From what began as a trickle of clients ten or so years ago, to now more than 100 per year, renunciation of US citizenship has become one of our main subjects of consultation for US citizens in New Zealand.
US citizenship comes with amazing opportunities, with the freedom to live, work and travel freely in one of the most diverse countries on earth. Not only that, for many people, US citizenship is an integral part of their identity.
But, what would lead a US citizen to renounce their citizenship, and is it the right thing to do?
Well, of course, this all comes down to the individual and their own motivations. But, one of the most frequent considerations is US taxation and the burden it creates.
Since FATCA laws began to be introduced around the world from 2010, the number of US citizens renouncing their citizenship each year has reached staggering figures.
For example:
3rd Quarter 2009 – 168 US Citizens formally renounced their citizenship
3rd Quarter 2023 – 754 US Citizens formally renounced their citizenship
Okay I get it, US citizens are renouncing in higher numbers every year, but why?
So for many, the burden of citizenship based taxation is one of the primary motivating factors affecting their decision. The United States is one of three countries worldwide which tie tax residency to citizenship. This means that a US citizen residing anywhere in the world, is still required to file US tax returns to the IRS each year, reporting their worldwide income.
This includes any New Zealand based US citizen, who has New Zealand sourced income, or even accounts such as KiwiSaver.
In addition, many US citizens overseas would consider themselves “accidental Americans”, US citizens who were born overseas to US parents, yet have never stepped foot into the USA. The tax obligations above still apply to accidental Americans.
Strict laws exist enforcing US tax compliance, and penalties for not filing can be severe.
But doesn’t New Zealand have a tax treaty with the USA? Are people double taxed?
NZ and the USA do indeed have a double tax treaty in place. Fortunately, for the vast majority of US citizens in New Zealand, no tax is due to the IRS each year. But, the US tax system is built around compliance, meaning tax returns must be filed each year to the IRS regardless of whether any tax is due.
The US tax system is also very complex, and even fairly basic situations where a client has just New Zealand wages and a KiwiSaver, can create many hours of reporting obligations each year.
I’ve heard US citizens also face challenges with certain investments?
That’s right, as part of the US tax code, exists a tax regime named PFIC, which stands for Passive Foreign Investment Company. A PFIC is any non-US company which generates at least 75% of its income from passive sources.
This brings any non-US ETF, index fund, managed fund, or most KiwiSaver funds into the PFIC tax net.
PFICs taxation was designed to be punitive, whereby unrealized gains made in the fund (ie the growth in a KiwiSaver) is taxed on an annual basis. In addition, the reporting obligations were made intentionally complex, even by IRS standards. Filing for PFICs as part of a tax return can be costly. This was all set up with the intention of deterring US citizens from foreign investments, and to rather invest in the USA.
This can create difficulties for US citizens living in New Zealand, trying to get ahead. Certain investments must be avoided, or managed carefully, and even opening accounts such as a PIE term deposit can have implications for the annual US tax return.
But, this doesn’t all mean renunciation is the only option?
Not at all. The vast majority of US citizens in New Zealand are able to manage their tax affairs each year, without a tax liability or overly burdensome tax filing.
However, in many cases, tax advice is needed to ensure that any tax traps are carefully prevented. Seeking professional assistance through companies such as the US Tax Team New Zealand, can ensure a smooth filing each year, with as tax efficient situation as possible.
This is necessary regardless of income levels. Whether you earn a low income with a simple situation or are a high net worth individual with multiple financial interests, navigating the path of both NZ and US efficiency is something worth getting advice on. For many US tax complexities, they are not threshold based (ie reporting is required from the first $1).
As mentioned at the beginning of the article, US citizenship holds amazing benefits and retaining citizenship is the preferred path for most US citizens around the world.
For those who do want to renounce, what are their options?
This comes down to their tax compliance history to date.
In most cases, in order to renounce US citizenship, you must have filed at least 5 consecutive years of returns prior to renouncing. So, for those who have been filing returns every year, they may at any time book their appointment at the Auckland Consulate to renounce.
For those who haven’t been filing however, there are amnesty programs available. Which one is most suitable though does require some assessment first.
For those who’ve filed at least one US tax return in the past, an amnesty program exists whereby 5 years worth of tax returns can be filed in one go, with all penalties for late filing waived. Once these 5 years have been filed, the individual is then free to book their appointment to renounce.
For those who’ve never filed a US tax return before, an alternative amnesty exists. Under this alternative program, the individual may renounce immediately (before having filed any returns), and the following year 6 years worth of tax returns are filed in one go. Again, all penalties for failing to file previously are waived.
There exists strict entry criteria to both of these different amnesty programs, and professional advice should be sought before beginning this process.
But, what if I just renounce and don’t file anything?
In this case, the person would be considered to have renounced for the purpose of tax avoidance and would become a “covered expatriate”, which I’ll cover shortly.
I’ve heard there is an “Exit Tax”?
There is indeed an “exit tax”, however fortunately very few US citizens fall into the category to owe an exit tax.
The exit tax is applied to “covered expatriates”, which is an individual who has:
- A net worth of $2m USD or more (about $3.3m NZD) as at the date of renunciation
- Average annual US net income tax for the 5 years ending before the date of expatriation is more than $171,000 for 2020.
- An individual who has not met their tax compliance obligations for the 5 years prior to renouncing
Anyone who does not meet the above criteria, is not subject to the exit tax.
As part of the tax treaty in place between the US and New Zealand, the US retains the right to tax former citizens (covered expatriates) for a period of 10 years after renunciation. In addition, many tax benefits of the treaty do not apply to covered expatriates, so it is essential to get the final US tax filing right first time.
It is important to note, that the above is generalized and there are exceptions to the “covered expatriate” rules, for certain individuals. Professional advice should be sought.
And the exit tax is?
The exit tax is a calculation whereby all of a persons assets are treated as if they were sold the day prior to renunciation. For most people, this would usually result in capital gains (ie you purchased a house for $500,000 ten years ago, and as of the date of renunciation it was worth $900,000, then your taxable gain for the exit tax is $400,000.
There are large exemptions available, so even if you meet the $2m USD covered expatriate threshold, you will not necessarily face a tax liability.
Will I need a lawyer?
While you are not required to seek legal advice or representation, consulting with a lawyer can help you understand the non-tax implications of the decision. It may not change your decision, but it will likely bring peace of mind and greater understanding.
Some instances where legal assistance is necessary however, is for those whose actual citizenship is unclear, or a history of unpaid debts to the IRS.
What is needed in nearly all cases however, is a tax professional experienced and qualified to assist those in New Zealand with US citizenship renunciation, such as The US Tax Team New Zealand.
So what next?
If you’re a US citizen considering renunciation, it is essential to obtain professional advice first. At the US Tax Team, renunciation is one of our areas of specialization. We assist clients through the process, and can determine the most beneficial filing route.
If you’d like to set up an appointment or obtain a quote for your US tax returns, contact us today info@usatax.nz or 09-242-3445.