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Part 1 – “Facts Are Stubborn Things” – The Possible Effect of The US “Exit Tax” On Canadian Residents



John Richardson 6

Although this series originally began on “April Fools Day”, I assure that this is NOT a joke.

This post will demonstrate how the U.S. “Exit Tax” affects “middle class Canadians who  have U.S. citizenship and wish to relinquish it. You will see how the “Exit Tax” imposes punitive taxes on Canadian assets and on income earned in Canada. You will also see how some U.S. assets are (in effect) exempted from the “Exit Tax”. We will learn from the example of a “Middle Class Canadian” with an average house in Toronto, a pension plan from the University of Toronto and a low value RRSP who decides that he no longer wishes to be a U.S. citizen.

This person has lived in Canada most (or perhaps all) of his adult life. You will see that he has NO U.S. assets and NO U.S. income. He was born in the United States, never officially relinquished U.S. citizenship and is therefore considered to be a U.S. citizen.

The U.S. imposes charges fees/taxes to NOT be a U.S. citizen. Everybody is required to pay an administrative fee of $2350 to no longer be a U.S. citizen. Others will have to pay an additional premium in the form of an “Exit Tax”.

In this particular case our “middle class Canadian”  would have be required to  pay the United States an additional fee in the form of an “Exit Tax”.

The amount of the “Exit Tax” is approximately $400,000 Canadian dollars.

Note that this “Exit Tax” is paid NOT on U.S. assets but completely on Canadian assets. It could very easily have been much more! Of course, if he had NOT been born ONLY a U.S. citizen he might not have to pay any Exit Tax (unless he was NOT living in Canada when he renounced) ….

This is all possible because of U.S. “citizenship (place of birth)” taxation.

The problem will be exacerbated by FATCA and by the agreement by the Government of Canada to assist the U.S. in the enforcement of FATCA in Canada

“Citizenship (place of birth) taxation” and FATCA are logically distinct but contextually related. The purpose of FATCA is to enforce “citizenship (place of birth) taxation.

This post will demonstrate  the graphic and horrific tax consequences of a middle class person in Canada who relinquishes  U.S. citizenship. If you understand this post, you will see that the claim that U.S. citizens abroad renounce citizenship to avoid taxes is absurd. In fact, it’s the exact opposite. Renouncing U.S. citizenship is more likely to subject a “long term, middle-class American abroad” to tax consequences that are horrific and unjust in the extreme.

How this works – the S. 877A “Exit Tax” rules in action  …

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 factual 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 Canada – 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 “Financial Facts”. Note that the persons assets do exceed the $2,000,000 dollar U.S. threshold. Notice also that this example is representative of a typical “middle class” person.

Financial Facts – All amounts were in Canadian dollars.

– 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. Yet he is a person with a “middle class” life style. The CPA graciously calculated the amounts to go on the Form 8854 (mandatory asset disclosure form) and calculated the Exit Tax (amount payable to the IRS to no longer be a U.S. citizen).

Our CPA calculated the “Exit Tax” based on the following five different fact patterns.

1. U.S. citizen only at birth – living in Canada – Canadian source INELIGIBLE (meaning Canadian source) pension

Exit Tax payable: $363,954 USD

2. Dual U.S./Canada citizen from birth – living in Canada

Exit Tax payable: $00.00 USD

3. Dual U.S./Canada citizen from birth living in U.K. – Canadian source INELIGIBLE (Canadian source) pension

Exit Tax payable: $363,954 USD

4. U.S.  citizen only at birth – living in Canada – U.S. source ELIGIBLE (U.S. source) pension

Exit Tax payable: $69,926 USD

5. U.S. citizen only at birth – billionaire – living in Cayman Islands – relinquishes before the age of 18 1/2

Exit Tax payable: $00.00 USD

A picture is worth a thousand words:

 

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And More…

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It’s because of the exacerbating factor of “citizenship (place of birth) taxation”

Notice that the most brutal and confiscatory effects of the U.S. Exit Tax are born by Americans abroad who have built their careers abroad and acquired their assets abroad. It is because of “citizenship taxation” that the U.S. is able to lay claim to income and assets earned in other countries. This results in (governments take note) U.S. confiscation taxation of capital earned in other countries.

As Ronald Reagan, remembering the wisdom of John Adams, used to say:

“Facts are stubborn things.”

The perverse application of the U.S. S. 877A “Exit Tax” is a graphic example of the immorality of a tax system that taxes people based on “place of birth”.

On April 2, 2015, in Part 2 of this series I will explore:

““How could this possibly happen? “Exit Taxes” in a system of residence based taxation vs. Exit Taxes in a system of “citizenship (place of birth) taxation”

Original Post By:  John Richardson

Next: Part 2 – Understanding “Exit Taxes” in a system of residence based taxation vs. Exit Taxes in a system of “citizenship (place of birth) taxation

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a dual citizen. I am a lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

I am also a member of the American Citizens Abroad Professional Tax Advisory Council (PTAC). This is an advisory panel focused on assisting American Citizens Abroad in an FBAR and FATCA world.

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.

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