The United States is one of only two countries (the other is Eritrea, a military dictatorship) that taxes its citizens and long-term residents, no matter where they live. Even Americans who haven't lived in the United States in decades must pay tax on their worldwide income as if you never left. What's more, they must comply with complex reporting obligations, with violations subject to draconian civil and criminal penalties.
Even "accidental" U.S. citizens born overseas with at least one U.S. parent, who never set foot in the United States, must file U.S. tax returns. Beneficiaries of deceased U.S. citizens living abroad must prepare U.S. estate tax returns and possibly pay estate tax, including non-U.S. citizens who never lived in the United States.
Congress and the IRS have also issued laws and regulations that force virtually any non-U.S. company dealing with Americans to comply with increasingly complex reporting obligations. As a result, tens of thousands of foreign banks, brokerages, and trust companies have jettisoned longstanding relationships with their U.S. clients. Overseas employers avoid hiring U.S. employees to avoid having the employees being forced to disclose financial details of the employer to the U.S. government. The nearly seven million Americans living overseas now are "persona non grata" in their adopted countries.
Given this reality, it comes as little surprise that approximately 50,000 overseas Americans give up their U.S. citizenship or residence each year. This estimate of the number of such "expatriates" is far higher than official IRS statistics indicate. (Read why the unofficial numbers are so much higher here.)
Many U.S. residents don't understand the tax and compliance burden faced by Americans living abroad. So when an American expatriates, the typical 'homelander" views the act as the tax equivalent of treason. The image of a former American living tax-free in some tropical paradise has thus become an irresistible populist target. Congressman Sam Gibbons (D.-Fla.), referring to expatriates, spoke of, "the despicable act of renouncing allegiance to the United States." Rep. Martin Frost (D-Tex.), justified sanctions against expatriates out of "basic patriotism and basic fairness." Neil Abercrombie (D-Hawaii), described expatriates as, "Benedict Arnolds who would sell out their citizenship, sell out their country in order to maintain their wealth."
The ferocity with which U.S. politicians seized upon the expatriation issue made sanctions against expatriates inevitable. Congress first enacted tax rules targeting expatriates in 1966. The rules were tightened in 1996, 2004, and most recently in 2008.
The 2008 amendments levy an "exit tax" applies to both U.S. citizens and long-term U.S. residents—green card holders who have resided in the United States for at least eight of the 15 years prior to expatriation. The tax is predicated on the legal fiction that you sell all of your worldwide property at its fair market value on the day before you expatriate. Tax on the fictional gain is due at the time your tax return is due for the year of expatriation. You can defer payment of the tax by posting acceptable security with the U.S. Treasury and paying an interest charge on the amount deferred.
The tax applies only to "covered expatriates." You're in this category if you:
- Have a global net worth exceeding $2 million; and/or
- Have an average annual net income tax liability for the five preceding years ending before the date of the loss of U.S. citizenship or residence exceeding $155,000 (2013, adjusted annually for inflation); and/or
- Fail to certify under penalty of perjury that you have complied with all U.S. federal tax obligations for the five years preceding expatriation.
No exit tax is due on the first $668,000 of unrealized gains (2013, adjusted annually for inflation). If both you and your spouse expatriate, the $2 million threshold and unrealized gain exemption are effectively doubled.
Permanent Exclusion from the USA?
Take that, you ungrateful expatriates! But that's only the beginning. In 1996, Congress enacted the "Reed Amendment" to the Immigration and Nationality Act. The amendment gives the U.S. Attorney General the discretion to deny entry into the United States to a former U.S. citizen who renounced U.S. citizenship in order to avoid U.S. taxation. Other categories of "excluded persons" are those with communicable diseases or other health conditions; those convicted of crimes involving moral turpitude or illegal drugs or with multiple criminal convictions; prostitutes; spies; terrorists; and draft evaders.
After Congress enacted the Reed Amendment, it was criticized for violating U.S. treaties and possibly the U.S. Constitution. Even after nearly two decades the Department of Justice has yet to issue official regulations to exclude expatriates from re-entering the United States. However, homelanders in the State Department and the Customs & Border Protection agency have used the Reed Amendment to justify visa and re-entry denials to expatriated Americans.
