Renouncing US citizenship and common questions relating to the process. US tax issues and the US Exit Tax

1. Expatriation
Matthew
Ledvinaa Primer (August 2018)

2. EXPATRIATION – A PRIMER (AUGUST 2018)
This primer provides a general summary of various US tax and non-tax issues
for individuals who are considering “expatriation.” This primer is organized in
a question-and-answer (“Q&A”) format and addresses the following—
1. What does “expatriate” mean for US
tax purposes?
2. What are some of the issues that an
individual should consider before he or
she expatriates?
3. Who is a “covered expatriate”?
4. Are there exceptions to being a covered
expatriate? If so, what are they?
5. What are the special tax regimes of the
so-called “Exit Tax”?
6. How does the mark-to-market regime
operate?
7. Does the mark-to-market regime apply
to an interest in a trust?
8. Does the mark-to-market regime apply
to deferred compensation items?
9. How does the covered gift or bequest
regime operate?
10. Are there reporting obligations? If so,
what are they?
11. Are there any travel restrictions to the
US?

3. Thefollowingissuesshouldbeconsidered-
- Whether the individual is a national or
citizen of another country (e.g., wheth-
er he or she holds a non-US passport
prior to the expatriation),
- Whether the individual would be a
“covered expatriate” subject to special
taxregimes(collectively,the“ExitTax”),
- Whether the Exit Tax would matter
given the covered expatriate’s factu-
al situation or, alternatively, whether
planning opportunities are available to
mitigate the tax consequences,
- Whether the individual has any family
members who are US persons,
- Whether the individual cares about
public disclosure that he or she has ex-
patriated, and
- Whether the individual would fre-
quently return to the US.
2. WHAT ARE SOME
OF THE ISSUES THAT
AN INDIVIDUAL
SHOULD CONSIDER
BEFORE HE OR SHE
EXPATRIATES?
For US tax purposes, an individual is an
“expatriate” if he or she has expatriated.
An individual “expatriates” when he or she
relinquishes his or her US citizenship or
ceases to be a long-term resident.
1. WHAT DOES “EXPATRIATE”
MEAN FOR US TAX PURPOSES?
Commonly, a US citizen expatriates when he or she
formally renounces his or her US citizenship before a
US diplomatic or consular officer at a US Embassy out-
side the US. The expatriation must be performed volu­
n­tarily with the intention to relinquish US citizenship.
A “long-term resident” is an individual who holds law-
ful permanent resident status (i.e., has a “green card”)
for at least 8 tax years during a period of 15 tax years
ending with the year that includes the expatriation. A
long-term resident can expatriate by filing US Depart-
ment of Homeland Security Form I-407 or by informing
the US Internal Revenue Service (the “IRS”) that he or
she is considered as a tax resident of another country
under an income tax treaty between such country and
the US and is claiming benefits under such treaty.

4. - The tax liability test is met if the expa-
triatehasanaverageannualnetincome
tax liability that exceeds a specified in-
flation-adjusted amount (USD 165,000
in 2018) for the 5 preceding tax years
ending before the expatriation date.
- The net worth test is met if the expa-
triate has a net worth of USD 2 million
or more as of the expatriation date (this
amount is not inflation-adjusted).
- The certification test requires the ex-
patriate to certify, under penalties of
perjury, his or her compliance with all
US tax and reporting obligations for the
5 tax years preceding the year that in-
cludes the expatriation date. The certi-
fication is made on IRS Form 8854.
Planning opportunities may
be available to address the
tax liability test (e.g., foreign
tax credit) and the net worth
test (e.g., gifting and valuation
discounts). If the expatriate
has not filed any US tax or
information return in the
preceding 5 tax years prior to the
expatriation, the expatriate will
fail the certification test unless
corrective measures are taken
(e.g., voluntary disclosure).
3. WHO IS A “COVERED EXPATRIATE”?
Subject to the exceptions discussed in Q&A 4, a “covered expatriate” means an
expatriate who meets the “tax liability test” or the “net worth test” or fails the
“certification test.”

