When do Covered Expatriates Pay Exit Tax at Expatriation?

When do Covered Expatriates Pay Exit Tax at Expatriation?

When do Covered Expatriates Pay Exit Tax at Expatriation

When do Covered Expatriates Pay Exit Tax at Expatriation? When it comes to expatriating from the United States, the IRS makes it unnecessarily complicated. One very common misconception is that simply because a U.S. person has a net worth of over $2,000,000 and/or a net average income tax liability that exceeds the five year prior average (increases based on inflation), that they will automatically owe exit tax when the expatriate from the United States — but that is incorrect.  There are actually two parts of this analysis:

  • is the person a covered expatriate; and
  • if they are a covered expatriate, is the person subject to exit tax

Let’s go through a few examples of the difference between being a covered expatriate and being subject to exit tax.

No Exit Tax Covered Expatriate (Example 1)

Dean is a US permanent resident who meets the long-term resident test. Therefore, he must conduct the covered expatriate analysis to determine whether or not he may be subject to exit tax.

It turns out Dean doesn’t trust the stock market, and therefore has all of $4,000,000 held in in cash — deposited in multiple bank accounts across different institutions for full FDIC protection.

Based on his net worth, Dean is a covered expatriate.

Is Dean Subject to Exit Tax?

No. Dean is not subject to exit tax because Dean does not have any mark-to-market gain on the cash and Dean does not have any deemed distributions of any prior tax deferred or ineligible deferred compensation.

Result: No Exit Tax

No Deemed Distribution Exit Tax: Covered Exception (Example 2)

Peter is a US permanent resident who also meets the definition of a Long-Term Resident.

Peter is a covered expatriate with a net value of $5,000,000.

Peter has $3,500,000i  =n cash and $1,500,000 in an Australian Superannuation.  The superannuation would be considered an eligible deferred compensation plan and deemed distributed the day before expatriation.

But,  Peter earned all of the deferred compensation before he was a US resident or had any US status.

Is Peter Subject to Exit Tax?

No. Peter is not subject to any US exit tax. First, Peter’s $3,500,000 cash is not subject to market to market or deemed distribution.  Second, as to the ineligible deferred compensation, there is an exception under 877A (d)(5) which exempts deferred compensation that is earned prior to a person becoming a US resident or citizen.

Result: No Exit Tax

Mark-to-Market Covered Expatriate & Exit Tax (Example 3) 

Randy is a legal permanent resident who is also a Long-Term Resident and ready to expatriate.

Randy’s net worth is around $6,000,000.

Of that $6,000,000, Randy has $3,000,000 of unrealized stock gains that will be deemed sold the day before he expatriates.

There is an exemption of about $725,000 that goes up each year with inflation. But even with the exclusion amount, Randy will have to pay exit tax on the unrealized gain (minus the exclusion amount).

Result: Randy should seek to plan before exiting.

Deemed Distributions & Covered Expatriate Status (Example 4)

Michelle is a US citizen who was naturalized around 35 years ago, but resides in Australia. She’s ready to give up her US person status — her net-worth is $5,000,000.

Michelle’s net-worth primarily consists of cash, aside from about $1,200,000 which is in foreign retirement.

 Michelle never paid any tax on the earnings in the US during the growth/contribution phases and it was earned while she was a U.S. citizen.

Presumably the money will be deemed distributed the day before she expatriates.

Unlike example #2 above, Michelle was a US person when she earned the foreign pension (and did not pay any tax, so has no basis in the pension) and therefore it would presumably not be exempt at the time of expatriation.

In conclusion, while exit tax an expatriation go hand in hand, just being a covered expatriate does not mean a person will be liable to the US government for any exit tax. Even if the expatriate would otherwise be liable, based on the mark-to-market exclusion amount and/or various exceptions to the exit tax — they may qualify for a waiver.

Interested in Exit Tax Planning & Expatriation Representation?

Our firm specializes exclusively in international tax and a focus on offshore compliance and expatriation.

Contact our firm today for assistance.

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