According to Jaime McLemore, a London-based associate at international law firm Withers, under U.S. tax law the rules for wealthy expatriates can be very harsh. U.S. citizens and certain green card holders with a net worth of more than $2 million are “covered expatriates” and are subject to a special tax regime where they are treated as if they have sold all their assets and U.S. taxes are due on the gains from the deemed sales. Further, their children, if U.S. citizens, are subject to tax at the applicable gift or estate tax rate when they receive a gift or bequest from the covered individual. There is an exemption for dual citizens from birth who reside in their other country of citizenship and those who expatriate before age 18 ½.
The rules also apply to those who exceed a U.S. income tax liability threshold or any expatriate who fails to certify that they have satisfied all U.S. tax obligations for the previous five tax years, according to McLemore.
“It’s important that anyone thinking of expatriating get advice before they do it. I’ve talked to people who gave up their passport, then come and ask, ‘What do I do now?’” she said. “At that point, it’s too late. The tax consequences are set as of the time you actually expatriate, so it’s important to plan in advance.”
”There are three triggers for the exit tax in the expatriation tax regime. The main trigger is the net worth tax,” she said. “If you have worldwide assets of $2 million or more on the date of your expatriation, the rules apply.”
“The second trigger is average U.S. income tax liability for the past five years. If it exceeds $161,000 – indexed for inflation – then the expatriation rules apply. There are not a lot that meet that threshold in the U.K. because they can take a foreign tax credit, but if they live in a low-tax jurisdiction such as Kuwait, it can trip them up,” she said.
“Finally, expatriates have to be able to certify that they have been compliant with U.S. federal tax obligations for the past five years prior to expatriating. They certify this on Form 8854,” she said.
No exceptions apply to this trigger, she added. "If you are a dual citizen residing in the country of your other citizenship, that won't get you out of tax if you can't certify compliance for five years," she said.
It’s routine for the noncompliance issue to trip up people who live outside the U.S. “Some of them aren’t even aware they were U.S. citizens,” she said. “They might have been born in the U.S., or have one parent who was a U.S. citizen. This happens because the U.S. is unusual in taxing its citizens, rather than other countries, which tax residents. They don’t realize they have compliance requirements.”