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Expat Tax Essentials
For Americans living overseas, keeping up with US tax obligations can be a hassle. This leads some to consider renouncing their citizenship. However, taking such a drastic step can lead to quite a few complications, such as the US exit tax.
What is the exit tax, and what does it mean for Americans abroad? Here’s what you need to know.
When US citizens and residents choose to sever their ties with the United States, they are expected to resolve any outstanding tax obligations. In some cases, that means paying an exit tax. The exit tax is not a penalty for leaving the US. Instead, it’s a final bill for your unpaid tax debts. This could include:
In essence, the exit tax allows former citizens and residents to fulfill their tax duties before permanently removing themselves from the US government’s tax jurisdiction.
Not everyone who leaves the US is required to pay an exit tax. Only US citizens and long-term residents the IRS considers “covered expatriates” are subject to this tax. When filing IRS Form 8854 to renounce your US citizenship or residency, you will provide the information needed to determine whether you’re a covered or non-covered expatriate.
For both US citizens and long-term residents, your status as a covered or non-covered expatriate will determine whether you have to pay an exit tax. So what’s the distinction? Let’s take a look.
US citizens who renounce their citizenship are the most common category required to pay an exit tax, as long as they qualify as covered expatriates. If you are a US citizen, the IRS will judge whether you are covered or not based on the following factors:
If your personal net worth exceeds $2 million when you renounce your citizenship, you will be considered a covered expatriate.
To calculate your net worth, the IRS will add up the value of all of your assets (including unrealized capital gains) and treat them as if you’d sold them all on the day of expatriation. (In almost all cases, the value of an asset will be determined by the current fair market value.)
This math can get complicated fast, especially if you have a retirement account or foreign pension. We recommend always getting help from a tax professional when calculating your exit tax liability. If you make a mistake, the penalties can be steep.
If the average net income tax over the past five years exceeds a set threshold, you will be considered a covered expat. The exact threshold changes from year to year to adjust for inflation. In 2022, it was set at $178,000.
When filing Form 8854, you will be asked to indicate whether you’ve filed tax returns for the previous five years. If you have not filed for all five years, you will be considered a covered expat.
Green Card holders who have lived lawfully in the US for eight out of the last fifteen years may be subject to the exit tax regardless of their income, net worth, or filing compliance. (Exceptions apply, especially if you have opted to be treated as a non-resident alien for at least one of those eight years.
The purpose of the exit tax is to pay off your final tax bill once and for all. The amount you owe will depend on what tax obligations you still have when you renounce your citizenship or residency. This includes taxes owed on the income or capital gains.
As the exit tax only deals with unpaid taxes, you won’t have to worry about double taxation. If you’ve already paid a tax on your income or assets, that won’t be included in your exit tax bill.
Once again, this calculation gets complicated. It’s never a good idea to attempt to determine your own exit tax liability without getting help from an expert.
Even if you currently qualify as a covered expatriate, you may be able to modify that. For example, you could strategically distribute your assets between yourself and your spouse. (The $2 million net worth standard only applies to your individual net worth.)
With that said, you should only ever use financial strategies that are 100% legal. The penalties for tax evasion can be devastating.
If your exit tax is likely to be more than you’re comfortable paying, you may want to reconsider renouncing your US citizenship or residency. Of course, this would mean you will still have to file an income tax return every year and possibly a few other tax forms, such as an FBAR or FATCA report.
(The good news is that most expats don’t end up owing any taxes when they file.)
An experienced expat tax professional can help you make the right decision. They can also help you meet your tax obligations no matter which choice you make.
Every US citizen must file an annual tax return regardless of where they live in the world. However, if you weren’t aware of that requirement, don’t panic. The IRS provides an amnesty program, the Streamlined Filing Compliance Procedures, to help expats come into compliance without facing any penalties.
To use the Streamlined Filing Compliance Procedures, all you have to do is:
Once you’ve completed those steps, the IRS will regard you as compliant. (You may even be able to claim certain expat tax benefits such as the Foreign Earned Income Exclusion or Foreign Tax Credit to reduce or erase your tax debt.)
This won’t necessarily protect you from the exit tax, though. You will need to file a tax return for any of the last five years you’ve missed—even if that means going beyond the three delinquent returns required by the Streamlined Filing Compliance Procedures. Then, you can check the box on Form 8854 stating that you’re up-to-date on your filing obligations.
Don’t wait to come into compliance. The IRS typically only offers amnesty if you reach out to them first. If they discover that you’ve failed to file and contact you first, you will lose the privilege of amnesty and face heavy penalties.
Hopefully, this guide has helped you understand how the exit tax can impact expats who renounce their US citizenship. If you still have questions, we have answers. In fact, we can even assist you in meeting your US tax obligations.
At Greenback Expat Tax Services, we’ve spent years helping expats file their US taxes accurately and on time. Just contact us, and we’ll be happy to help you in any way we can. For example:
No matter what you need, we’re your one-stop shop for expat tax assistance.