Leave America, Pay an Exit Tax?

While Republicans and Democrats in the U.S. Congress disagree on almost everything else, there's virtual unanimity on one issue: the "need" to punish anyone who wants to permanently disconnect from the U.S. tax system. 

Citizens of every major nation, save the United States, can simply leave their own country for an extended period, and permanently end the requirement to pay income or capital gains taxes.  But U.S. citizens are subject to all U.S. federal taxes wherever they live, no longer how long ago they left the United States. 

Even "accidental" U.S. citizens--e.g., people born in the United States to non-U.S. parents, but never again lived in the United States--are subject to these rules.  Non-U.S. citizens who have lived in the United States for at least eight of the 15 years are also subject to these rules.

The only way out for U.S. citizens who wish to legally free themselves from the oppressive U.S. tax system is to acquire a passport from another country, and subsequently, give up their U.S. citizenship and passport.  Yes, it's a radical step…but it's the only way to accomplish what a citizen of almost any other country can accomplish simply by an extended period of non-residence.

And that's not all.  If you actually have the gumption to give up your U.S. citizenship—or long-term U.S. residence—the Tax Code has a zinger for you.  It applies if you have a net worth exceeding US$2 million or an average income tax liability exceeding US$136,000 for the five-year period before you expatriate.

Should you meet either of these tests, U.S. law imposes an "alternative tax regime" for a period of 10 years after expatriation.  Generally, expatriates covered by these regulations must pay income tax for the 10-year period at rates applicable to U.S. citizens.  However, because the rules apply mainly to U.S.-source income, it's relatively easy to avoid U.S. taxes for the 10 years after giving up U.S. citizenship. 

Congress now wants to change that with an outrageous law that would impose the first-ever exit tax on former U.S. citizens or long-term residents.  Last year, both houses of Congress approved legislation that would require expatriates who are subject to the alternative tax regime to additionally pay a tax on all unrealized gains of their worldwide estate that exceed US$600,000.  The tax would be due within 90 days of expatriation.

This bill also imposes a draconian 30% withholding tax on unrealized gains in an expatriate's IRA or other pension plan.  And don't think about gifting assets to family members or friends still living in the United States: a separate 30% tax applies to such gifts or bequests.

Don’t want to pay the tax?  If you fail to do so, or defer the tax by posting a bond with the U.S. Treasury, the bill would forever bar you from returning to the United States. 

I don't know when this legislation will be reintroduced, but support is virtually unanimous for it on both sides of the aisle.  It's not a question of whether the exit tax will become law—only when.  My sources in Washington, D.C. tell me that sometime before the 2008 election, it's a near-certainty that the exit tax will become law. 

I'll be tracking the progress of this deplorable proposal once it's reintroduced this year.  I've also prepared a special report on expatriation and the implications an exit tax will have on Americans considering expatriation.  To learn more about this report, click here.

Copyright © 2008 by Mark Nestmann