For Americans who want to renounce their US citizenship, the decision depends not only on their national identity, but also on how much taxes they will have to pay when they officially leave the country.
While an American who renounces his citizenship will no longer have to pay US taxes on his worldwide income, he may have to pay an exit tax, also known as an exit tax, depending on his net worth and other internal rules. The Internal Revenue Service (IRS) laid out.
“You can’t just hand your passport over to a border agent and say, ‘I’m done,'” says Darren Coleman, senior portfolio manager at Raymond James Ltd.’s Portage Cross Border Wealth Management. in Toronto. “It’s a lot more than that.”
Mr Coleman says advisers should discuss with their US clients the various steps involved in opting out – and ensure they have the right legal and tax expertise during the process.
“You really can’t make any mistakes when you do this,” he says.
For advisors who want to help clients make this move, the goal is to avoid being considered an “expatriate” to avoid paying the exit tax, a US federal tax on unrealized assets when someone ends their relationship with USA
Additional U.S. withholding taxes may apply later on payments from certain types of deferred compensation arrangements, accounts and trusts, says Stephen Flynn, partner and Canadian-U.S. cross-border tax expert at Andersen LLP in Vancouver.
Americans can avoid the exit tax if they meet three conditions on their official departure date:
1. Their average annual net income for the past five years is less than $172,000 (as of 2021, the rate changes annually based on inflation);
2. They have fully complied with their US tax obligations for those five years;
3. They are valued at US$2 million or less.
With some planning, Mr Flynn says the first two conditions are relatively easy to meet for those looking to avoid exit tax.
However, the third home equity requirement can be an obstacle for many Americans, especially those who are older and whose assets have increased in value over the years.
Mr Flynn also notes that since the conditions were introduced in 2008, the US$2 million threshold has not increased with inflation.
He adds that Americans can still use strategies to reduce equity, such as gifting assets to family members while they are still U.S. citizens. Although the US has a gift tax, he notes that its exemption is currently around US$12 million, which is set to be significantly reduced by 2026.
However, Americans who successfully renounce their citizenship but as insured expatriates may not end up in the US tax system, Mr. Flynn says. Any US citizen who receives a gift or is a beneficiary of a former US citizen who is an expatriate under a will is still taxed at 40 percent of the value of those assets.
“It’s very important,” he says, “and it’s a real concern for people who have children who are US citizens or residents.”
The importance of the reason for the rejection
Alexander Marino, head of the U.S. tax practice at Moodys Tax Law in Calgary, who leads the firm’s waivers group in Canada, saw a record number of people seeking waivers during the pandemic, in part because people had more time to go through the lengthy process. .
These steps include not only working with experts to determine if a waiver is the right decision, but also submitting and reviewing document packages before the final step of meeting in person with a consular officer at a US embassy or consulate for a formal waiver.
In addition, Mr. Marino says that US residents should ensure that they properly communicate the reasons for refusal, especially if they plan to return as a visitor.
He points to the Reed Amendment, also known as the Expatriate Exclusion Clause, which bars certain former US citizens from re-entering the country if they are deemed to have waived taxes for reasons or purposes.
“Knowing what to say in an interview is critical,” he says.
Mr Marino says advisers should also be aware of these issues to protect their clients – and themselves. He notes that advisers are required to identify who their US citizen clients are under the Foreign Account Taxation of Canada Act (FATCA), an international agreement signed between Canada and the US
His team at Moodys works with advisers to help them determine whether clients are US citizens, particularly as some may not be aware or understand the implications of not disclosing the information. For example, he says, some people may have lived in Canada all their lives but have American parents, which means they are also US citizens.
“You have to ask the right questions,” he says.
Once it is determined whether a client is a US citizen, Mr Marino says advisers can work with them – with the help of their US legal professionals – to decide the pros and cons of opting out. The process includes strategies to reduce or completely avoid US exit tax by properly severing ties with “Uncle Sam.”
Mr Flynn adds that the waiver also has non-tax implications.
“If you change your mind years later, you don’t get any special status just because you used to be a U.S. citizen,” he says. “You will go to the back of the line, just like everyone else trying to become a US citizen.”
The U.S. government publishes the names of Americans who refuse, he adds.
Mr. Flynn also says Americans who opt out are still taxed on assets or income earned in the U.S., just like a Canadian who works or owns assets in the U.S.
“The difference is that you avoid the larger net of your worldwide income and worldwide assets because you’re no longer a U.S. citizen,” he says.