Expatriated: Leaving the Land of the Free

Since 1996, the United States Treasury has been required to publish a quarterly list of people who give up citizenship or permanent residency. The process, undertaken by 1,800 people in 2011, is called expatriation.

With the U.S. elections coming up in November, one issue on Americans’ minds home and abroad is taxes: Who should be paying them and how should they be spent? Increasingly, Americans have begun voting with their passports, choosing to renounce citizenship in favour of a smaller tax bill, or just less hassle.

Among the renouncers is Denise Rich, songwriter for Aretha Franklin, Mary J. Blige and Jessica Simpson. Rich has Austrian citizenship through her deceased father, and according to her Florida-based lawyer Michael Heidt, has chosen to live in London with her daughters and long-time Austrian partner Peter Cervinka.

She is only one of a number of celebrity expatriates who have made headlines over the past few months. Other notable big spenders/earners include Facebook co-founder Eduardo Saverin, a Brazilian citizen now residing in Singapore, who gave up citizenship shortly before the company’s initial public offering in May 2012.

"For the longest time it was just under the radar, you never heard of it," says James C. Sexton, president of Esquire Group, a U.S. tax consultancy with offices in Vienna. "But when Saverin expatriated, it exploded over here [in the U.S.]."

In much of the coverage, both in America and abroad, Saverin was painted as an opportunist who came to the States, got citizenship, attended Harvard, became a billionaire, and when it came time to pay taxes, gave up his citizenship. In the past, CEOs and bank executives renouncing citizenship never made media waves, Sexton pointed out. "Saverin was probably the first ultra-wealthy person people could identify with."

The real reasons people expatriate are much more complicated, he says, but the media "basically paint it like it’s a bunch of rich people trying to get out of paying taxes."

 

Rich and mobile

The reality is much less sinister. The reason for the spike in numbers over the past few years is partly a reaction to the Heroes Earnings and Relief Tax (HEART) Act signed by President George W. Bush in 2008, which obliged people with a net worth of over $2 million to pay an "exit tax" on unrealised gains on worldwide property and investments. So essentially, renouncers are taxed as if they had sold everything the day before they expatriated.

This was a game changer for wealthy U.S. citizens who spend much of the year in other countries and only three or four months in America. If they expatriated, they would lose the right to do business in the United States.

"Under the old rules they couldn’t leave," Sexton explained, "because three to four months was over the limit to stay in the U.S. as a non-citizen, and the tax laws – the way they applied to those expatriates – were very unfavourable." But since the law change in 2008, if you pay the exit tax, you essentially become a regular foreigner. You can spend three to four months in America and only pay tax on the money you earn in the U.S. during that time.

"So now you have this big explosion of people expatriating, because they can keep the same lifestyle, but not have the taxation that’s attached to U.S. citizenship."

Unlike all other OECD countries, U.S. taxes are based on citizenship, rather than residency. In Austria, for example, citizens with no established residency or capital gains in Austria become irrelevant to the taxing authorities.

Heightened U.S. reporting requirements since 2010 have led to a range of problems for Americans banking or investing outside of the United States. As a result, patterns of expatriation have also changed: Before 2011, Sexton estimates that 70% of the expatriation cases he dealt with were American-born; now many more are dual and naturalised citizens. And not just rich ones.

"Most of the people are not wealthy, just your average person, who works a normal job, who has a regular salary and maybe owns an apartment or a house somewhere." Esquire’s Vienna branch has taken on quite a few more Austrian clients, born dual citizens with an American parent, for instance, but very little connection to the United States.

"They don’t want to pay every year to do tax reporting for a country that they don’t have much to do with," he explained. "And also, they don’t want to have to gather all the documentation. Our [U.S.] tax returns ask for so much more information than an Austrian tax return does. It’s a lot of work."

 

Time is money

Even with tax rates that are often higher outside the U.S., many Americans living abroad have chosen to avoid the frustrating paperwork that has resulted from new laws aimed at policing offshore accounts (See "FATCA: The Long Arm of the U.S. Tax Law" TVR March 2012)."Clients think, ‘Now I have to find out not only what it will cost me to file the taxes each year, but also the amount of time I’ll have to invest gathering the information necessary. Why? What benefit am I getting?’"

Many countries, like Austria, have laws prohibiting the release of account holder information (other than by court order). However, this has not stopped American authorities from pressuring foreign governments and financial institutions to turn over account information of U.S. nationals’ savings and investment accounts. Because of this, many non-U.S. institutions avoid the situation altogether and will often not accept Americans as account holders.

British architect and painter Gunter Paul Pueschel was born in Germany in 1946, emigrating to the U.S. with his parents in 1949. He has lived in London for the past three decades, where he prepared and filed annual U.S. tax returns. Since the new laws, the paperwork has become so complex that he spent up to $1,500 a year in preparation fees despite owing no tax, he told The Wall Street Journal. He formally expatriated in late 2011 stating, "I decided such expenditure was unwarranted."

Giving up citizenship is not the end of the courtship with the IRS, however. Expatriation has a hefty price tag. Besides the "exit tax" mentioned above, certain "covered expatriates" – people with an average annual income tax of over $147,000, with a net worth of over $2 million, or people who have not filed tax returns for the five years prior to expatriation – are bound to the IRS for life.

They are subject to gift and inheritance taxes. If a U.S. citizen or green card holder receives a gift or inheritance exceeding the yearly exclusion amount ($13,000 in 2012) from a covered expatriate, they pay the highest gift or estate rate. This mostly affects expatriates who plan to leave their estate to children who maintain U.S. citizenship or green cards.

In the country’s infancy, during the American Revolution, the slogan "No taxation without representation" was what came to define liberty. It was opposing tariffs by the British that brought Americans together as a nation. Now the topic of taxation is pulling Americans apart, dividing them on multiple fronts.

Expats who have a choice may decide to forfeit their right to vote in favour of no longer being accountable to the "Land of the Free".

See also "Keys to the City: Taxing the Expats" in TVR Feb 2012.