What it means
The mechanism is a deemed sale. The tax authority pretends your worldwide assets were sold at market value on the day before expatriation, works out the gain and taxes it, even though nothing has actually been sold and no cash has changed hands.
In the United States the rules apply only to a covered expatriate, meaning a person who meets one of three tests: a net worth of $2,000,000 or more, an average annual income tax liability over the previous five years above an inflation-adjusted threshold, or a failure to certify five years of tax compliance. Most people who renounce citizenship meet none of them and pay nothing at all.
An exclusion shields a slice of the deemed gain, an amount adjusted for inflation each year that has recently sat a little below $900,000. Everything above the exclusion is taxed at the relevant capital gains rate, while certain assets, notably deferred compensation and interests in some trusts, are handled under separate rules.
The practical problem is liquidity, because a tax on unrealised gains still has to be paid in real money. Somebody whose wealth sits in private company shares or property can face a large bill with no obvious way to fund it, which is why a deferral election exists in exchange for posting security and paying interest.
Other countries take different approaches. Canada and Australia operate their own deemed disposal rules on departure, several European states apply exit charges to substantial shareholdings, and the details differ enough that anyone contemplating a move needs advice covering both countries involved.
In practice
Real-world examples.
Example
A software founder holding shares worth $40,000,000 in a private company plans to renounce US citizenship. She discovers the deemed sale would create a bill she cannot pay without selling shares she is contractually locked out of selling for another two years.
Example
A retired engineer with a net worth of $1,400,000 renounces citizenship after thirty years abroad. Because he fails none of the three covered expatriate tests no exit tax arises, though he still files a final return and certifies five years of compliance.
Example
A permanent resident who has held a green card in eight of the past fifteen years learns that surrendering the card triggers the same expatriation rules as renouncing citizenship. She had assumed the regime applied only to citizens and had made no plans at all.
Formula
Calculation
Net unrealised gain = market value of worldwide assets - total cost basis
Taxable gain = net unrealised gain - exclusion amount
Exit tax = taxable gain x applicable capital gains rate
Suppose a covered expatriate owns assets worth $12,000,000 with a combined cost basis of $4,500,000. The net unrealised gain is $12,000,000 - $4,500,000 = $7,500,000.
Applying an exclusion of $900,000 leaves a taxable gain of $7,500,000 - $900,000 = $6,600,000. At a combined long term capital gains and investment income rate of 23.8%, the exit tax is $6,600,000 x 0.238 = $1,570,800, payable even though not one of those assets has actually been sold.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Nadia Ferrant, an invented founder of a private logistics software business, had lived in the United States for two decades and wanted to return permanently to her country of birth. Her net worth was around $18,000,000, of which $9,000,000 represented unrealised gain on shares in her own company.
Because her net worth exceeded the $2,000,000 threshold she counted as a covered expatriate. The deemed sale produced a taxable gain of $9,000,000 - $900,000 = $8,100,000 and, at 23.8%, an exit tax of $8,100,000 x 0.238 = $1,927,800 on shares that no buyer had offered to purchase.
In this fictional case her advisers found two routes: elect to defer the tax until the shares were genuinely sold, which required posting security and paying interest in the meantime, or sell a minority stake to an existing investor to raise the cash. She chose a partial sale, and the wider lesson from this invented example is that expatriation planning belongs several years before the departure date rather than in the month of it.
Watch out
Common mistakes.
- Assuming the exit tax applies to everyone who leaves, when it applies only to those who meet one of the covered expatriate tests.
- Treating renunciation as a way of escaping an existing tax bill, since taxes already owed remain due and the exit charge is added on top of them.
- Forgetting that long term green card holders can be caught by the same rules as citizens when they surrender permanent residence.
Questions
People also ask.
Do I pay expatriation tax if I simply move abroad?
No, moving does not trigger it, because the charge arises on giving up citizenship or long term permanent residence rather than on changing where you live.
Can the tax be deferred?
Yes, an election is available on an asset by asset basis, but it requires adequate security, a waiver of treaty rights and interest charged on the deferred amount.
Does anyone else inherit a problem from this?
Yes, gifts and bequests from a covered expatriate to US recipients can attract a separate succession charge, so the consequences follow the family as well as the individual.
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