The recent trend of globalization has spurred Americans of all ages to explore the option of global mobility. The number of US citizens choosing to pursue their education and careers overseas or even get married and retire in foreign countries is growing every year.The reasons people choose to leave the United States may vary. For some Americans, the lure is the exposure to a culture that is completely new, as they get to experience a lifestyle that is totally different from their own. Students have the tendency to look for places that offer better educational prospects and degrees that are recognized internationally, preferably at a lower cost than they would be back home. For others, it may be a decision based largely on immediate financial implications, as they end up making or saving more money by going overseas than they would if they lived in their home cities.
Whatever the reasons may be, each year, thousands of US citizens realize their expatriate dream by moving to other countries, mainly across Europe and the Asia Pacific region. A majority of them relocate on their own, but there is a small percentage that takes their family and dependants along.
While there are numerous benefits to leading the expat life, it is important to consider all aspects of the moving before taking any decision. Did you know that leaving the US can actually have a significant negative financial impact on your family if they do not travel with you? Becoming an expat will affect not just you but also your family members in the US as well as any other intended American beneficiaries that you may have.
Unfortunately, tax money is pursued quite vigorously by the US tax authorities, and you can’t expect to avoid taxes by moving to a foreign country. As a matter of fact, the authorities are making it very difficult for people to relinquish their US citizenship in order to eliminate their tax obligations. Do bear in mind that the US has signed treaties with more than 42 nations across the globe so that the IRS and foreign tax agencies can exchange tax information on residents.
If you believe that you aren’t obligated to pay taxes in the US just because you are earning in a different country and are paying local taxes there, you couldn’t be more mistaken. What’s more, you may also be liable to pay an expat tax in the US.
Being an American expat, it is important for you to file your returns in the US, even if you aren’t earning an income in the foreign country. Legally, this isn’t necessary if you don’t owe any tax amounts to the US. However, it should be done as a preventative measure, since there is a statute of limitations on any tax disputes. In case there is a dispute on back taxes, you could start running out the clock on the statute in case you have already filed your returns. However, if you haven’t filed your returns, the IRS has the right to conduct a personal audit on you at any point in the future. Furthermore, you are liable to bear the consequences in case they decide against you. To avoid such problems, the IRS has prepared a guide for US Citizens living abroad. You can access a copy of it online, by logging on to www.irs.gov/pub/irs-pdf/p54.pdf.
As a US citizen or long-term permanent resident, if you are thinking about becoming an expatriate, you are likely to have a lot more than just an exit tax imposed on you, under Code 877A.
After the final regulation is published for any tax imposed under the Code 2801, an American recipient of bequests and gifts from people who have relinquished their residency status (expatriates) will be required to file a new form 708, i.e., the US Return of Gifts of Bequests from Covered Expatriates Form, in order to report all such gifts received. This law has been in effect since June 17, 2008. In simple words, if your family receives any kind of money or other items of commercial value from you, or any other covered expat, they are required to declare it and pay the tax that is due to the government.
Gifts & Bequests Considered Covered Transfers
Code 2801 has imposed a tax on American residents and citizens who are in receipt of a “covered gift” or a “covered bequest” from any “covered expat”. This is regardless of whether the covered expat has acquired the transferred property or not. The amount of tax imposed under this code is calculated as per the highest gift or estate tax percentage that was in effect at the time of the transfer. The current rate in 2016 is 40%.
Determining if the transfer is a covered gift or a covered bequest will depend on whether the donor or decedent is a covered expat.
The term covered expat is used to describe any individual who has relinquished his or her American citizenship. Alternately, a person who terminates his or her long-term permanent residency status on or after June 17, 2008, is also regarded as a covered expat.
On the date of their expatriation, the covered individual either meets a net worth test of US $2 Million (this has not been indexed for annual inflation) or takes a US Income Tax Liability Test. In 2016, US $161,000 average net income tax liability over 5 years was indexed annually for inflation. An individual may fail to certify under penalty of perjury that he or she has complied with all the legal tax obligations in the US for the next 5 taxable years.
Do bear in mind that there are notable exceptions for the transfers that have been properly reported by the covered expat (or a personal representative of the expat) on gift or estate tax returns that have been filed in time. For example, a gift of property in the US that is reported on the gift tax return will be regarded as an exception. This also includes transfers made to charitable organizations as well as certain family members (especially spouses), as long as it qualifies under the gift or estate tax marital or charitable deduction.
