Tax Expatriation By Vernon K. Jacobs, CPA  & J. Richard Duke, J.D., LLM

Most people would assume that if you give up your U.S. citizenship, you should also be able to become free of any U.S. tax obligations. Over the past few years, newspaper and t.v. have certainly led us to that conclusion. That's only partly true and therefore partly false.

Once you expatriate, you are free of U.S. taxes with respect to any foreign (non U.S.) source income or assets.

But, you will continue to be subject to U.S. taxes on any U.S. source income to which you have a right at the time you give up your citizenship.  Examples would include untaxed gains on investments, uncollected payments on an installment note, undistributed benefits from a pension plan or annuity, uncollected income from a business and any income that has accumulated in a controlled foreign corporation at the time you expatriate. The IRS can pursue former citizens for up to ten years to collect those taxes. However, any income earned outside the U.S. after expatriating and any income from investments held outside of the U.S. after expatriating would be free of U.S. taxes. In addition, any assets that were outside the U.S. would be free of any U.S. estate taxes.

Before the 1996 Health Insurance and Accountability Act, the tax law included a provision (IRC Section 877) that imposed taxes on a U.S. person who gave up their citizenship in order to avoid taxes. However, the IRS had to assert thattax avoidance was a motive for expatriating. Because they had to establish that tax avoidance was the intent of the taxpayer, they often had difficulty in doing that. So they prevailed on the Congress to change the law so that anyone with a net worth of $500,000 or more would be presumed to have given up their citizenship in order to save taxes. And, anyone with an average annual income tax of $100,000 or more for the past five years would also be presumed to have expatriated for a tax avoidance purpose. The law also offered little in the way of recourse for those who wished to get a ruling from the IRS to establish that they did not have a tax avoidance purpose in changing their citizenship.

These limits were increased in 2004 by the American Jobs Creation Act. The thresh-hold for the average income tax was increased to $124,000 and the thresh-hold for net assets was increased to $2 million. Both of these amounts are to be indexed for inflation.

The Congress passed a provision in the 1996 immigration law that held that anyone who relinquished their citizenship for the purpose of avoiding taxes would be barred from coming back to the U.S. - even to visit. There has been quite a bit of discussion about that controversial law and whether it is constitutional.  Thus far, we are not aware of any instances where that provision of law has been enforced or challenged in the courts.

As a practical matter, if you cash in all your tax deferred investments, deferred payment arrangements and any pension benefits, you would not have any tax obligation to the U.S. after relinquishing your citizenship. The person who leaves with all cash (or equivalent assets), should be able to work and invest thereafter without any further tax obligations to the U.S.

About the authors: Vernon Jacobs is a CPA who provides tax accounting and consulting services for clients with international interests.   J. Richard Duke, JD, LLM is an attorney who specializes in international tax law and is an Adjunct Professor of international tax law. Sponsored by Offshore Press, Inc., Copyright, 2006, All rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. Phone (913) 362-9667. Email to Offshore Press  Vernon K. Jacobs, Webauthor.