Two of the leading presidential candidates have proposed a Wealth Tax which would be assessed annually based on the total value of a taxpayer’s worldwide personal assets. The details differ between the candidates but both plans carry a yearly levy of 1% – 8% on the asset value in excess of a particular dollar amount. While the new tax would only apply to a relatively small number of very affluent individuals, it raises the prospect that the super-rich might pack up and leave the US for any country with a more favorable tax scenario.
So, what are the tax consequences if a wealthy individual decides not to stick around and be taxed out of his or her fortune? For those who wish to renounce their US citizenship, there is a little-known tax in our Internal Revenue Code (IRC) known as the Exit Tax, also called the Expatriate Tax. IRC Section 877 was enacted in 1966 to treat the act of expatriation as a taxable event on the built-in gains that accrued while the departing citizen enjoyed the privileges and protections of being in the US. The tax can apply to anyone who relinquishes his or her US citizenship. It also may apply to long-term residents who are not citizens but hold a “green card” and wish to terminate their status.
By satisfying one of the following three tests, the taxpayer becomes a “Covered Expatriate” and the Exit Tax is triggered:
- The Net Worth Test: The aggregate net value of the taxpayer’s worldwide assets is greater than $2 million. However, each spouse’s net worth is calculated separately so a married couple could have up to $4 million in net assets without incurring the Exit tax. The $2 million threshold is not indexed for inflation.
- The Tax Liability Test: The average annual income tax liability over the last five years is more than $168,000 for 2019 (adjusted annually for inflation). Under this test, you must use your joint tax liability if you file your income tax return jointly even if only one spouse is expatriating.
- The Noncompliance Test: The taxpayer has failed to be compliant with their income taxes for the past 5 years. Under this test, a departing individual must be able to certify under penalties of perjury that he or she has filed properly and included all required income during the prior five years.
If an expatriating person meets any one of these tests, the Exit Tax must be calculated and included on the final Form 1040 for the partial year ending on the date of renunciation. The tax is imposed as if all worldwide property were deemed sold for their fair market values on the day before the expatriation date. The phantom gain on this deemed sale is taxed at the capital gains rate, which can be as high as 23.8%. However, the gain on the deemed sale is reduced by an exemption amount of $725,000 for 2019 (indexed for inflation).
The date of relinquishment of citizenship is the earliest of: the date one renounces citizenship before a diplomatic officer of the US, the date one furnishes the state department a signed statement of voluntary relinquishment, or the date of loss of nationality by the State Department or a US Court. The date a green card holder abandons his or her long- term resident status is the date of filing form I-407 with the Department of Homeland Security.
The act of expatriation is permanent and irrevocable. Before you decide to flee this country for the sandy beaches of the Cayman Islands, call our firm to help you determine whether your exit strategy will include the Exit Tax.
By Cheryl DeVoe, CPA
- This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.