Saying Goodbye To Uncle Sam: Expatriation - U.S. Citizens And Green Card Holders Living in Canada

The United States has had income tax expatriation rules for many years, which may apply taxes when individuals give up their U.S. citizenship, or properly surrender their green cards. The rules are a bit like the taxes that can apply to Canadians moving out of Canada as far as a deemed disposition of assets is concerned.

Giving up U.S. citizenship alone does not necessarily mean that taxes will apply, or that you necessarily will be exempted from continued U.S. tax filing obligations. It’s all in the details.

You must file Form 8854, Initial and Annual Expatriation Statement, with your final tax return to get out of the U.S. tax system.

Renunciation of U.S. citizenship must

1. be taken in the presence of a diplomatic or consular office,
2. be taken outside the United States,
3. be in the precise form prescribed by the Secretary of State.

Once done this is irrevocable and will cost you U.S. $2,350 filing fee.

Taxpayers wishing to expatriate must notify the State Department when they want to revoke their U.S. citizenship, or the Secretary of Homeland Security if they wish to terminate their green card.  Reporting your expatriation will be required on Form 8854 on a one-time basis and will be submitted with your final 1040 tax return. 

Forms and Information Required in An Application for Expatriation

There’s lots of detail, including signing or submitting the many documents, including but not limited to the following:

1. Form DS - 4079 Request Determination of Possible Loss of United States Citizenship.
2. Form DS-4080 Oath/Affirmation of Renunciation of Nationality of United States.
3. Form DS-4081 Statement of Understanding Concerning the Consequences and Ramifications of Renunciation.
4. Submit proof of citizenship in another country—passport etc.
5. Submit U.S. social security card and U.S. birth certificate.

You are deemed to have expatriated on the date you attend the U.S. consulate, and then you file U.S. tax, and other returns for the year of expatriation up to that date.

Taxes Payable On Expatriation For Covered Expatriates

Only covered expatriates pay tax on expatriation, so if you are, or can get yourself out of that situation you escape the income taxes.  A covered expatriate is a U.S. citizen, or long-term resident (green card holder for eight or more years), and who meets any one of the following tests at the time of expatriation:

• The individual’s net worth is at least US$2,000,000 (CDN$2,800,000)
• The individual’s average annual net income tax liability for the five prior years exceeds U.S. $190,000 (CDN$280,000) and inflation-adjusted
• The individual fails to certify on Form 8854 the meeting of all federal tax obligations for the previous five years.

Covered Expatriates: Capital Gains Exemption 

Under U.S. tax rules, covered expatriates may be required to pay tax on deemed capital gains on worldwide assets at the time of expatriation, if such gains exceed a US$821,000 (CDN$1,149,000) – adjusted annually for inflation. Capital gains on such deemed sales are considered without regard to other tax preferences under the Internal Revenue Code, such as the US$250,000 principal residence exemption.

Effectively, the expatriate files a normal tax return up to the date of expatriation including regular income for the year to the date of expatriation, plus the deemed capital gains on expatriation. 

For green card holders, the cost base of assets for calculation of the gain is no less than their fair market value at the time of original immigration to the USA.  This rule does not apply for most other provisions to the Internal Revenue Code which only recognizes the historical cost of assets.

Assets Deemed To Have Been Sold At Time Of Expatriation

All your worldwide tangible and business assets are deemed to have been sold (market to market rule) except for certain U.S. deferred compensation plans discussed below and include the following assets: 

1. Marketable securities
2. Real estate including principal residences
3. Businesses and partnerships
4. Personal assets such as cars and boats

Obviously, there is no such deemed disposition in Canada, so there will likely be repeat tax on such gains on such assets when taxpayers eventually sell them, gift them away, or die. That can be a big kick in the pants for high wealth Americans living in Canada and may well prevent expatriation.

Punch Two: Tax on Deferred Compensation Including RRSPs/RRIFs and Canadian Pension Plan Balances

Deferred compensation amounts including interests in certain trusts are not subject to the tax on deemed asset sales, but instead, balances in such plans are either

1. deemed to have been received on the day before they expatiate or,
2. are subject to a 30% U.S. withholding tax when funds in such plans are withdrawn.

Deferred compensation liable for tax on expatriation includes the following:

1. Eligible deferred compensation—401K plans etc: 30% withholding on future withdrawals.
2. Ineligible deferred compensation—Canadian-based plans: deemed distributed with applicable tax.
3. Specified deferred compensation—Roth, IRAs and other plans: deemed distributed with applicable tax.
4. Interests in non-grantor trusts: capital gains plus a 30% withholding tax on future distributions.

In Canadian terms, a non-grantor trust is a typical trust set up by most Canadians in their tax and estate planning where the settlor of the trust surrenders all control over trust assets to the trustees.

Americans with large RRSP/RRIF balances need to do some special planning.  An RRSP/RRIF is deferred compensation for U.S. tax purposes and fully included in income on expatriation.  RRSP contributions will not be recognized, so the full RRSP balance will be taxable on expatriation.  Unless the RRSP/RRIF is collapsed before expatriation, the plan will be fully taxed in the U.S. without any foreign tax credit available, and then taxed in Canada as withdrawals are made, or a deemed disposition occurs on death.

The best solution may be to collapse the RRSP/RRIF before expatriation (perhaps over two years to reduce the annual income).  By doing this, the income will be recognized in the U.S. as foreign source income, and eligible for a foreign tax credit, so there should be a matching of income on both sides of the border to prevent double income tax.

The treatment of Canadian pension plans is even worse, because they are too expensive to be surrendered as a solution and will be fully taxed in the U.S. on expatriation, and then again as they come into income in Canada in the normal course.

Gifts and Bequests Following Expatriation

The Internal Revenue Code imposes a special transfer tax on gifts and bequests made by the expatriate at the highest estate or gift tax rates (for the rest of their life and on death) on gifts and bequests to a U.S. citizen by the expatriate.  The United States taxes U.S. residents at the highest estate or gift tax rates in this case, and the tax is paid by the U.S. recipient.   This gift and bequest tax does not apply unless the expatriate meets either the US$190,000 income threshold test, or the US$2 million asset test based on values at the time the gift is made, or on the value of estate assets immediately before death.   

Conclusion

Ordinary folks should be able to plan around the expatriate tax or at least minimize it and leave their U.S. citizenship behind with relatively little financial pain.

But not so much for high wealth taxpayers with large holdings in expensive homes, ownership of significant RRSP balances and with lucrative pension plans.

The new law is less onerous to taxpayers in the following circumstances: 

• Taxpayers holding unappreciated assets with less than US$821,000 in gains (indexed) at the time of expatriation and no substantial deferred compensation plans.
• Taxpayers who were citizens of both countries from birth and meet certain conditions.
• Taxpayers who have no U.S. citizen family members who will be gift or estate beneficiaries. 
• Taxpayers turning age 18 ½.

For those wishing to expatriate it certainly can be done.  But it’s complex, especially looking for tax minimization, and the filings are very detailed and time consuming.  From time to time, U.S. tax legislators threaten drastic action for people expatriating solely to escape U.S. tax, such as a ban from entering the United States ever again. 

Ed Arbuckle CPA FCA

Email: edarbuckle1@gmail.com

www.disabilitytaxplanning.ca