You can pay the Exit Tax NOW, or the Estate Tax LATER!
Sir John Templeton was one of the world’s greatest investors. In 1955 he founded the Templeton Growth Fund in Toronto, Canada. Of course, it is now a PFIC. and PFICs are “tax cancer” for U.S. citizens. U.S. citizens who invest in it will be severely punished. A good explanation of how PFICs work is here. (If you are U.S. citizen you should consider selling all non-U.S. mutual funds.) In 1969, John Templeton renounced his U.S. citizenship and moved to the Bahamas. In so doing, he avoided the U.S. estate tax. Furthermore, at the time that he renounced, the U.S. did not have an “Exit Tax”.
It’s a Brave New World – You can’t leave the U.S. for free!
Times have changed. U.S. citizens may well be (and almost certainly will become) “covered expatriates” and subject to the “Exit Tax”. A nice overview of the “Exit Tax” may be found here. As a general principle, you are “deemed” to have sold all of your assets on the day prior to your expatriation. In many cases, the “deemed sale”, will generate “deemed profits”. You are then taxed on those “deemed profits”. (assuming you are a “Covered Expatriate”).
Who is a “covered expatriate?”
The provisions of the tax apply to “covered expatriates”, defined as those who meets any one of the following three tests:
- Income Tax Test
The expatriate’s average annual U.S. income tax liability over the 5 years prior to expatriation was over $145,000 (for renunciations as of 2010; the figure will be adjusted annually for subsequent years).
- Net Worth Test
The expatriate’s net worth is at least $2 million.
- Compliance Test
The expatriate does not certify that he met all U.S. tax obligations for the five years before expatriation.
Should the possibility of an “Exit Tax” deter one from renouncing U.S. citizenship?
Perhaps or perhaps not. Remember that to pay the “Exit Tax” now, means that your Estate Tax will not be subject to the “Estate Tax” on your death. (I understand that it is unclear how the Estate Tax will work in the future. That said, I would bet on the Estate Tax becoming more onerous.) This issue should be considered very carefully – especially in the case of U.S. citizens who are married to non-U.S. citizens.
A nice overview of the U.S. estate tax is here. U.S. Estate Tax is levied on both U.S. citizens and on U.S. property (regardless of citizenship). Of note is:
How the estate tax applies – AND OBVIOUSLY THIS IS SUBJECT TO CHANGE
U.S. estate tax applies to the fair market value of the world-wide property of a U.S. citizen, a Green Card holder, and an individual resident in the U.S. at the time of their death. As well, U.S. estate tax generally applies to property situated in the U.S. that is owned by non-residents of the U.S. In calculating an individual’s taxable estate, deductions for debts and certain expenses are permitted. However, for Canadian residents, the permitted deductions are prorated based on the value of their U.S. gross assets over their world-wide assets.
Again, note that the Estate Tax is levied on both “U.S. persons” and “U.S. property.
One must consider all circumstances. If you are a “Covered Expatriate” you need some good legal advice. But, here are some considerations that should convince you to give this issue some thought. For many of you, the stakes are very high and you will need good legal advice. This post is not legal advice. At most, this post is for the purpose of raising questions that you need to discuss with a lawyer who specializes in this kind of work!
That said, here are three considerations (and there are many more), to get you started.
1. Paying the “Exit Tax” NOW means that you are not a U.S. citizen when you die. As a result YOU AS A PERSON and your estate would NOT be subject to the U.S. estate tax on your death. But, U.S. PROPERTY may be subject to the Estate Tax. (So be careful what you own.) In general that is good news. It means that the former citizen can do what he wants with his estate INCLUDING LEAVING IT TO A NON-U.S. PERSON SPOUSE (see below). But, there is a notable exception.
A U.S. citizen who renounces U.S. citizenship cannot leave his estate to a U.S. citizen heir without that heir paying substantial taxes.. The details are somewhat technical. But the bottom line is this: if your goal is to leave substantial assets to a U.S. citizen heir, you need to consider this prior to renouncing. Perhaps, the gift should be made while you are still a U.S. citizen.
See the example here.
2. If a U.S. citizen is married to a spouse that is NOT a U.S. citizen he/she is restricted in the gifts that you can give him/her. This is really quite extraordinary. If a U.S citizen is married to a U.S. citizen there is no problem making gifts. But, if a U.S. citizen is married to a non-citizen spouse, the U.S. citizen is restricted in making gifts to the non-citizen spouse. This is incredibly offensive. It appears to be based on the assumption that U.S. citizens are the property of the U.S. government. Furthermore, the U.S. property right in it’s citizens is more important than the marital relationship. Thanks to “Todundsteur” for explaining this in a comment thread at the Isaac Brock Society.
Don’t know where you’ve been getting your tax advice but you need to do some more research.
A US citizen can die in 2012 and leave his spouse (or anyone else) $5,000,000 free of Federal estate taxes.
What he cannot do is claim the unlimited spousal deduction that would allow him to leave her more than that.
But, if he really needs to worry about an estate in excess of $5m to his foreign spouse he can establish a Qualified Domestic Trust (QDOT) to take advantage of the unlimited marital exclusion and thereby defer US estate taxes until spouse goes to her Reward.
There’s plenty of real problems for US citizens abroad without having to invent new ones.
