Tax & Financial Consulting Services
They Want Slaves on the Plantation - Including You
The United States is the only major country on the planet that taxes citizens on their worldwide income, no matter where those citizens happen to live. It's not like that everywhere else. If you were born in England, Ireland, Japan, or almost any other country, all you need to do to avoid the obligation to pay tax on your worldwide income is leave. The same is true if you move somewhere else. Want to stop paying taxes? You move again. Then after an extended period - normally one year or longer - you no longer have any obligation to pay taxes on your income outside that country (although you may continue to be subject to gift and estate taxes).
But not the USA. To permanently disconnect from U.S. tax obligations, a U.S. citizen must not only leave the United States, but also take the radical step of giving up U.S. citizenship. This process (from a U.S. standpoint) is called expatriation. Why? Because the U.S. owns you...more about that later.
Leave the USA, Pay an "Exit Tax"
Congress has now once again amended these "anti-expatriation" provisions in a new bill. Both houses approved the bill unanimously, and sent it to President Bush for his signature. The primary purpose of the Heroes Earnings Assistance and Relief Tax Act of 2008 is to provide a range of tax breaks for veterans. But the law also imposes the first-ever "exit tax" on even moderately wealthy expatriates. I predicted Congress could pass an exit tax bill like this over a year ago, and now it has.
Once President Bush signs this bill, the law will require future expatriates to pay a tax on all unrealized gains of their worldwide estate, including most offshore trusts. And the tax applies not only to former U.S. citizens, but also to long-term green card holders who have resided in the United States for at least eight of the 15 years before they expatriate. (Fortunately, long-term residents can "opt out" of the exit tax.)
How are you supposed to pay the tax without selling your assets? That's your problem - not the IRS's - although the bill permits deferral in certain circumstances.
You Don't Need to be "Rich" to Pay the Exit Tax
It would be one thing if the exit tax only affected billionaires. But, with only a few exceptions for dual nationals and others with strong ties to another country, the law applies to any expatriate that:
1. Has an average annual net income tax liability that exceeds US$139,000, adjusted annually for inflation for the five preceding years ending before the date you lose your U.S. citizenship or terminate your residency
2. Has a net worth of US$2 million or more on such date
3. Fails to certify under penalty of perjury that he or she has complied with all U.S. federal tax obligations for the preceding five years or fails to submit any proof of compliance the IRS demands.
If you qualify under any of these criteria, you may be subject to the exit tax. The good news - if there is any - is that the first US$600,000 of gains is excluded. This exclusion doubles to US$1.2 million for a married couple filing jointly, when both expatriate. This exclusion will increase by a cost of living adjustment factor after 2008.
Gains will be calculated "mark-to-market," or the difference between the market value on the expatriation date and the market value at acquisition. Expatriates who were not born in the United States may elect to value their property at its fair market value on the date they first became a U.S.resident, rather than when they first acquired it.
This phantom gain will presumably be taxed as ordinary income (at rates as high as 35%) or capital gains (at either a 15%, 25%, or 28% rate), as provided under current law. When you actually sell the assets, you won't have to pay any additional taxes. However, your adopted country might tax the gain a second time, leading to double taxation on the same income.
Your Retirement Plan Takes a 51% Cut
And now for the really bad news: Once you expatriate, you'll pay up to a 51% tax on distributions from retirement plans. The same goes for most other forms of deferred payments. If there's a silver lining, it's that the tax isn't due until you actually receive payments from the plan.
Plans covered by this provision include:
• Qualified pension, profit sharing and stock bonus plans
• Qualified annuity plans
• Federal pension plans
• Simplified employee pension plans
• Simplified retirement accounts
The IRS imposes this extra 51% tax on these plans in two steps. First of all, the entity that makes the payment (like your pension fund) must withhold a 30% tax from any distributions to a "covered expatriate." That entity must also withhold a second 30% tax for payments to a "non-resident alien individual." Applying these two taxes sequentially equals a 51% net tax.
Similar rules (but with some added complexities) apply for distributions from non-grantor trusts. These are trusts where the expatriate isn't even treated as the trust's owner under the grantor trust rules. Your individual retirement account is NOT eligible for this treatment. If you're a "covered expatriate," you must pay income tax on the entire value of the plan, as if you received it in a lump sum. (Fortunately, no "early distribution" tax applies if you're under age 59 1/2.)
The bottom line: with the exit tax, Congress has made the most significant change to the anti-expatriation rules since their inception in 1966. In doing so, the IRS has sent wealthy U.S. citizens and long-term residents a clear message: You're slaves on our plantation. And if you want to exercise your right to leave, you'll pay dearly for the privilege.
If you don't believe you are a slave and property of the U.S., just look on the back of your Social Security card. Who's card is it? Yours or the property of the US? Remember, you are your SS#...111-22-3333 in the eyes of the government...nothing more...nothing less.
Tax & Financial Consultant, RFC
866-361-3872 toll free fax
"Those who do not learn the lessons of history indeed are condemned to relive them."