In 1868, Congress enacted the Expatriation Act. The Act boldly claimed severing all your legal ties to your home country — or “expatriation” — is a “natural and inherent right of all people, indispensable to the enjoyment of the rights of life, liberty, and the pursuit of happiness.”
But of course, we have “evolved” as a nation since the wise 19th Century Congress approved this Act.

Case in point: On June 17, 2008, President Bush signed into law a statute that seriously impedes your rights as an American to expatriate. This new law imposes an exit tax on all your unrealized gains that exceed US$600,000 on your worldwide estate. That exemption doubles if you’re married, and both you and your spouse expatriate.

Of course, by enacting an exit tax, Congress made a mockery of the long revered Expatriation Act. But honestly the news isn’t all bad. For most people interested in expatriating, the exit tax is a vast improvement over the law it replaced.

Tax Avoidance Anywhere But Here

If you’re a citizen of almost any country other than the United States, it’s relatively easy to legally avoid paying taxes. You just need to leave for an extended period — normally one year or longer. After that, you no longer have to pay tax on your income outside that country (although you may still have to pay gift and estate taxes).

But if you’re a U.S. citizen, the whole process is much more complicated. To avoid the IRS, you need to not only leave the United States, but you also must hand over your U.S. citizenship and passport. Over the years, many wealthy Americans have done just that.

However, the idea of wealthy Americans living tax-free in a tropical paradise is a pretty easy target for fast-talking politicians. Given their views, it’s no wonder the politicians enacted an exit tax to keep wealthy Americans from expatriating.

Congress Gives Expats an Unintended Gift

This new exit tax will affect your plans to expatriate if you’re a U.S. citizen or long-term resident (eight of the preceding 15 years) and have any of the following:

 A global net worth exceeding US$2 million

 An average annual net income tax liability for the five preceding years exceeding US$139,000 (2008 amount adjusted for inflation)

 Failure to certify compliance with all U.S. federal tax obligations for the five-year period preceding expatriation

However, you’re not a“covered expatriate” subject to the exit tax unless, in addition to meeting one of these criteria, you also have more than US$600,000 in unrealized gains at the time you expatriate. And with the capital gains tax at historic lows, you may be able to sell all your appreciated assets and pay as little as 15% on the gains.

Under the prior law, covered expatriates had to wait 10 years to completely break free of U.S. tax obligations, but now you can receive the same tax treatment as any other non-resident alien. I don’t think Congress intended this outcome, but it’s now the law.

But unfortunately, there’s one exception. If you plan to expatriate, you have to deal with a transfer tax equal to the top estate tax rate (45% in 2008) on future gifts or bequests that exceed US$12,000 annually. The only exceptions are for gifts and bequests to a spouse or U.S. charity.


How an Expat Becomes a Tax Exile
Internet entrepreneur Eddie is 36 years old. He and his wife Judith have two school-age children. Their net worth is about US$5 million, including US$2 million in unrealized gains. In 2007, Eddie and Judith’s joint income exceeded US$1 million, so they paid more than US$400,000 in total taxes. To avoid this tax burden, they decide to expatriate and take the following steps:
 Acquire citizenships and passports from the Commonwealth of Dominica for all four members of the family, for a total cost of US$130,000.
 Form a non-U.S. corporate business entity for Eddie’s business with a non-U.S. web hosting facility.
 Acquire a temporary residence permit in the Netherlands Antilles, where Eddie and Judith will pay tax only on their personal income, and get a tax savings of approximately US$350,000 annually.
 After five years of continuous legal residence in the Netherlands Antilles, the expat family will be eligible to apply for Netherlands citizenship. The Netherlands is an EU member, so their new passports will give them the right to live and work in any of 27 EU member states.
Once Eddie’s family obtains their Dominican passports and moves to Netherlands Antilles, they’ll formally give up U.S. citizenship.

But in the meantime, they’re liquidating sufficient assets (including substantial precious metals holdings) so that they won’t be considered covered expatriates. Since both Eddie and Judith plan to expatriate, they have a joint exemption from the exit tax of US$1.2 million.
The tax savings more than makes up for the total cost of their Dominican passports and the taxes paid on the sale of their appreciated assets.

Save a Cool $75,000 in Tax, Courtesy of Uncle Sam
As long as you don’t have unrealized capital gains over US$600,000 (including gains in most types of pension and retirement plans), expatriation is now much simpler than under previous law. Essentially, all you must do is:
 Obtain a passport from another country, if you don’t already have one
 Move to that country or obtain a residence permit in another acceptable country
 Then appear before a U.S. consular officer to swear an oath to relinquish or renounce U.S. citizenship
You can qualify for a second passport based on your marital status, religion or ancestry. You can also gain “instant” citizenship from a handful of countries (Dominica, St. Kitts/Nevis, and Austria). While obtaining citizenship through investment costs a minimum of US$75,000 (from Dominica), plus legal fees, there’s one consolation.
The exit tax law — I suspect unintentionally — exempts an expat from the first US$600,000 in unrealized gains from any tax whatsoever. (The only exception is for some U.S. assets like real estate.)

If you have unrealized gains of at least US$600,000, that’s a tax break worth a minimum of US$75,000 (15% of $600,000). It’s worth even more if your unrealized gains come from assets subject to a higher capital gains rate. And if you’re married, and both you and your spouse expatriate, your tax break is worth at least US$150,000!

One thing is certain. The anti-expatriation laws are unlikely to become any more lenient in the future. If you’re considering expatriation, now would be a good time to begin your planning.

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