COVID-19 restrictions have severely limited services at US embassies and consulates around the world. As a result, renouncing one’s US citizenship has become very difficult, and in many cases, just about impossible at the current time. This gives individuals more time to make sure they have properly planned for expatriation. It’s a big step.
I am working with more and more individuals who are quite anxious to give up the little blue book and move on with their lives and “other” citizenship(s). However, I am also seeing that many have not done the required tax “due diligence” and do not fully understand the tax implications of their planned renunciation.
More Audits of Expatriates Expected /Virtual Currency
The Internal Revenue Service (IRS) is currently focusing on persons who have expatriated. The agency has instituted a so-called “compliance campaign” looking into expatriations that took place on or after June 17, 2008. Thus, more and more audits of expatriates can be expected.
Increasing numbers of Americans abroad are using virtual currency. Virtual currency is also the subject of another IRS compliance campaign. Any expatriating individual who holds virtual currency should be certain that virtual currency transactions have been properly reported. It is a tricky area and one that is very much so in the IRS’ crosshairs.
Let’s take a quick look at the law surrounding expatriation (all amounts are in USD):
US Expatriation Tax Rules in a Nutshell
The US “expatriation tax” provisions rules apply only to certain US citizens who have renounced or relinquished their citizenship. (The expatriation tax regime also applies to long-term residents, generally those holding a green card for 8 out of the past 15 years, who have ended their US resident status for federal tax purposes).
Under the US expatriation rules, an individual will be treated as a so-called “covered expatriate” if any one of the following tests apply:
- The individual’s average annual net income tax 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 ($172,000 for 2021). Note – this means income tax paid by the individual, not his or her income.
- The individual’s net worth is $2 million or more on the day before the date of expatriation or termination of residency.
- 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.
If any one of these tests is triggered, the individual is a “covered expatriate” (CE). A CE is subject to the “Exit Tax” or “Mark-to-Market” regime which generally means that all property owned by the CE worldwide is treated as sold for its fair market value on the day before the expatriation date. This “pretend” gain is then taken into account for the tax year of the deemed sale and subject to tax, usually at capital gains rates. An exception for a certain amount of gain (which is adjusted annually for inflation) is provided in the tax law. On account of this exception, some individuals may not be impacted by the “Exit Tax”, but the exception is calculated a very specific way and professional guidance should be taken. Special tax rules apply to certain deferred compensation items and to trust distributions. In short, there are many complicated rules.
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 transfer tax. This transfer tax is currently 40% of the value of the gift or inheritance. More information about the transfer tax can be found on my tax blog posting here.
Waiting for the CLN – Understanding Your Status and Ability to Travel to the US
US immigration and nationality laws as well as US tax laws are implicated when one gives up US citizenship. From an immigration perspective, the question often arises about the ability to travel to the US after relinquishing US citizenship. Can one travel to the US while waiting for the United States Department of State (DOS) to issue a so-called Certificate of Loss of US Nationality (CLN)?
US Travel Limbo While Waiting for CLN? Valid Foreign Visas in US Passport?
The DOS had an unofficial policy mandating that those who gave up their US citizenship surrender their US passport to the Consulate or Embassy after the official oath of renunciation had been taken by the individual. The passport was retained at the Consulate or Embassy. After the renunciation proceedings, the Consulate or Embassy would send the renunciation application to DOS headquarters in Washington, DC. There the relevant paperwork would be reviewed and the application for renunciation either granted or denied. Processing of this paperwork can take a long time, especially since the number of renunciations has been dramatically increasing and now we have COVID-related backlogs. If the renunciation is approved, the individual is issued the CLN. The date of the loss of US nationality reflected on the CLN is the date the oath of renunciation was taken at the Consulate or Embassy (rather than the actual date of issuance of the CLN).
Under the DOS’ long-standing policy position while issuance of the CLN was pending the renunciant was considered to remain a US citizen. (We’ll discuss in another blog post if this means he is still taxed as a US citizen). Since the individual remained a US citizen, he could not be issued a visa to visit the US for any purpose simply because US citizens are not eligible for visas. However, since the individual’s US passport was being held by the Consulate or Embassy pending issuance of the CLN, he could not use the US passport to travel to the US. To further exacerbate matters, different US Consulates and Embassies applied different rules with some cancelling the US passport and issuing a visa, while others did not cancel the passport (but retained it) and denied the visa. Lacking any clear guidance, it was impossible for individuals who planned to give up their US citizenship but who needed to travel to the US to know what to do.
What to do
This DOS policy was challenged on grounds it unconstitutionally infringed the individual’s right to travel to the US. DOS officially changed its policy and its Foreign Affairs Manual was updated advising the officers at all US Embassies and Consulates to return US passports to any recent US citizen renunciant who had plans to travel to the USA or who needs the passport because it contains valid foreign visas. If you plan to visit the USA or, if you have visas to enter foreign countries stamped in the US passport remember that you have certain rights with regard to the passport.
Foreign Affairs Manual relevant information is excerpted below (in italics) and can be found at 7 FAM 1227(e) here.
Status of the U.S. passport(s) pending approval of the CLN:
…(3) The post should not cancel the U.S. passport, but rather retain the passport in a secure location until the approved CLN is received back from CA/OCS/ACS;
(4) If the intended expatriate advises the post that he or she needs the U.S. passport immediately because of intended travel to the United States:
(a) The consular officer should return the passport to the individual for such travel only until the loss of nationality case is approved. …. Use of a U.S. passport for travel to countries other than the United States after the individual has signed the Form DS-4080 or Form DS-4079 may be considered inconsistent with an intent to relinquish citizenship, including the rights and privileges pertaining thereto. Therefore, such travel, which could affect approval of the CLN, should be avoided to the extent possible.
(b) Individuals awaiting approval of a CLN who travel to the United States should be well advised to also carry their foreign passport if they hold one, in the event that the CLN is approved while the individual is in the United States. The status of the individual in such a situation is within the jurisdiction of the U.S. Department of Homeland Security.
NOTE: Under a proposed Departmental rule published in the Federal Register on December 14, 2017, a passport will be invalid immediately upon approval of a CLN for the passport bearer. (82 Fed. Reg. 58778 (December 14, 2017) (proposed new provision at 22 CFR 51.4(g)(8)). Individuals awaiting approval of a CLN intending to travel to the United States should be mindful of the proposed new rule.
(5) If the intended expatriate advises the post that he or she needs the U.S. passport immediately because it contains valid foreign visas, the individual may hold the U.S. passport until approval of the CLN. Procedures outlined in paragraph (4) above are applicable, including procedures for return of the U.S. passport to post prior to receipt of the CLN.
(6) When the post receives the approved CLN, the post should promptly cancel all unexpired passports (books and cards). Do not damage the entry-exit or visa stamp or foreign visas if possible. The canceled passport(s) may be returned to the expatriate upon request…”
I have been working on expatriation matters for almost 30 years and have assisted in numerous highly complex expatriations as well as those that are more straightforward . If you need help with your case, please get in touch to arrange a consultation. firstname.lastname@example.org
Posted April 1, 2021
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