Minimising Exit Tax for US Covered Expatriates: A Step-by-Step Guide
Last update: 23rd February 2024
Author: Alistair Bambridge, a Chartered Accountant with over 20 years of experience specializing in US expatriate tax and Covered Expatriate status. Recognised for his expertise, Alistair has been awarded “The Best for High Net Worth Clients” by Spears and “The Best for Expatriate Tax.” He is a trusted figure in tax advisory, regularly contributing insights to renowned platforms such as CNN and BBC. Leading Bambridge Accountants, he has assisted thousands in successfully navigating the complexities of renouncing US citizenship, establishing him as a leading authority in the field.
If you find yourself classified as a US "Covered Expatriate," it means you've either renounced your US citizenship or ended your long-term residency. Here's what you need to know and how you can manage your situation effectively.
We are experts in the worldwide treatment of US Expatriates who hold the Covered Expat status. Contact us with any questions you have.
What is "Covered Expatriate" Status?
A "Covered Expatriate" refers to someone who has renounced US citizenship or ended long-term residency, with specific tax conditions: net worth over $2 million, high average annual net income tax, or failure to certify tax compliance for the last five years.
Tax Implications for US Covered Expatriates:
Exit Tax: Assets are deemed sold for their fair market value the day before expatriation, leading to possible capital gains tax.
Deferred Compensation: Items like pensions or stock options are taxed as if received on the day before expatriation.
Non-Grantor Trusts: If a covered expatriate is a beneficiary, distributions received post-expatriation are subject to immediate taxation.
Gift and Estate Tax: Covered expatriates may be subject to US gift and estate taxes on transfers of U.S. property to US persons.
Compliance Requirements: Filing Form 8854 to certify compliance with all federal tax obligations for the five years prior to expatriation.
Future US Income: US-sourced income post-expatriation can still be subject to US tax.
Minimizing Exit Tax
With strategic planning and expert guidance, it's possible to minimise the financial impact of holding the Covered Expatriate Status. Below, we break down essential strategies to effectively reduce the Exit Tax for US Covered Expatriates.
Valuation
Assess the fair market value of your assets before expatriation.
Lower asset values can reduce the Exit Tax burden.
Consider professional appraisals for accurate valuations.
Gifts
Utilise the annual tax-free gift allowance to reduce your net worth.
Gifts can be given to family members or trusts, lowering your taxable estate.
Keep within the legal limits to avoid additional taxes.
Timing
Plan your income recognition strategically.
Deferring income until after expatriation can reduce taxable income in the US.
Accelerating deductions before expatriation can lower tax liability.
Retirement Accounts:
Understand the tax implications for different types of retirement accounts.
Withdrawals from certain accounts may be taxed differently if taken before or after expatriation.
Consider the timing and amount of withdrawals to optimise tax efficiency.
By carefully considering these factors, US-covered expatriates can effectively minimise their Exit Tax and manage their financial transition more smoothly.
Required Documentation for "Covered Expatriates"
Filing Form 8854 is a critical step in finalising your expatriation from the U.S. Ensuring you have all the necessary documentation and information will help make the process smoother and help you comply with U.S. tax laws as a covered expatriate.
Personal Details
What’s Needed?
Your full name, Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN), mailing address, and date of birth.
Purpose
To identify you in the IRS system and ensure your expatriation status is correctly recorded.
How to Prepare
Ensure all personal information is current and accurate. If you don’t have an SSN or ITIN, you may need to apply for one before filing.
Tax Compliance Status
What’s Needed
Certification that you have complied with all U.S. federal tax obligations for the five years preceding the year of expatriation. This includes filing all necessary tax returns and paying all due taxes.
Purpose
To verify that you are not expatriating to avoid U.S. tax responsibilities.
How to Prepare
Gather your tax records for the past five years, including copies of filed returns and records of tax payments. If there are any unfiled returns or unpaid taxes, address these before expatriating.
Assets and Liabilities Balance Sheet
What’s Needed
A detailed listing of all your global assets and liabilities as of the day before your expatriation date.
Purpose
To determine your net worth and assess if you meet the net worth test for covered expatriate status.
How to Prepare
List all assets (e.g., real estate, stocks, bonds, and other investments) and all liabilities (e.g., mortgages, loans, and other debts). Use fair market values for assets. If necessary, get professional appraisals.
Income Statement for the Expatriation Year:
What’s Needed
An overview of your income for the year you expatriate, including the total income up to the day before your expatriation.
Purpose
To calculate any exit tax owed based on income and gains up to your expatriation date.
How to Prepare
Compile information on all sources of income, including employment, investments, and any other income. Ensure you have accurate records and statements to support the figures provided.
