The United States of America was founded on the principles of liberty, limited government, and the pursuit of happiness. However, the practical application of these ideals leaves quite a lot to be desired these days. In fact, the US Government is undoubtedly the biggest Big Brother of them all when it comes to poking its nose into its citizen's financial affairs and attempting to regulate personal behavior. Consequently, being a forced contributor to the world's number one economic and military superpower may not seem quite as exciting to you as it once was. Furthermore, you may have decided that your personal freedom and happiness in the "Land of the Free" is not quite up to your enlightened personal standards. Let's say you've visited one or more countries elsewhere on this globe, and now find yourself considering a full-time move from US shores to live the good life in your newfound expatriate paradise. If you're a US citizen or resident alien, leaving your US taxes behind is not quite as simple as leaving your US home behind. The US is almost unique in the world in that it taxes on the basis of citizenship, not residency. This means that you can leave the US, abandon your US residency (thereby negating any need for costly US government support services), and take up legal, permanent residence in a foreign land... and still be liable for US taxes! Regardless of where you're actually living, the IRS still considers you a bona fide, full-liability taxpayer entitled to the fullest possible privileges(?) of supporting your country's legislation-happy bureaucracy in all its glory. Not only that, but also you're subject to the same income tax filing requirements as onshore taxpaying residents. However, you can be granted exemptions under US tax law if you follow the rules. These exemptions can render you tax-free if you're in the right income bracket! But if you don't qualify, then there's another approach you could use. Renouncing your US citizenship could be the ultimate answer for you. We'll cover both approaches in this article.
Sneak Under the $74,000 WireIf you're not presently a large earner - and if you're not employed by the US government or any of its agencies including the Armed Forces - the foreign-earned income exemption could be an excellent opportunity for you to avoid paying any US income tax once you're no longer living in your home and native land. You could qualify for a complete exclusion from income tax if your foreign-earned income is presently less than $74,000 USD. This means you wouldn't owe the IRS a penny! Even if you earn more, your first $74,000 of earnings would be tax-free and only the remainder of your income will be subject to tax. This could still result in tremendous savings to you. As far as the IRS is concerned, "foreign-earned income" is generally defined as money earned for services performed outside of the US. "Outside of the US" includes not only the 50 states, but also Puerto Rico, the Northern Marina Islands, the Republic of the Marshall Islands, the Federated States of Micronesia, Guam, and American Samoa. Additionally, you may not claim the income exclusion for Cuba, Libya, or Iraq, as government restrictions prohibit US citizens and residents from engaging in transactions relating to travel to, from, or within those countries. An important point to note: once you've excluded your income, you may not claim any credits or deductions related to that excluded income. This would include IRA contributions or any other normal deductions you might make in a normal, onshore tax return. Your money is effectively off the IRS radar screens once it's excluded.
You Could Also Benefit From Housing CostsAnother benefit you could be eligible for is tax exclusion of allowable housing costs in excess of the specified base amount, which is presently $9,865 USD annually or $27.03 USD per day on a pro rata basis (if you lived less than the full year outside the US in the previous tax year). So if your allowable costs are $50 USD per day, for example, you could deduct $22.97 USD for each day you qualify as having a foreign tax home (more on this in a moment). Allowable housing expenses include rent, utilities other than telephone charges, and real and personal property insurance. These items could have been paid or incurred during the tax year by you or another entity on your behalf; for example, you can include the rental value of housing provided by your employer in return for your services. Additionally, you can also include the allowable housing expenses of a second foreign household for your spouse and dependents if they couldn't live with you because of dangerous, unhealthy, or otherwise adverse living conditions at your tax home. Items that don't qualify under the housing exclusion include the cost of home purchase or other capital items, the wages of domestic servants, or deductible interest and taxes.
But Do I Qualify?Now that you can see the possibilities, you must pass a simple testimposed by the IRS. You must fall under one of the following threecategories to take advantage of the $74,000 exclusion as well as theexcess housing allowance:If a US citizen, you must be a legal (bona-fide) resident of a foreigncountry (or countries) for an uninterrupted period that includes acomplete tax year; orA US resident alien who is a citizen or national of a country with whichthe United States has an income tax treaty in effect, and who is alsoa legal resident of a foreign country (or countries) for anuninterrupted period that includes a complete tax year; orA US citizen or a US resident alien who is physically present in aforeign country or countries for at least 330 full days during anyperiod of 12 consecutive months.Examined closely, you are trying to pass one of two tests: either you're abona-fide resident of one or more foreign countries for an entire year, oryou're just physically present in one or more foreign countries for nearly thesame length of time.What either of the above categories do is establish a new "tax home" foryou that's outside the US. Generally, your tax home is your main place ofbusiness, employment, or post of duty where you are permanently orindefinitely engaged to work. You should not expect to spend a greatdeal of time in the US if you wish to qualify for a new foreign tax home. Ifyou spend too much time stateside, the IRS will still consider you to haveyour abode in the US and refuse you the exemption. However, beingtemporarily present in the US (or even maintaining a dwelling there) doesnot necessarily mean that your tax home remains in the United States.An additional point to consider is that even if you don't fully qualify undertime requirements in any of the three categories (due to a major crisissuch as war, civil unrest, or similar adverse conditions in your foreigncountry), you could still be eligible for the exclusion. However, you must beable to show that you could have met the minimum time requirements ifthe crisis had not prevented you from conducting normal business in yournew jurisdiction.
