23 March 2018
An individual may become a US citizen at birth by being born within the US or by having a US citizen parent. All US citizens are subject to US federal income taxation on their worldwide income, even if they reside in a foreign country. On the other hand, an individual who is non-resident for US federal income tax purposes is only subject to US federal income taxation on certain income from US sources and income that is effectively connected to a US trade or business.
If an individual renounces his or her US citizenship, he or she may be required to pay a mark-to-market exit tax on a deemed disposition of his or her worldwide assets. The former citizen is subject to this exit tax if he or she meets one of the following three tests: (1) has an average annual net income tax liability for the five taxable years preceding the year of expatriation that exceeds a specified amount (adjusted for inflation, $160,000 in 2015) (the ‘tax liability test’), (2) has a net worth of $2 million or more as of the expatriation date (the ‘net worth test’), or (3) fails to certify, under penalty of perjury, compliance with all US Federal tax obligations for the five taxable years preceding the year in which he or she renounces US citizenship (the ‘certification test’).
The US Department of Treasury issues its ‘Greenbook’ on an annual basis, which provides an explanation of President’s revenue proposals. The Greenbook released in February 2015 provides a new proposal including a new exception to the exit tax for certain dual citizens. A limited exception to the tax liability and net worth test currently exists for qualifying dual citizens; however, this proposal expands that exception. It is important to note that unlike the UK where an annual Autumn Statement is released including changes to the tax laws, in the US, the Greenbook is simply a proposal and there is a rather long and involved process before this proposal becomes a law.
The impetus for the proposal is a recognition that certain individuals who became citizens of the US and another country at birth may have had minimal contacts with the US and may not learn until later in life that they are US citizens (colloquially referred to as ‘Accidental Americans’). In my experience, an overwhelming number of Accidental Americans would like to relinquish their newly discovered US citizenship in accordance with the established procedures of the US Department of State, but learn that doing so requires them to pay significant US federal income tax both in past tax compliance, and in a potential exit tax.
Under the proposal an individual will not be subject to tax as a U.S. citizen and will not be a covered expatriate subject to the mark-to-market exit tax under section 877A if the individual:
- became at birth a citizen of the United States and a citizen of another country,
- at all times, up to and including the individual’s expatriation date, has been a citizen of a country other than the United States,
- has not been a resident of the United States (as defined in section 7701(b)) since attaining age 18½,
- has never held a U.S. passport or has held a U.S. passport for the sole purpose of departing from the United States in compliance with 22 CFR §53.1,
- relinquishes his or her U.S. citizenship within two years after the later of January 1, 2016, or the date on which the individual learns that he or she is a U.S. citizen, and
- certifies under penalty of perjury his or her compliance with all U.S. Federal tax obligations that would have applied during the five years preceding the year of expatriation if the individual had been a nonresident alien during that period.
We regularly assist clients who are renouncing US citizenship, and it is good to see a sensible proposal that is pro-taxpayer. As mentioned above, there is a long process before this proposal would become a law, but it is always good to see proposals trend towards fairness on behalf of the taxpayer.