5. If an expatriate qualifies for
the “dual-national exception”
or the “minor exception,” the
tax liability test and the net
worth test do not apply, but the
certification test still applies.
Thus, if an expatriate qualifies
for the dual-national exception,
for example, and meets the
certification test, he or she is
not a covered expatriate even
if his or her net worth is USD
2,000,000 or more on the
expatriation date.
- The dual-national exception is available
if the expatriate — (1) became at birth a
citizen of the US and a citizen of another
country, (2) as of the expatriation date,
continues to be a citizen of, and is taxed as
a resident of, such other country, and (3)
has been a US resident for not more than
10 years during a 15 year period ending
with the year during which the expatria-
tion date occurs.
- The minor exception is available if the ex-
patriate relinquishes his or her US citizen-
ship before the age of 18 1/2 and has been
a US resident for not more than 10 years
before the date of relinquishment.
The Exit Tax applies to covered expatriates. The
Exit Tax includes the following tax regimes— (1)
the mark-to-market regime, (2) the modified tax
regime with respect to interests in nongrantor
trusts, (3) the modified tax regime with respect to
deferred compensation items, and (4) the covered
gift or bequest regime. These regimes are summa-
rized in the Q&As below.
4. ARE THERE
EXCEPTIONS TO
BEING A COVERED
EXPATRIATE? IF SO,
WHAT ARE THEY?
5. WHAT ARE THE SPECIAL
TAX REGIMES OF THE SO-
CALLED “EXIT TAX”?

6. 6. HOW DOES THE MARK-TO-MARKET REGIME OPERATE?
Step 1: Any gain from the deemed sale is taken
into account for the tax year of the deemed sale
notwithstanding any other provisions of the US
tax code. Generally, the amount of the gain from
the deemed sale of a property is the excess of its
fair market value on the date before the expatria-
tion over its adjusted basis (e.g., purchase price)
as of such date.
Step 2: the total gain from the deemed sale is
reduced (but not below zero) by an inflation-ad-
justed exclusion amount. In 2018, the exclusion
amount is USD 713,000. The exclusion amount is
allocated property-by-property in proportion to
the property’s built-in gain over the total gain.
Step 3: the loss from the deemed sale is taken into
account for the tax year of the deemed sale as
provided under the US tax code (except the loss
disallowance for “wash” sales of stock or securi-
ties does not apply).
Step 4: the taxable income from the deemed sale
is the amount in Step 2 minus the amount in Step
3. The covered expatriate may elect to defer
the payment of tax attributable to any property
deemed sold.
Under the mark-to-market regime, all property of a covered expatriate is deemed
to be sold for their fair market value on the date before the expatriation date.
Generally, the excess of the total gain from the deemed sale over an inflation-
adjusted “exclusion amount” minus any loss from the deemed sale is subject to
income tax. The rules for determining the tax liability can summarized as follows-

7. 7. DOES THE MARK-TO-MARKET
REGIME APPLY TO AN INTEREST IN
A TRUST?
8. DOES THE MARK-TO-MARKET
REGIME APPLY TO DEFERRED
COMPENSATION ITEMS?
The answer depends on whether the trust is a “grantor trust” or
a “nongrantor trust” with respect to the covered expatriate.
- The mark-to-market regime applies to the property of a trust of
which the covered expatriate is treated as an “owner” under the
so-called “grantor trust rules” (e.g., the covered expatriate can
revoke the trust). Such a trust is a grantor trust.
- The mark-to-market regime does not apply to any interest in a
nongrantortrust. Amodifiedtaxregimewithrespecttointerests
in nongrantor trusts applies. Under the modified regime, any di-
rect or indirect distribution of property to a covered expatriate
from a nongrantor trust is subject to a 30 percent withholding
tax. The trustee must deduct and withholding 30 percent from
the taxable portion of the distribution. Also, if appreciated prop-
erty is distributed from a nongrantor trust, the gain is required
to be recognized by the trustee as if the property had been sold
by the trustee and the proceeds distributed to the covered expa-
triate. For purposes of this modified tax regime only, the term
“nongrantor trust” means the portion of any trust, whether US
or non-US, of which the covered expatriate is not considered as
the “owner” under the grantor trust rules as determined on a
date before the expatriation date. This rule implies that a trust
can be a nongrantor trust to a covered expatriate even if it is
entirely owned by another person under the grantor trust rules.
The mark-to-market regime does not apply to deferred compensa-
tion items. Depending on the classification of the deferred com-
pensation item, the manner of taxation is, generally, either of the
following— (1) the payer deducts and withholds 30 percent from a
taxable payment when such payment is made to the covered ex-
patriate, or (2) the covered expatriate is treated as having received
his or her entire accrued benefit as a distribution on the date be-
fore the expatriation date and reports such amount on his or her
final US tax return. For this purpose, deferred compensation items
include (but are not limited to) retirement and pension arrange-
ments and certain retirement accounts and can also include stock
options, stock appreciation rights, and restricted stock units.

