Should I Cash Out Before I Expatriate from the US
When a US Person is either a Long-Term Resident or a US Citizen, they are several hoops they have to jump through in order to properly relinquish their Long-Term Lawful Permanent Resident status or renounce the US citizenship. For some Taxpayers, they may be considered a covered expatriate –– which results in lingering tax consequences after the US person is no longer a US person. Likewise, some covered expatriates may also get stuck with an exit tax. Therefore, careful consideration is required in determining whether or not it is worth retaining US assets even after the Taxpayer has moved abroad and is no longer a US person for tax purposes. Let’s go through five (5) common facts to be aware of:
Real Estate and FIRPTA
FIRPTA refers to the Foreign Investment in Real Property Tax Act. For US persons, there are no FIRPTA implications, because it primarily refers to nonresident aliens. While most capital gains that are US-based are tax-exempt for nonresident aliens, US real estate sales are still taxable. To ensure that the nonresident alien pays proper tax on the sale of their home and other real property, the IRS withholds 15% of the sale price, not the gain –– at the time of sale. This may result in a substantial withholding amount — especially with today’s real estate prices — which may far exceed the tax due. The taxpayer can apply for a withholding exemption certificate, but that comes with other headaches as well, not the least being escrow being stalled — and even canceled — if the IRS is too slow in getting out the withholding certificate.
Dividends vs Interest
In general, dividends generated in the United States are still taxable to non-resident aliens — and subject to a 30% withholding, unless the treaty modifies the withholding — and the proper forms are filed. Conversely, interest is typically not taxable to nonresident aliens. Therefore, taxpayers who have left the United States must carefully consider whether or not they want to maintain their investments in the US and what type of investment income they are generating. For example, bond interest vs bond-fund dividend.
Capital Gains and 183 Day Rule
In general, when a nonresident alien has capital gains generated from the United States, those capital gains are not taxable in the United States – – but there are some exceptions, and the main exception (beyond real estate) is 183-day+ residence in the United States. In other words, if the taxpayer is present in the United States for more than 183 days and the resident alien’s tax home is the US, then this can be a tax problem
“A nonresident alien who is present in the United States for 183 days or more is taxed on U.S. source capital gains only if the alien’s tax home is in the United States. This provision affects mainly foreign government-related individuals, foreign students and foreign scholars, all individuals who typically remain in the United States for long periods of time as nonresidents.”
Withholding on 401K
Whether or not to cash out the 401(k) is based in part on whether or not the taxpayer is a covered expatriate and — whether they are moving to a treaty country. If the person is a covered expatriate, then the US is going to withhold 30% and the taxpayer irrevocably waives the right to reduce 401K withholding based on treaty provisions. Conversely, if the taxpayer is not a covered expatriate, then they may qualify under a tax treaty to reduce the withholding — and at the end of the day, they may not owe any tax. Likewise, even if a person is a covered expatriate, just because they cannot reduce the withholding does not mean that they cannot reduce their tax liability — depending on whether they have to pay tax in the foreign country or not. Overall, it is generally a much bigger headache for the Covered Expatriate to maintain the 401(k) — and therefore often times they will cash out when leaving the United States.
Dealing with US Tax is a Hassle
The biggest decision in determining whether or not to cash out before expatriation is the level of headache and hassle that each taxpayer would have to undergo in order to maintain the investment in the United States. Taxpayers should consult with a Board-Certified Tax Law Specialist at the time of expatriation to assess the different options.
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