Renouncing U.S. citizenship for tax purposes is something you shouldn’t do in a hassle. Before making such a life-changing decision, you must weigh all of your options. Some expats renounce their U.S. citizenship to stop paying taxes. It also relieves them from filing tax returns, a process that is complicate in itself.
It is important to keep in mind that renouncing your U.S. citizenship means that you may still have to pay taxes, depending on your financial situation. Therefore, if you know any family member or close friend who is contemplating renouncing U.S. citizenship for tax purposes, tell them to consult with a reputable tax preparation company first. For this purpose, call us today for guidance. We have been serving a wide range of clients for many years, and we can resolve any tax-related issues.
Procedure for Renouncing Your U.S. Citizenship
If you have made up your mind about renouncing your U.S. citizenship, you need to request for a Certificate of Loss of Nationality from a U.S. Consulate. Before moving further, you must know that you are applying for renunciation—not relinquishment of citizenship, a process for which you have to perform an expatriating act.
For instance, an act that is commonly interpreted as relinquishment of citizenship is the decision to join another country’s army. Meet with an employee in the consulate and inform them about your decision to renounce your U.S. citizenship. The rest of the process is fairly straightforward.
Earlier, renouncing U.S. citizenship was free, but as of now, you are required to pay $2,350 for the entire procedure. Although some expats view this fee as a discouraging factor from proceeding with the renunciation process, there are those who consider it as a fair trade to relieve them from U.S-based taxes.
Motivations behind Renouncing U.S. Citizenship for Tax Purposes
As explained before, the first and foremost reason behind renunciation is to save yourself from the U.S. tax regulations. Lately, the addition of fees and other layers have made it hard for Americans to manage their taxation from overseas.
For example, take the FATCA (Foreign Account Tax Compliance Act), a tax reform that came into effect in 2010. This reform has encouraged many to renounce their citizenships. This is because the law takes into account the property, bank accounts, and financial assets of U.S. citizens that are stashed abroad. FATCA enforces citizens to document these financial accounts. Even if these citizens have any notable ownership in a foreign company, they must report it as well.
Double taxation is another issue that tilts citizens towards renouncing U.S. citizenship. The taxation system in the U.S. enforces taxes on anyone with citizenship, including those who live and earn their livelihood abroad. Therefore, as a U.S. citizen who just moved abroad for work, you are required to pay taxes in both the U.S. and your new country.
However, one thing that many people are unaware about is that renouncing your U.S. citizenship does not instantly allow you to avoid taxes. For instance, after renouncing your U.S. citizenship, you have to file a Form 8854 and submit a copy to the Department of Treasury. Moreover, you also have to submit a proof of your tax returns for the last five years.
The purpose of this filing is to evaluate if, as a covered expat, an exit tax applies on the distribution of your assets. To verify your status as a covered expat, you have to satisfy the following conditions:
- On average, the tax liability for your annual net U.S. income in the last five years (preceding the renunciation year) is more than $165,000.
- On your expatriation day, you need to have a net worth of $2 million or more.
- You were not negligent with your tax filing in the last five years preceding the renunciation year.
If you want to become a covered expat before renouncing your U.S. citizenship, you are required to pay an exit tax. The initial capital gains worth $713,000 are not taxed; however, even then, a huge tax bill may await you.
In some cases, it is possible that you can avoid paying such taxes on your income and assets while renouncing your U.S. citizenship. For instance, citizens carrying American and Canadian nationalities are exempt from these taxes. On a similar note, if you have not passed 18½ yet, you can avoid these tax obligations while renouncing your U.S. citizenship. Keep in mind that both of these exemptions only apply if you lived outside the U.S. for the past 15 years. Additionally, you also have to show proof of proper tax filing in the last five years.
Renouncing your U.S. citizenship for tax purposes brings several benefits to the table like saving yourself from the double taxation. However, in most cases, renunciation is irreversible. Hence, you must check which citizen-based rights you are sacrificing in exchange for tax relief so you can make an informed decision in the end.