Net Worth Test & Expatriation
Net Worth Test & Expatriation: When a US person decides that they want to expatriate from the United States, one of their biggest concerns (understandably) is determining whether or not they will become subject to the notorious US Exit Tax. Not everyone who wants to expatriate is subject to exit tax. In order to possibly be subject to the exit tax, a person must be considered a covered expatriate. And, to be considered a covered expatriate, a person must meet one of the three tests. The test that most people fail — and makes them potentially a covered expatriate — is the net worth test.
On the one hand, it’s nice to have accumulated sufficient wealth to be considered high net worth. On the other hand, the IRS is not kind to people with a high net worth.
Let’s review the basics of the Expatriation Net Worth Test.
$2 Million Dollars Net
In order to be considered high net-worth, the person must have a net asset value of $2,000,000 or more.
Unfortunately, unlike the net income tax liability test (which adjusts each year for inflation) — the net worth test has been stuck at $2,000,000 for many years. Therefore, if a person has a net worth of $2,000,000 or more, then they will fail the net worth test and be considered a covered expatriate (unless an exception or exclusion applies).
Net Worth vs Gross Value
It is important to keep in mind that it is a net worth test and not a gross value test. Therefore, just because a person owns an asset worth $2,000,000 or more does not mean in and of itself that they have met the net worth test.
Here is a simple example: David has been a Green Card Holder for the last 9 years. He is considered a Long-Term Resident, and therefore has to go through the three (3) covered expatriate tests. He has a home worth $2.4 million, but it has a $700,000 mortgage on it. This is the only asset that David has, and he has no other money or investments. David would not meet the net worth test because when he factors in the mortgage and the value of the home, David’s net worth is 1.7 million and not 2.4 million.
What is Included in the Net Worth Test?
Nearly all types of assets and investments would be included.
Some common examples include:
- Pension Accounts
- Life Insurance
- Hard Assets
- Precious Metals
If a person meets the net worth test and therefore is a covered expatriate, then they must determine whether or not they have an Exit tax. In fact, two people with the exact same net worth they have very disparate outcomes when it comes to calculating exit tax.
Exit Tax Example 1
In David’s situation above — even if his home was not his primary residence — based on the mark-to-market exclusion of $737,000 (adjusts for inflation), David will not owe any pay exit tax.
Exit Tax Example 2
David’s sister Michelle is also expatriating, but her (only) asset includes a stock that she purchased once she became a US person. She spent $300,000 for stock, which is now worth $2.4 million. For Michelle, there is a significant amount of capital gain that will be factored in to her mark-to-market exit tax calculation.
Since she only has $737,000 of exclusion — Michelle will have a hefty exit tax unless she plans appropriately.
How Exit Tax Planning Can Help
Once a person knows they will be considered a covered expatriate — and oftentimes there is no way around it (based on net-worth or net income tax liability) — a person can plan around it. The mark-to-market calculation is based on the fair market value on the day before expatriation and there is currently no look-back period — so gifts can be made in order to reduce net-worth. Ideally, a person will avoid covered expatriate status — especially if they are high net worth and plan on giving gifts to US person children. If that is not possible, then possibly transferring assets to the spouse can help reduce the net worth or exit tax of the person exiting the US. If the other spouse intends on expatriating as well, some further analysis must be considered before making the transfers.
High Net Worth is Only One Factor for Exit Tax
In conclusion, simply because a person has a high net worth and qualifies as a covered expatriate does not necessarily mean they will become subject to exit tax. A person can be a covered expatriate because of a high net-worth but not be subject to exit tax. This will depend on whether they have any mark-to-market gain or deemed distributions (for ineligible deferred compensation or tax deferred investments).
As with anything international tax related — planning and execution are very important.
Interested in Expatriation from the U.S.?
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