A growing number of American expats are considering renouncing their U.S. citizenship for tax reasons – but it’s not as simple as it sounds.
The United States is one of only two countries in the world that requires its citizens to pay income tax based on their citizenship rather than their place of residence.
Consequently, life for American expats comes with certain cumbersome obligations, such as filing tax returns in two countries, navigating strict reporting requirements, and encountering potential roadblocks from European banks wary of U.S. clients.
For some, especially those who are settled abroad long-term, it feels easier to renounce their citizenship than to deal with the lifelong tax burden.
Renunciation is a big decision, but it’s often misunderstood. Many assume it’s a simple way to cut ties with the IRS, but the reality is more complex and can affect you in ways you may not have considered.
What renouncing actually means
There’s more to renunciation than filling out a few forms. It’s a formal, legal act that must be done in person at a U.S. consulate by signing an Oath of Renunciation. It can only be performed outside of the U.S.
It can be costly too, carrying a price tag of $2,350 (€2,002). Citizenship ends when the Department of State approves and issues the Certificate of Loss of Nationality (CLN), but that’s not the end of the journey. You can read more about the renunciation process here.
What changes immediately
The first outcome is the goal: you’re no longer a U.S. citizen.
As such, your U.S. passport is no longer valid. You also lose the right to vote in U.S. elections and to any consular protection. It’s important to be aware that you will become stateless if you renounce without holding another citizenship.
You would stop being a U.S. citizen as of the time of the consulate appointment, provided that it is later approved by the Department of State in Washington DC, which is normally not an issue for an adult applicant.
Photo: UnsplashThe part people get wrong
Here’s where lots of people get confused. Taxes don’t automatically end upon renunciation of U.S. citizenship. You’re still required to file a final U.S. tax return along with Form 8854; if the latter isn’t filed, you may find yourself on the receiving end of a $10,000 (€8,595) penalty and may fail the compliance certification test, resulting in covered expatriate status.
While you would stop being a U.S. citizen as of the time of the appointment, you would file a dual status return the following year, along with Form 8854. That is because you will have been a U.S. citizen for part of the year.
Will you owe an exit tax?
Some expats may have to pay an exit tax when renouncing their citizenship, but most won’t. You might fall into this group if you have a high net worth (over $2M, or €1.7), you’ve had a U.S. tax bill of over $206,000 (€177,000) on average over the past 5 years, or if you can’t certify compliance with U.S. tax over the past 5 years.
So, how exactly is this “exit tax” calculated? The simplest way to explain it is that the U.S. treats it as if you sold your assets the day before you renounce (even if you haven’t sold anything). Only gains above a certain amount are taxed, and there’s a large exemption of around $890k (€757k). As a result, most people don’t end up paying anything.
Life after renunciation
Once your divorce with Uncle Sam is finalised, you’ll no longer have to pay tax on worldwide income – only on U.S.-sourced income, if any. If you do still have income coming from the U.S. (for example, renting out property in the U.S., receiving dividends from U.S. companies, or selling U.S. real estate), you will still need to file Form 1040-NR, which is a tax return for non-U.S. residents.
You can still own U.S. property, invest in the U.S., and, in most cases, still receive Social Security, such as retirement benefits you’ve already earned.
When travelling back to the U.S., you’ll be treated like any other non-U.S. citizen and will have to follow standard immigration rules, for instance, applying for a visa or an ESTA to enter the country. Of course, it’s still possible to visit friends and family, but don’t expect any special treatment at the border.
Benefits
There are several clear benefits for American expats of renouncing U.S. citizenship, such as less paperwork, a clearer financial situation, no FBAR reporting (from the year after expatriation onwards), and easier long-term financial planning. You can read more about these benefits in detail in our previous article on the pros and cons of renouncing U.S. citizenship.
Before taking the plunge, it’s important to know that you must also certify five years of tax compliance on Form 8854. It’s not uncommon for expats to be behind on filing, so this step is often the most complex. Failure to do so can result in covered expatriate status.
You’re not on your own
Understanding both the renunciation process and the tax side is crucial before making this life-changing decision. It’s not always straightforward, and in these instances it can help to speak to a specialist who can break it down for you and help with the compliance and paperwork. The experts at 1040 Abroad have over two decades of experience in the field and have helped over 10,000 expats worldwide.
Let a 1040 Abroad expert help you decide whether U.S. citizenship renunciation is right for you
