Net-Worth at Expatriation vs Exit Tax
Net-Worth at Expatriation vs Exit Tax: The concept behind the exit tax is simply that the Internal Revenue Service does not want US person expatriates who have unrealized gains contained within certain assets to have an opportunity to escape the clutches of the US tax system by expatriating and giving up their US status. Ensuring that the IRS has their chance to get their grubby little hands on your hard earned money — they developed the exit tax. It is important to note that the exit tax is not a wealth tax per se. In other words, it is not based specifically on how much money a person has when they expatriate (although this may cause an expatriate to become a covered expatriate) — but rather the amount of unrealized gain in certain assets, along with on distributed income from various tax deferred accounts (IRA for example) and ineligible deferred compensation (Such as Foreign Pension).
Net-Worth vs Exit Tax
A person may have a high net worth, but still now owe any exit tax at the time of expatriation. Conversely, a person may have a lower net worth but have significant unrealized gains or other tax deferred income or deferred compensation income that could become subject to exit tax — and result in a substantial tax liability.
Here is an Example
David is a US Citizen who is worth $4,000,000. He bought $4,000 worth of stock 25 years ago, that is now worth $4,000,000. Chances are that absent some exit tax planning, David will have to pay tax on a portion of the gain minus the exclusion amount.
Conversely, Dean is a US Citizen who is worth $25,000,000 — but it’s all in cash. Dean will not owe any exit tax when he expatriates, because there is no mark-to-market gain or deemed distribution on cash in a bank account.
Stated another way, the idea behind the exit tax is that the US government wants a portion of the tax that they would have received on unrealized gain.
The nearly $4,000,000 of unrealized gain in David’s stock is subject to capital gains tax when he sells it. Therefore, if he expatriates, then the US will consider the day before he expatriates as the date of the sale based on whatever the fair market value is at that time — noting that David really has no plans to sell the stock.
With Dean, the US government is not entitled to any tax on his cash because there is no unrealized gain in the cash.
Planning for Expatriation is Important
Before relinquishing a green card or renouncing US citizenship, a person should determine whether they are a covered expatriate and if so, if there is a way to either avoid that status or avoid exit tax. Just having a high net worth does not equate to owing exit tax at expatriation. Likewise, even an expatriate does not have an extraordinarily high net-worth — significant unrealized capital gains another ineligible deferred compensation or tax deferred income may result in a substantial exit tax — which is why exit tax planning before expatriation is incredibly important.
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