8. A covered gift or bequest is any pro­
perty acquired (directly or indirect-
ly) by gift from an individual who is a
cove­red expatriate at the time of such
acquisition or by reason of the death
of an individual who was a covered
expatriate immediately before death.
A covered gift or bequest does not in-
clude the following—
- Any tangible or real US situs property
shown as a taxable gift on a timely filed
gift tax return by the covered expatriate,
- Any US situs property shown on a
timely filed estate tax return of the es-
tate of the covered expatriate, and
- Any property with respect to which
the marital or charitable deduction
would be allowed.
For these purposes, a US trust that re-
ceives a covered gift or bequest is treat-
ed as a US citizen. As a result, the US
trust is subject to the special transfer
tax upon its receipt of such gift or be-
quest. Also, a US citizen or resident who
receives a distribution of property from
a non-US trust is subject to the special
transfertaxtotheextentthatsuch prop-
erty is attributable to a covered gift or
bequest received by the non-US trust.
Many details regarding the covered gift
or bequest regime need to be clarified,
and guidance has not been provided by
the IRS. The IRS has stated that it will re-
leaseguidance. Pendingsuchguidance,
the reporting and tax obligations for
covered gifts or bequests are deferred.
Under the covered gift or bequest
regime, a US citizen or resident who
receives (directly or indirectly) certain
gifts or bequests from a covered
expatriate (“covered gift or bequest”)
is subject to a special transfer tax. The
tax equals the amount of such covered
gift or bequest in excess of an inflation-
adjusted “annual exclusion amount”
times the highest gift or estate tax rate
applicable on the date of receipt of the
gift or bequest. In 2018, the annual
exclusion amount is USD 15,000, and the
highest gift and estate tax rate is 40%.
9. HOW DOES THE COVERED
GIFT OR BEQUEST REGIME
OPERATE?

9. 10. ARE THERE THE REPORTING OBLIGATIONS?
IF SO, WHAT ARE THEY?
11. ARE THERE ANY TRAVEL RESTRICTIONS TO THE US?
Generally, an expatriate must obtain a visa to
travel to the US unless the expatriate is eligible
to use the Visa Waiver Program (“VWP”) and has
a valid Electronic System for Travel Authorization
(“ESTA”) approval prior to travel. The VWP allows
citizens of participating countries, e.g., France,
Germany, Switzerland, and the UK, to travel to the
US without a visa as long as the duration of stay is
90 days or fewer.
Under the so-called “Reed Amendment,” the US
Department of Homeland Security (to which the
US Attorney General transferred enforcement du-
ties) may deny expatriates the right to be admitted
into the US if the enforcement agency determines
that the expatriate renounced US citizenship for
the purposes of avoiding tax. To our knowledge,
the Reed Amendment has never been officially
enforced. However, anecdotal evidence suggests
that it has been applied in isolated cases, and cer-
tain members of the US Congress have proposed
legislation that, if enacted, would more definitive-
ly deny expatriates admission into the US.
In connection with the expatriation, the following
reporting must be made by the expatriate or the
IRS, as the case may be—
- The expatriate must file “dual-status” US income
tax returns (IRS Form 1040NR with IRS Form 1040),
an expatriation statement and certification (IRS
Form 8854), and, if applicable, a notice to the
withholding agent of the expatriation and waiver
of treaty benefits (IRS Form W-8CE). The expatri-
ate may also need to inform his or her banks and
other financial institutions (collectively, “FIs”) of
his or her change of status from a US person to a
non-US person. The FIs may request a completed
IRS Form W-8BEN and a copy of the expatriate’s
Certificate of Loss of Nationality.
- The IRS must publish in the Federal Register
(which is accessible by the public) the names of
persons who have relinquished their US citizen-
ship in a calendar quarter. The publication is
made 30 days after each calendar quarter.

10. Matthew
Ledvina
Expatriation
– a Primer (August 2018)