US Exit Tax Tips From a Financial Advisor
Tiffany Woodfield, Senior Financial Advisor, Associate Portfolio Manager, CRPC®, CIM®, TEP®
Summary of Key Points
The US exit tax is the final opportunity for the United States to tax long-term green card holders or US citizens who expatriate.
Exit tax generally applies only to covered expatriates.
Not all covered expatriates are ultimately subject to the tax.
Covered expatriate status is determined by net worth, average net income tax liability, or failure to certify five years of tax compliance.
The IRS applies a mark-to-market regime, treating worldwide assets as sold at fair market value the day before expatriation.
The decision to renounce US citizenship is personal, and you should consider your identity, assets, and professional advice, not taxes alone.
Video Script
In this video, I’m going to go over how exit taxes work in the US. If you’re thinking of moving from the US to Canada or another country, then this video will help make sure you don’t overpay tax or renounce your citizenship unnecessarily.
Stay to the end for my personal opinion on whether renouncing your US Citizenship is actually the best option.
I’m Tiffany Woodfield, a Cross-Border Financial Advisor and the co-founder of SWAN Wealth Management. I work with US and Canadian clients every day, and over the years, I’ve seen how much stress the question of taxes can cause dual citizens.
If you’ve moved so that you can enjoy your next adventure or pursue a career opportunity, the last thing you want is to be worried about the IRS.
So let’s get into it!
First, what is the US exit tax?
In simple terms, it’s the US government’s last chance to tax you if you’re giving up long-term residency or US Citizenship. So if you’re not planning on doing either of those things, you likely don’t need to worry about this.
Next, who needs to be worried about the exit tax?
If you’re considered a covered expatriate as opposed to a non-covered expatriate, then you may be at risk of paying the exit tax.
It is important to know that not all covered expatriates will owe exit tax.
Next, how do you know if you’re a covered expatriate?
Currently, there are three tests that will help you determine if you’re going to be a covered expatriate when you leave the US.
1) First, there’s the net worth test.
If you’re single and your worldwide net worth is $ 2 million or more the day before you expatriate or give up residency, you may be considered a covered expatriate.
Be sure to note that your worldwide net worth includes your home.
If you’re married, then as a couple, if your shared worldwide net worth is $4 million or more, you may be considered a covered expatriate.
Of course, if you’re not planning on renouncing your citizenship or giving up your long-term residency, this won’t apply to you.
2) Next, there’s the net income tax liability test.
As of 2022, if your average annual net income tax liability for the 5 years before your expatriation date is over $178,000 US, you may be considered a covered expatriate.
So if you were to renounce your citizenship in 2022, you would look at your annual net tax liability from 2017-2021.
You’d need to know if the amount of tax you owed each year from 2017 to 2021 was an average of $178,000 US.
Figuring out your annual net income tax liability can be complicated because it includes your regular income tax liability plus your alternative minimum tax and is adjusted for inflation. I recommend working with your accountant to figure out what your average annual income tax liability has been for the past five years.
3) Finally, you’ll be considered a covered expatriate if you cannot certify your tax compliance for the past 5 years following the guidelines on FORM 8854.
You will need to file all tax returns that are due, or you may be considered a covered expatriate.
To review, a covered expatriate may be subject to the exit tax.
However, there are exceptions. I recommend speaking to a cross-border tax lawyer about your situation before you renounce.
We have worked with several knowledgeable tax lawyers who have helped clients navigate this process.
Next, let’s talk about something that can often trip people up: how the IRS decides the capital gains which will be included in your worldwide income and taxed accordingly.
As a covered expatriate, the IRS has a market-to-market regime. This means all your assets are deemed to be sold at fair market value the day before you expatriate. So if you were to expatriate on July 2nd, all your assets would be deemed sold on July 1st and assessed at the fair market value.
If any of your assets have increased in value since the day you purchased them, this capital gain will be included in your worldwide assets and may be taxed.
However, as of 2022, the first $767,000 of capital gains on a deemed sale are exempt. So if you have $1 million in capital gains, only $233,000 may be subject to the exit tax.
Even if you think that you won’t have to pay any exit taxes and you’re under the exclusion gain of $767,000, it’s important that you speak to a professional tax lawyer about your situation. This isn’t simple to calculate, and there are potential tax liabilities from deferred assets such as an IRA.
When you start to calculate your worldwide assets, include trusts, personal assets, business assets, pensions, retirement accounts, and real estate.
If you find this information helpful and want to read more, go to our website and read the full article on Exit Taxes in the US. It has even more information, so I’ve included the link below.
Finally, who should renounce US citizenship? Is it worth it to renounce?
I can’t give you legal advice, but I can tell you what I’ve seen with my clients. For some clients renouncing is the best choice, whereas for others keeping their citizenship is best.
There isn’t a cookie-cutter answer. But no matter what, you shouldn’t make a decision based on fear or worry. If you have the right cross-border team, keeping your citizenship and filing your US taxes each year isn’t as complicated as you might think. With proper planning, what may seem complicated becomes manageable and relatively simple.
From my experience with clients renouncing is a very personal decision. It shouldn’t just be about the bottom line or the frustration of having to continue to file back to the IRS.
I like to ask my clients to consider how they view themselves.
Were they born in the US and grew up believing in the country's values and systems? Or did they grow up in Canada and take a great career opportunity after university in the US and are now back living in Canada?
The most important thing is to weigh both the logical and emotional sides of giving up your US citizenship.
Finally, if you’re planning on moving across the border and have assets you want to protect, I recommend you schedule a call with a cross-border advisor well in advance. The biggest and most costly mistakes happen when people don’t plan in advance.