When does “Covered Expatriate” Status -NOT- matter?

Posted on Updated on

Maybe this question, “When does “Covered Expatriate” Status -NOT- matter?” sounds more like a philosophical question?

What does “matter” mean in this context? !?!?!?

Back to being a bit more practical and serious . . .      😉

Assuming the point of the discussion is taxes, and whether additional taxes will ever be owing, being a “covered expatriate” can have adverse tax consequences.  Sometimes, however, being a “covered expatriate” will cause no additional taxation to either (1) the “covered expatriate” or (2) future beneficiaries.

It all depends upon the facts of the particular circumstances.

BTW – Did detective Joe Friday from Dragnet ever say – “Just the facts, ma’am“?

“Covered expatriate” status is the “general rule” for U.S. expatriation tax rules.  There are some exceptions (income tax liability, net worth, and dual nationality exceptions), which hopefully a particular U.S. citizen (“USC”) or long-term resident can fall into, so as to avoid the adverse tax consequences of “covered expatriate” status.

Those adverse tax consequences can be summarized into two categories of taxes:

  1. “Mark to Market” taxation on unrealized gains of worldwide assets, arising from the renunciation of U.S. citizenship (i.e., the so-called “exit tax”);  See, Inflation Adjusted Exclusion Amounts Since Inception of 2008 “Mark to Market” Expatriation Tax Law: Example   and
  2. The tax payable by U.S. beneficiaries whenever they receive so-called “covered gifts” and/or “covered bequests.”  See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.”

The first tax is what most people talk and write about.

The second tax, can often times be the most costly over the long-run and is little understood for lots of reasons; the least of which is the Treasury and IRS have still not issued required regulations.  See, Proposal to U.S. Treasury and IRS: awaits Final Regulations on “Covered Gifts” and “Covered Bequests”

People of modest means often think they have nothing to worry about if they are a “covered expatriate” at the time they cease being a USC or a long-term resident.  This is where they may be deeply mistaken; if they have any future U.S. beneficiaries (e.g., children who were born in the U.S. or who might move to the U.S. many years out into the future).  Moreover, these U.S. beneficiaries do not need to receive substantial assets, in order to be subject to sizable U.S. taxes in the future.

The first “mark to market” tax is not an issue, if the USC has relatively little assets and relatively little “unrealized gains” in those assets.  For instance in 2015, the unrealized gains excluded from taxation 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). Only individuals with assets of significant value, i.e., with unrealized gains greater than US$690,000 would be concerned with this first tax.

However, those former USCs who have future U.S. beneficiaries who might receive gifts or bequests, will be subject to the second tax that is currently 40% of the amount of the gift or bequest received.  This imposes the tax at effectively the highest estate and gift tax rate, which is currently 40%.

If, the covered expatriate has no unrealized gains of greater than US$690,000 and no future U.S. beneficiaries, they probably will not be too concerned with their status as a “covered expatriate.”

The problem is that someone today may have little or no idea that although today, she or he has no U.S. beneficiaries, they may have one more in the future.

In other words, someone might renounce their citizenship today with no U.S. citizen or resident children.  However, in the future, one of those children might move to the U.S., might marry a U.S. citizen and have U.S. citizen children (grandchildren to the “covered expatriate”) or become a naturalized U.S. citizen.

If that were to be the case, the former U.S. citizen (e.g., mom or dad) might be reluctant to leave any assets for their child who later moves to the U.S., knowing that effectively 40% of the value of those assets will go to Uncle Sam for the tax under IRC Section 2801.

As stated earlier, it all depends upon the facts of the particular family and life circumstances; some of which might change in the future in unforeseeable ways.

– “Just the facts, ma’am

2 thoughts on “When does “Covered Expatriate” Status -NOT- matter?

    […] to repeal the current U.S. “expatriation tax” on (1) mark to market income and gains (When does “Covered Expatriate” Status -NOT- matter?) and (2) the 40% tax on covered gifts and inheritances (see, Proposed Regulations for “Covered […]

    […] . . . in that it addresses principally civil federal tax law [the East] but sometimes (not never 🙂 ) crosses over from civil to criminal [the West]. In that May 2020 post, I covered the indictment in the Northern District of California of a Russian citizen who had become a naturalized U.S. citizen (“NUSC”). As a NUSC he necessarily was a “covered expatriate” upon renunciation as has been explained here in other posts. See, When does “Covered Expatriate” Status -NOT- matter? […]

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.