Expatriation (and Income Tax)

The headline news that co-founder of Facebook, Eduardo Sevarin, gave up or renounced his U.S. citizenship to avoid income and estate tax could result in increased interest in expatriation. 

This story is interesting on several fronts. First, people talk about tensions between different countries, but there clearly is a growing international capitalist and cultural elite where borders don't really matter. These people wield immense power and Facebook’s Eduardo Severin will continue to have more power in America than most Americans.

Second, this may be an example of a trend where recent immigrants to the U.S. are not really interested in staying in the country long-term. A more common example is students at universities returning to Asia, or even “maternity tourism” where mothers from foreign countries “drop” their baby(s) on U.S. soil to give the child U.S. citizenship for some future “insurance policy” or “legacy”.  Fundamentally, Americans have to ask themselves if they really want to share U.S. citizenship with people that don't seem to have a strong commitment to being here or who will become "traitors".  The legal definition of a U.S. citizen must change for immigration, cultural and other valid reasons.

It is also clear that the U.S. needs to change the tax code in light of Severin’s “Benedict Arnold” maneuver. The fact that this guy can benefit from the entire U.S. legal and economic framework and simply lower his tax obligations by leaving the country is ludicrous and shocks the senses.

The process of giving up one’s U.S. citizenship, however, has many consequences and needs to be explored here; especially for those taxpayers who have assets or property offshore.

• To expatriate legally, a U.S. citizen must file Internal Revenue Service (IRS) Form 8854 Initial and Annual Expatriate Statement in which they certify that they are in compliance with U.S. Federal tax laws. It also requires notice to the Department of State and to the Department of Homeland Security as to the expatriate’s long term residency, or dual residency, in another country. It also requires the expatriate to make a declaration as to which country’s tax treaty or foreign tax credits they are invoking or claiming. A disclosure must also be made with regard to foreign assets 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.

• A taxpayer must obtain or already have a second citizenship before surrendering their U.S. Passport at a U.S. Embassy and filing IRS Form 8854, otherwise the expatriate will be a “stateless” person.

• For additional information please see: IRS Notice 2009-85 – Guidelines for Expatriates Under Section 877a.

A reason for renouncing citizenship is to limit the income and estate taxes. The elimination of the “Bush Tax” when it expires December 31, 2012 will result in estate taxes being imposed on estates of $1.0M or more instead of $5.12M as it is currently. 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 on 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, (approximately 1,800 per year) is to give up their U.S. citizenship and move to a jurisdiction which lacks the worldwide approach to assets, property and taxation. Some foreign diaspora who are either foreign born and naturalized U.S. citizens or who were born in the U.S. may move back to their original country of origin or “motherland”; while others will take up citizenship in other “tax havens”.

Expatriation for some individuals is a form of tax protest; an international or global “Boston Tea Party” if you will. It is not an answer or solution though for those people who currently have unreported foreign financial accounts, and who have failed to file with the Treasury Department the required Foreign Bank and Financial Accounts Report (FBAR). See Form TD F 90-22.1 and Instructions.

People or scofflaws who have failed to comply with rules and laws regarding expatriation and reporting of FBAR’s run the risk of civil and criminal penalties and should highly consider the Offshore Voluntary Disclosure Program (OVDI) “amnesty” type of arrangement rather than considering expatriation as a means to avoid taxation or legal compliance. Another option may be considering immediate gifting programs, including charitable contributions, as part of an individuals’ overall tax planning or asset protection strategies.

If you have a U.S. Passport and are a U.S. Citizen living abroad as an expatriate YOU ARE NOT EXEMPT from the requirement to file a return with the IRS.  I have spoken to several American citizens living in the Jakarta Metro area for many years as an expat who live here with an Indonesian spouse under either a Temporary Social Visit Visa ("KITAS") or a Permanent Resident ("KITAP") and who work and have income in Indonesia from employment or a business enterprise and they [erroneously] believe that their foreign income is exempt from U.S. IRS income tax reporting.

Don't be surprised if one day when you return to the U.S. a sharp and astute U.S. Customs & Border Protection (CBP) agent questions you about how long you have lived outside of the U.S. and asks you some income related questions.  They do, after all, have access to the "all seeing eye" computer database repository IBIS and TECS which links in with the IRS and other law enforcement agencies.  

To be exempt you would have to denounce your U.S. citizenship and give up your U.S. Passport and be an Indonesian citizen or national.  You cannot have "dual citizenship" by keeping your U.S. Passport and maintaining U.S. citizenship, then claiming to be "Indonesian".  If you are an adult you do not have "dual citizenship".

As a U.S. citizen or resident alien, your worldwide income generally is subject to U.S. income tax regardless of where you are living. Also, you are subject to the same income tax return filing requirements that apply to U.S. citizens or residents living in the United States.

However, several income tax benefits might apply if you meet certain requirements while living abroad. You may be able to exclude from your income a limited amount of your foreign earned income. You also may be able either to exclude or to deduct from gross income your “housing amount” which is the excess, if any, of your allowable housing expenses for the tax year over a “base amount” which is 16% of the annual base salary of U.S. Federal Government employee Grade GS-14 / Step 1 ($84,697 for 2012) figured on a daily basis, times the number of days during the year that you meet the bonafide residence test or the physical presence test. 

Allowable housing expenses are the reasonable expenses (such as rent, utilities other than telephone charges, and real and personal property insurance) paid or incurred during the tax year by you, or on your behalf, for your foreign housing and that of your spouse and dependents if they lived with you. You can include the rental value of housing provided by your employer in return for your services. You can also include the allowable housing expenses of a second foreign household for your spouse and dependents if they did not live with you because of dangerous, unhealthy, or otherwise adverse living conditions at your tax home. Allowable housing expenses do not include the cost of home purchase or other capital items, wages of domestic servants, or deductible interest and taxes.  

To claim these benefits, you must file a tax return and attach Form 2555 Foreign Earned Income. If you are claiming the foreign earned income exclusion only, you may be able to use the shorter Form 2555-EZ, Foreign Earned Income Exclusion, rather than Form 2555.

You may, on your U.S. return, be able to claim a tax credit or an itemized deduction for the foreign income taxes that you pay. Also, under tax treaties or conventions that the United States has with many foreign countries, you may be able to reduce your foreign tax liability. 

See the following IRS publications for further information and instructions:

• Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens Abroad

• Publication 514 - Foreign Tax Credit for Individuals,

• Publication 901 - U.S. Tax Treaties (discuss in detail the treatment of your foreign income, the foreign tax credit, and the general tax treaty benefits available to you.)