The responsibility of reporting any covered bequest of gift and paying the tax amount due falls entirely in the recipient in the US. These obligations go all the way back to June 17, 2008, and include all the gifts covered as well as the bequests that have been received since that date.
Furthermore, as per the proposed regulations, the recipient in the US also bears the onus of determining if he or she has received something that is a covered gift or bequest. This means that the recipient should find out if the decedent or the donor is a covered expat or was one when the transfer was made.
According to the provisions made by the proposed regulations, the US recipient can seek the consent of the covered expat and could request that the IRS disclose specific return information (about the expat). However, while the IRS may provide the information, it does not determine the expat’s status.
This means that every individual US citizen who has received a possible bequest or gift from an expat should start collecting information from them, to determine if that transfer falls under the Code 2801 tax impositions. Doing so will prepare the recipient to file Form 708, if needed, after all the final regulations are published.
As per the proposed regulation, Form 708 has to be filled out and filed by or before the 15th day of the 18th calendar month following the end of the calendar year in which the transfer was made. This gives the US recipient a lot of time to gather the required information and fill out the necessary paperwork before filing the return.
US recipients that get a covered gift or bequest before the final regulation is published are usually given a fair amount of time to file the Form 708 and pay the tax.
Planning ahead for covered expats: As a US citizen or a long-term permanent resident considering expatriation, it is best for you to make any transfers to your family or other beneficiaries in the US prior to making the move. This enables the recipients to take advantage of their lifetime gift tax exemption of US $5,450,000 in 2016, which has been reduced by taxable gifts of the prior years. This reduces the post-expatriation Code 2801 taxable amount of the American beneficiaries. Moreover, the US recipient of a transfer is permitted a yearly exclusion amount under Code 2801 (C), equal to the annual gift tax exclusion amount (which is US $14,000 in 2016). You may, therefore, want to limit the yearly transfers made to the recipients within the amount mentioned in Code 2801 (C).
Planning ahead for US citizens (recipients): Since you know that the Code 2801 tax rate is 40% for 2016, you could set aside the necessary funds for paying the tax liability, not just for the transfers you have received but also for any future gifts and bequests that you are expecting. Alternately, if you are likely to receive a large covered gift or bequest from an expat, the two of you could discuss the possibility of him or her relinquishing their citizenship or residency status before making the transfer.
The Foreign Account Tax Compliance Act (FATCA)
Your family members and beneficiaries aren’t the only parties to be adversely affected financially in case you decide to expatriate. You are also likely to pay taxes that you had never heard of in your home country.
In the last few years, a number of American expats worldwide have been thinking about giving up their American citizenship because of the introduction of this law. According to the US Treasury, 4,279 individuals decided to renounce their US citizenship in the year 2015. This was an increase of 20% from the previous year, which was record-breaking in itself.
A majority of US expats believe that in FATCA, introduced in 2012, was designed to target overseas bank accounts held by well-to-do Americans. This notion is strengthened by the fact that the US is one of the only two countries in the world which follows citizenship-based taxation (the other one being Eritrea).
All US expats are required to file tax returns regardless of where they live, and they often pay American taxes in addition to the ones that they are subject to in their country of residence. This is known as double taxation, which kicks in after Americans cross a certain yearly earning allowance (US $ 106,000).
However, FATCA further expands the scope of income that can be taxed. It holds local banks responsible for identifying US Citizens among their customers and reporting them to the US Taxation Authorities. Any error on a bank’s part could result in penalties as high as 30% of the bank’s entire dealing with the US.
Unfortunately, many Americans overseas are therefore actually being denied basic banking facilities because of this. Banks would rather refuse a customer than run the risk of a hefty fine. In fact, banks are going as far as closing down accounts of customers they believe may be “accidental Americans”, which could be anyone with one American parent or even people of different nationalities born in the US.
To make matters worse, under FATCA, an American expat’s pension and savings can also be taxed and this is money most cannot afford to lose. Several expats are therefore taking the decision to save their hard-earned money by giving up their US citizenship.
The increase in the number of Americans willing to renounce their citizenship rose to an alarming level in November 2015, causing a huge backlog of paperwork. The authorities then increased the fee for renunciation by around 400%, to US $2,350. However, this move has not deterred people from working overseas and giving up their US citizenship.
Of course, renunciation of citizenship is far from a feasible option for those expats who still have family ties in the US.