Renouncing US citizenship has been on the rise due to tax burdens, bureaucratic obstacles, and challenges unique to “accidental Americans.”
Recent data shows that nearly 6,000 Americans have given up their citizenship during the first half 2020. This is a significant increase.
This trend highlights the complex tax policies and legal requirements which make it difficult for some to maintain US citizenship, especially those with dual nationality living abroad.
Renunciation is a solution that appeals to both the ultra-wealthy as well as accidental Americans who want to avoid double taxation or complex financial reporting requirements.
Why Citizenship Renunciation is on The Rise
Double taxation rules can be a challenge for Americans living abroad, as they are required to file and pay taxes in the US as well as their country of residence.
The US is one of the few countries that enforces citizenship-based taxation. This system requires worldwide income reporting.
Although credits and exclusions can reduce the actual tax paid by many, compliance costs and penalties are high, and some may consider renunciation.
According to government statistics, the number US citizens renouncing citizenship increased tenfold by early 2020.
These individuals are faced with a lengthy process that involves expensive paperwork, high fees and the potential loss of entry to the US.
This increase is largely due to “accidental Americans”, who are people born in the US but have no ties to it.
Accidental Americans and tax pressures
Accidental Americans are US citizens who may not be aware of their American citizenship until they receive a notification from financial institutions.
Fearing compliance with US tax laws under the Foreign Account Tax Compliance Act, many foreign banks decline to provide services to American customers.
FATCA requires that all foreign banks report accounts held by US Citizens, adding layers of compliance and complexity for both banks and clients.
Renunciation is a good solution for accidental Americans who have limited or no ties with the US.
Renunciation is financially difficult due to the cost of $2,350 and an exit tax that applies to those with significant assets.
The ultra-wealthy are exploring global options
High-net worth individuals are also looking for alternatives to US citizenship.
Some people are renouncing their citizenship to avoid high taxes on income, estates, and capital gains.
Wealth advisors report the ultra-wealthy are increasingly acquiring secondary citizenships in tax friendly jurisdictions.
Programs in Portugal and the Caribbean offer second citizenship through investment. This allows individuals to escape US taxation while maintaining ties with their home country.
The exit tax is a harsher measure for the wealthy. It applies to those who have a net worth of over $2 million, or an annual income that exceeds certain thresholds.
Before the IRS can allow renunciation, all assets, including retirement funds, are taxed.
While a second passport may be helpful, wealthy renunciants should carefully consider the implications, as they may face reentry restrictions into the US.
FATCA and compliance costs drive renunciations
FATCA, which was introduced in 2010, has played a major role in the renunciation of citizenship.
FATCA, a law designed to combat tax evasion and tax fraud, requires that individuals and institutions report extensive information about foreign accounts.
FATCA requirements are causing Americans living abroad to struggle more and more, as they complicate even basic financial transactions like opening a bank or mortgage account.
Many foreign banks refuse to provide services to Americans because of the reporting requirements. They view them as high-risk customers.
The administrative burden of filing annual tax returns, coupled with the potential penalties for non-compliance adds to the incentive for renunciation.
Renouncing citizenship: the process and its pitfalls
Renouncing US Citizenship is a multi-step procedure. Individuals must obtain citizenship in another country and make a formal renunciation of US citizenship at a US Embassy. They also have to pay outstanding taxes and a fee.
The IRS imposes an exit tax on global assets including IRAs for high-net-worth individuals.
Renunciation has lasting consequences, including the possibility of being banned from entering the US again.
Some may be able to obtain a second passport through countries with favorable agreements, but others, particularly those with passports obtained from investment programs, may have difficulties entering the US.
The trend of renouncing US citizenship is a popular one among those who want to avoid US taxes, but it is not widespread, especially among accidental Americans or the ultra-wealthy.
The larger issue is the US tax policy which imposes expensive obligations on citizens who live abroad.
Experts predict that until there is a change from citizenship-based taxes to residence-based taxation models, the number of Americans who give up their citizenship will continue to increase, even if it is incrementally.
This post Why record number of Americans are giving their citizenship may be updated as new information unfolds.
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