Inflation Adjusted Exclusion Amounts Since Inception of 2008 “Mark to Market” Expatriation Tax Law: Example
The current “expatriation” “exit tax” forces a “covered expatriate” to pay U.S. income taxation on their unrealized gains (the “mark to market” concept) as if they sold their worldwide assets.
An “unrealized gain” is the amount of gain “built into” the property or other investment of the individual, which has yet to be sold or otherwise disposed of by the him or her. For instance, the diagram below reflects various assets held by a “Covered Expatriate” which includes Mexican real estate with a tax basis of US$200,000 but a current fair market value of US$1.1M. This means the unrealized gain in that Mexican real property is US$900,000 (US$1.1M – US$200K).
Who is a “covered expatriate” is a very important legal analysis that needs to be considered for each U.S. citizen who wishes to renounce or “long-term resident.” See, The dangers of becoming a “covered expatriate” by not complying with Section 877(a)(2)(C) (9 March 2014).
Importantly, the law provides for an exclusion from taxation on the former (a) U.S. citizen’s (“USC”) or (b) long-term resident’s unrealized gains. (See, Who is a “long-term” lawful permanent resident (“LPR”) and why does it matter? – 19 Aug. 2014). In other words, no U.S. income tax is due and payable by a “covered expatriate” if they did not have assets with unrealized gains greater than a certain threshold amount.
That threshold amount has been changing annually, since the initial US$600,000 that was originally adopted into the law in 2008. It is changing due to annual inflation adjustments.
The current 2015 exclusion amount adjusted for inflation is US$690,000. See, The “Phantom” Gain Exclusion from the “Mark to Market” Tax – Increases to US$690,000 for the Year 2015 (15 November 2014).
Hence, in this case, if the only asset owned by the “covered expatriate” (assuming she became one in 2015) was the real estate in the above example with unrealized gain of US$900,000, only US$210,000 would be subject to the “mark to market” tax on expatriation (i.e., the exit tax). This is because $690,000 of the total US$900,000 unrealized gain will be excluded from taxation (US$900K – US$690K).
The Mark to Market tax regime imposes taxation on this amount, even though the real estate is never sold. This means, the “covered expatriate” must come “out of pocket” to find the cash and means necessary to pay the tax imposed under the law.
There is no economic benefit obtained from this annual inflation adjustment if a U.S. citizen or long-term resident waits to become at a later time a covered expatriate; unless they consume, deplete or lose their assets in the interim. But at least, there is an inflation adjustment, so the taxpayer is not subject to an increasing amount of gain subject to tax as time progresses and inflation eats away at the true economic value and economic growth of the individual’s assets.