What renouncing your US citizenship means for your taxes

Many American expats consider renouncing their US citizenship as a way to simplify their life abroad. Being a US citizen overseas can have an impact on all kinds of everyday activities, including paying your taxes, opening a bank account, accessing investment opportunities and accruing a pension. However, renouncing your US citizenship isn't as straightforward as just handing your passport back. This article will take a look at the reasons for and practicalities behind giving up US citizenship.

Reasons why Americans renounce their citizenship

The US is one of the few countries in the world that taxes its citizens on their worldwide income, regardless of their country of residence. This system of taxation means that expats often have to file an overseas annual tax return with the IRS. As well as the extra administration that this causes, it can also lead to double taxation and other financial constraints. 

For many Americans abroad, these issues, as well as the extra costs of complying, make giving up one's US citizenship an appealing option.

How to renounce your US citizenship

In order to renounce your US citizenship, you must pay a renunciation fee and visit your local embassy or consulate. These are the basic steps for renunciation:

• Complete the required forms
• Pay the renunciation fee (currently 2.350 US dollars)
• Attend an in-person appointment

Once your application has been approved, you will receive a "Certificate of Loss of Nationality". This officially severs your ties to the US, and confirms that you have formally relinquished your US nationality.

Your tax obligations before renunciation

Before you can start the process of giving up your US citizenship, you must ensure you have resolved any outstanding tax matters with the IRS. Renouncing your citizenship does not erase your existing tax obligations, and in some circumstances, can trigger new ones. Here's how to inform the IRS of your intention to give up your citizenship:

• File all your outstanding tax returns: Submit tax returns for the past five years, making sure you pay any taxes or penalties owed.
• File FBARs: Submit Foreign Bank Account Reports (FBARs) for the past five years. This tells the IRS the highest balances in any foreign accounts that you hold.
• Submit Form 8854: Form 8854 documents your intention to expatriate and the IRS uses it to determine whether or not you qualify as a "covered expatriate". If you do, this can trigger additional tax obligations.

Covered expatriates

If the IRS determines that you are a covered expatriate, you may be subject to the exit tax. This is a one-time tax on your unrealised gains, and is calculated as if you sold all your assets on the day before your US citizenship is formally renounced.

You are considered a covered expatriate if you meet one (or more) of the following three criteria:

1. Net worth test: Your net worth is 2 million US dollars or more on the date of expatriation.
2. Tax liability test: Your average annual net income tax liability over the past five years exceeded a specified threshold.
3. Compliance test: You fail to certify that you have complied with all your US tax obligations for the past five years.

Green card holders

The exit tax also applies to green card holders who are classified as long-term residents. To be a long-term resident, the holder must have had their green card for at least eight of the past 15 years. If this is the case, they are treated similarly to US citizens for tax purposes when expatriating.

Born abroad to American parents

For individuals born outside of the US to American parents, the rules are different. You may qualify for an exception to paying the exit tax if one of the following applies to you:

• You have never lived in the US as a tax resident
• You hold the citizenship of another country at the time of renunciation

Understanding whether you meet the criteria for the exit tax is crucial, as it can have significant financial implications.

The exit tax

The exit tax is calculated based on the fair market value of your worldwide assets that exceed a threshold, which is, on average, 866.000 US dollars (as of 2024). Hypothetical gains are calculated and you will need to pay tax on them as if they were realised. 

Expats with significant assets, such as real estate or investments, must make sure they carefully evaluate the cost implications of the exit tax before deciding to renounce their US citizenship.

Retirement accounts

Special consideration is given to retirement accounts, such as IRAs or 401(k)s, when calculating the exit tax obligations. For these types of accounts, the IRS assumes that they will be liquidated and taxes the entire balance as income. Expats with substantial retirement savings in the US should work with a tax advisor such as Expats Overseas to mitigate this burden.

Filing taxes after renunciation

Once you have renounced your US citizenship, you are still required to file a final US tax return for the portion of the year that you were still a US citizen. This includes Form 8854 to document your expatriation and allow the IRS to calculate if any exit tax is due.

After this, your obligation to file US tax returns is over, except in cases where you have US-sourced income.

Planning ahead

Renouncing your US citizenship is a significant decision, and one that takes careful planning. To minimise tax liabilities, it is highly recommended that you:

• Work with a qualified tax advisor to ensure full compliance.
• Consider restructuring your financial holdings before expatriation.
• Evaluate the impact on your family, especially if you plan to leave inheritances to US-based heirs.

Travelling to the US after renouncing your citizenship

Don't forget - once you have renounced your US citizenship, you will be entering the US as a foreigner. Make sure you understand the entry requirements for your new nationality. 

Most travellers need to apply for an Electronic System for Travel Authorization (ESTA) before visiting. Applying for this is straightforward, and if you are approved you do not have to apply again for another two years.

Consult an advisor

While renouncing US citizenship can relieve the annual burden of having to file your taxes in two countries, it isn't a decision to be taken lightly. The tax implications, particularly the exit tax, can be significant.

Consulting a financial advisor and preparing well in advance can help you minimise your obligations and be confident that you are making the correct decision.

Expats Overseas specialises in assisting individuals with the renunciation process, tax filing obligations, and post-renunciation planning. Contact them for a free, no-obligation consultation to address your tax concerns and simplify your expatriation journey.