Part 2 – Understanding “Exit Taxes” in a system of residence based taxation vs. Exit Taxes in a system of “citizenship (place of birth) taxation
Let’s begin with some politics …
In an interesting post Robert Wood writes:
Both Mayor Johnson and Senator Cruz are U.S. citizens. Both Mayor Johnson and Senator Cruz either have or are renouncing the citizenships of the countries where they were born. There will no tax consequences to Senator Cruz for renouncing Canadian citizenship. Mayor Johnson will probably be spared America’s draconian “Exit Tax” (assuming he was born a dual citizen) for renouncing U.S. citizenship. The “Exit Tax” (if applicable) is a very serious thing. Robert Wood notes that:
To leave America, you generally must prove 5 years of U.S. tax compliance. Plus, if you have a net worth greater than $2 million or have average annual net income tax for the 5 previous years of $157,000 or more (that’s tax, not income), you pay an exit tax. There is an exemption of approximately $680,000. Giving Up A Green Card can cost you too. Some people expatriate under the immigration rules and never file anything with the IRS, a practice that is generally unwise. But then, no one wants to get on the wrong side of the IRS.
As the following tweet suggests, Senator Cruz was very lucky that he was born in Canada (which does NOT impose a tax on renouncing Canadian citizenship) and NOT in the United States (which does impose a tax on renouncing U.S. citizenship).
Tweet From @ExpatriationLaw: “Hostility over FATCA.” Ya think? Ted could easily cruz out of Canada. But, America has a wall to keep its people in. (Robert Woods Forbes Article)
Introduction – What is an “Exit Tax”?
Victoria Ferauge begins an excellent article about Exit Taxes with:
Exit taxes have a terrible reputation. It’s almost impossible to have a discussion about them without having someone bring up the practices of past totalitarian regimes like the USSR or Nazi Germany who taxed Jews before they left their territories. Not exactly the kind of company that modern states wish to be associated with and if you ask a citizen of such a state today whether or not he thinks an tax/penalty/fee in order to leave a country is a good idea, it’s pretty likely that he will answer, “Of course not.” There is something very fundamental about the freedom to move where one likes in order to seek other opportunities (provided that the destination country is agreeable) and most people think that states should not be permitted to hold their citizens or visitors captive.
An “Exit Tax” is generally a tax levied on the value of gains accrued on your assets at the time that you permanently “leave” the “taxing jurisdiction” of your country of residence. But, what does it mean to “leave” the “taxing jurisdiction”?
The Nazis and Soviets imposed taxes when people physically moved from their country of residence. In other words, the emigrant left the tax system because he physically moved to another jurisdiction. Although associated with “nasty regimes”, “Exit Taxes” are not uncommon. Canada has a “Departure Tax”. The Wall Street Journal recently reported that Japan is considering an “Exit Tax”. Note that all countries except the United States utilize “residence-based taxation”. Therefore, one “exits” the tax system by ceasing to be a “resident” of the country.
The United States does NOT (at least yet) impose taxes because one physically moves from the United States to another country. The United States, under S. 877A of the Internal Revenue Code, imposes “Tax responsibilities of expatriation”. “Expatriation” is triggered by relinquishing U.S. citizenship. In other words, the United States imposes a tax on choosing to no longer be a U.S. citizen. It’s not a tax on physically “Exiting” the jurisdiction. It IS a tax on choosing to no longer be part of the political community. This follows from the fact that the United States uses “citizenship taxation. The U.S. “Exit Tax” is clearly – because of “citizenship taxation” – a tax without precedent in the world.
Citizenship taxation – The perverse effects
The United States bases its “taxing jurisdiction” on “citizenship”. Birth in the U.S. is sufficient to acquire U.S. citizenship (see the 14th Amendment of the U.S constitution). U.S. citizenship is rarely chosen by people. It is usually “conferred” on people.
As London Mayor Boris Johnson is reported to have said:
It’s an accident of birth that has left me with this thing. I’ve got to find a way of sorting it out,
Is it easy to “sort U.S. citizenship” out? In November of 2014, Mayor Johnson had commented:
It’s very difficult to give up.
