U.S. citizens and lawful permanent residents (green card holders) are subject to income tax on their worldwide income no matter how long they may live outside the United States. This generates substantial income tax for the U.S. Government. When certain people relinquish their U.S. citizenship or green cards, the government imposes an Exit Tax in an attempt to recover the lost tax revenue.
Who is Subject to the Exit Tax?
Generally, the Exit Tax may apply if you are:
A U.S. citizen who gives up U.S. citizenship; or a green card holder who relinquishes your green card, after having held it for at least 8 out of the last 15 years;
o Your net worth is $2,000,000 or more on date of expatriation or
o You meet the 5 year average tax liability test or
o You are not fully U.S. tax compliant for the previous 5 years prior to expatriation
If you meet the above tests, the U.S. government considers you a “Covered Expatriate” and you may have to pay an Exit Tax. You are tainted with the Covered Expatriate label for the rest of your life.
How is the Exit Tax Calculated?
If you are a Covered Expatriate, you are deemed to have sold all their worldwide assets (i.e. stocks, bonds, real estate etc.) at their fair market value on the date of expatriation. Any gain recognized by this deemed sale is reduced by an exemption amount (currently about $700,000). Any gain over and above the exemption amount is typically taxed at capital gains tax rates (15% or 20%).
You are also deemed to have taken a complete distribution of your Individual Retirement Accounts, which means that the value of your IRAs become immediately taxable at tax rates up to 37%. If you are an employee of an International Organization, your defined benefit pension may also be subject to immediate taxation!
Are there Other Tax Consequences of the Exit Tax?
One other major consequence is that any gifts or bequests made by a Covered Expatriate to a U.S. citizen or other U.S. tax resident makes the beneficiaries subject to a 40% “inheritance tax”, with no exemptions allowed.