Exit Tax in the US — Everything You Need to Know If You’re Moving

Everything You Need to Know if You’re Leaving the US

Written by Tiffany Woodfield, Portfolio Manager, CIM® CRPC®
Reviewed by: Bryan E. Fitzpatrick. Associate Counsel, Pushor Mitchell

Reading Time: 6 minutes 40 seconds

If you're planning on leaving the US to live in another country, then you've probably heard about the US Exit Tax.

This article will cover who needs to pay the Exit Tax (Expatriation Tax) in the US and the essentials everyone concerned about the US Exit Tax needs to know.

Please note that this information is general in nature. You need to speak to a cross-border lawyer and cross-border accountant about your particular situation if you are worried you may face the exit tax.

In my work as a cross-border financial advisor, I've spoken with hundreds of people who are planning a move across the border. The biggest concerns for most of my clients are the IRS and surprise taxes. You certainly have no issue paying taxes, but there's no need to overpay your taxes.

Before we dig into the topic of ‘exit taxes’, please note that working with an excellent cross-border lawyer is critical if you have substantial assets and are moving from the US. In addition to that, you should be working with a cross-border accountant and wealth management team. Build your team long before your move, and you'll have the best results when it comes time to move assets across the border.

TABLE OF CONTENTS

1. What is the Exit Tax in the US?
2. How is the Exit Tax Calculated?
3. Covered vs. Not Covered Expatriates
4. Do You Have to Renounce Your US Citizenship?
5. Do You Have to Renounce Your US Residence?
6. Pensions and the US Exit Tax
7. Tax-Deferred Accounts and the US Exit Tax Investments Cost Basis
8. Is Double Taxation Something to Worry About?
9. With the Exit Tax, Your Best Defense is a Good Offense

What is the Exit Tax in the US?

The exit tax in the US is a tax that may apply to US citizens or long-term residents who terminate their US citizenship or residency if they are considered covered expatriates.  You are considered a long-term resident if you have been a US green card holder for eight of the past 15 years.

The exit tax in the US is the last chance for the IRS to tax you before you renounce or give up your green card. It is similar to an estate tax as it taxes the gains of your assets even if you are not selling anything. The US government imposes this tax on the implicit gain of all your worldwide assets, including your home. 

In comparison, Canada's departure tax is based on residency. The government imposes a "departure tax," which is the difference between the market value on the date of arrival in Canada and the market value on the date of departure.

When you leave the US and terminate your citizenship or residency, you will be considered a covered or non-covered expatriate. Three considerations determine if you are a covered or non-covered expatriate. We'll go over these considerations later in this article.

How is the Exit Tax Calculated?

For anyone who expatriated after June 17, 2008, the exit tax is calculated as though you liquidated all of your assets on the date before expatriation. Thus, you are taxed on the calculated net gain. 

This tax applies whether or not an actual sale was made and whether there are notional gains on your home. For the IRS, it doesn't matter if the gain had partly arisen before the taxpayer moved to the US.

>>>>>A notional gain is theoretical gain because you don’t have to have sold the home.

Deemed Disposition of Capital Assets

With the deemed disposition of capital assets, your exit tax is calculated* as though you have sold your worldwide property for fair market value (FMV) the day before you expatriate. If you have unrealized gains of more than $725,000 US (2019)**, you will need to include these gains on your tax return. The excess will be taxed as capital gains. Keep in mind you cannot use the home exclusion of $250,000.

The home exclusion refers to when your home meets the requirement of primary residence and you have owned the home for at least two years. If this is the case, you may be eligible to exclude tax on capital gains up to $500,000 if married or filing jointly. Or you may be eligible to exclude tax on capital gains up to $250,000 if you are single.

*You will need to speak to a cross-border lawyer to determine your potential exit tax.

**Based on 2019 numbers indexed to inflation.

Deemed Distribution of Tax-Deferred Assets

A lot of people are relieved by concluding they don’t owe tax as they are under the unrealized gains of $767,000*.  What comes as a surprise is the potential tax liability from the deemed distribution of tax -deferred assets. These assets are the retirement plans a covered expatriate owns, such as an IRA or HSAs. They are not considered capital assets, so they cannot be subject to capital gains tax. However, if you are a covered expatriate, you will pay ordinary income tax on the "deemed distribution" of your account.  The way this works, it's as if you took the distributions the day before you expatriated and the early withdrawal penalty doesn’t apply.

