The U.S. is virtually the only major country in the world that imposes income taxes and estate taxes on it citizens or long term residents (U.S. “persons”) no matter where they live, where their assets are located or where their income is realized. A U.S. person could spend thirty years in a foreign country and still be subject to the U.S. tax laws. 

By contrast, most other countries impose taxes on the income of their residents. Some countries (like Canada) impose tax on the worldwide income of their residents but if a Canadian citizen moves to a low tax country (a tax haven), they have no legal duty to pay taxes to Canada after moving. Similar rules apply in most European countries. Thus, tax havens are valid and legal for nearly everyone in the world except U.S. persons. The only way a U.S. person can escape from the yoke of U.S. taxes is to give up his or her citizenship or residency.  

In spite of the high taxes imposed by the U.S., the tax rates in many foreign countries are even higher. The primary advantages of expatriation are for the U.S. citizen (or permanent resident) who has substantial investment assets that can be moved to a low tax country, like a tax haven. By changing citizenship to a foreign country, the U.S. person will be subject to local taxes on any salaries or business profits in that country, but can avoid U.S. taxes on that income. IN addition, the expatriate can avoid taxes entirely on the income derived from any assets kept in a tax haven. In addition, expatriation can be an effective way to avoid huge estate taxes on large estates. 

For many years, the U.S. has imposed income taxes on unrealized gains derived by U.S. citizens or long term residents  for up to ten year after they give up their citizenship. In addition, U.S. estate taxes would be imposed on any U.S. based assets for up to ten years after expatriation. However, any future earned income and any investment income realized from new savings outside the U.S. could be arranged to be free of U.S. taxes.  And, any “tax paid” assets that could be moved outside the U.S. could be free of U.S. estate taxes. “Tax paid” assets are those assets with no deferred income or unrealized gains. The current expatriation tax scheme basically seeks to collect the income taxes on all untaxed income or gains at the time of expatriation. However, that’s an extremely simplified explanation of some very elaborate and complicated tax rules.

The 1996 tax law introduced stronger rules to be sure that these untaxed gains or income (such as in an IRA or annuity) would be subject to tax if they were sold within ten years after expatriation. That law introduced a rule where there is a presumption of a tax avoidance motive if the taxpayer has more than $622,000 (for 2004) of net worth or an average tax bill for the past three years of more than $124,000. Taxpayers with a net worth or average tax bill in excess of these amounts are required to file income tax returns with the IRS for ten years after they expatriate -- and they are required to pay taxes on some types of income that would otherwise be exempt if they had never been a U.S. citizen or  resident.

And, a 1996 immigration law included a provision that basically made it either impossible or extremely difficult for anyone who expatriates in order to save taxes to return to the U.S. to visit relatives. That forces a family to leave some relatives behind or to take an entire family at the same time. It has effectively deterred a lot of expatriation even though it has not been enforced as far I can tell.

The 1997 tax law introduced a number of other technical changes to prevent U.S. taxpayers from using tax free exchanges or controlled foreign corporations to avoid some of the tax rules on expatriates. 

In late 2002, some members of Congress proposed an "exit tax" on anyone who expatriates, but it appears (as of early October, 2002) that this proposal will not become law this year. Even so, it has been proposed many times before and is likely to come back in future tax bills.


Vern Jacobs