Knowing your status is key to breaking up with the IRS through expatriation
Giving up U.S. citizenship isn’t an easy decision to make, especially since there are benefits to having it. For example, if you are career-minded and interested in the larger, more diversified U.S. economy, or you want to find employment with a Canadian affiliate of an American company, holding the status of U.S. citizenship can be an advantage.
But when it comes to taxation, there are plenty of reasons to consider cutting ties with the Internal Revenue Service (IRS).
For starters, being a U.S. citizen can be, well, taxing. The tax obligations and restrictions of U.S. citizens, even those who are non-resident, can be onerous, to say the least, and include such things as:
- Filing U.S. tax returns and paying U.S. income taxes.
- Paying gift tax on gifts to any recipients, including a spouse if he/she is not an American, if the gift exceeds a certain threshold.
- Restrictions on types of financial assets in order to avoid additional reporting or double taxation.
- Restrictions on how to run a non-U.S. based business or on how to be part of non-U.S. family wealth.
- Additional complexities with non-U.S. inheritance.
- Full disclosure of a financial accounts and assets, even those received through employment, if the American has a signature authority.
These obligations apply to any U.S. citizen, no matter where they reside or where their assets are held. This includes those who are considered ‘Accidental Americans’ – people who discover for the first time that they are considered U.S. citizens.
Yes, that might be the case even if you’ve spent your entire life as a citizen and resident of Canada, so it is important to explore how to become tax compliant south of the border. Feigning ignorance will not likely save you from the long arm of the IRS, and the only thing costlier than paying and/or reporting U.S. taxes is not doing so. In fact, the fines and penalties associated with willfully ignoring obligations can be financially devastating.
So, knowing your status is the first step in changing your status.
The only way to relieve yourself of these obligations is to renounce U.S. citizenship. The legal process involves an appointment with the U.S. consulate, remitting a USD $2,345 administrative fee to receive a Certificate of Loss of Nationality, and the physical surrender of your U.S. passport.
From a tax perspective, renouncing may also require paying U.S. taxes and filing additional forms disclosing all financial aspects of your life, but it is probably the lesser of two evils over the long term; by retaining U.S. citizenship you must file lengthy tax returns with potentially hefty penalties, and possibly pay taxes annually).
Obviously, this process is more straightforward for those who are aware of their U.S. citizenship and already have a social security number. For those to whom U.S. citizenship has come as a surprise, you may have to acquire a social security number in order to file your first … and maybe shortly after that, your last U.S. tax return.
So, the first step is to know who you are in the eyes of the IRS. If you are a U.S. citizen (accidental or otherwise) or long-term resident (i.e. long-term green card holder), you are a U.S. taxpayer no matter where you live. If you are a U.S. citizen or long-term resident who decides to give up citizenship or green card, the IRS will consider this as an act of expatriation.
What kind of expatriate are you?
Now, what kind of expatriate are you?
Knowing who you are in the eyes of the IRS is knowing whether you are a non-covered or covered expatriate. Most think being covered is a good thing. Not necessarily. If you are a covered expatriate, you have to pay exit tax on your worldwide assets in order to extricate yourself from the U.S. tax system.
Unfortunately, exiting as covered does not guarantee that your U.S. tax obligations will stop. They may remain, and may even pass to your loved ones if they ever receive a gift or inheritance from you.
How do you know if you’re a covered expatriate? Simple. You must satisfy any one of the following three tests:
- Your net worth was $2 million or more when you expatriated. This is based on the accounting of all your assets, including your principal residence, future employer pensions, family trust assets, personally held Canadian corporation, etc.
- Your average U.S. tax owing for the five years prior to expatriation was above a certain threshold (indexed for inflation each year).
- You didn’t file your tax returns correctly or pay all your tax for the five years prior to expatriation.
So, if you are a covered expatriate you will want to know exactly what that means. And that means understanding the exit tax. But that one is a story in itself.