The Tax and Reporting Burdens of US Citizens and Permanent Residents
If you’re a US citizen or have a green card, you have some unique responsibilities. You must pay taxes on your worldwide income, even if you live outside the United States. This includes not just regular income tax, but also taxes on things like investments, gifts, and estates.
There are many other obligations that come with US citizenship or permanent residency. For instance, you must annually disclose detailed information about any non-US investments you have to the IRS and US Treasury Department. The Treasury can then share this information with almost any US or foreign government agency.
You also face additional tax pitfalls related to your non-US investments and business activities. US tax rules for interests in foreign mutual funds, corporations, and trusts are just a few examples of the “tax traps” that US taxpayers can accidentally trigger.
The Rise of Expatriation
Faced with these burdens, a rapidly growing number of US citizens and permanent residents are taking the legal step of giving up their green card or US citizenship and passport. IRS data shows at least 1,788 people went through this “expatriation” process in 2011. This is almost 8 times more than in 2008, and more than the total for 2007-2009 combined.
But an even larger number of non-resident US citizens and green card holders are unaware of their ongoing tax and reporting obligations. An estimated 7 million US citizens live outside the country, yet only a few hundred thousand file US tax returns. This widespread lack of knowledge is partly due to how easy it is to become a US citizen, such as by being born within US borders or to a US citizen parent.
Aggressive IRS Enforcement
Starting around 2008, the IRS began enforcing these rules much more strictly, especially for US citizens living abroad.
Accidental US Citizenship and Tax Consequences
Here’s how it played out for one Mexican man who found himself unexpectedly a US citizen.
This gentleman, now well into retirement, grew up in a small town in Mexico near the US border. When he was born, the town lacked medical facilities, so his parents drove to the nearest hospital – which happened to be just inside the US border.
Fast forward 70 years, and this man decided to buy a condo in San Diego to escape the hot Mexican summers.
But at the closing, he encountered a strange surprise – the documents listed him as a US citizen. Despite his belief that this was a mistake, the broker assured him it was correct since he was born in the United States.
Our protagonist thought that would be the end of it. But when he arrived in San Diego, he received a notice from the Internal Revenue Service. It informed him that he was required to file US tax returns, and there was no record of him doing so for the previous three years. The IRS demanded an immediate response.
A few days later, the man went to the local IRS office to try to resolve the situation. But he was shocked to learn the IRS had already started an examination. The agent began using ominous terms like “willful failure to file” and “criminal penalties.”
At this point, the man hired a tax defense attorney, spending around $100,000 in legal fees. He received word that he would not face criminal charges. But he still had to pay a $500,000 penalty, which was 25% of the peak value of his unreported non-US accounts from 2003-2010. Unfortunately, those accounts had dropped in value by 35% during the 2008-2009 economic turmoil.
On top of the penalty, the man also had to file six years of back tax returns. He also had to file disclosures for his interests in Mexican corporations and other entities. This required converting the Mexican financial statements to US accounting standards. It cost an extra $50,000.
In total, this man’s accidental US citizenship ended up costing him $650,000. And he received no real benefits from being a US citizen. Unsurprisingly, he then filed to formally renounce his US citizenship.
The Benefits of Expatriation
Expatriation, or giving up US citizenship or a green card, offers a way to permanently exit the US tax system.
Expatriates no longer have to pay US taxes on their non-US income or report their foreign investments. They also avoid the restrictions on offshore investments imposed on US persons.
But, expatriation is a major decision. It requires having citizenship in another country. And it means losing the automatic right to live and work in the US without a visa.
How to Move Out of the US Permanently… ASAP.
Thinking about saying goodbye to Uncle Sam? Here’s everything you need to know about expatriation. The good. The bad. And the often unspoken. You can learn more here: How to move out of the US.
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.
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 US citizens and permanent residents living overseas.
Schedule a free no-obligation consultation with a Nestmann Associate to see if expatriation is right for you.
