Renouncing US citizenship: tax implications, exit tax & what to expect

Losing citizenship to the country that founded the concepts of “land of the free” and “home of the brave” is a serious step American expats contemplate only after years of living abroad. While it may sound far-fetched, thousands of Americans renounce their citizenship every year.

A primary concern for those emigrating is taxation, as managing American taxes can become very complicated when earning money in several foreign countries.

Even though you live abroad for an extended period of time, you are still considered a U.S. citizen and, therefore, subject to taxation based on citizenship rather than residency. This can be quite a burden. Regardless of where you reside or work, U.S. tax laws must still be adhered to.

​Renouncing U.S. citizenship is not all about taxes. It is a serious legal action with far-reaching consequences, including travel, banking, investment, and one’s relationship with the U.S. government.

This article will focus on the US tax implications of giving up one’s citizenship, the exit tax and who it applies to, as well as what to expect before and after taking the oath of renunciation. Keep in mind that the tax implications and other consequences of giving up your US citizenship will vary depending on your specific circumstances.

What does it mean to renounce US citizenship?

Renouncing U.S. citizenship is a legal process that almost always takes place at a U.S. embassy or consulate abroad. This involves showing up to the facility, filling out and signing paperwork, and attesting under penalty of perjury that you know what you’re doing by giving up your citizenship.

During the meeting, which could last a few minutes, a consular officer will verify through questions that the person understands the effects of acquiring a foreign nationality. The procedure concludes with the issuance of a Certificate of Loss of Nationality (CLN).

Your U.S. passport will be canceled by order of the Department of State, and you will cease to be considered a U.S. citizen. You will be treated as a foreign national for all future immigration proceedings, and you will be required to comply with all tax regulations as they pertain to aliens.

This decision is usually final and can not be reversed.

Why do people consider renouncing US citizenship?

There are many reasons why people consider moving abroad. It is not always a case of cost.

One of the more commonly discussed factors in moving abroad is taxation.

The United States stands out as one of the few countries that taxes its citizens worldwide. This means expats will still be required to file annual tax returns with the IRS. The tax return would need to report all worldwide income and disclose any foreign bank and investment accounts.

There is another group of expats – particularly those who are self-employed or actively involved as investors. While not particularly affected by taxation issues on their expat residency, they are not left unaffected either.

These expats must contend with duplicate tax filings, foreign bank account restrictions, and any changes to U.S. tax rules that are not applicable in their new country of residence.

However, many people’s focus when thinking about renouncing citizenship is on taxes. But renunciation affects so much more than just taxes, including visas, access to banking and other services in the US, and estate and long-term financial planning. So, for many people, renunciation of citizenship is a much more nuanced and detailed calculation.

Overview of US tax obligations before renunciation

Before renouncing citizenship, individuals are generally expected to comply with US tax laws.

This can involve preparing annual tax returns, reporting worldwide income, and disclosing foreign financial accounts when required. The expat’s experience may be complex, involving many forms and reporting systems.

Most renunciants are required to certify under penalty of perjury that they have complied with all US tax laws for at least eight full tax years prior to the date of renunciation. If the renunciants have not properly reported their income on their US tax returns, the IRS will classify them as “seriously delinquent” taxpayers after renunciation.

As taxes may be influenced by tax compliance, the preparation process can be an important factor.

What is the US exit tax?

One of the first tax issues that anyone considering expatriation should understand is the “exit tax”.

The exit tax, also known as the mark-to-market tax, is levied on certain individuals upon abandonment of citizenship. The theory behind the tax is that the IRS treats an expatriate as having liquidated all his worldwide assets at the time of his departure from the country.

​Also known as the “deemed sale” or “mark-to-market” approach, this methodology values gains and losses as if every asset were sold on December 31 of each year. In other words, unrealised capital gains from stocks, businesses, real estate or other investments could be considered as taxable, even though there is no real transfer of ownership.

Not everyone pays the tax. Whether someone owes tax depends on their classification under IRS rules.

Who is considered a covered expatriate?

The concept of a covered expatriate is central to understanding the exit tax.

An individual may be classified as a covered expatriate if they meet certain criteria. These may include exceeding a specific net worth threshold, having an average annual tax liability above a set level, or failing to certify tax compliance for previous years.

Tax implications upon renunciation as a covered expatriate. Under certain circumstances, an individual may be classified as a “covered expatriate,” which could be a factor to consider when deciding whether to renounce citizenship. Covered expatriates are subject to additional tax rules, which can affect the way in which assets are treated and how taxable income is calculated.

​Things can change, and thresholds and requirements may need to be met again. People take a bit of time to consider their situation.

How the exit tax works (simplified)

In simplified terms, the exit tax calculates potential gains across a person’s assets as if everything were sold the day before renunciation.

Unrealized appreciation is subject to tax. A portion of capital gains may be taxable when they are realized. Thresholds and exclusions, if any, are subject to change and are governed by current Internal Revenue Service regulations.

