Expatriation Tax (Emigration Tax)
The term expatriation tax refers to a tax placed on a person that abandons their citizenship and ceases to be a tax resident of that country. In the United States, the expatriation tax takes the form of a capital gains tax, which is assessed on all unrealized capital gains on the date nationality is renounced.
Also referred to as an exit or emigration tax, an expatriation tax ensures citizens that cease to be a tax resident of a country pay taxes on the earnings realized while residing in that country. The United States is one of the few countries in the world that taxes overseas citizens. The Heroes Earnings Assistance and Tax Relief Act of 2008 outlines the taxation process for anyone that expatriates on or after June 17, 2008.
Expatriation tax provisions are complex, and individuals typically require the help of an attorney. The Internal Revenue Code (IRC) Sections 877 and 877A apply to long-term residents of the United States that end their resident status for federal tax purposes. Generally, if any of the below applies, an individual is considered a “covered expatriate”:
- Average annual net income for the five years ending before the date of expatriation exceeds threshold values published by the IRS and indexed for inflation. For example, an individual’s net income threshold was $157,000 in 2014.
- Net worth of $2,000,000 or greater.
- Failure to certify on Form 8854 they’ve complied with federal tax obligations in all of the preceding five years.
If an individual qualifies as a covered expatriate, IRC Section 877A imposes a mark-to-market process. This means all property of the covered expatriate is considered sold for its fair market value on the day before their expatriation date. This gain is deemed a sale during the tax year and includable in gross income on their federal income tax return, and reduced by the exclusion amount (which was $680,000 in 2014). This rule applies to all assets, including deferred compensation plans such as the 401(k), 403(b), pension plans as well as stock options.