Renunciation of U.S. Citizenship to Save U.S. Tax (5/17/12; Revised 5/20/12)

There is a good article on renunciation of U.S. citizenship to save U.S. tax in this mornings Tax Notes Today.  Marie Sapirie, Facebook Expat Is Latest Billionaire Without Borders, 2012 TNT 96-1 (5/17/12).  I do and have a link to the article.

This article discusses the brouhaha over Eduardo Saverin's renunciation of citizenship.  Saverin is a Facebook founder with a minority interest in the company going public.  His renunciation of citizenship is speculated to save him millions in U.S. tax.

Ms. Sapirie has some very good comments on the tax aspects of renouncing citizenship.  I have exerpted them and present those exerpts here

Section 877A, enacted as part of the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008, revised the exit tax consequences imposed under section 877 by establishing a mark-to-market regime in which the property of covered expatriates is treated as being sold for fair market value on the day before the expatriation date. Any gain arising from the deemed sale is taken into account for the tax year of the deemed sale, less an exclusion amount that is indexed for inflation. An expatriating taxpayer may elect to defer payment of the tax until the property that was marked to market is disposed of.  

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Regardless of whether they meet the 877(a) tests, before expatriating all individuals must certify that their past five years of U.S. tax returns are fully compliant. Before that certification can be made, many nonresident citizens must file returns and foreign bank account reports, Mehany said. Part of the analysis in that step is to determine whether it is in the taxpayer's interest to enter the offshore voluntary disclosure initiative or to explore other planning alternatives before starting the expatriation process to allow the taxpayer time to become compliant, she said.

Expatriates must ensure they do not fall back into the tax system by spending too many days in the U.S. after they have expatriated. Also, if they have sources of U.S. income within the 10 years after expatriation, they will have to file Form 1040-NR, "U.S. Nonresident Alien Income Tax Return," in accordance with section 877(b), Mehany said. 

Estate planning is another important part of expatriation for wealthy taxpayers. The estate tax is one of the biggest concerns for individuals who are contemplating expatriation, Mehany said, adding that many people are ending up with citizenship in a jurisdiction with a higher income tax rate than the U.S., but avoid the estate tax because the jurisdiction has larger exemptions, lower rates, or greater availability of trust structures that hold wealth outside the estate. 

Ironically, the estate tax is one reason some taxpayers decide not to leave. In some cases, entire families expatriate together, but other expatriates still have a U.S. spouse or children. If future heirs will remain U.S. citizens and the estate, perhaps because of the location of the assets, will be subject to U.S. tax, expatriation won't always produce a significant tax savings in the long run, Mehany said.

Addendum 5/20/12:

A new article on the subject with practice considerations is Laura Sanders, Should You Renounce Your U.S. Citizenship? ( WSJ 5/18/12), here.  A key excerpt from the article is:

Get ready for questions. Expatriation involves an exit interview with a U.S. official, usually abroad—although not always in the host country. Experts say the meeting is typically short unless officials are worried about irregularities, in which case it can last much longer. 

You need somewhere to go. How to find a new home? Some countries, such as Ireland and Italy, often welcome relatives or descendants of their citizens—but don't always offer tax advantages. In other nations you must have a stronger argument, such as a big investment there. 

On its website, the Caribbean nation of St. Kitts and Nevis says its Citizenship-by-Investment Program requires a real-estate investment of at least $400,000 or a contribution to a public charity of at least $250,000. 

You might owe an exit tax. U.S. citizens who expatriate are treated as though they sold all of their property the day before they renounce, even if they will continue to own it and pay property or other taxes. 

Capital gains (net of losses) are taxed at the current top rate of 15%, after an exemption of $651,000. The tax on some assets, such as an individual retirement account, will be at ordinary income rates up to 35%, notes Dean Berry, an attorney with Cadwalader, Wickersham & Taft in New York. 

The tax applies to U.S. taxpayers whose net worth is greater than $2 million or whose average annual income tax for the past five years is $151,000 (adjusted for inflation). 

There are important exemptions; one involves people who have been dual citizens from birth. For more information, see the instructions to IRS form 8854. 

You will have to certify that you have been tax-compliant for the last five years. The upshot: Expatriation is a bad strategy for coping with past noncompliance. 

Your heirs could get a big tax bill. The U.S. heirs of wealthy taxpayers who renounce their citizenship usually owe inheritance tax equal to the U.S. estate tax on assets left to them by the expatriate. (This doesn't apply to spouses who are U.S. citizens.)

For example, a woman worth $50 million renounces her citizenship and becomes a citizen of the Bahamas. If she leaves each of her three grandchildren in the U.S. $10 million, each will owe (at current rates) $3.5 million of federal tax on the bequest, as a substitute for estate taxes the woman didn't pay. 

You might find travel more complicated. World-wide travel might require getting more visas, Fragomen's Ms. Weintraub notes, and you might not be able to re-enter the U.S. without one. Once here, it may be hard for you to spend more than 120 days a year (on average) in the U.S., and you must not appear to be using your visitor status to live in the U.S. 

There is more: Under the "Reed amendment," named after a Democratic senator from Rhode Island, U.S. officials may bar entry to any person who renounced citizenship for tax reasons. This provision is rarely, if ever, invoked—Ms. Weintraub has never heard of a case—but it is on the books. Experts say the attention surrounding Mr. Saverin's case could revive it, and recently lawmakers proposed raising the exit tax. 

Is all this hassle really worth a tax savings? You be the judge.

U.S. Citizens considering renunciation of U.S. citizenship need wise counsel in considering whether renunciation is right for them.  If you are considering this, look for an attorney with experise who can make all of the consequences of renunciation meaningful to your particular situation.  Many lawyers (including myself) may know the tax rules but what we don't bring to the table is actual experience as to the other ramifications of renunciation, so make sure you get counsel with experience.


 Articles:
 Quentin Hardy, A Facebook Co-Founder Reflects on the Path Forward (NYT 5/16/12), here.