New Rules for Expats: Leaving America with Dignity

Congress has debated the merits of various tax measures for expatriates for more than 20 years. The most straightforward approach is an exit tax on all untaxed asset appreciation on departure. Fortunately, this complex tax policy has been constrained by civil rights concerns of those who view exit taxes as inappropriate barriers to free population movement, historically used by totalitarian-style regimes to detain their oppressed inhabitants. In spite of this controversy, several enlightened governments, notably Canada and Australia, have recently adopted this approach, with mixed results. The United States uses another approach ... for now. The world is going global, and the U.S. tax system is keeping up with the times. The American Creation Act of 2004 (the Jobs Act) established special rules for individuals emigrating from the United States, including all traditional expatriates--people giving up citizenship--and even certain aliens relinquishing permanent residency. They subject the wealthy to at least 10 years of stricter reporting, and monitor and tax certain post-departure income. The less-wealthy are allowed to leave with minimal fuss, but must report their departure to claim U.S. tax freedom. The U.S. tax system is unique in its global approach to taxation. U.S. citizens always are required to pay income tax on their worldwide income from all sources, subject to various credits, exemptions and exceptions, and any gifts they make or estates they leave are generally subject to U.S. transfer taxes. Enhanced disclosure requirements, an intent-driven tax regime and the inclusion of long-term residents in the anti-avoidance regime tightened these rules in 1996. The chink in the armor in the 1996 revisions was the focus on the taxpayer's intent to trigger the full antiavoidance tax system. Determining intent has proven nearly as costly and elusive as the daunting task of determining the fair value of unsold assets at departure. NEW LEGISLATION, NEW RULES The new rules apply to all departing expatriates retroactively from June 3, 2004. In addition to the 10-year postexpatriation self-assessment and reporting system, the net-worth threshold also has been increased, exempting more of the less-than-wealthy from continuing tax payment and return filing obligations. This will allow those individuals to move freely with no special postdeparture U.S. taxes or reporting responsibilities after an initial filing. Expensive and time-consuming letter ruling requests no longer are required. When citizens (or long-term residents) move to locations where there is a U.S. tax treaty, those provisions also must be considered in determining the individual's U.S. tax reporting obligations. An expatriate continues to be a U.S. resident for tax purposes, and liable for U.S. tax on worldwide income, until the formal acts of expatriation and associated reporting are complete. Under the new law, all citizens and long-term residents remain U.S. residents until the later of the day they perform an expatriating act (give up citizenship or green card status) or file an information return with the IRS documenting their expatriation and financial status. FITTING INTO THE TAX SYSTEM The United States taxes noncitizens (aliens) based on their U.S. activities. If an alien's presence in the United States is casual, only U.S. source income is taxable and transfer taxes (on estates and gifts) apply only to specific classes of U.S. assets. The tax profile of aliens changes significantly when they become U.S. residents. For income tax purposes, this is objectively based on immigration status (the green card test for those that obtain lawful permanent residence) or physical presence (the substantial presence test). For estate and gift tax purposes, residence is based on domicile. An alien who becomes a resident is subject to the same income tax rules as any U.S. citizen. Most resident aliens can change their residence status freely, leaving the United States at will, with few U. …

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