Over the last couple of weeks we have been discussing the expatriation process. A citizen or long-term resident who wishes to permanently sever ties with the United States (i.e. expatriate) must take certain legal steps and pay any taxes due to the United States. Failure to take the appropriate steps will not relieve an individual’s obligation to file future U.S. tax returns and report and pay tax on his or her worldwide income.
Depending on an individual’s financial situation, an expatriation tax may apply. If this is the case, the expatriating individual is generally subject to income tax on the net unrealized gain in his or her property as if the property had been sold for its fair market value on the day before the expatriation date, but up to $693,000 (2016 amount) of gain can be excluded. Certain assets, such as eligible deferred compensation, are excluded from the “deemed sale” calculations and are taxed under a different set of rules.
In this week’s blog, we will discuss the fictional Farkle family, U.S. citizens who have become disillusioned with the United States.
The Farkle family is native to New York. John and Jane Farkle have two sons, both in their teens. John and Jane have become increasingly disillusioned with the U.S. political climate and have been living abroad with their sons for the last three years. They have been happier in their new adopted country and, after much soul-searching have decided to give up their U.S. citizenship. They have already started the process of applying for citizenship in the foreign country in which they reside.
When they contact a U.S. immigration attorney to assist them with renouncing their U.S. citizenship, the attorney asks them about their U.S. tax filings. The Farkles explain that when they lived in the United States, they used a CPA to prepare their tax returns. However, once they moved abroad they began working with a local accountant who assisted them with filing their foreign returns.
The immigration attorney informs them that as U.S. citizens they must file U.S. income tax returns each year no matter where they live, and certain additional returns and forms might apply due to their foreign activities. She advises them to contact a U.S. tax advisor to sort out their tax situation. She also warns them that there may be an expatriation tax.
The Farkles locate a U.S. CPA who has worked with other clients living abroad. He helps them get current with their U.S. tax filings and does a projection of the expatriation tax. The Farkles are shocked at the amount of expatriation tax that would be owed. They own outright their dream home in the foreign country, have a joint brokerage account and both have substantial 401(k) accounts, but the biggest problem is that Jane owns, jointly with her sister, a Miami apartment building that she and her sister inherited from their grandfather 30 years ago. The property is fully depreciated and the potential gain on sale is substantial. Jane would not only be over the expatriation tax threshold, but the tax due on the deemed disposition of her share of the Miami property would put a dent in their joint brokerage account, something they do not feel comfortable with.
Although Jane would get an increased basis in the Miami property for U.S. purposes due to the expatriation tax, John and Jane learn that a later disposition of the property would result in taxes due to their foreign country of residency based on gain calculated using the original basis. They also learn that Jane’s continued ownership of the Miami property, after expatriation, will create continued U.S. taxation issues.
Adding to the confusion are the estate and gift tax rules that will apply even after expatriation for gifts or bequests they make to U.S. citizens or residents.
Jane and John place the expatriation process on hold in order to reevaluate their decision based on the tax issues they have just learned about, and to determine how best to proceed should they still desire to expatriate.
Stay tuned. Next week we will discuss what John and Jane decided.