As the number of US citizens choosing to renounce their US citizenship continues to climb worldwide, we receive an ever larger number of enquiries on different aspects of renunciation.
As we’ve covered in one of our previous articles, there are various routes to renunciation, but all lead toward the same inevitability, the final tax return to the IRS.
As part of the final return, US persons whom have renounced (along with some green card holders) are required to submit Form 8854, the “exit tax” form.
In our brief article, we’ll delve a little further into this form and its purpose.
Purpose
Form 8854 is filed as part of the final tax return as a tax resident of the USA. As a reminder, US tax residency is tied to citizenship, so in most cases, tax residency ends when US citizenship is renounced.
It is to be submitted the year after the renunciation has taken place, and must be timely filed (by the due date of your tax return).
It can be filed at any time after renunciation is confirmed, however it is generally more efficient to do so as part of the final tax return filing.
This form is designed to capture the net worth of a former US person as of the day prior to renouncing their US citizenship, and to determine the unrealised capital gains in which the person is departing the US tax system with.
Unrealised gain definition - Unrealised gain is the increase in the value of an asset that has not been sold.
Of course, these are gains which may have eventually been taxable income for the IRS, had the individual retained their citizenship.
In addition, the form is also designed to capture undistributed value in both domestic and foreign non-grantor trusts. As a brief summary, a non-grantor trust is a trust which will eventually benefit the US person, but is currently non-taxable to the beneficiary.
The exit tax form enables the IRS to see any future benefit that the former US person may have received, and in some cases, to ensure it is taxed before leaving the US tax system.
Content of the 8854
The form captures basic information regarding the taxpayer, the history of their US citizenship (ie start date, end date, by birth/naturalisation etc), and other pertinent information for the form.
Where it becomes more time consuming however, is the net worth calculation.
This requires us to disclose the entire worldly possessions of the taxpayer as of the day before renunciation, including:
- Items possessed
- Original purchase price and date
- Estimated fair market value as of the day prior to renouncing
From this information, we must then calculate the capital gains that exist amongst the taxpayer’s possessions. For example, this would capture the increase in value in a home, a car, artwork, or anything else which may have gone up in value since the original purchase.
In addition, the form captures information with regards to future potential benefit from a non-grantor trust.
Implications
For most individuals, whilst all of this information is calculated and the unrealised gains determined, there is no exit tax to pay.
However, for covered expatriates, indeed a tax may apply on the unrealised gains.
This of course is to ensure that a former US person cannot build up a large sum of unrealised gains, and then exit the US tax system without having ever paid tax on those gains.
In addition, having a future beneficiary interest in a non-grantor trust can also cause tax implications.
For non-covered expatriates however, no exit tax would being owing on the above.
But, what if the former US person doesn’t file this form?
Part of the Form 8854 is certifying to the IRS that the taxpayer has been compliant with their US tax obligations for at least the 5 prior years (you can read more about this here).
By failing to file Form 8854, the former US person is also failing to certify to the IRS that they have indeed been compliant. The specific guidance from the IRS states:
All U.S. citizens who relinquish their U.S. citizenship must file Form 8854 in order to certify, under penalties of perjury, that they have been in compliance with all federal tax laws during the five years preceding the year of expatriation. Individuals who fail to make such certification will be treated as covered expatriates... whether or not they also meet the tax liability test or the net worth test
As you can see, the final two lines are the most important here. For those individuals (non-covered expatriates) who wouldn’t ordinarily be subject to the exit tax, would indeed be treated as covered expatriates, and thus face an exit tax as a result of failing to file Form 8854 on time.
In addition, significant penalties exist for those who fail to file this form.
Does the 8854 need to be filed only once?
For most people yes, however covered expatriates and those with non-grantor trust beneficiary interests may be required to continue filing this form annually for a period of time after renouncing.
Summary
Form 8854 is wrought with complexities, and contains high penalties for failure to submit the form accurately. In addition, determination of a covered/non-covered expatriate can be complicated, but is crucially important when establishing whether an individual can be subject to an exit tax bill or not.
It is always best to obtain professional advice when considering renunciation, and the potential tax implications.
At the US Tax Team New Zealand, we offer tax consulting to assist with renunciation, compliance, estate and investment planning to name a few. Reach out to us today – info@usatax.nz or 09-242-3445