This is Part 5 of a 15 part series on the Exit Tax.
The 15 parts are:
Part 1 – April 1, 2015 – “Facts are stubborn things” – The results of the “Exit Tax”
Part 2 – April 2, 2015 – “How could this possibly happen? Understanding “Exit Taxes” in a system of residence based taxation vs. Exit Taxes in a system of “citizenship (place of birth) taxation”
Part 3 – April 3, 2015 – “The “Exit Tax” affects “covered expatriates” – what is a “covered expatriate”?”
Part 4 – April 4, 2015 – “You are a “covered expatriate” – How is the “Exit Tax” actually calculated”
Part 5 – April 5, 2015 – “The “Exit Tax” in action – Five actual scenarios with 5 actual completed U.S. tax returns.”
Part 6 – April 6, 2015 – “Surely, expatriation is NOT worse than death! The two million asset test should be raised to the Estate Tax limitation – approximately five million dollars – It’s Time”
Part 7 – April 7, 2015 – “The two kinds of U.S. citizenship: Citizenship for immigration and citizenship for tax”
Part 8 – April 8, 2015 – “I relinquished U.S. citizenship many years ago. Could I still have U.S. tax citizenship?”
Part 9 – April 9, 2015 – “Leaving the U.S. tax system – renounce or relinquish U.S. citizenship, What’s the difference?”
Part 5 – The “Exit Tax” in action – 5 actual scenarios and 5 actual tax returns
In order to see the graphic and brutal confiscatory effects of the U.S. Exit Tax in action I asked a licensed U.S. CPA who specializes in International Tax to consider the following scenario:
Relinquishment date: A person who renounced U.S. citizenship on November 1, 2014.
Profile: He was a “middle class” person who was completely tax compliant in his country of residence. He was a saver and investor. He had worked hard for this money.
The CPA was asked to calculate the Exit Tax based on the following scenario. Note that the persons assets do exceed the $2,000,000 dollar U.S. threshold. Notice also that this example is representative of a “middle class” person.
Financial Facts – All amounts were in Canadian dollars.
Average cost of a detached Toronto home tops $1-million http://t.co/drLU7xWhsm – Putting Canadians with U.S. citizenship at financial risk!
— Citizenship Lawyer (@ExpatriationLaw) March 24, 2015
– pension income from Canadian sources of $50,000
– principal residence bought in 1985 for $100,000 with a fair market value on November 1, 2014 of $1,200,000. The CPA calculated the taxes under the assumption that the relinquisher WOULD be entitled to the $250,000 capital gains deduction that would normally be available under S. 121 of the Internal Revenue Code. It is NOT clear that he would be entitled to this deduction under the S. 877A rules. Note that if the S. 121 deduction does NOT apply the taxes owing will be significantly higher.
– pension from the University of Toronto with a present value of $900,000
– RRSP with a value of $500,000
– 500 shares of Telus common shares with a deemed sale on November 1, 2014 and a cost basis of half that. In other words the shares doubled.
Note that this person clearly exceeds the $2,000,000 U.S. threshold and is therefore subject to the Exit Tax. The CPA graciously calculated the amounts to go on the Form 8854 and calculated the Exit Tax.
I further asked him to run different scenarios based on whether the relinquisher had a a pension from a U.S. University (Eligible pension) and whether the person had the pension from the University of Toronto (ineligible pension). Hang on to your seats. You will be shocked at the result. Absolutely shocked.
In each case the CPA provided a completed 1040 and Form 8854.
The Results – How the Exit Tax is likely to affect Americans abroad – Five scenarios
Scenario 1: Person born in the U.S. without Canadian citizenship
Here is his 8854:
Here is his 1040:
Final U.S. Tax Return: Total U.S tax owing: $363,954.00 USD
Scenario 2: Person born in the U.S. as a dual Canada U.S. citizen or born in Canada to a U.S. citizen parent (making the person a dual citizen from birth).
Here is his 8854:
Here is his 1040:
Final U.S. Tax Return: Total U.S. tax owing: $0.00 USD
Scenario 3: Person born in the U.S. as a dual Canada U.S. citizen or born in Canada to a U.S. citizen parent (making the person a dual citizen from birth). But, rather than living in Canada when he relinquished he was living in the U.K. (meaning he was NOT living in the country of dual citizenship from birth)
Here is his 8854:
Here is his 1040:
Final U.S. Tax Return: Total U.S. tax owing: $363.954
Scenario 4: Same as either Scenario 1 or Scenario 3 with only one difference – the pension instead of being from the University of Toronto (ineligible) was from the University of California (eligible).
Here is his 8854:
Here is his 1040:
Final U.S. Tax Return: Total U.S. tax owing: $69,926 USD
Scenario 5: I then asked the same CPA to run a final tax return for a VERY WEALTHY U.S. citizen who relinquishes U.S. citizenship prior to the age of 18 1/2.
I changed the facts to reflect the fact that this individual does NOT have the benefits of a lifetime of hard work and savings. When the “Exit Tax” was enacted Senator Kennedy claimed that the “Exit Tax” was really a “billionaires amendment“.
