Many Canadians move to the US for work and decide to secure a US green card. When tastes or fortunes shift, some return to Canada. Then, there are American citizens who move away from the US, and along with green card holders who left the US, are often surprised by the requirement to file US taxes on worldwide income, even though they no longer live there. While some later decide to renounce US citizenship or surrender a green card to simplify their filing requirements, it is important to plan carefully for the tax impacts of this decision, including US exit taxes.
What’s the US Exit Tax and Who Should Care?
The US exit tax is a special expatriation tax that applies to both US citizens and long-term residents who have ended their resident status for US federal tax purposes. The terms US citizen and long-term resident are defined terms. While most individuals know whether they are US citizens or not, this may be less clear for some, such as individuals born to US parents outside the US.
The US tax code defines who is considered a long-term resident. It includes individuals who have held a green card or have had lawful permanent resident status in the US in at least 8 of the last 15 years, ending with the year of expatriation. There are a couple rules that US green card holders should be aware of.
The first, is that holding a green card for one day in a year counts as a full year towards the eight of fifteen years test. This is because the test counts any day in which you held the green card as holding that green card in the year and a full year is added when assessing an individual’s long-term resident status.
The second key point green card holders often miss, is that even if a green card is expired, those years still count for the purpose of the lawful permanent resident test. The days are no longer counted, only when the green card is abandoned by filing a Form I-407 with the USCIS in person, or by mail, or is revoked.
US green card holders who are tax residents of another country with which the US has a treaty, may make treaty elections to avoid years resident in another country counting towards the US test. This election is not possible for US citizens.
Nonetheless, both US citizens who give up their citizenship and long-term residents who surrender green cards, have them revoked, or make a non-resident treaty election, should carefully assess the impacts of the US exit tax.
Exit Tax Rules US Citizens and Residents Should Know
Giving up US citizenship or a green card generally results in an expatriation event. Individuals who are considered covered expatriates often have extra tax to pay and paperwork to file. Those who are non-covered expatriates complete a Form 8854 and carry on with life in their new country.
Who is a Covered US Expatriate?
There are three key tests to consider in determining whether an individual is a covered expatriate or not.
- Certification Test – If your tax obligations for the prior five years have not been satisfied, you are immediately considered a covered expatriate. If you are planning for an expatriation event, this is the very first item to review. Ensure that you have been tax compliant for the last few years.
- Net Worth Test – If your net worth exceeds US$ 2 million, then you are also considered a covered expatriate. This number is not currently indexed for inflation. Hence, excluding the impact of exchange rates, this number generally makes it easier to be considered a covered expatriate, as time passes.
- Net Income Tax Liability Test – If your prior five years’ average tax liability exceeds US$171,000, you are considered a covered expatriate.
Exceptions to Being a Covered Expatriate
Fortunately, it may still be possible to avoid the covered expatriate status even if you are considered a covered expatriate under the net worth test, or the net income tax liability test. If you are a covered expatriate because you failed the certificate test, then no exception applies. As such, it is best to ensure tax compliance prior to an expatriation event occurring.
Exceptions to being considered a covered expatriate include:
- If you became at birth, a citizen of the US and a citizen of another country and, as of the expatriation date, you continue to be a citizen of and are taxed as a citizen of that country;
- If your relinquishment of US citizenship occurs before attaining age 18 ½ and you have been a resident of the US for not more than 10 taxable years before the date of relinquishment; and
- Meeting the certification test.
How the US Exit Tax is Computed?
Computing US exit tax generally requires factoring in just about all assets owned at fair market value and you pretend to have sold them the day just before you expatriate. This includes IRAs, deferred compensation, trust distributions and even deemed dispositions on PFICs. Fortunately, for 2020 expatriations, the first $737,000 of capital gain recognized on expatriation is exempt from US taxation. Because this amount is indexed for inflation, it increases each year.
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Karlene J. Mulraine, EA, CPA, CA, CPA (NH) is the President of Cross-Border Financial Professional Corporation. Follow us on Linkedin and Twitter, or hang out on Facebook.
The views expressed in this article are those of the author and should not be relied on to make decisions. Consider discussing your specific circumstances with an appropriate specialist.