Boris Johnson, the former mayor of London has officially divorced the United States. He was one of 5,411 individuals who decided to break up with America in 2016, setting a new expatriation record.
Mr. Johnson renounced his US citizenship last year, making good on a promise he had earlier made once he learned that his accidental birth in the US left him liable for significant US tax even though he paid taxes to the United Kingdom. His name appears on the “name and shame” US Treasury List published in the Federal Register just 2 days ago (see page 27 for his listing “Alexander Boris Johnson”).
Congratulations Mr. Johnson, on your divorce. We hope you did not have to pay a large property settlement to your former country of citizenship!
Since we understand that Mr. Johnson had a net worth of USD 2 million, he could have been treated as a so-called “covered expatriate” (more on this below). We hope he qualified for the so-called “dual national exception” contained in Internal Revenue Code (IRC) Section 877A(g)(1)(b).
Dual National Exception Likely Saves Boris a Bundle
Meeting the exception permits an expatriating individual to escape treatment as a so-called “covered expatriate” subject to imposition of the “expatriation” regime rules such as the Exit Tax and Section 2801 transfer taxes.
In order for an individual to meet this exception, the individual must have full tax compliance for the 5 years prior to the expatriation year and must meet both statutory requirements (I) and (II) below:
An individual shall not be treated as [a covered expatriate] if—
(i) the individual—
(I) became at birth a citizen of the United States and a citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country, and
(II) has been a resident of the United States (as defined in section 7701 (b)(1)(A)(ii)) for not more than 10 taxable years during the 15-taxable year period ending with the taxable year during which the expatriation date occurs, …
Hopefully, Mr. Johnson met the statutory requirements and will duly and timely file Form 8854 this year noting on that Form that he qualifies for the dual-national exception.
For those not in the know, here’s some basic information about expatriation, “covered expatriate” status and its often deadly tax consequences:
Am I a “Covered Expatriate”?
Under the US expatriation rules, an individual will be treated as a “covered expatriate” if any of the following tests apply:
- The individual’s 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 ($161,000 for 2016 and $162,000 for 2017).
- The individual’s net worth is $2 million or more on the date of expatriation or termination of residency.
- The individual fails to certify on Form 8854 that he or she has complied with all US federal tax obligations for the 5 years preceding the date of expatriation or termination of residency.
The tax certification requirement is usually the most troublesome provision for so-called “Accidental Americans” who reside outside the US, and are often blissfully unaware of their US tax filing duties until they learn of their unpleasant surprise.
What Happens If I Am a “Covered Expatriate?”
If any one of the three tests is triggered, the individual is classified as a so-called a “covered expatriate”.
Under the “Exit Tax” or “Mark-to-Market” regime, generally, all property owned by the covered expatriate worldwide is treated as sold for its fair market value on the day before the expatriation date. This ‘phantom’ gain is then taken into account for the tax year of the deemed sale and subject to tax, usually at capital gains rates.
An exception for a certain amount of gain (which is adjusted annually for inflation) is provided in the tax law. On account of this exception, some individuals may not be impacted by the “Exit Tax”. The amount of gain that can escape tax is $693,000 for 2016 and $699,000 for 2017. See the Internal Revenue Service (IRS) announcements for inflation adjustments for 2016 here and for 2017 here.
In addition, a 3.8% “net investment income tax” will likely also apply to this deemed gain if certain modified adjusted gross income thresholds are met. The Exit Tax must be computed via one’s Form 1040 with the gain or loss being reported on the relevant part of the 1040 for the part of the year that the taxpayer is still considered a US person. You can read more here about the 3.8% surcharge and how it impacts US persons abroad.
The tax burdens don’t stop there. Onerous tax rules apply to the covered expatriate’s deferred compensation plans and specified tax deferred accounts.
Special Transfer Tax
In addition to the Exit Tax, US recipients of any gift or bequest at any time in the future from the “covered expatriate” will be hit with a special tax upon receiving that gift or inheritance under Code Section 2801. In essence, this is an alternative way for the US to recoup US Gift or Estate taxes that it would otherwise have received (upon the making of lifetime gifts, or upon death) had the individual not given up his US citizenship or long-term residency. Currently, the tax rate is 40% and must be paid by the US recipient on the value of the gift or bequest from the covered expatriate (e.g., if the covered expatriate leaves a $1,000,000 bequest to his US citizen son, the son must pay $400,000 to the IRS pursuant to Section 2801. Ouch!).
US recipients of a gift or bequest from a former American should be ready for what appears will be an uphill battle with the IRS about the taxability of their gift or inheritance, since the burden of proving that the person was not a “covered expatriate” is firmly placed on the recipient. Do you know how to protect US recipients of your gifts/ bequests from a 40% take by the IRS? My colleagues and I have been brain-storming about what should be done now in order to prepare for this likely scenario. I am available to discuss possible planning.
Get the Right Advice
Individuals who plan to divorce the US should have a complete understanding of the laws regarding “expatriation”. The individual must carefully examine the rules for tax filings that are required (for example, Form 8854 and the final income tax returns reflecting dual status tax years). These issues, as well as possible tax planning, should be discussed with a tax professional before the divorce goes through.
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