Therefore, I thought it would be appropriate to postulate a situation of a billionaire and see what kind of “Exit Tax” he would be subjected to.
I hypothesized the following facts about this young man:
Net worth of one billion dollars. The one billion dollars is composed of the following:
– Real Estate owned around the world – 250 million USD
– Expensive cars and yachts equipped with champaign (I don’t even know how to spell it) – 250 million USD
– Controlled foreign corporation (probably triggering an additional reporting requirement) politicians – (lots of Subpart F income and undeclared cash – – 250 million USD
– Family trust of which he is the beneficiary – 250 million USD
This person is the opposite of the “hard working”, “tax compliant”, “saver and investor” described above.
Total 1 billion dollars of assets
Let’s assume that he achieved five years of U.S. tax compliance prior to June 2014.
Here is his final 8854:
Here is his final tax return:
Final U.S. Tax Return: Total U.S tax owing: $0
Summary – A picture is worth a thousand words – the charts
Do you think this is punitive? It’s WORSE than you think
The university professor, who has lived most of his life in Canada, with the Canadian University pension, and all of his assets in Canada is required to pay $363,954 U.S. dollars as an Exit Tax.
Professional advisers need to consider MORE than the amount of the tax payable. They need to consider:
Where does the money come from to pay the Exit Tax?
If you look at his/her composition of assets, you will see that he has no cash. Since this is a tax that is payable on a “pretend realization” and not an “actual realization”, there is no cash to pay the tax. Where, must he/she do to pay the tax?
Possibility 1 – Sell Assets
Pension – No access to this pool of capital
Telus Shares – Not worth enough to generate the required cash. But, in addition the sale of the Telus shares WILL generate a significant capital gains tax in Canada.
RRSP – If he “collapses” all or part of his RRSP, it will be taxed as ordinary income in Canada.
House – If he sells the house, the sale will NOT be taxable in Canada.
The cash can be generated ONLY by selling his/her house.
Possibility 2 – Borrow the $363,954 USD (approx $455,000 Cdn based on an 80 cent dollar)
In other words:
In order to “relinquish U.S. citizenship”, this life long Canadian resident, who was NOT lucky enough to be born as a Canadian citizen must choose between:
– selling his home; or
– borrowing $455,000 CDN
Final thoughts …
I hear people talking about the U.S. “Exit Tax”. I am convinced that they don’t understand the complexity, the incredible unfairness or the punitive application.
Assuming that the U.S. has “Exit Taxes” at all, do you believe a person with this financial asset profile, should pay such different amounts of tax based on questions like:
Were you born both a U.S. citizen and a dual citizen?
If you were born a dual citizen, should the tax payable depend on whether you are living in the country of second citizenship?
Should the fact that the University of Toronto pension is in Canada instead of from the University of California in the United States mean that it should be confiscated?
What about the young man renouncing prior to the age of 18 1/2? He was after all a billionaire. Yet he escapes the “Billionaire’s Amendment”.
Honestly, you can’t make this kind of unfairness up.
But, ain’t that America – one of the few remaining countries in the world where, contrary to what President Obama claims:
“The circumstances of your birth very clearly DO determine the outcome of your life!”
There are many laws that are unfair and punitive. Some are “known” to be unfair and punitive”. Some exist as unfair and punitive laws, that simply lie in wait, to “snare the unsuspecting”. I have never seen an article or post about the “Exit Tax” that demonstrates the profound injustice in its application. I wonder, why not?
The S. 877A rules are complicated, convoluted and therefore difficult to understand. The best way to hide “Evil” in the legislative process is to:
1. Enact legislation in very technical language that is difficult to understand; and then
2. Bury it in the Internal Revenue Code (which is almost impossible to understand).
Make no mistake about it. The Internal Revenue Code of the United States is a perfect place to hide evil legislative intention.
I wonder if this law would exist if it were described as follows:
Many “middle class” U.S. citizens abroad, who worked and saved a lifetime for retirement, by investing in assets outside the United States, who then renounce U.S. citizenship will have to pay the United States a tax based on:
1. The increase in the value of their principal residence located outside the United States
2. The increase in value in other assets they have anywhere in the world including outside the United States
3. A tax based on treating the present value of their pension located outside the United States as ordinary income
4. A tax based on treating their RRSP located outside the United States as ordinary income.
The result could be the confiscation of between 15 and 50% of their retirement assets LOCATED OUTSIDE THE UNITED STATES. Furthermore, the tax will be based NOT on the actual realization of income, but based on a “pretend realization” of income (meaning that there is no cash to pay the tax).
That’s what the S. 877A rules really mean in application.
This has been:
Part 5 – “The “Exit Tax” in action – Five actual scenarios with 5 actual completed U.S. tax returns.”
On April 6, 2015, I will post part 6 – “Surely, expatriation is NOT worse than death! The two million asset test should be raised to the Estate Tax limitation – approximately five million dollars – It’s Time”