Is Expatriation Right for You?
We’ve helped dozens of US citizens and permanent residents (“green card” holders) give up their US nationality or residence status. This is called expatriation.
It’s a big decision—one that has implications far beyond possibly paying an “exit tax” upon your permanent departure.
Some of the considerations you need to review include:
- Will you be able to return to the United States to visit relatives, receive medical treatment, etc.?
- Does the passport you’re using in place of a US passport provide sufficient visa-free travel options for the countries you wish to visit regularly?
- Do you have a non-US home where you can not only live comfortably, but also become integrated with the local community?
- Do you have US assets or sources of income that would actually be subject to higher tax if you expatriate?
- How will your US pension and social security income be taxed after expatriation?
Why Do People Expatriate?
One reason is taxation. The United States taxes its citizens and permanent residents on their worldwide income, no matter where they live. It’s the only country in the world, other than tiny Eritrea, a totalitarian dictatorship, that follows this policy.
In virtually all other countries, individuals end their liability to pay income tax after a sustained period of non-residence. This is generally one year or longer. But to legally and permanently give up US tax liability on their worldwide income, US citizens must also give up their US citizenship and passport.
“Big Media” emphasizes the tax aspect of expatriation when it talks about high-profile expatriates like Eduardo Savarin or Tina Turner. But the truth is that the majority of individuals who give up US citizenship or permanent residence pay at least some tax in their adopted country.
We’ve discovered the motivations for our expatriation clients to take this step are more nuanced than mere tax avoidance. Several non-tax factors make it increasingly difficult for US citizens or permanent residents to live outside the United States.
What It’s Really Like to Expatriate
The actual process of expatriation isn’t as arduous as you might think.
You’re likely to encounter bureaucratic incompetence and unexplained delays. But giving up your US nationality is a legal right.
You can read a case study here: What it’s really like to expatriate.
Navigating Mandatory Financial Disclosures
A case in point is the overwhelming compliance burden US taxpayers living overseas face. The information reporting regime they face is complex, overlapping, and evolving. Even minor violations are subject to draconian penalties.
Take for instance, the ubiquitous Treasury Form TD F 90-22.1, the “foreign bank account reporting form.” Fail to file this form and you could be imprisoned for five years and fined $500,000. True, sanctions typically are much less severe, but many other mandatory disclosure forms exist, all of them easy to miss, and all with significant penalties for non-compliance.
What’s more, US laws force foreign banks and other financial institutions to enforce US tax and reporting rules with respect to their US clients. If the banks fail to do so, they face a 30% withholding tax, starting in 2014, on many types of US source income, and possibly on other capital transfers. Often, it’s easier for foreign banks to “fire” US clients than deal with this risk.
The result is that many Americans, especially those living abroad, have decided their US citizenship or residence is more trouble than it’s worth.
The decision to turn in your US passport or green card is a big one. It requires that you get a second passport, if you don’t already have one. It also requires that you live permanently outside the United States, if you don’t already do so.
The Importance of Getting a Second Citizenship Before You Expatriate
Although it’s not legally required, a second passport from another country is strongly recommended before you give up your US citizenship. This is true no matter if you renounce or relinquish.
Without a second citizenship, the act of expatriating will render you stateless. You won’t have the right to legally live anywhere. Stateless people who manage to stay out of detention camps and refugee centers live on the margins of society, since they lack official papers. In most cases, the only way they can qualify for legal residence is to make a successful claim for refugee status.
For an entertaining, but romanticized, view of statelessness, watch The Terminal. This movie is based on the true account of Mehran Karimi Nasseri. After being expelled from Iran, he spent 18 years living in a departure lounge of the Charles de Gaulle Airport in Paris until he finally qualified for refugee status in France.
How to Get a Second Passport: 7 Legal Ways
Thinking about a second passport? There are just seven official (legal) ways to get one. Find out which one is the best option for you: How to get a second passport.
Five Reasons Nestmann Clients Expatriate
Expatriation is a radical step. So why bother?
We count at least five reasons to consider this step. This is especially true if you’re one of the over nine million Americans who live full-time in another country.
1) Duplicate tax obligations. The United States is one of only two countries that impose income tax on its citizens on their worldwide income if they live in another country. Eritrea, a totalitarian dictatorship, is the other one. Complying with US tax rules is hard enough if you’re living in the United States. But if you’re living in another country, you must now file two sets of tax forms each year. In most cases, you can credit the taxes you pay in your adopted country against your US obligations. But this is time-consuming and expensive to file two sets of tax forms each year.
2) Onerous reporting obligations. The first effort by Congress to require companies and individuals to disclose the assets they held internationally was in 1960. Subsequent laws decreed in 1962, 1970, 1976, 1986, 1996, 1997, 1998, 2005, 2010, and 2011 expanded reporting obligations and increased penalties for noncompliance. With each successive enactment, a growing network of uncoordinated reporting obligations and draconian penalties came into existence. The resulting hodgepodge is difficult even for international tax specialists to navigate. And it’s not just tax forms with which you need to be concerned although it’s those forms that are best known. For instance, if you’re enrolled in a non-US retirement plan, the odds are you need to report that plan as a foreign trust. That’s hardly an intuitive conclusion.
