Thinking About Expatriation or Giving Up U.S. Citizenship?

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Recently by Mark Nestmann: Expatriation: The Empire Strikes Back

One month ago, President Obama signed into law a bill that reinstated the estate tax. And within the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” appears a significant tax savings opportunity for anyone thinking about “expatriation” – giving up U.S. citizenship or permanent residence. (For a primer on expatriation, click here.)

For 2011 and 2012, the estate tax is reinstated with an exemption of $5 million and a top rate of 35%. Beginning in 2013, the exemption reverts to only $1 million. The opportunity is that the $5 million exemption is “unified” with the gift tax. In other words, you can make gifts of up to $5 million during your lifetime to anyone you choose, with no gift tax liability.

If you do so, though, you’ll no longer have any exemption left from estate tax, at least under current law. But if you expatriate after making a $5 million gift, it doesn’t matter. That’s because you won’t be subject to estate tax on your non-U.S. property anyway.

Let’s say you have a net worth of $10 million and are considering expatriation. Of that $10 million, $5 million represents unrealized gains in a portfolio evenly divided between securities and precious metals. If you were to sell the portfolio today, the tax on the sale would come to $1,075,000 (15% on the sale of the securities and 28% on the sale of the metals).

Why is that important? Because, under the expatriation law, anyone who is what the Tax Code calls a “covered expatriate” may be subject to an “exit tax” on their unrealized gains. In other words, when you expatriate, you may have to pay tax on income you never received.

The most common way to become a covered expatriate is to have a net worth of $2 million or more, so someone with a net worth of $10 million would definitely qualify. For 2011, the first $636,000 in unrealized gains from a covered expatriate isn’t subject to the exit tax. The $636,000 exclusion must be allocated across your entire portfolio according to the relative weight of each asset class subject to different tax rates. So, returning to our example, the exit tax would be:

$2.5 million – $318,000 x 28% = $610,960 $2.5 million – $318,000 x 15% = $327,300 Total: $938,260

What if, prior to expatriation, you gave to your loved ones remaining in the United States a gift of the appreciated assets with a value of $4,364,000, plus another $636,000 in cash? You would then pay zero exit tax. Yes, you would have a significantly smaller estate, but Uncle Sam would also forever relinquish the right to tax the balance of the gain (which amounts to $636,000), resulting in a total tax savings of $1,075,000.

It’s true that the recipient of the gift will eventually need to pay tax on the income. And, unlike property received through inheritance, property received as a gift doesn’t benefit from a “step-up” in basis. That is, the recipients of the gift must pay capital gains tax on the difference between the selling price and the price at which you acquired the property. With inherited property, under current law, the acquisition price “steps up” to its value at your death.

So why not wait and make a bequest to your loved ones so that they get the step up in basis? While you’re no longer subject to estate tax once you expatriate, as a covered expatriate, gifts or bequests larger than $13,000 annually (adjusted for inflation) to any U.S. person are subject to a sort of “substitute” estate tax. The recipient of the gift or bequest must pay the tax. The tax is imposed at the highest rate applicable for the year in which the U.S. person receives the tax. That rate is 35% for 2011, but is almost certain to increase in future years.

Even if you don’t plan to expatriate, if you have a large estate, this strategy may make sense. Remember, unless Congress acts by the end of 2012, the lifetime gift tax exemption reverts to $1 million, with an additional $1 million estate tax exemption. By making large gifts in the next 23½ months, you can do so on a much more tax-advantaged basis than you could in 2013.

If you’re prepared to expatriate, The Nestmann Group, Ltd. can assist you in every phase of giving up U.S. nationality or long-term residence. Contact us at info@nestmann.com for more information.

Reprinted with permission from The Sovereign Society.

Mark Nestmann is a journalist with more than 20 years of investigative experience and is a charter member of The Sovereign Society's Council of Experts. He has authored over a dozen books and many additional reports on wealth preservation, privacy and offshore investing. Mark serves as president of his own international consulting firm, The Nestmann Group, Ltd. The Nestmann Group provides international wealth preservation services for high-net worth individuals. Mark is an Associate Member of the American Bar Association (member of subcommittee on Foreign Activities of U.S. Taxpayers, Committee on Taxation) and member of the Society of Professional Journalists. In 2005, he was awarded a Masters of Laws (LL.M) degree in international tax law at the Vienna (Austria) University of Economics and Business Administration.

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