Ensure you have detailed records and valuations for all assets and liabilities.
Overview of the Process of Filing as a "Covered Expatriate"
Below is a quick overview of the process of filing as a Covered Expatriate. This includes many of the steps we will take to ensure you are both compliant and liable to minimal tax. Ideally, we start the process with planning a few years before you plan to renounce so that we can ensure the most tax-efficient outcome.
Initial Assessment and Data Collection
Client Consultation: Once you have booked in your formal consultation with us, we will arrange a video or phone call to discuss your current tax situation, expatriation intentions, and financial status. This is to determine whether you meet the criteria for being a "Covered Expatriate.
Document Gathering: We will now request all necessary documents, these include previous tax returns, details of all global assets and liabilities, income statements, and proof of compliance with U.S. tax laws for the last five years.
Preliminary Assessment: An evaluation of your net worth and tax compliance status will now be conducted to confirm your "Covered Expatriate" status. You will then be provided with a detailed overview of potential tax liabilities, including the Exit Tax.
Preparation and Filing
Form 8854 Preparation: Form 8854, including your income statement, will now be filled out, ensuring accuracy in reporting personal details, tax compliance status, and a balance sheet of assets and liabilities
Review and Submission: Once you have reviewed and approved Form 8854 and accompanying documentation. We will file the form alongside your final tax return, if applicable, or submit it independently if a tax return is not required.
Confirmation of Filing: We will then send confirmation from the IRS that Form 8854 has been successfully filed. Keep copies of all filed documents for future reference.
Post-Filing Follow-up and Compliance
IRS Communication: We will monitor communications from the IRS regarding your expatriation filing. Responding to any requests for additional information and clarify or correct any issues as necessary.
Exit Tax Calculation and Payment: If applicable, you will now have to pay Exit Tax based on deemed asset sales. We will discuss arranging payment to the IRS or discuss options for deferral if applicable.
Ongoing Compliance: We can now conduct a debrief call to discuss any continuing U.S. tax obligations, such as reporting and paying tax on U.S.-sourced income or fulfilling any deferred tax agreements.
Waiting Times and IRS Interactions
Processing Time
IRS processing times can vary, especially for complex cases. Typically, the review process can take several months.
IRS Notices
You may receive notices or requests for additional information from the IRS. Prompt and accurate responses are crucial.
Finalization
Once the IRS has processed the expatriation filing and any due taxes have been paid, the expatriation process is considered complete. However, the IRS may audit the filings, so maintaining documentation is critical.
Conclusion
Understanding and navigating the US "Covered Expatriate" status requires a detailed approach and awareness of the associated tax implications. At Bambridge Accountants, our goal is to provide clarity and guidance throughout this complex process. Our expertise is rooted in a deep understanding of the unique challenges faced by those renouncing US citizenship or ending long-term residency.
Our process begins with a thorough assessment of your financial situation and tax history to determine your Covered Expatriate status accurately. This includes a comprehensive review of your global assets, liabilities, and past tax compliance. By identifying key areas of concern and opportunity, we aim to ensure a complete and accurate filing, minimizing the risk of future complications.
Once we've gathered all the necessary information, we meticulously prepare and review Form 8854, focusing on every detail required by the IRS. This form is critical in finalizing your expatriation from the U.S. and must be completed with precision. Our team ensures that your personal details, tax compliance status, and financial information are reported accurately, reflecting your situation correctly and favorably
Following the submission of Form 8854 and any related documents, our service extends to monitoring communications from the IRS, addressing any queries, and ensuring that any additional requests are fulfilled promptly and accurately. We understand the importance of maintaining open lines of communication with the IRS and strive to facilitate a smooth, uninterrupted process.
In terms of Exit Tax calculation, our team provides comprehensive support in evaluating your assets and determining the applicable taxes, exploring opportunities for minimization where possible. Should there be any tax obligations arising from the expatriation, we guide you through the payment process, discussing options such as installment payments or deferrals, based on your circumstances.
Our commitment extends beyond the filing process. We provide ongoing advice and support to ensure that you understand and can manage any continuing US tax obligations. This may include advice on how to handle U.S.-sourced income or guidance on complying with deferred tax agreements.
In conclusion, the journey through expatriation and its tax implications can be intricate. By leveraging our expertise at Bambridge Accountants, you can navigate this path with greater ease and confidence. Our approach is tailored to provide clear, comprehensive support, ensuring that you are informed and prepared every step of the way.
For more detailed information or specific queries, feel free to reach out. We're here to assist you through each stage of your expatriation journey.
We are committed to providing you with the support and expertise necessary to navigate the complexities of expatriation smoothly and effectively.