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Thinking of renouncing your US citizenship? Then do it now!

To overcome its fiscal problems, the U.S. Congress is looking at ways of punishing Americans who try to renounce their citizenship

July 20, 2013

Alexander-MarinoCALGARY AB, Jul 20, 2013/ Troy Media/ – If you are one of the many U.S. citizens contemplating renouncing your U.S. citizenship, Congress recently sent a fairly clear message that now, as opposed to later, may be the right time to get out of the club.

Last month U.S. Democratic Senators Jack Reed and Chuck Schumer filed an amendment to the immigration reform bill which attempted to ensure that the U.S. Department of Homeland Security could exclude certain individuals from re-entry into the U.S. – forever.

The proposed amendment was never voted on in the House and died before reaching the floor. If the proposed amendment had made its way into law, it would have excluded from re-entry not only former U.S. citizens who renounce for tax avoidance purposes (as is the current law), but also renouncing individuals who are considered “Covered Expatriates” under Internal Revenue Code Section §877A.

What is most important to take away from the failed passage of legislation is that the issue of renouncing one’s U.S. citizenship is again front and centre on Congress’s radar and the only guarantee moving forward is that any potential changes will not make things any easier to get out.

The first quarter of 2013 saw the highest number of U.S. citizens renouncing their citizenship in history. This record number of U.S. citizens looking to get out represents substantial losses in the number of taxpayers and tax dollars collected on behalf of the IRS (during life and at death). Congress is clearly aware of this fact and appears poised to put the brakes on the mass exodus.

Under the failed amendment, a renouncing individual who was classified as a Covered Expatriate under §877A, would have had to prove to the Department of Homeland Security by “clear and convincing” evidence that he or she did not renounce for tax avoidance purposes. The burden of proving this negative would have fallen on the renouncing Covered Expatriate if he or she desired to ever re-enter the U.S.

So how does a renouncing U.S. citizen become a Covered Expatriate under §877A? Section 877A defines a Covered Expatriate as an individual who meets the requirements of subparagraph (A), (B), or (C) of §877(a)(2). Section 877(a)(2) classifies a renouncing U.S. citizen as a Covered Expatriate if he or she meets one or more of the following criteria:

  1. has an average annual net tax liability for the five preceding years of more than $155,000 U.S. (2013 amount adjusted for inflation);
  2. has a net worth of over $2,000,000 U.S.; or
  3. fails to certify compliance with U.S. tax obligations for the prior five years.

When questioned regarding the proposed amendment, Senator Reed stated:

“American citizenship is a privilege. But it seems that a privileged few are trying to game the system by accumulating wealth and benefiting from the greatness of the United States and then renouncing their citizenship to avoid paying their fair share of taxes. They are welcome to leave our country, but they should not be welcomed to return without playing by the rules and paying what they owe.”

While the failed passage of this amendment is a clear victory for those looking to renounce their U.S. citizenship in the near future, the fact that Congress has already attempted to bring legislation before the floor in an effort to make the penalties associated with renouncing even more severe, should send a loud and clear message to all those looking to renounce their U.S. citizenship . . . “GET OUT NOW”.

The original Reed Amendment, and current law (discussed below), was passed in the 1990’s. Fast forward almost two decades and the same issues regarding the lost U.S. tax revenue of expatriates still exists today. The proposed and rejected Reed-Schumer Amendment would have changed the current law governing the renunciation of U.S. citizens by:

  1. Automatically excluding any Covered Expatriate that triggers the expatriate exit tax under §877A;
  2. Creating a mechanism to allow a Covered Expatriate (individual caught under §877A) to petition the U.S. Department of Homeland Security for a determination that tax avoidance was not one of the principle purpose of expatriation; and
  3. The Department of Homeland Security may make that determination if the Covered Expatriate can establish through clear and convincing evidence that tax avoidance was not one the principle purposes for the expatriation.

In a nutshell, all Covered Expatriates would have had the burden of proving that tax avoidance was not a primary purpose of their renunciation. Under the original Reed Amendment, the burden is with the U.S. government to show that the renouncing U.S. citizen did so to avoid U.S. tax. This shifting of the burden of proof is enormously important and greatly increases what is at stake for a Covered Expatriate. Under the original Reed Amendment, the advantage was clearly with any renouncing U.S. citizen (whether a Covered Expatriate or not). It can be very difficult for the U.S. government to meet its burden of proof regarding tax avoidance motives. Under the failed Reed-Schumer Amendment, the advantage would have been squarely with the U.S. government when dealing with a Covered Expatriate.

If similar legislation to the failed Reed-Schumer Amendment later becomes law, the importance of avoiding the U.S. exit tax under §877A will be even more important than before. Not only would the repercussions of being classified as a Covered Expatriate under §877A result in a deemed disposition of the renouncing individual’s worldwide assets under the exit tax rules, but the burden to prove that a primary purpose of the renunciation was not to avoid U.S. tax, would have fallen on the Covered Expatriate and not the U.S. government.

This automatic presumption of having renounced for tax avoidance purposes would have resulted in the Covered Expatriate having to retain counsel and present evidence before the Department of Homeland Security to prove that he or she did not renounce for tax avoidance purposes. The burden of proving a negative is extremely difficult in any situation. The result would be that the Covered Expatriate would have been required to spend time and resources fighting an uphill battle of proving through “clear and convincing evidence” that a principle purpose in their renunciation was not to avoid U.S. tax. The Covered Expatriate would have been forced to make a circumstantial argument before the Department of Homeland Security in hopes that the governing body involved sees the facts in the taxpayer’s favour. If not, the Covered Expatriate would have been denied re-entry into the United States in addition to being hit with the exit tax.

Avoiding being classified as a Covered Expatriate under §877A will take on an even greater importance if future legislation similar to that of the failed Reed-Schumer Amendment ever becomes law in the weeks, months, or years to come. As the law currently stands, avoiding §877A and the U.S. exit tax is very important. Standing alone, the exit tax can have devastating tax consequences to a renouncing U.S. citizen who is not prepared accordingly. Assuming a variation of the Reed-Schumer Amendment one day becomes law, the scope and effect of not being labelled a covered expatriate under §877A cannot be understated.

While the Reed-Schumer Amendment failed to become U.S. law, the danger of inadvertently being barred from the U.S. while also being hit with the U.S. exit tax may still be of real concern for those considering renouncing in the near future and beyond. It is fairly safe to say that Congress is aware of the renunciation problem they are facing, and smart money would be on another amendment or bill attempting to become law in the near future.

This fact, accompanied with the Foreign Account Tax Compliance Act (FATCA) set to go into effect in 2014, may make now the best time to renounce one’s U.S. citizenship. The magnitude of what could be at stake when an individual looks to renounce their U.S. citizenship in the future has the potential to be exponentially greater if Congress continues on its path to curb the record number of renunciations in 2013 and beyond.

Any U.S. citizen who renounces their citizenship under the current Reed Amendment, or a potential future variation of the failed Reed-Schumer Amendment, needs to understand the repercussions and timing of this decision moving forward.

Alexander Marino is a Tax Associate at Moodys Gartner Tax Law LLP.

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