People do NOT choose where they were born. Therefore, the United States bases its “taxing jurisdiction” on a U.S. place of birth – an immutable characteristic. Should somebody be required to pay taxes based on an immutable characteristic like “place of birth”? Listen to the following two points of view and particularly the claim that:
If you want to be a U.S. citizen, you have to pay for it.
Tweet From @ExpatriationLaw: Q. ‘Why should I pay US taxes?’ American-born London mayor Boris Johnson by RT News via #soundcloud https://soundcloud.com/rttv/american-boris?utm_source=soundcloud&utm_campaign=wtshare&utm_medium=Twitter&utm_content=https://soundcloud.com/rttv/american-boris … A. US Cit costs
The “Exit Tax” is one reasons why U.S. citizenship is “very difficult” to give up
This analysis will demonstrate how expensive it can be for somebody to divest himself from the involuntary acquisition of U.S. citizenship. It will also demonstrate how the people who pay the highest price to divest themselves of U.S. citizenship NOT Homeland Americans who remove their assets from America but are Americans abroad who have lived their lives abroad and acquired all of their assets abroad. I will demonstrate how people who are appear to be similarly situated, will pay very different prices, to sever ties with the United States of America.
Two further resources describing the U.S. “Tax responsibilities of expatriation”:
First, I included a discussion of the U.S. “Exit Tax” in a submission I wrote for the Government of New Zealand which may be found here.
Second, there is a nice “Readers Digest” description of the “Exit Tax” at ReunciationGuide.com.
Some FAQS – “taxing jurisdiction” – “residence” or “citizenship”
Question: What does it mean to leave the “taxing jurisdiction” of your country of residence?
Answer: It means that you cease to meet the jurisdictional basis for taxation.
Question: What is the jurisdictional basis to subject a person to taxation?
Answer: For all countries except the United States of America, the “jurisdictional basis” for taxation is residence. For the United States of America the “jurisdictional basis for taxation” is citizenship. (Although “domicile” is also a basis for “taxing jurisdiction”, I am going to ignore this.)
Question: What happens if I am a Canadian resident and I move from Canada?
Answer: Canada will levy a “Departure Tax” which is based on the increase in value of your Canadian assets. You can learn about Canada’s “departure tax” here.
Question: What happens if I am a Canadian citizen and I renounce Canadian citizenship?
Answer: As Ted Cruz will attest to, no tax consequences will be imposed. The jurisdictional basis for taxation in Canada is residence.
Question: What happens if you are a U.S. resident and you cease being a U.S. resident?
Answer: If you are a U.S. citizen, and you move from the U.S. you will NOT be subjected to tax consequences. The U.S. “jurisdictional basis for taxation” is NOT residence. If you are a “Green Card Holder”, (a permanent residence VISA), if you cease to be a U.S. resident you may be subject to the U.S. “Exit Tax”.
Question: What happens if you are a U.S. citizen and you renounce U.S. citizenship?
Answer: Because the U.S. uses “citizenship” as the “jurisdictional basis for taxation”:
No matter where you reside in the world, no matter where your assets are in the world, no matter where you resided when you accumulated those assets, you will potentially be subject to the U.S. Exit Tax. The “Exit Tax” will be based on all your assets – including assets that are outside the United States.
So far this all sounds terribly academic. Very few people know somebody who has been subjected to the U.S. “Exit Tax”.
Conclusion: The United States of America does NOT impose an “Exit Tax” if one physically leaves the United States (as do all other “Exit Tax” regimes). It imposes the “Exit Tax” if you relinquish your U.S. citizenship. This is one more way that “citizenship taxation” leads to perverse results.
Tweet From @ExpatriationLaw: How do #Americansabroad perceive the U.S. #ExitTax? Nice collection of educational comments here http://thefranco-americanflophouse.blogspot.ca/2012/08/diaspora-taxes-exit-tax.html?showComment=1345776184786#c2589734014778730008 …
Original Post By: John Richardson