Termination of US Citizenship or Residency: The Tax Man Cometh


By Cynthia Hoffman

The news media is abuzz with the story of Facebook co-founder Eduardo Saverin, who recently gave up his U.S. passport to become a citizen of Singapore, where he had been living. The general consensus is that Saverin dropped his American citizenship in order to avoid paying tens of millions in U.S. taxes after Facebook’s initial public offering. New York Senator Charles Schumer has even proposed legislation that would bar former citizens like Saverin from reentering the U.S. if they are deemed to have renounced citizenship in order to avoid taxes.

While the reason for Saverin, and former U.S. citizens who have renounced their citizenship, can be speculated and debated, one thing is for certain: the IRS is out there looking for a tax form and possibly a tax charge associated with this action. The rules that apply to former citizens apply likewise to U.S. resident aliens who terminate residency.

Internal Revenue Code (IRC) Section 877A(g)(4) provides that a citizen will be treated as relinquishing his or her U.S. citizenship on the earliest of four possible dates. Taxpayers who expatriated or terminated residency after June 16, 2008 are subject to expatriation rules under IRC Section 877A. The rules apply to taxpayers meeting any of the following: 

  • Average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ( $151,000 for 2012);
  • Net worth is $2 million or more on the date of expatriation or termination of residency. 
  • Fail to certify on Form 8854 that taxpayer has complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation or termination of residency.

IRC Section 877A imposes a mark-to-market rule, which generally means that all property of a covered expatriate is deemed sold for its fair market value on the day before the expatriation date. This rule further provides that any gain arising from the deemed sale is taken into account for the taxable year of the deemed sale notwithstanding any other provisions of the Code. Any loss from the deemed sale is taken into account for the taxable year of the deemed sale to the extent otherwise provided in the Code, except that the wash sale rules of IRC 1091 do not apply. The amount of any gain or loss subsequently realized (i.e., pursuant to the disposition of the property) will be adjusted for gain and loss taken into account under the mark-to-market regime, without regard to the exclusion amount. A taxpayer may elect to defer payment of tax attributable to property deemed sold.

Under IRC Section 877A(a)(3), the amount that would otherwise be includible in gross income by reason of the deemed sale rule is reduced (but not to below zero) by an exclusion amount, which is to be adjusted for inflation. For calendar year 2012, the exclusion amount is $651,000.

Taxpayers who expatriate or terminate residency must file Form 8854 – Initial and Annual Expatriation Information Statement. This form must be filed to comply with the annual information reporting requirements if the taxpayer is subject to tax under IRC Section 877. A $10,000 penalty may be imposed for failure to file this form. The IRS will send notices to expatriates that have not complied with these filing requirements, including imposing the penalty.

As for Saverin, some people would argue that he and expatriates like him are practicing a perfectly rational arbitrage in a world of diverse systems and growing opportunity. Rather than question the loyalty of such global citizens, perhaps Congress should examine what their choices tell us about how Americans can succeed in the knowledge economy of the future.

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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