Thinking about renouncing your U.S. citizenship or Green Card? Beware of the exit tax.
The number of Americans wanting to renounce their U.S. citizenship or Green Card is on the rise, and if you’re one who’s planning your exit strategy there’s a big factor you should consider before making any moves: the U.S. exit tax.
Giving up your Green Card or relinquishing your U.S. passport isn’t a decision to be made lightly, so we’ve outlined a few of the most important things you should understand about taxes before sealing the deal on expatriation.
What is the U.S. exit tax?
When you renounce your U.S. citizenship or decide to give up your Green Card, you need to tie up loose ends with the IRS by ensuring you’re all paid up on your U.S. taxes. For some, that means being charged an exit tax on your income in your last year of citizenship or residency. Why? Because some of your assets — like capital gains on home ownership or funds in retirement accounts — haven’t been taxed yet.
Who has to pay the U.S. exit tax?
Not everybody who leaves the country has to pay an exit tax — only those citizens and long-term resident Green Card holders who the IRS says fall in the category of covered expatriates. To be considered a covered expatriate, you must meet one of the below standards:
- You have a personal net worth of over $2 million at the date of expatriation. This is per person, so, theoretically, both you and your spouse could each be worth $1.9 million and still avoid the exit tax
- Your average net income tax liability from the past five years is over a set amount ($171,000 for 2020)
- You fail to indicate on Form 8854 that you’ve filed a tax return for each of the past five years
It’s a little different for Green Card Holders — if you’re considered a long-term resident (or Green Card holder for 8 of the past 15 years) you could be subject to the exit tax. But, if you are a Green Card holder and have only had it for two years, you may not be considered a long-term resident and then wouldn’t have to worry about the exit tax.
What's included in the exit tax net worth calculation?
Not sure if your net worth is over $2 million? To calculate net worth, the IRS calculates the value of all your assets (including capital gains on stocks and property values, gains in U.S. retirement accounts, and funds in foreign pensions) and treats them as if you’d sold them on the day of expatriation.
Calculating the exit tax is tricky in general, but if you’ve got retirement accounts and foreign pensions it jumps to a whole new level of complexity. The IRS considers the present net value, the type of pension or retirement account, estimated accrued benefit of future distributions, where the pension is held and where the work was done, and that’s just scratching the surface.
We don’t recommend trying to calculate your exit tax amount on your own — this is one scenario where getting it wrong can have harsh consequences, so it can be helpful to have an expert handle the paperwork.
What else should I know about the exit tax before filing for expatriation?
First, understand that expatriation is not your only option. If you’re stressed about your U.S. tax situation, talk with an advisor and see if they can help lower your tax burden.
Second, if you know any of your past tax filings have been incorrect, you need to get them amended before beginning the expatriation process. When you file Form 8854, you’ll need to check a box that verifies your last five years of taxes have been filed and are correct. If you check this box but have mistakes on past returns, you can get yourself into legal troubles.
Can I avoid the exit tax when renouncing my Green Card or U.S. citizenship?
There are ways you can minimize the amount of tax you owe during expatriation — such as minimizing your taxable income or minimizing capital gains through spousal distribution — but you won’t be able to get around having to pay taxes completely. The penalties for tax evasion are steep and trust us—it’s not worth it.
If you’re hesitant to renounce citizenship but see your U.S. tax obligation as a burden while living overseas, you do have another option — simplify your tax situation. You should discuss these with your tax and financial advisor first, but here are a few ways you can make your U.S. taxes easier:
- Consolidate your foreign accounts. If you have more than one foreign account, you’re increasing your foreign account reporting obligations and, as a result, the cost of your U.S. tax return.
- Avoid foreign mutual funds. The U.S. taxes these accounts (known as PFICs) pretty heavily, putting a damper on your future financial goals.
- If you’re a business owner or contractor, make sure you keep U.S. taxes in mind when scheduling business activities.
Worrying about your U.S. taxes? Relax. Expat tax help from H&R Block is only a few clicks away
We get it — taxes are complicated enough without throwing another country into the mix. That’s why no matter where in the world you are, we’ve got a tax solution for you—whether you want to DIY your expat taxes or file with help from an advisor. Thousands of U.S. expats have benefited from the expertise here at H&R Block’s Expat Tax Services—join them and get started with Virtual Expat Tax Preparation from Block today!