*based on 2022 and indexed to inflation

 A distribution is when you actually take money out of your retirement plan.  A deemed distribution is when you don’t take any money out of your retirement account, but for tax purposes the IRS considers it as though you did take the money out. 

If, as a covered expatriate, you hold other eligible retirement plans such as a 401(k) or 403(b), they are considered deferred compensation and have additional options to consider. 

You could defer the tax and have your retirement plan administrator withhold 30% when you eventually take money out. Keep in mind the US-Canada Income Tax Treaty does not offer relief for these distributions.  Which means you will be stuck with the 30% withholding tax on the money you take out.

If an ineligible plan which is one where the IRS cannot ealy collect the tax like a foreign pension plan.  Then the income is deemed to have been distributed the day before expatriation and added to the covered expatriate’s tax return.

Foreign Grantor Trusts

Canadian RRSPs, RRIFs, annuities and locked-in retirement plans are treated as foreign grantor trusts. Therefore, you need to speak to a cross-border lawyer to determine how to value these.

Covered vs. Not Covered Expatriate

Since covered expatriates have to deal with the US exit tax, you may now be wondering if you are going to be considered a covered expatriate or not.

Here are a few important ways to identify whether you will be considered a covered expatriate or not:

1. Net Worth Test for Singles: If your personal, worldwide net worth, including your home, is $2 million or more on the date you terminate residency or expatriate, you are a covered expatriate.
2. Net Worth Test for Married Couples: If you are married and your worldwide net worth is $4 million or more on the date you terminate residency or expatriate, you are a covered expatriate.
3. Net Income Tax Liability: If your average net income tax liability (not taxable income) is over $178,000* for the past five years, you are a covered expatriate. If you are married and file jointly, then it is the net tax liability of your joint returns regardless of whether only one of you is expatriating. 
4. Certify Tax Compliance: The third way you may be considered a covered expatriate is if on Form 8854 you cannot certify the past five years of US tax compliance.

*based on 2022 and indexed to inflation

Do You Have to Renounce Your US Citizenship?

You do not have to renounce your US citizenship when you move to Canada. This decision is a personal one. However, you have to consider the facts and the emotional ties you have to the US.

If you have moved to Canada, the benefit of renouncing may be that you will no longer have to continue filing a US tax return declaring foreign bank accounts or filling out Form 5471 for a foreign company. You will also no longer have the additional levels of complexity that apply to US persons investing in Canada, so it simplifies your tax situation overall. And you won't have a fear of future tax law changes in the US. 

However, the opportunities in the US have always been enticing. The job market, as well as lifestyle opportunities, are great in the US. Life can be unpredictable. If you give up your citizenship, remember it is permanent. Keep in mind the United States has a 7- to 10-year waitlist to get citizenship.

If you work with a competent team of cross-border lawyers, accountants, and financial advisors, you can keep your US citizenship and have the benefits of both countries.

Do You Have to Renounce Your US Residence?

You may wonder about whether you need to give up your US residence when moving from the US. The answer is no. You do not need to sell all your assets or renounce your US residence. You can certainly keep your vacation property or home. 

However, it is important to understand that travelling to and from the US may not be as easy as previously. In addition, you want to make sure that if you renounce your US citizenship, you don't do this until you already have another nationality. Otherwise, you will not have the protection of any government. 

 

Pensions and the US Exit Tax

You've given up your citizenship and moved to Canada. You're enjoying your next adventure. You're finally spending more time travelling, being in the outdoors, and perhaps relaxing with some great wine. 

You've been filing your US tax returns yearly. But now you have decided you don't want to work or live in the US any longer. And you're considering renouncing. 

But if you renounce, can you still get social security?

Social Security represents money you paid for years, and you want to make sure you get it back. In short, social security benefits are usually available to those who qualify, even if you no longer live in the US. 

However, there are specific rules for a non-resident alien (NRA)*, so you will need to understand the rules and exceptions. 

