When renouncing U.S. citizenship can be an important retirement planning tool for #Americansabroad http://t.co/x66fV9f5fs – It's NOT #FATCA
— Citizenship Lawyer (@ExpatriationLaw) October 11, 2014
On October 10, 2014 Kelly Phillips Erb (AKA @TaxGirl) published a “Guest Post” on the question of whether one one would give up U.S. citizenship because of taxes. It was a very will written post which detailed the horrors that Americans abroad experience in attempting compliance with a tax code that “puts most of their lives in the penalty box”. I recommend the post to you. There are a number of comments about the post at the Isaac Brock Society.
The post concludes with:
So will I renounce to avoid taxes? Not exactly, because I DON’T OWE taxes due to my very low income. BUT IN ORDER TO AVOID THE CONSTANT THREAT, like a huge hammer hanging over my head, of “INFORMATION FILING PENALTIES” as I grow older and less able to cope. To protect my executors from those same things?
YES, I’m afraid I shall have to. I have put off taking this step until now, partly because of the cost and my fear of the long journey to the embassy in a distant city; but mainly in the hope that my beloved homeland would regain its wisdom and fix its mistakes by switching to an equitable system of residence-based taxation with penalties that reflect only a percentage of tax actually owed.
And now it seems I have waited too long. A price increase from $450.00 to $2,350.00 was just announced. I may be trapped. I am becoming desperate to escape, but unable to afford it.
What a silly situation this would be, if it weren’t so very tragic.
Oh my dear, sad homeland. I do so wish you happiness and a return to shared prosperity. Please do the same for me. Thank you.
*Tisha (who prefers not to be identified by last name) remembers fondly her years in Pennsylvania and its wonderful people. She now feels she is too old to start over again, and so remains in her mother’s country.
Yes, this is an accurate description of life as a “tax compliant” American abroad. The rules of “tax compliance” are too confusing, too expensive to comply with and too frightening for many to risk retaining their U.S. citizenship. (But, one would have to be “tax compliant” to really understand this.) Those Americans abroad who are NOT tax compliant must live with the constant fear of being discovered. With the advent of FATCA, discovery becomes more likely.
Therefore (as I have always maintained), there are two groups of Americans abroad with problems:
Group 1 – Those who are tax compliant
Group 2 – Those who are not tax compliant
Since Americans abroad have problems, (whether they are “tax compliant” or not), the real problem is that they are Americans who have left the United States.
It’s no surprise that many Americans abroad feel they must renounce their U.S. citizenship. It’s also no surprise that are “becoming desperate to escape”.
That said, not all Americans abroad are “desperate to escape”. (They usually do NOT have a full understanding of the tax, form and penalty regime that applies to them.)
I want to share a scenario that I am encountering more and more with Americans abroad. And yes, it is related to taxes (or at least to U.S. tax laws). The tragedy is that many Americans are NOT aware of this until it is too late.
Consider this very realistic, very common and very likely scenario for Americans abroad in Canada.
Retired senior citizen who has lived in Canada almost all his life. He is a dual Canada U.S. citizen with a net worth under two million U.S. dollars (the magic number that leads to being a “covered expatriate”) who has a small pension and lives in a fully paid off house. Most of his net worth is in the value of the house. The cash flow generated by the pension is just enough to cover basic living expenses. General inflation is a worry. The costs to maintain the house are also a worry. The costs to maintain the house are increasing every year. It’s clear that the house must be sold for a number of reasons which include the inability to afford the maintenance of the house in the long run.
Most Canadians use their principal residence as a vehicle of financial planning. That’s becaue under Canadian tax laws, a principal residence is a “tax free capital gain”. Unlike U.S. residents Canadians do NOT receive a tax deduction for mortgage payments. Income taxes are far higher in Canada than in the United States. This is part of the policy reason for Canada’s allowing a “tax free” capital gain on the sale of the principal residence. Canadian resident taxpayers are able to sell the house, take a “tax free” capital gain and invest that capital in an income generating vehicle.
As a U.S. citizen this senior citizen is NOT able to sell the house without paying a significant part of the proceeds to the U.S. government in the form of a capital gains tax. The U.S. does (subject to a partial exemption) subject the capital gain on a principal residence to taxation. As a U.S. citizen, this senior is subject to taxes in both Canada and the U.S. The U.S. will tax the same gain that Canada will exempt from tax.
This senior simply cannot afford to lose the capital that will be lost on the sale of the home that is a U.S. capital gains tax. It’s not an option. On the other hand, he can’t afford the costs to keep the house.
Solution: The only way to maintain his retirement capital is to renounce U.S. citizenship before selling the house.
This senior must choose between being a U.S. citizen and having enough capital to live on in retirement.
Unfortunately this is a “real life” scenario that I am seeing more and more of. It’s a very real problem. It’s a the result of being subject to one tax system (Canada) that encourages the use of a principal residence as a vehicle for retirement planning and a second tax system (U.S.) that does not encourage the use of a principal residence as a vehicle for retirement planning.
It’s obvious that seniors in the situation of having to downsize their principal residence must renounce U.S. citizenship prior to doing taking this step. This is simply a practical reality.
So, yes there are situations where it makes sense to renounce U.S. citizenship to avoid U.S. taxes.
To put it simply: It’s unfair, unreasonable and unjust for the U.S. to impose taxation on retirement planning assets in Canada. In this instance, renouncing U.S. citizenship is a necessary part of the retirement plan!
In the scenario above: If the senior gentleman renounces his US citizenship, then sells his home a short time later, will the IRS come after him for capital gains in the future? How long should he wait until it is “safe” to sell the home? Does the IRS watch for people doing this? Do they “track” you, and are you still liable for taxes after you renounce? Did this gentleman file US tax returns? If so, did he claim the tax deduction for mortgage payments? If he did, does the IRS want that money back?
Here is a related scenario: A husband and wife are divorcing. They are both dual US/CDN citizens. He recently moved out, back to the US. She resides in Canada with the children. She asks him to put the title of the family home in her name only, in lieu of future child support. The house has increased in value significantly since its purchase. He agrees, and it is written in the divorce order. Then, she renounces her citizenship, and files her final US tax return the following year. A short time later, she sells the home, ideally free of any capital gains or obligation to the IRS. Once again, my questions are as above: After renouncing, does the IRS continue to monitor the wife in Canada? I believe on the form 8854, the wife would have had to list the home as an asset in her name. Is the IRS going to want a “piece” of that down the road? Also, if the couple, while married and filing jointly for 10 years, claimed the tax deduction for mortgage payments every year, does the IRS want that back? Will there be any penalty to the husband for signing over the house to the wife? (The wife was still a US citizen at the time of the divorce agreement.) Thanks for your info.