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Voluntary Disclosure May be Less Costly than Relinquishing Citizenship

According to a recent article by Michael Klein, a record number of Americans renounced their United States citizenship last year. Klein speculates that this occurrence is largely due to a fear of civil and criminal liability under the Foreign Account Tax Compliance Act (FATCA) for undisclosed foreign bank accounts.

FATCA requires foreign banks to report foreign bank accounts worth more than $50,000 held by U.S. citizens to the IRS. A person who willfully fails to file their Foreign Bank and Financial Accounts (FBARs) with the IRS may be subject to a civil penalty of up to $500,000 and a criminal penalty of up to ten years in jail.

However, many of these people may have jumped out of the frying pan and into the fire by subjecting themselves to an expiration (exit) tax. The cost of paying the exit tax can often outweigh the costs associated with making an offshore voluntary disclosure.

I.          Who does the exit tax apply to?

The exit tax applies to the following U.S. citizens:

(1)  Any person whose annual income tax for the 5 years prior to renunciation is greater than a specified amount that is adjusted for inflation ($147,000 for 2011, $151,000 for 2012, and $155,000 for 2013),

(2)  Any person whose net worth equals $2 million or more at the time of renunciation, and

(3)  Any person who failed to certify that he or she complied with all U.S. federal tax obligations for the 5 years preceding renunciation.

In addition, the exit tax applies to green card holders. A Permanent U.S. Resident will be subject to the exit tax if he or she:

(1)  Held the green card for 8 of the previous 15 years,

(2)  Has a worldwide net worth of $2 million or more, or

(3)  Had an average U.S. net income liability over the previous 5 calendar years of $147,000 or more.

II.        How is the exit tax applied?

 a.         The Income Tax Element

If you are subject to the exit tax, the IRS will tax you on the net gain earned on the expatriate’s worldwideassets. For the purpose of expatriation, the exit tax will apply as if the expatriate liquidated all of his or her assets prior to renunciation of citizenship without regard to whether a sale actually occurred or the gains were partially earned prior to becoming a Permanent Resident. For the 2013 calendar year, the first $663,000 gain is exempt from taxation.

b.         The Inheritance Tax Element

The inheritance tax element applies to persons who make a gratuitous transfer to a child residing in the U.S. after relinquishing citizenship. The current transfer tax rate for gratuitous transfers in this scenario is 40%.

III.       Are their any other consequences to renouncing citizenship?

 Yes. The “Reed Amendment,” enacted in 1996, bars former U.S. citizens who are suspected of renouncing citizenship solely to avoid paying taxes from re-entering the U.S.

IV.       Conclusion

Renouncing your U.S. citizenship can exacerbate your problems if you have an undisclosed offshore account as you could additionally face problems with the exit tax. Moreover, moving out of the U.S. may not end the U.S. government’s inquiry in to undisclosed foreign account after you leave as the U.S. has many income tax and extradition treaties with foreign nations. Contact us before the IRS follows you abroad. We can help you make a domestic or foreign (or both) voluntary disclosure and avoid serving jail time.