Looking at Mr. Biden’s tax proposals and now faced with his win of the presidency, coupled with Democrat control of the House, Americans abroad are in for a rough time. This is especially true for anyone considering giving up US citizenship or long term permanent residency (LTR). Those thinking about expatriation must take immediate action to ensure tax planning is completed before the year-end. Not much time! Waiting is not an option. I expect that once this information becomes more widely known, we will see an increase in numbers renouncing US citizenship and abandoning green cards. For those wishing to learn more about the US tax issues associated with expatriation, please see my category of “Expatriation” containing all of my posts on this topic.
Below are a few bullet points to explain the urgency. Those wishing more detailed information can listen to the short podcast. Along with John Richardson, an attorney based in Canada who deals extensively with citizenship issues, I discuss the problems to be faced if Mr. Biden’s tax proposals are enacted into law.
1. Planning for an escape from the US will be much, much harder. As a result, a greater number of individuals hoping to expatriate will be treated as “covered expatriates” and subject to the US harsh 877A exit tax regime (as well as the transfer tax regime for US recipients of gifts or inheritances from the covered expatriate). Why is this so?
Readers of my blog will recall that one of the three alternative tests for “covered expatriate” status is having a net worth of US$2 million or more at the time of expatriation. Tax planning for this is usually accomplished by the individual making gifts so that the net worth will fall below the $2 million threshold. Gift tax can be avoided when making these gifts by using the so-called “lifetime exemption” amount. The currently available amount is a very generous USD 11.58 million. Thus, with proper planning the individual can make gifts tax-free (up to the USD11.58 million amount) to loved ones prior to expatriation and at the same time reduce net worth below the USD2 million threshold. A very detailed discussion on this issue is at my earlier blog post here.
Simply put, Mr. Biden’s tax proposals will reduce the currently available lifetime exemption to much lower amounts as existed prior to 2017, as adjusted for inflation. As a ballpark number this amount would be somewhere at approximately US$6 million. That is a huge reduction from the current generous amount of USD11.58 million. So, individuals planning to expatriate and needing to employ a gifting program must act now. The magic cut-off date for implementing a smart tax plan is December 31. That’s the date we know with certainty that the US tax laws will remain unchanged. After that, anything goes.
2. “Covered expatriates” will be paying a much higher “exit tax”. For those who will owe exit tax, long-term capital gain rates will no longer exist for many if Mr. Biden has his way. Mr. Biden’s plans include an increase in the top tax bracket of individuals from the current top rate of 37% up to 39.6% for taxable income above $400,000. His plans also include an increase of the tax rate on long-term capital gains and “qualified dividends” from 20% to a whopping 39.6% on income above $1,000,000. As a result, the exit tax can be assessed at the highest marginal rate of 39.6%.
3. Mr. Biden’s tax plans will cause pain in other ways that individuals should understand, so they can make an informed decision on expatriation. For many individuals who are not planning on expatriating and who wish to remain tax compliant, this information is an important head’s up. Tax planning can and should be undertaken as soon as possible.
- For Americans abroad with their business established in a foreign corporation, other surprises may be in store. The Global Intangible Low-Taxed Income or so-called “GILTI” provisions enacted in 2017 by the Tax Cuts and Jobs Act (“TCJA”) turned the world of international taxation on its head for “controlled foreign corporations” (CFC). GILTI income was introduced as a brand new category of income for shareholders of a CFC to contend with. GILTI is income that is deemed repatriated in the year it is earned. In other words, the tax law “pretends” that the GILTI income is paid out to the CFC’s US shareholder, even though no actual distribution has been made. Of course, the result is US taxation on this “pretend” income distribution. Biden plans to double the tax rate on GILTI from the current 10.5% to a whopping 21%. In addition his plan would eliminate the GILTI exemption for so-called qualified business asset investment.
- The plan would also increase the corporate income tax rate from 21% to 28%. This will directly impact US shareholders of CFCs wishing to use a very favorable exemption initiated by the Treasury called the “high tax kickout”. Very broadly if a taxpayer can show that the foreign corporation pays tax at a 90% or greater rate than the highest US corporate tax rate, then the exemption is available. Currently, the exemption applies if there is an 18.9 percent foreign country tax rate based on the current US corporate rate of 21 percent. If Mr. Biden increases the current corporate tax rate to 28%, then a taxpayer must show that the foreign country tax rate is 25.2% or greater. It should be noted that the Democrats have proposed doing away with this high-tax kickout exemption via the “Blocking New Corporate Tax Giveaways Act’’. (Full details at my blog post here.)
- Mr. Biden’s plan calls for eliminating the basis ‘step-up’ at death for inherited property. Under current law, the income tax basis of assets owned by a decedent at the time of death generally is “stepped up” to fair market value as of the date of death. Mr. Biden plans to change this treatment.
- As mentioned, Mr. Biden’s tax proposals will increase the tax rate on income over $400,000 from 37% to 39.6%. In addition the plan will equalize the tax treatment of ordinary income and capital gains by subjecting capital gains and qualified dividends of taxpayers with income over $1 million to a 39.6% rate.
Act Now or Pay the Price!
I cannot emphasize this enough. Tax planning can and should be undertaken as soon as possible.
IRS Relief Procedure for Expatriation
Many individuals who have not been tax compliant but who wish to give up US citizenship may be able to take advantage of a more recently announced IRS relief procedure, the terms of which are unprecedented. Lucky individuals who meet the criteria will not have to pay the back taxes otherwise owed, or any penalties or interest! Expatriation never looked better. But, this deal may not be on the table too long, and since qualifying for the procedure depends on how much income tax is owed, don’t wait for the tax rates to rise under a Biden administration.
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