Paying Foreign Income TaxShould you be residing in a country where you must pay income taxes, a limited amount of the foreign income tax you pay can either be: Credited against your remaining US tax liability (usually to your advantage, as it reduces your US tax liability and may be carried back or forward to other years); Or deducted in figuring taxable income on your US income tax return (this only reduces your taxable income and may be taken only in the current year); You must treat all foreign income taxes in the same way, therefore you can't deduct some foreign income taxes and take credits for others.
Don't Forget to FileYou must always file a tax return for each year that you remain a US citizen. You could find yourself in hot water with the IRS if you fail to do so, even if the net result (had you filed) would have resulted in no tax payable. However, if your tax home is outside the US or Puerto Rico, you're automatically granted an extension (usually to June 15) to file your return and pay any tax due. You don't have to file a special form to receive the extension but must attach a statement to your tax return showing that you are eligible for it.
Some useful forms to be aware of, and which should be filed with your tax return: Form 2555-EZ (Foreign Earned Income - Easy) if you were not selfemployed, if your income was less than the exclusion amount, and if you're not claiming business and moving expenses (or the housing exclusion) then this is the paper you need for your $74,000 exclusion
Form 2555 (Foreign Earned Income) use this one if one or more of the restrictions for 2555-EZ are not fulfilled. For example, you could be selfemployed, earning more than $74,000, or claiming various expenses including the housing exclusion
Form 1116 (Foreign Tax Credit) if you wish to take advantage of the tax credit and deduction privileges available if you are already paying income tax in your new tax home
Getting Extreme With US Citizenship Maybe the $74,000 exemption isn't enough for you. Or maybe just the idea of filing a bunch of forms every year for Big Brother isn't something you want to do. Maybe you want to be permanently tax free in the paradise of your choice. And maybe you already have an alternate citizenship and accompanying passport, courtesy of your birth, parentage, religion, or other means. For whatever reason, US citizenship isn't vital to you any more. Then you might want to consider going all the way and renouncing that US citizenship. This isn't for everyone, and you should think very carefully about this. Aside from the emotional and psychological consequences of renouncing something you may hold dear, there could be negative financial repercussions and travel restrictions for you to worry about. The key issue of concern with renouncing US citizenship is that the IRS may deem you're doing so primarily for tax avoidance reasons. How do they decide? In typical paranoid bureaucrat fashion, you are automatically presumed to be a tax avoider if your average annual US income tax liability for the previous five tax years is greater than $100,000 USD; or, your net worth is greater than $500,000 USD Nobody said the rules were fair. However, you may be able to exonerate yourself if you can obtain (within one year of renouncing your US citizenship) an IRS ruling certifying that tax avoidance was not one of the principal reasons you relinquished your citizenship status. You might even be able to obtain an IRS ruling in advance (before you leave), although it remains to be seen how much documented proof the tax bureaucrats would require for this. Why is the determination of tax avoidance so important? If the government decides you're a tax avoider, here's what they do: You’re still liable for income tax on all US-source income for 10 years after shedding your US citizenship; and, during that 10-year period, you'll also be subject to US estate and gift taxes that expose you to tax liabilities those "normal" non US-citizens wouldn't pay in similar situations. In other words, you're subject to a pure "expatriate tax" designed to punish you for daring to leave the mighty US of A Unless you are prepared to wait 10 years to unwind certain estates and properties you may hold, this could be a serious problem. And as if that isn't bad enough, former US citizens who are deemed to have renounced their citizenship in order to avoid paying taxes can be barred from entering the US. However, the language of the statute is very broad and therefore the extent of its application remains unknown.
It Isn't Getting Better!There is new legislation on the way, which promises to make everything even worse. The Rangel-Matsui bill (HR 3099) toughens the rules on taxmotivated expatriation and takes aim at gift and estate tax avoidance. The legislation imposes an exit tax on the unrealized appreciation of an expatriate’s assets - with an exemption on the first $600,000 USD ($1.2 million USD for a married couple) - just as if the expatriate had sold his or her assets for their fair market value on the date of expatriation. An expatriate would be defined as: Any individual who renounces or relinquishes US citizenship; Any 'long-term resident' of the United States who relinquishes his or her Certificate of Lawful Permanent Residence (known as a 'green card'); or Any 'long-term resident' of the United States who commences to be treated as a resident of a foreign country under the provisions of a double tax treaty without waiving the benefits of that treaty. Additionally, the bill would impose a tax on the receipt (by US citizens) of gifts or bequests from expatriates in any case where US gift or estate taxes would normally not apply. (The tax would be reduced by the amount of any foreign gift and estate taxes paid.) This provision is directed at wealthy individuals who might expatriate while their families continue to maintain US citizenship. Other countries including Canada have departure tax laws, but it is only in the US that renunciation of citizenship is necessary to avoid global taxation.
In ConclusionGiven the severity of existing and proposed laws, you will need expert legal and tax advice before considering expatriating from the US. However, it can be done if you're willing to pay the price, and once free, you should be free forever. If you are serious about leaving, start with the $74,000 exclusion while exploring and living in foreign countries, and continue monitoring expatriation legislation for pending changes. HR 3099 isn't law yet, so it's still possible to find freedom even in an un-free world.
