The headline news that a co-founder of Facebook has given up his U.S. citizenship to avoid income and estate tax may trigger a lot of interest in expatriation. Some people will read the news of the expatriation of Mr. Sevarin as validating expatriation for tax purposes. The process of giving up U.S. citizenship has several compelling and discouraging aspects, particularly for those taxpayers who have assets offshore.
To expatriate legally, a U.S. citizen must file Form 8854 with the IRS in which they certify that they are in compliance with federal tax law. This includes foreign asset disclosure and foreign income reporting. The soon to be expatriate must also pay an exit tax of 15% of the appreciated value of all their property subject to a statutory exclusion of $600,000 adjusted for inflation.
All of the technical issues are discussed in IRS Notice 2009-85. The key point for consideration is that the taxpayer must obtain or already have a second citizenship before surrendering their U.S. Passport at a U.S. Embassy and filing Form 8854, otherwise the expatriate will be a “stateless” person.
A reason for renouncing citizenship is to limit the income and estate taxes. The elimination of the “Bush Tax” when they expire December 31, 2012 will result in estate taxes being imposed on estates of $1.0M or more instead of $5.12M as they now. The estate tax rates will also go up from 35% to 55%. So, an individual who has assets of $5.12 M will have an estate tax of $2,266,000 January 1,2013 instead of zero now.
For an individual that has assets that are likely to appreciate the possible increase in capital gains tax when the “Bush” tax cuts expire may also a factor. The capital gains income tax rates will go up from 15% to 20%. That means every $1.0 M in gain costs an additional $50,000.
Both the income and estate and gift tax apply to worldwide income and worldwide assets.
The choice for some taxpayers, (about 1,800 per year) is to give up their U.S. citizenship and more to a jurisdiction which lacks the worldwide approach to taxation. Some will move back to their country of origin, others will take up citizenship in “tax havens”. Regardless, expatriation is for some a form of tax protest. It is not an answer, however, for those who currently have unreported foreign financial accounts, and have failed to file FBAR’s or otherwise make proper disclosures on. These people still run the risk of civil and criminal penalties and should consider the Offshore Voluntary Disclosure Program (OVDI) instead of expatriation. Other should consider immediate gifting programs, including charitable contributions as part of their tax planning strategies.