Part I – Prologue – A Tweet Worth A Thousand Posts
For a “Readers Digest” version of the post that is to follow, simply click on the link in the above tweet!
To see examples of the deemed income inclusions and the U.S. tax owing click on the links to Appendices, B, C and D below.
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Outline And Structure
This post is for the purpose of alerting Americans abroad and their advisors to a particularly difficult and unjust aspect of renouncing U.S. citizenship. The punitive treatment of the non-U.S. pension is a reason for many Americans abroad to consider renunciation earlier (when they are not “covered expatriates”) rather than later (when they may be subject to the confiscatory rules applied to “covered expatriates”).
Part I – Introduction – The General Message
Part II: Renunciation/Relinquishment and the confiscatory case of the “ineligible” (non-U.S.) pension … A Deeper Dive
Part III: Renunciation/Relinquishment and the retention of the “eligible” (U.S.) pension … A Deeper Dive
Part IV – Conclusion
Appendix A – How Internal Revenue Code Sections 877A and 877 Lead To The Confiscation Of The Non-U.S. Pension
Appendix B – Dual Status tax return with a 1 million USD income inclusion on the day before expatriation
Appendix C – Dual Status tax return with a 1 million USD income inclusion on the day before expatriation with a $100,000 tax credit carry forward
Appendix D – Dual Status tax return with (1) a full actual distribution of the pension in Canada on the day before expatriation (generating a foreign tax credit in the current year)
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Part I – Introduction – The General Message
The warning! Some Americans abroad who renounce U.S. citizenship can expect to have punitive taxation imposed on the value of their non-US pensions. This is a tax imposed by a “deemed distribution” (not actual) of the the pension. Because there was no “actual distribution” those affected will need to find another source of funds to pay the tax. Significantly, the tax does NOT apply to U.S. pensions. Those renouncing who have U.S. based pensions may NEVER be taxed on the value of those pensions.
Once an individual’s net worth reaches 2 million USD, that individual is generally subject to this tax. This means that renunciation may become very costly. Americans abroad with non-US pensions and their advisors should be aware of (and plan around) this problem.
In this post I am joined by CPA Olivier Wagner who has generously provided excerpts from mock U.S. tax returns which demonstrate how confiscatory the U.S. Exit Tax rules are when applied to non-U.S. pensions (and therefore to Americans abroad). You will find his returns in Appendixes B, C and D at the end of this post.
The mock tax returns show that a U.S. citizen living outside the United States who:
– is a “covered expatriate”
– has a non-U.S. pension with a present value that includes a taxable amount of $1,000,000 USD
will be subject to an immediate tax of $344,963 triggered by renunciation of U.S. citizenship.
Because this tax is NOT imposed on those with U.S. based pensions, this tax applies disproportionately to Americans abroad, who earned their pensions while living outside the United Sates.
Of course, if he had renounced before reaching the 2 million USD net worth mark, he could possibly renounce and pay no exit tax on the value of his pension. Financial planners and other advisors take note!!
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