced supra.

[16] I.R.C. § 2103.

[17] Convention with Respect to Taxes on Income and Capital, US-Can., Sept. 26, 1980, as amended most recently in 2007.

[18] Income Tax Act, RSC 1985, c.1 (5th Supp.), s. 40(2)(b) (as amended); I.R.C. § 121 (2018).

[19] Income Tax Act, RSC 1985, c.1 (5th Supp.), s. 110.6 (as amended).

[20] See Moodys Gartner Tax Law and Kim G.C. Moody, “US Citizens Resident in Canada – Common Circumstances Where US Tax May Be Payable,” Moodys Gartner Tax Law LLP Blog (14 December 2011), http://moodystax.com/us-citizens-resident-in-canada-common-circumstances-where-us-tax-may-be-payable.

[21] This is in addition to the difficulties facing individuals born on US soil traveling on a Canadian passport.

[22] 8 U.S.C. §1182 (2011). Crimes of this nature include theft, DUI, and drug-related offenses.

[23] 78 Fed. Reg. 31 (February 14, 2013).  Names of individuals who lost their US citizenship in quarter ending December 31, 2012. https://gpo.gov/fdsys/pkg/FR-2013-02-14/pdf/2013-03378.pdf.

[24] See https://www.intltax.typepad.com/.

[25] I.R.C. § 877A.

[26] I.R.C.§ 877A(g)(2) provides that an “expatriate” means any US citizen who relinquishes his or her citizenship and any long term resident of the US who ceases to be a lawful permanent resident of the US Long term resident defined in I.R.C. § 877A(g)(5).

[27] I.R.C. § 877(e)(2). An individual is deemed a long term permanent resident if he or she held a US green card for eight of the previous fifteen years.

[28] I.R.C. § 877A(a)(1).

[29] I.R.C. § 877A(g)(3) and (g)(4).

[30] 2018 amount (indexed annually for inflation). I.R.C. § 877A (a)(3); Rev. Proc. 2017-58.

[31] I.R.C. § 877A(d)(4).

[32] I.R.C. § 877A(e)(2).

[33] I.R.C. § 877A(c).

[34] I.R.C. § 877(a)(2).

[35] I.R.C. § 877A(g)(1)(B)(i).

[36] I.R.C. § 877A(g)(1)(B)(ii).

[37] See US Dept. of State, Renunciation of US Citizenship (Feb. 1, 2008),

https://travel.state.gov/content/travel/en/legal/travel-legal-considerations/us-citizenship/Renunciation-US-Nationality-Abroad.html; 8 U.S.C. § 1483(b) (2008); 22 C.F.R. § 50.50 (2008).

[38] 8 U.S.C. § 1501 (2008).

[39] See https://travel.state.gov/law/citizenship/citizenship_776.html.

[40] Id.

[41] Id.

[42] 8 U.S.C. § 1182 (2011).

[43] 8 U.S.C. § 1182(a)(10)(E)(2011). (Any alien who is a former citizen of the United States who officially renounces US citizenship and who is determined by the Attorney General to have renounced US citizenship for the purpose of avoiding taxation by the United States is inadmissible.)

[44] Mark-Up of Immigration Legislation: Hearing Before the H. Comm. On the Judiciary, 104th Cong. (1995) in Fed News Services (1995).

[45] 8 U.S.C. § 1182(a) (2011).

[46] There is a $2,350 USD fee for renunciation of US citizenship, payable at the time of the exit interview. This fee was increased from $450 USD on September 12, 2014. In addition, there are a number of heightened security measures when appearing for a matter at a US Embassy or Consulate General office. See  https://canada.usembassy.gov/consulates/security.html for details.