About Renouncing US Citizenship and Tax Treatment for Expats

About Renouncing US Citizenship and Tax Treatment for Expats

About Renouncing US Citizenship and US Taxes for Expats

It is not uncommon for US citizens (and long-term lawful permanent residents) to consider renouncing their US citizenship — and there are many different reasons for wanting to renounce. One common situation is when a person is an accidental American who resides overseas and only recently learned that for one reason or another, they are actually a US citizen and therefore not subject to US tax and reporting. Other taxpayers may, for example, may have become naturalized and already have citizenship in a different country — and therefore, no longer have use for  US citizenship. Less common — but becoming more common as of late — are US citizens who may have been US citizens at birth but no longer want to deal with the business rules and tax implications of being a US citizen and therefore want to renounce their US citizenship. This may be a very costly endeavor, especially for taxpayers who have to purchase second citizenship as well as may become subject to the exit tax if they need the covered expatriate test. Either way, the key question is whether or not a person should renounce their citizenship –– let’s go through some of the basics.

Benefits of Renouncing US Citizenship

It’s always good to start on a positive note – so let’s begin with the pros:

Avoiding US Tax on Worldwide Income

The United States tax system is unique in that it follows CBT or “Citizen-Based Taxation) which is one of only two countries in the entire world that taxes US persons based on their US person status and not their residence. In other words, if you are a US person and reside overseas then you are still taxed on your worldwide income — even if you have not resided in the United States for that entire year and/or all of the income is sourced outside of the United States. By giving up or renouncing US citizenship, you are no longer subject to US tax on your worldwide income.

Investment Planning with CG and Interest

Even after renouncing US citizenship, many former US citizens realize that investing in the United States economy can be a safe and effective investment. By planning properly, non-resident aliens can now invest in the United States and plan to earn only earn capital gains and/or interest income, which is typically not taxed by the United States — unless certain exceptions apply. If the taxpayer happens to be in a country that does not tax capital gains or interest, they may realize a significant reduction in their tax liability.

Easier to Plan with CFC, GILTI, and Subpart F

When it comes to being a US person with a foreign business, there are many tax and reporting hurdles to overcome — as oftentimes there is a mismatch between the US tax rules and the foreign country tax rules — which may lead to very unfair tax consequences.  This is especially the case in which the foreign business is owned more than 50% by US persons. If the US person renounces their US Citizenship, then when the former citizen creates a foreign business, they can circumvent these issues of being a controlled foreign corporation, Subpart F income, etc.

May Significantly Reduce Tax Liability

By no longer being a US person and limiting the amount of US-sourced income that would still be taxable, a former US citizen may be able to significantly reduce –– if not eliminate — US tax liability.

Easier to Open Foreign Bank Accounts

As a result of being a US person, many foreign financial institutions do not want to cater to US citizens — and therefore will not open foreign accounts to US citizens. Once a person is no longer a US citizen it is easier to open foreign accounts and now they no longer have to deal with some of the international information reporting issues such as FBAR and FATCA.

Cons to Renouncing US Citizenship

There are some detriments to announcing your citizenship, the taxpayers should be aware of:

Harder to Travel to and Around the US

Sometimes, a person may want to reside in the United States for more than six months in the current year and after expatriating from the United States, unless they were to become a lawful permanent resident—which typically defeats the purpose of renouncing US citizenship — it can become more difficult to obtain a visa and/or travel to the United States. While there are many visa options available (E-2; EB-5, B1/B2), the US government has been constricting the available number of visas.

US Income subject to FDAP

When a person is a nonresident alien but still earned US-sourced income that is taxable — and not effectively connected income — the income is considered FDAP, with a general withholding rate of 30%. There may be some wiggle room in situations in which a taxpayer can rely on the tax treaty to reduce withholding, but depending on which country the former US citizen resides in, this may not be available – and in situations in which there are 401(k) for example, the tax implications can be significant.

Withholding problems for Covered Expatriates

When a person renounces US citizenship, if they were considered a covered expatriate at the time they renounced, then there are many lingering tax implications that they have to be aware of, especially if they plan on giving gifts to US persons.

About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and expatriation.

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