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US citizenship-based taxation: is expatriation the only way out?

by Glenn Snow

The United States stands as one of only two countries in the world (Eritrea being the other) that assesses personal income tax based on citizenship as well as residency.

This distinctive tax system subjects US citizens to taxation on their global income and gains, irrespective of their place of residence. Consequently, managing tax affairs becomes notably intricate for US citizens living overseas, and experienced specialist tax advisers for international US-connected individuals are needed to identify tax planning opportunities, ensure compliance, and assist in avoiding or mitigating double taxation pitfalls.

US citizenship-based taxation and the UK’s remittance basis regime

With the application of the unique citizenship-based taxation regime, the need to consider US taxes does not end with departure from US soil. It is therefore crucial that US citizens acquaint themselves with their tax and reporting obligations and fully grasp the dos and don’ts. Some will find the need to carefully plan and consider matters with multiple taxing jurisdictions to be overwhelming. 

Subject to an assessment of immigration considerations, ties to the US and other personal factors, some individuals may decide that expatriation is the only way out. If so, they should expect another dance with complexity as they assess whether they are going to be exposed to an exit tax, mark-to-market tax, and the impact of the transfer tax as they leave their US citizenship behind. The perception from the US Congress is that an expatriating individual should pay tax on the way out because their scope to recoup future taxes from a non-US person is obviously far reduced.

The focus of this article is on US citizens living in the UK, but it is worth noting that US green card holders are also subject to US tax and certain international reporting requirements, even if their green card has expired.

To frame this, we will consider a US citizen who has moved to the UK as a non-domiciled individual. The UK has (for now) a remittance basis regime which allows for eligible non-domiciled individuals to limit their tax exposure to UK-sourced income and certain remitted funds, which can be hugely advantageous for many. However, the US citizen in this situation remains subject to tax on their worldwide income and gains in the US on the income and gains that are protected from UK tax. Whereas a non-US citizen could reduce their tax exposure with this approach.

The benefits of the remittance basis are drastically reduced for US-connected individuals because they have a base level of US tax exposure regardless. If they decide to forego the remittance basis option then they will be taxed in both the US and the UK on the same income and gains, but with subtle differences. These subtle differences can cause double-taxation or a higher global tax rate on the income/gains. Some of these issues can be managed with appropriate tax planning.

Additional international information reporting requirements

In addition to the above, for overseas Americans there are often additional forms required to report foreign tax credits, foreign-earned income exclusions, foreign bank account reporting, passive foreign investment companies, foreign trust reporting for non-US personal pension plans, and so on, with sometimes disproportionate penalties for failure to comply.

Expatriation – accidental Americans

The tax burden for US citizens is like no other. If we note that it is relatively easy to acquire US citizenship and there are many “accidental Americans” in the world, then it is no surprise that the concept of expatriation continues to be a popular topic within that circle. We also have discussions with US-connected individuals who are seriously considering expatriation because of the onerous filing obligations and the intrusive nature of the international information returns. 

In our experience, expatriation is often not motivated by tax but more by paperwork and the costs of compliance. There are many tax obstacles to overcome for US citizens living overseas but these can often be managed.

Although the reported numbers of US taxpayers abroad relinquishing their citizenship rises almost every year, it is still a tiny fraction of the overall population, and the vast majority will work with tax advisers to help navigate their way through the multiple jurisdiction minefield and retain their citizenship. Many continue to have plans to return to the US or have family there and therefore the thought of expatriation is a non-starter. In summary, the tax position should rarely feature as the motivation for an expatriation.

Click here to read more about Common Everyday International Tax and Reporting Issues for Americans Living Overseas

Glenn Snow is a tax director with 16+ years’ experience advising on complex US/UK cross-border tax. He was shortlisted for 2020 Citywealth Accountant of the Year, featured in Citywealth’s 2020 Future Leaders Top 100, voted a leading PC advisor in eprivateclient’s Top 35 Under 35, and is a Recommended Advisor in Spears 500.

23 May 2024