In an apparent effort to make a Reed Amendment type exclusion regime more enforceable, in 2012, Senators Charles Schumer (D.-N.Y.) and Bob Casey (D.-Pa.) introduced legislation to retroactively punish wealthy expatriates. The “Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy Act” (or Ex-PATRIOT Act) would punish covered expatriates by forbidding them from ever re-entering into the United States. They would also face a 30% percent tax on future gains from U.S. investments. Both the tax and re-entry provisions would be retroactive and encompass individuals who gave up U.S. citizenship for the 10-year period prior to enactment of the statute.
While the bill as drafted would apply only to former U.S. citizens, it refers to existing law that also applies to long-term U.S. residents (LTRs). These persons have held U.S. green cards for eight of the last 15 years. The status of green card holders under this proposal is thus unclear.
The bill would exempt expatriates from these punitive provisions if they could prove to the U.S. Treasury that their loss of U.S. citizenship did not result in substantial tax reduction. Presumably the IRS would issue regulations to clarify this issue. For instance, the IRS could decree that former expatriates who can prove that they pay 90% or more of the tax they were paying in the United States to a foreign government wouldn't be subject to these rules.
The Ex-PATRIOT Act didn't become law in 2012, but now Schumer and Casey have reintroduced it (S.A. 1252) for 2013. They hope to make it part of the immigration reform bill now before Congress. There’s a good chance that in the current political atmosphere, this could become a successful tactic to garner political support for other immigration reforms. Think of it this way: if you were a politician in Washington, D.C., and wanted to get re-elected, would you dare to vote against it?
Should S.A. 1252's provisions become law; I also think the courts will uphold its tax aspects, including retroactive application to individuals who expatriated prior to its coming into effect. The Supreme Court has repeatedly held this is perfectly sound policy, despite the U.S. Constitution’s prohibition of laws with retroactive effect (ex post facto laws). Such laws are unconstitutional only when criminal activities are involved, the Supreme Court says. The prohibition doesn’t apply if “only” money or property is at risk (United States vs. Carlton).
I'm less certain about permanent exclusion from the United States. If the Reed Amendment—or the Ex-PATRIOT Act–were ever officially enforced, they would be open to court challenge on numerous grounds, including conflict with numerous U.S. treaties of “Friendship, Commerce, and Navigation” and similarly titled treaties, and the non-discrimination provisions of U.S. tax treaties.
It would also be subject to constitutional challenges. While the United States has the right to exclude certain classes of individuals from entering the United States, that’s not why Schumer and Casey introduced the Ex-PATRIOT Act. The sole purpose for the proposal is to deter wealthy persons from giving up citizenship in the first place. That is, faced with the certainty that they will never be able to re-enter the United States, they will make the decision not to expatriate.
This must be the purpose, because there’s no other rational reason why such a statute could be proposed. Wealthy visitors to the United States spend money and pay sales taxes on almost everything they buy. If they invest in the United States, they may also pay local, state, and/or federal taxes.
When a law infringes a fundamental right, such as the right to expatriation, U.S. courts have ruled it must be reviewed under a standard of "strict scrutiny." Such laws may be upheld only if they meet a "compelling interest." Does excluding wealthy, free-spending, tax-paying visitors out of the United States serve a compelling national interest? Senators Schumer and Casey think it does. I’m not sure the courts will agree.
However, from a political and fiscal perspective, homelanders clearly have the upper hand. In their mind, expatriation is treasonous and must be punished. Even if the Ex-PATRIOT Act isn't enacted in 2013, similar proposals will return in the future.
If you think you're a possible candidate for expatriation, and are willing to accept the possibility that you may never be able to return to the USA again, we can assist you in every step of the process, as we have for dozens of former U.S. citizens or long-term residents. We can help you acquire a suitable citizenship and passport, choose a country in which to acquire permanent residence, and assist with every phase of your expatriation. 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. Contact us for more information.