What’s more, the penalties for violating these reporting rules are draconian. For instance, failing to properly report a foreign trust can result in the IRS requiring you to fork over 35% of its value – in this case 35% of your foreign retirement assets. Expatriation is the only way to permanently end these reporting obligations and the penalties that accompany them.
3) Inability to maintain financial accounts anywhere in the world. Laws like the infamous Foreign Account Tax Compliance Act (FATCA) have made it difficult for Americans living abroad to carry on the most basic financial and business relationships in their adopted countries. FATCA, for instance, forces foreign financial institutions to follow US tax and reporting rules with respect to their US clients. If these institutions fail to do so, they face a 30% withholding tax on many types of US source income and other capital transfers. In many cases, it’s easier to “fire” US clients than deal with this risk. As a result, Americans living abroad report their financial accounts being closed. We’ve also heard reports of Americans abroad being denied mortgages and even insurance coverage.
What’s more, as part of ongoing “de-risking” strategies, US financial institutions are increasingly closing accounts of Americans living abroad. Thus, they’re finding it difficult to obtain financial services anywhere in the world.
4) Inability to work or conduct business. Another challenge to Americans abroad is getting a job or forming a business. One client’s employer told him he’d be fired unless he gave up US citizenship within 30 days, due to the employer’s correct perception that the client’s position as a company officer would require the client to disclose confidential information about the company to the IRS and Treasury. For the same reason, it’s increasingly difficult for US citizens or permanent residents to enter into business relationships with foreign persons or companies. They (the foreigners) simply view Uncle Sam as an uninvited and unwanted intruder into the relationship.
5) Inability to have a normal retirement. Most countries offer bona-fide residents the opportunity to make tax-advantaged contributions to retirement plans; schemes similar in concept to an IRA or 401(k) in the United States. But with only a few exceptions, the IRS considers the buildup in value in a non-US retirement plan to be taxable. That means retirees pay taxes twice on the same income; once when it’s generated within the plan (by the United States) and a second time when the income is distributed (by the country offering the plan). In high-tax countries like Canada, the effective tax rate in this income can exceed 70%.
Eight Reasons Why Nestmann Clients Don’t Expatriate
There are some definite downsides to expatriation.
Here’s a list of eight practical reasons why you might not want to expatriate.
1) You’re only living abroad temporarily. Many multinational companies temporarily post their employees abroad. And while those employees may face some of the difficulties we alluded to elsewhere in this section (e.g., maintaining banking relationships), these problems will be resolved once they return to the United States.
2) You live and work abroad but think you might want to eventually return to the United States. Even if you see yourself as permanently living outside the United States, if you think you might want to return, expatriation is not a good option.
3) You don’t qualify for a second citizenship and passport. To avoid statelessness, you should get a second citizenship and passport before you expatriate. But if you’ve ever been convicted of a felony or are on any kind of sanctions list maintained by the Treasury Department’s Office of Foreign Assets Control (OFAC), you might not be able to qualify for one. There are some workarounds we’ve helped clients with. But it’s much easier to qualify for a second citizenship and passport without these challenges.
4) Most of your income comes from US sources that can’t be shifted abroad. If you live in a country without a tax treaty with the United States and have US source income, you could be worse off tax-wise expatriating than if you remained a US citizen . For instance, if you receive pension and Social Security income from the United States, filing tax as a US citizen means you’ll have the opportunity to take a standard deduction and other deductions, minimizing your tax burden. But after expatriation, these sources of income will be subject to mandatory withholding taxes: 25.5% on your Social Security payments; 30% on your pension. You might be able to credit this tax against the tax liability in your adopted home country, but make sure you can before you expatriate. Otherwise, you could end up paying thousands of dollars more in tax each year as a non-citizen than you do as a citizen.
5) You don’t think you’ll qualify for a visitor’s visa to return to the United States if you expatriate. Obtaining a US visitor’s visa after expatriation can be a challenge. That’s especially true if you’re a wealthy (or relatively wealthy) “covered expatriate.” But if you remain a US citizen, you can always re-enter the country on your US passport.
6) Most of your income comes from a military pension. Most payments from military pensions end if you expatriate. An exception may apply if you receive a pension due to service in the military as a civilian. but be certain to check with a lawyer who understands the military pension system before you decide to expatriate.
7) You don’t feel a need to expatriate. We have plenty of clients who are content with their lives as US citizens permanently living abroad. They’ve set down roots and don’t suffer from the hardships from which Americans living outside the United States often experience.
8) The foreign earned income exclusion (FEIE) or the tax incentives in Puerto Rico provide a satisfactory alternative to expatriation. Under the right circumstances, these alternatives could substantially reduce your tax liabilities.
Need Help?
We can assist in every phase of giving up your US citizenship or long-term residence. This includes helping you get a second passport before giving up US citizenship.
And if you’re not ready to expatriate, we can help you take advantage of tax breaks in the Tax Code that apply to U.S. citizens and permanent residents living overseas.
Schedule a free no-obligation consultation with a Nestmann Associate to see if expatriation is right for you.