May 4, 2012 at 9:21 am
Could you please explain this in step by step detail – just want to be clear on your point.
Are you saying that if a U.S. citizen living abroad dies and is married to a non-U.S. citizen spouse, that he cannot take advantage of an “unlimited spousal deduction” that would be available if he had a U.S. citizen spouse. In other words, the issue is the fact of having an “alien spouse”.
U.S. citizen married to U.S. spouse can transfer the complete estate?
U.S. citizen married to an alien cannot transfer the whole estate?
If so, that strikes me as yet another reason to renounce.
May 4, 2012 at 10:14 am
If a US citizen’s spouse is not a US citizen then, regardless whether he dies in Peoria or Bumphuque, Egypt his estate may not claim the marital deduction for the value of assets transmitted to the spouse.
This is true even if they live in the USA and the surviving spouse is a green card holder.
Under present law this is a matter of concern only to US citizens the value of whose worldwide taxable estates exceeds the $5,000,000 exemption amount.
You can give the first $5mm US estate tax-free to your wife, your mistress or Vladimir Putin.
While some might see this as an additional reason to renounce, please bear in mind that after death, you are unlikely to give a rat’s hairy hindquarters about any of this.
Your non-US citizen widow-to-be, however, might see this as an incentive to get her sweet foreign butt down to the local federal building and start her naturalization ball rollin’.
3. Under no circumstances should you allow a U.S. citizen spouse to be an executor of your estate. (This issue would often arise when a non-U.S. spouse has the misfortune to be married to a U.S. person). I am not going to get into the reasons here. Your lawyer will explain this to you. Just don’t do it. Some of you may should get your wills changed NOW!
One obvious conclusion:
If you are a U.S. citizen living outside the United States, and you:
– have citizenship in another country;
– do NOT intend to return to the U.S.;
– do not want to put up with the incredible costs and unpleasantness associated with U.S. citizenship;
You should consider renouncing U.S. citizenship prior to becoming a “Covered Expatriate”. Young people should give special consideration to this!
The reality is that U.S. citizenship has been priced out of the market for those who are not extremely wealthy.
In closing – It’s not just about taxes – Repeating a comment that I made on another post …
Renunciation is a personal decision. The issue is not whether U.S. citizenship is an “asset”. Let’s imagine that it is. The value of that “asset” must be measured against the costs. This should be “measured very carefully” with “legal or financial analysis”.
Okay, let’s do that.
Financial Aspects of The Cost of Retaining U.S. citizenship
Everybody has a different situation. But, remember that if you renounce you will have to have five years of tax compliance. That may or may not come at a cost (depending on whether you have been filing US tax returns). I have the impression (but have no actual knowledge) that some are to date with their filings and others not. Furthermore, some of you are worried about filing U.S. taxes when you may not be U.S. citizens.
For those up-to-date on the filings, and have no impediment to renouncing, then the issue becomes the possibility of the exit tax. It is important to consider the exit tax may or may not end up being a cost. It may end up being a prepayment of the estate tax (we don’t know which way the estate tax is going).
Those who are subject to the exit tax (who don’t see it as a prepayment of the estate tax) may have a financial reason to NOT renounce.
But, those who are NOT subject to the exit tax (remember we are talking finanical analysis) have a very sound financial (if this were the only consideration, but of course nobody would renounce for purely tax reasons) to renounce. Why? Through inflation it won’t take long for you be a “convered expatriate”. Owning a house in Vancouver would do the trick. Remember again that the U.S. has an estate tax to deal with eventually. Now, I don’t know how the U.S./Canada tax treaty affects that.
Those are “some” of the possible financial considerations and one part of the cost.
Non-Financial Aspects of the Cost of Retaining U.S. Citizenship
Simple you are treated like a criminal and with the advent of FATCA you are required to live under supervision. You can’t live a normal and productive live. Plus you have to continue to think and worry about this.
Sure U.S. citizenship can be viewed as an “asset” (in limited circumstances). The question is whether the costs outweigh the value of this asset in any significant way. This is for you to decide.
Finally, unless I am missing something, there is no way to renounce without being in tax (and possibly FBAR) compliance.
The very existence of a discussion about renouncing U.S. citizenship assumes that people want to be in compliance. Many of you seem to be worried that you are not in compliance because you became Canadian in the 70s or early 80s and have not been filing tax returns. This has been the subject of numerous discussions. I suggest:
If you have committed an expatriating Act (becoming a Cdn citizen for example or being a justice of the peace) prior to 1986, a clear reading of s. 349 gives you ample grounds to argue that you are not a U.S. citizen. If you are in this situation your time would be much better spent working on the “state of your U.S. citizenship” (no pun intended) instead of filing tax returns. If you are not a U.S. citizen, then you should not be filing U.S. tax returns.. Furthermore, unless you can find something in s. 349 of the INA that says that loss of citizenship is conditional on the issuance of a CLN then …
So, there is a logical and financial analysis to this issue.
As Phil Hodgen says: “U.S. citizenship is a problem to be solved”. That may be a way to view the solution.
Update – August 29, 2013:
Speaking of Phil Hodgen, here is an interesting article he wrote on the relationship between citizenship renunciations and the estate tax. Enjoy.