Giving Up U.S. Citizenship

By Brian Gourlay, MST
CPA, Partner
bgourlay@srgcpas.com

 

Recently Eduardo Saverin (the lesser known co-founder of Facebook) and Denise Rich (songwriter and ex-wife of pardoned tax evader Marc Rich) made headlines by formally renouncing their U.S. citizenship.  Although neither has formally acknowledged it, the general consensus is both did so to reduce their income taxes.

Why not just leave?

If you feel the tax burden here in California is too high, you can move to one of the states that doesn’t have an income tax, or to a state with a lower tax rate.  A number of our clients have done exactly that.  So why didn’t Mr. Saverin and Ms. Rich simply move (to Singapore and London, respectively)?  Giving up one’s citizenship seems a bit extreme.

The U.S. taxes based on citizenship or residence.  If you’re a U.S. citizen, you are subject to U.S. taxes on your world-wide income, even if you are living outside of the country.  So, if Mr. Saverin and Ms. Rich had merely moved and retained their U.S. citizenships, they would still pay U.S. taxes on their income—as well as taxes to their new countries of residence.

To completely avoid this double tax problem you need to give up your U.S. citizenship.  Of course, being a citizen of the United States does have its benefits.  If you are vacationing on the Arabian Sea and Somali pirates take you captive, it’s helpful to be a U.S. citizen.  Other countries send cables expressing outrage.  America sends Navy SEALs.

Giving up citizenship to avoid U.S. taxes has been a sophisticated tax planning tool for decades.  Congress first became aware of this technique in the mid-1960s, when Elizabeth Taylor made the mistake of mentioning she would save considerable tax dollars by giving up her U.S. citizenship.  (Ms. Taylor was born in London of U.S. parents, so she was a citizen of both the United States and United Kingdom.)  The resulting uproar caused Congress to pass a new tax law, Section 877, that became known among tax professionals as the “Elizabeth Taylor statute”.

Tax planning today

The rules have changed considerably since Section 877 was first passed in 1966.  Today’s law, which is modeled after Canada’s, levies an Exit Tax on those giving up their citizenship.  In a nutshell, the government charges soon to be ex-citizens a tax as if they have sold all their assets at fair market value on the date they renounce.  This is also known as the “mark-to-market tax”.

The first $651,000 in gain is exempt from tax (for 2012).  This mark-to-market tax does not need to be paid all at once.  You can defer the payment of the tax until you actually sell the property, although the IRS does charge interest on the deferred taxes.

It appears the timing of Mr. Saverin’s departure was fortuitous: he gave up his citizenship in 2011, before Facebook went public.  At that time the value of his stock was relatively low, so his exit tax should have been considerably less than what he would have paid as a U.S. citizen.  We’ll never know the exact figure, but it appears Mr. Saverin will save hundreds of millions in taxes by renouncing his U.S. citizenship.  (Oh, and Singapore does not tax capital gains.)

The process of giving up one’s citizenship is relatively straightforward, and becoming more popular.  In 1998, 232 U.S. citizens expatriated.  In 2007 there were 432 new expatriates.  Last year the number rose to 1,788.  Not all of those renounced for tax reasons, of course.  If you are considering this option there are a few caveats to keep in mind:

You need to have citizenship in another country in place before rescinding your U.S. status.  (How are you going to travel if you don’t have a passport?)

  • You need to move to another country, and limit the amount of time you spend visiting the U.S. to no more than 30 days per year for the ten years after you renounce your citizenship.
  • Giving up your citizenship is public record: after filing Form 8854 (yes, the IRS truly has a form for everything) your name is published in the Federal Register.  This is how the expatriation of Mr. Saverin and Ms. Rich became public information.

The above is provided as a topic of general interest to our readers and should not be used for tax planning purposes.  If you are interested in exploring how these rules could benefit you, please contact our office.

For more information, please give me a call at (818) 995-0090 or email me at bgourlay@srgcpas.com.

 

 

August 15, 2012 Posted in Tax