Well, if my dream last night has anything to do with reality, the world is in for a big shakeup. In my dream, President Trump came to me for US tax advice on expatriation – that is giving up one’s US citizenship (or, green card in the case of long term residents). What a bizarre twist! I really did have this outlandish dream and indeed, it was so outrageous, that it woke me up.
Some Americans may in fact be wishing that this dream will come true; yet others will consider it a bad dream, perhaps a nightmare. Well, I don’t “do” politics. But, politics aside, I decided it might be a good idea to write up a post about the US tax issues associated with expatriation and for illustration purposes, show how these might affect the President.
Many of my readers may already know that if an individual expatriates and is treated as a “covered expatriate”, the tax laws will exact some serious revenge. The post will first examine who qualifies as a “covered expatriate”, using President Trump as the hypothetical example. It will then turn to the tax consequences that will befall such an individual (and possibly their families and others close to them).
Who is a “Covered Expatriate?” – Might President Trump be One?
Under the US expatriation rules, an individual will be treated as a “covered expatriate” if any one of the following three tests apply:
- TEST ONE: The individual’s average annual net income tax (that means tax paid to the Internal Revenue Service) for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation (the amount is $171,000 for 2020).
Lots of people want to see President Trump’s tax returns including, members of Congress, New York state prosecutors and plenty of voters. In my dream, President Trump would hand over his tax returns to me for analysis on this issue. 🙂 If the news reports are true, I would probably find that he has paid too little in income tax to worry about this test. And by little, I mean zero. The Washington Post, Politico and The New York Times have all reported that President Trump paid no income tax in many years before his entrance into politics. An article here by the Tax Policy Center explains why this may be so.
- TEST TWO: The individual’s net worth is $2 million or more on the date of expatriation or termination of residency. (No inflation adjustments available for this test!).
Ah, President Trump would have problems with this one! Forbes estimate of the President’s net worth is US$ 3.1 billion as of September 2019. And to think it all started in my hometown of Brooklyn, New York, when the President was working with his father and making deals in the real estate development business. However, regardless of net worth, it might be possible for the President to escape the expatriation tax regime entirely if he could claim citizenship from birth to another country. This is called the “dual national” exception and is detailed at my tax blog post here. So, President Trump can look into the laws of Germany and Scotland to examine if this might be possible based on the ancestry of his parents, but in reality, the nuances of the test (including full tax compliance and limited physical presence in the US) mean he would not qualify, despite the fact that President Trump has said he “feels Scottish”.
- TEST THREE: Finally, “covered expatriate” status will result if the individual fails to certify on Form 8854 that he or she has complied with all US federal tax obligations for the 5 years preceding the date of expatriation or termination of residency. This includes income, gift, employment taxes and any other taxes contained in Title 26 of the US Code (including, surprisingly, excise taxes such as the 1% excise tax on premiums paid toward a foreign life insurance policy). Under this test, the individual must certify that he has been fully tax compliant for the 5-year period.
Could President Trump pass this “tax compliance” hurdle? According to the media, President Trump declared a $916 million loss on his 1995 income tax returns, generating a humungous tax deduction that could allow him to legally avoid paying any federal income taxes for up to 18 years. According to The New York Times, President Trump’s tax avoidance maneuver was, “conjured from ambiguous provisions of highly technical tax court rulings, [and] clearly pushed the edge of the envelope of what tax laws permitted at the time.” It went on to quote a senior fellow of the nonpartisan Tax Policy Center: “Whatever loophole existed was not ‘exploited’ here, but stretched beyond any recognition”.
Without seeing more of President Trump’s tax returns, we cannot know whether the claimed losses were attributable to poor economic results, permissible tax rules, or possible tax noncompliance. In any event, this particular expatriation test involves compliance for the 5 years prior to expatriating. If the losses in question could be carried forward for 18 years, the time frame expired after 2013 (1995 + 18 = 2013) and thus, would not be relevant to this inquiry since the relevant years of tax compliance would be 2014-2018 (assuming expatriation this year, 2019). Of course, we do not know the President’s tax situation as he has never disclosed his tax returns. Given their undoubted complexity, the analysis of tax compliance would take some time to complete.
His Family Would Suffer Tax Consequences Too!
President Trump has five children from three wives. He also has ten grandchildren. All of these individuals are US citizens. Expatriation by a “covered expatriate” would punish them too by hitting them in their pockets with the 40% transfer tax discussed more fully below.
Aside from the tax problems associated with any idea of expatriating, the President still has to realize his goal to “Make America Great Again”! So, just consider my dream as another piece of “fake news”. President Trump is not going anywhere any day soon.
Let’s move on to the tax rules affecting “covered expatriates”.
Expatriation Tax Regime
For starters, a “covered expatriate” will be subject to the “Exit Tax” or “Mark-to-Market” regime. Under this regime, generally, all property owned by the covered expatriate worldwide will be treated as having been sold for its fair market value on the day before the expatriation date. This ‘pretend’ or ‘phantom’ gain is then taken into account on the tax return for the tax year of the deemed sale. The gain is subject to tax, usually at capital gains rates. In addition, a 3.8% “net investment income tax” will likely also apply to this deemed gain if certain modified adjusted gross income thresholds are met. You can read more here about the 3.8% surcharge. The Exit Tax must be computed on the individual’s IRS Form 1040 with the gain (or loss) being reported on the relevant part of the 1040 for the part of the year that the taxpayer is still considered a US person.
The tax burdens don’t stop there. Special onerous tax rules apply to the covered expatriate’s deferred compensation plans and specified tax deferred accounts. Generally in cases involving US (domestic) plans this will mean imposition of a 30% withholding tax on later distributions. In cases involving foreign plans, the tax treatment can be even harsher resulting in immediate taxation by calculating the present value of the covered expatriate’s interest in the deferred compensation item and including it in taxable income for the year of expatriation. The big problem here is that the individual will not have received the deferred compensation payouts – so he is being taxed all at once without cash to pay the tax.
In addition to the Exit Tax, US recipients of any gift or bequest at any time in the future from the “covered expatriate” will be hit with a special tax upon receiving that gift or inheritance. Under current rules, this special transfer tax is set at 40% of the gift or bequest.
A Big Step Needs Proper Planning
Expatriation is a big step and the Internal Revenue Service has now made it the subject of a new campaign. In many cases planning can be done to prevent “covered expatriate” status. It requires expert tax advice from a seasoned professional. This is an area in which I have decades of experience (and not just in my dreams!). Let me know if you need expatriation advice.
Posted November 27, 2019
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