To learn more about those rules, visit this post from the SSA Website.

*once you renounce, you are considered a non-resident alien

Tax-Deferred Accounts and the US Exit Tax Investments Cost Basis

When you renounce, what happens to the investments you have in a US account?

1. You will need to notify your brokerage firm and bank by filing a W-8CE
2. The cost basis for US investments such as stocks, bonds and mutual funds will be taken at the value of the day before you renounced.
3. You will file a 1040NR for any US-sourced income.
4. You will still receive a year-end statement detailing capital gains, interest, and dividends.

Is Double Taxation Something to Worry About?

In most cases, you don't face double taxation if you move from the US to Canada. I can't speak to what happens if you move from the US to other countries as that isn't my area of expertise.

However, the Canada-US Income Tax Treaty usually prevents double taxation. This tax treaty is designed to prevent individuals from being taxed on the same income in the same year. However, this isn't always a guarantee. 

Usually, once you are a resident of Canada, which has a higher tax regime than the US, you won't likely owe any US tax. This is because you can claim a foreign tax credit for the taxes you paid in Canada. But there can be cases of double taxation. For example, the difference in the type of income and the timing of income inclusion can cause double taxation.

A cross-border accountant is a critical member of your team. They will ensure you are maximizing your foreign tax credits and have proper tax planning.

With the Exit Tax, Your Best Defense is a Good Offense

When facing the US exit tax, you need to put together a good team to ensure you don't overpay. When you work with a team that understands your situation and can navigate the complexities of cross-border wealth management, your life becomes much simpler. There's no need to make this more stressful by trying to do it all on your own. Many accountants, lawyers, and financial advisors specialize in working with cross-border cases. Now is the time to put together your team.

Your cross-border team should include:

• an excellent cross-border accountant specializing in the US and Canada
• an excellent lawyer who understands cross-border estate planning
• an excellent lawyer who understands cross-border immigration and citizenship issues and renunciation of U.S. citizenship  
• an excellent wealth management team including a cross-border financial advisor and financial planner

You deserve to enjoy this next stage of your life and not worry about what you may have missed or whether you're going to have an unplanned taxable event. 

My clients often say they want to be onside with the IRS and be compliant. They just don't want a surprise that they didn't expect. You want to sleep well at night knowing that you're covered on both sides of the border.

If possible, we recommend that you start putting your team together two years before your move. Doing so will give you more flexibility when planning your financial move.

Key Takeaways:

• The exit tax is the last chance for the IRS to tax you before you leave the country permanently.
• The exit tax is calculated as if you had sold all your assets the day before you expatriated.
• Three main things determine whether you may be a covered or non-covered expatriate. You need to know your worldwide assets, including homes and properties, net tax liability, and whether you've been tax compliant for the past five years.
• Renouncing is a very personal choice, and it is permanent.
• Double taxation is possible, but its threat is greatly reduced by working with a proper team.

Next Steps

If you’re planning on moving to Canada and need assistance with moving your investments, estate planning, and portfolio management, please get in touch. At SWAN Wealth we specialize in cross-border financial planning and wealth management.

Read More Cross-Border Planning Guides:

Cross-Border Estate Planning Guide

Roth IRA Canada: How to Manage Your Investments Across the Border

The Ultimate Financial Planning Resource for Dual Citizens or Green Card Holders Living in Canada

401k in Canada - How to Stay Onside with the IRS and Avoid a Large Tax Bill

Retiring to Canada - A Financial Planning Guide

Financial and Tax Planning for US Citizens Living in Canada

Canadian RRSP Facts for Dual Citizens, Expats and Canadians

About the Author

Tiffany Woodfield is a portfolio manager, dual-licensed financial advisor, and the co-founder of SWAN Wealth Management, along with her husband, John Woodfield. Tiffany specializes in advising clients who live both in Canada and the United States and want to simplify their cross-border financial plan, move their assets across the border, and optimize their investments so they can minimize their tax burden. Together Tiffany and John Woodfield help their clients simplify their cross-border finances and create long-term revenue streams that will keep their assets safe whether they live in Canada or the US.

Schedule a Call

Book a 15-minute introductory call with SWAN Wealth Management. Click here to schedule a call.