Rules that apply to different types of assets can vary. For example, rules applicable to retirement accounts and deferred compensation plans differ from those for other types of investments.

Due to the complexity of the tax issue, the timing and planning may vary depending on the particular circumstances.

Key forms and reporting requirements

Renouncing US citizenship involves specific reporting requirements.

​One of the key forms to understand is Form 8854, which is used to certify that an individual is in compliance with all U.S. tax laws and to determine whether such an individual will be treated as having expatriated. This form gathers extensive information about an individual's assets, income, and financial history.

In general, taxpayers will also file a final tax return covering their period up to the date of renunciation. This may be a dual-status return, depending on when that date falls.

Please note that individual circumstances may affect eligibility for these forms. You should refer to the latest guidance from the IRS to confirm your eligibility before attempting to complete the form.

Timeline and process of renunciation

The renunciation process usually involves several steps.

Begin by reviewing your tax situation, ensuring compliance, and addressing any missed filings for past years or updating your financial records.

​Next, schedule an embassy/consulate appointment Next, a person will have to schedule an appointment at a US embassy or consulate. The person must sign documents during this appointment that formally renounce their citizenship.

​There is a government fee to pay as well, which is among the highest in the world for renouncing citizenship.

After the appointment, the paperwork must be processed, and the Certificate of Loss of Nationality will be issued. Times may vary from consulate to consulate and even from month to month.

Tax implications after renunciation

Although most non-US sources of income are not subject to US taxation, expats should be aware that some sources of income may still be taxed upon relinquishing US citizenship. This fact is rarely clearly explained by either the expat or the authorities, and it is often misunderstood, even by attorneys who practice expat taxation.

US persons may also be taxed by the United States on their worldwide income from sources outside the United States. Examples of worldwide income include investment income, real estate rental income and business income derived from foreign countries. Before considering renunciation, it helps to understand how US tax rules apply to digital nomads living abroad.

You may also have different reporting obligations.​

Each state has different rules, so it's crucial to understand your state's tax laws in relation to your post-divorce financial situation.

Considerations for digital nomads and expats

For digital nomads and long-term expats, renouncing citizenship can raise additional considerations.

One factor is residency in another country. To renounce US citizenship, taxpayers must ensure they have the appropriate immigration status and a valid passport from their country of residence.

Financial institutions that served our members are adapting to new banking regulations. These regulations have affected bank requirements for non-US citizens regarding account access and required documents.

Travel is another one. After renouncing citizenship, as a non-U.S. citizen, foreign nationals entering the U.S. must comply with the applicable visa rules and/or participate in one of the visa waiver programs. Even before making long-term decisions, many expats choose to maintain a US address while living abroad for banking and documentation.

​These considerations highlight the importance of long-term planning.

Common misconceptions about renouncing US citizenship

There are several misunderstandings about the process.

A common myth about expatriation is that losing citizenship exempts an individual from all taxation. It does not. Prior to expatriation and during the period in which an individual formally surrenders his citizenship, the person is still required to pay taxes.

One of the many myths we have to deal with is the misconception that everyone must pay an exit tax when they leave the United States. While not inaccurate in general, it only applies to certain individuals.

​Another common misconception is that filing for bankruptcy is an easy process or can be done quickly. While the process of bankruptcy appears relatively straightforward on paper, real-world cases involve far more than paperwork. Issuing bankruptcies carries not only legal repercussions but also far-reaching implications for a person’s financial history, making it not a simple matter that can be completed in a rush.

​Understanding these nuances can help set realistic expectations.

When professional guidance may help

Because of the complexity involved, many individuals choose to consult professionals when considering renunciation.

This may include tax advisors, legal professionals, or financial planners who are familiar with expatriation rules.

Professional guidance can help interpret requirements, review potential tax implications, and provide clarity based on individual circumstances.

Conclusion

Renouncing US citizenship is a significant decision that involves legal procedures, tax compliance, and long-term planning. While some individuals consider it a way to simplify their financial life, it also comes with trade-offs that should be carefully evaluated.

Understanding renouncing US citizenship taxes, including the exit tax and reporting requirements, is an important part of the process. Because rules can be complex and outcomes vary, individuals may want to review their situation thoroughly before making a decision.

For some, it may be a strategic choice. For others, it may not be necessary. The key is to approach the decision with clear information and a full understanding of the potential implications.

FAQs

What taxes do you pay when you renounce US citizenship?

Some expats will have to pay an exit tax, while others will just have to file their final annual tax returns.

What is the US exit tax?

The exit tax is a tax that may apply to some individuals as if their assets were sold before they renounced their U.S. citizenship.

Who qualifies as a covered expatriate?

A covered expatriate is an individual who meets one of three criteria: net worth, tax liability or compliance status.

Do you still pay US taxes after renouncing citizenship?

You may still owe taxes on US-source income, depending on your situation.

What is Form 8854 used for?

Form 8854, Initial and Annual Statement of Specified Foreign Financial Assets, Certification and Identification: Used to certify compliance with tax laws and to determine whether the individual has become a “covered expatriate”.