Renouncing Citizenship, Tax for Expats and the Effect on Your 401K

Renouncing US citizenship remains a hot topic for many Americans living abroad, and isn’t likely to fade from the limelight anytime soon. As we’ve mentioned, 2015 was a record-breaking year for renunciations, with 4,279, to be exact. If you’ve considered renouncing, there are many factors you need to consider – one of which is how your 401k will affect your tax for expats if you give up your passport. Get the facts below.

What Do I Need to Know About Renunciation?

With a majority of US expats left feeling that politicians are not representative of their interests, it’s no surprise that an ever-increasing number of Americans abroad desire to give up their citizenship and the need to pay tax for expats. In fact, our recent US Expat Opinion Survey reveals that just 7% of respondents feel that the US government is representative of their interests.

If you’re thinking about renouncing now or in the future, you may be wondering how it’ll affect you when it comes to your finances, and of course, tax for expats. You should know that there are costs involved with breaking up with the US – including a $2,350 fee payable to the US Department of State. If you fall within certain tax liability thresholds and have assets worth over $2 million, you will also be required to pay an exit tax in order to sever ties with the US.

In addition to the financial side of renouncing, you also have to consider potential future challenges. Once you’ve renounced, you can’t change your mind and request to regain US citizenship. Also, it will make any future travel back to the US exponentially more difficult.

If you’re considering retiring overseas, check out our tax guide for Americans retiring abroad to get the facts you need in order to successfully make the transition.

What About My 401k Earnings?

If you have a sizable 401k that you’ve earned while living and working in the US, there are certainly considerations to make before taking the plunge. A big factor will depend on where you’re going to be a citizen. As you know, you must have gained citizenship in another country before giving up your US citizenship. Here are a few factors to consider:

Tax Treaty

If the country in which you become a resident has a tax treaty, you’ll want to research the specific treaty to see how a foreign 401k investment would be treated locally. In general, you could expect the treaty to say you’ll be taxed either in your resident country or in the United States. Doing your research will help you determine in which country you’ll pay tax for expats.

Form 8854

This is the expatriation form you’ll be required to fill out before parting ways with the US. If you have a US 401k, you must check box 7A (which states “Do you have any eligible deferred compensation items?”), as a 401k would fall into this category. If you must check box 7A and you have a sizable 401k plan, you might be considered a ‘covered expat.’ This means your net tax for expats liability is over $160,000 for the past 5 years or you have a net worth exceeding $2 million.

Covered expats may be required to pay an exit tax, and will have one of two tax options regarding deferred compensation plans. You can elect to have received a full payout on the day before you renounce, and are taxed accordingly on your US tax return, or you can elect to forego tax treaty benefits on these items and your retirement income will be taxed at a flat 30% tax rate when distributed.

When it comes to how renouncing citizenship will affect your 401k, what it really boils do to is whether you are considered a covered expatriate or not. You can expect to incur tax for expats if you’re a covered expat, so plan accordingly. It’s also a good idea to research your resident country’s tax treaty, to understand how your retirement income will be taxed locally. Preparing yourself for what to expect can help you determine if renunciation is the best option for you!

Have More Questions About Your 401k and Renouncing Citizenship?

Our team of expat-expert CPAs and IRS Enrolled Agents can help answer all of your 401k-related questions, so you’ll understand your obligations regarding tax for expats. Contact us today!

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