Key US Tax Considerations Before Divorcing Uncle Sam
The number of Canadians renouncing US citizenship has increased in recent years. Many more are in a months-long queue to part ways with uncle Sam. But before you do, there are key things to consider.
Are You a US Expatriate?
US expatriates generally include US citizens, green card holders, or long-term residents that have removed themselves from the United States. When a US citizen, or long-term resident experiences an expatriation event (such as surrendering a green card), they may be considered a “covered expatriate.” This notion of a “covered expatriate” is key, as you may be subject to an “exit tax” for divorcing Uncle Sam.
Most find it easy to determine whether or not they are a US citizen. The concept of a long-term resident, however, is less clear. The US Internal Revenue Service considers a long-term resident to be an individual who has been a green card holder for eight of the last 15 tax years.
Be careful how you count those tax years. Why? It only takes six years and two days to be considered to have met the eight-year test to be a long-term resident. This is because rather than years being counted based on elapsed time, they are counted based on the number of tax years in which a green card holder held that status. So, if you are granted a green card on December 31, 2018 of a tax year – well, you held it in that tax year and 2018 counts as a year. However, keep in mind that years in which a valid treaty election is made by a US person to be treated as a non-resident alien, may be excluded when computing eight years of the last 15 years.
Covered Expatriate Tests
Once you have figured out whether you are a long-term resident, or US citizen and you are expatriating from the US, there are key tests to consider in determining whether you are a “covered expatriate.” These tests basically consider whether you have either been compliant enough, or worth enough, for an exit tax to apply. To avoid an exit tax, these tests must either not be met, or an exception to the test should apply.
- Test #1 – Certification Test: You prior five years’ tax obligations have not been satisfied;
- Test #2 – Net Worth Test: Your net worth is above U.S. $2 million; and
- Test #3 – Average Liability Test: Your average income tax liability for the previous five years exceeds $165,000.
Exceptions to the Covered Expatriate Test
If you met the tests above, but one of the exceptions below applies, it may be possible to avoid the US exit tax:
- Dual citizen exception: This exception may apply to someone who became a US citizen at birth and at the time of their birth, they became a citizen of another country and continue to be a citizen of that country and are also taxed as a resident of that country on their expatriation date.
- Young adult exception: This exception may apply, if the relinquishment of US citizenship occurs prior to attaining age 18 ½ and if you have not been a resident of the US for more than ten taxable years, before the relinquishment date.
Calculation of the Exit Tax
Put simply, a covered expatriate generally computes taxes for divorcing Uncle Sam, or exiting the US tax system. This is generally computed as if a pretend sale of one’s assets occurred at fair market value. Note that the net gain from that deemed sale is generally reduced by US $713,000 for the 2018 calendar year, with some exceptions.
Thinking of renouncing US citizenship, or surrendering a green card? Got US tax and Canadian tax compliance issues? Contact Cross-Border Financial Professional Corporation – When Perspectives Matter!
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.