Important part

At a news conference this morning, Sens. Schumer and Bob Casey, D-Pa., will unveil the “Ex-PATRIOT” – “Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy” – Act to respond directly to Saverin’s move, which they dub a “scheme” that would “help him duck up to $67 million in taxes.”

Full article

http://abcnews.go.com/blogs/politics/2012/05/senators-to-unveil-the-ex-patriot-act-to-respond-to-facebooks-saverins-tax-scheme/

Thoughts

• - I’m surprised it took them this long to introduce this.

• - Once we’ve managed to insulate ourselves from the rest of the world and its capital, THEN our economy will take off!

• - Perhaps if our system wasn’t such a nightmare, people wouldn’t want to leave.

Yes, John. It is a full-blown Moronathon on Capitol Hill.  (PS:  Senator Schumer is also a “D”.  Not to say that the “R” people are sane.  Not at all.  I just need to point out that Sen. Schumer is a “D”.  Also from New York.  Wasn’t that the site of a world-famous stock market once upon a time?)

By curious coincidence, the last few years of tax law and tax enforcement are propelling the United States to a position where currency restrictions will be easy to implement.

If you can’t send your money abroad, at least you can jump on a plane and leave the country, right?  Well, funny you should mention that.  

OK.  Time to take off the tin foil hat, Phil.  Red pill or blue pill?

This is called citizenship-based taxation.  The power to tax you is based on your citizenship, rather than your residence.

This blog is all about dispelling hand-wavy knowledge and replacing it with stone-cold fact. It is time to do this with citizenship-based taxation, at least partially.

The hand-wavy answer to the question “Which countries impose income tax on their citizens living abroad?” is usually “The United States, the Philippines, and Eritrea.”  That is wrong.

Philippines

The Philippines taxes its citizens living abroad only on Philippines-sourced income.  National Internal Revenue Code Section 23(B) says:

A nonresident citizen is taxable only on income derived from sources within the Philippines[.]

Eritrea

Eritrea is mentioned as a country that taxes its citizens abroad.  The tax rate is 2%.  In fact, this appears to be an thinly-disguised method of extortion.

I am unable to get any first-hand information from the Ministry of Finance, so you may feel free to treat my conclusion here as entirely hand-wavy.  Or, tell me what you know so we can all get smarter.

United States

That leaves the United States, in all of its glory, as the only country that taxes its citizens no matter where they live.

Somewhere in the Far East or Pacific?

An email from a CPA in New York this morning (I won’t tell you her name but her initials are Susan Brown Otto) triggered this blog post.  She mentioned she had heard that there is an island nation in the Far East or the Pacific that also imposes citizenship-based taxation.  She was unsure of this.  I don’t know of any such country.

Again, if anyone out there can bring us from darkness into light, it would be much appreciated.

Now here is the economic reason he gave up his U.S. citizenship last September, pre-IPO.

How he was taxed when he gave up citizenship

When you give up your citizenship, the IRS pretends that you sold everything the day before.  Let’s pretend Eduardo Saverin cancelled his citizenship on September 30, 2011.  That means the IRS pretended he sold everything he had on September 29, 2011.

Among other things he owned was a giant stack of Facebook stock.  Eduardo’s tax lawyer (if smart) went and bought a really expensive valuation opinion on what the stock was worth on that date.  Eduardo acquired the stock at as close to zero as you can be.  So the entire amount was capital gain.

Example.  Eduardo owned 100 shares of Facebook stock that he bought for $100 at founding.  On the day before he expatriated his stock was worth $1,000.  He has a really well-documented valuation opinion to prove it.  (Remember, at this point Facebook is pre-IPO.  There was a secondary market for this stuff so it’s reasonably easy to get reasonably close to what the stock was worth).

Eduardo has capital gain of $900.  He happily pays tax to the U.S. government on that $900 capital gain.

How he’s taxed after he gives up citizenship

Now Facebook goes all IPO ‘n stuff.  His 100 shares are suddenly worth $2,000.  Remember.  Eduardo is a nonresident alien — a noncitizen of the United States who also happens to not be living in the United States.  He sells the stock for $2,000.  He pays U.S. capital gain tax of ZERO.

Whaaaaaa?

Or as Reddit would say, ffffffffuuuuuuuuuuuuu!

Yep.  True story.  Zero tax in the USA.

A nonresident alien does not pay capital gain tax on stock sales of U.S. companies.  Not just Facebook.  It could be Google, Apple, anything.  Nonresident investors do not pay capital gain tax on their stock sales.  (Usual disclaimer – exceptions to the rule exist everywhere but for the well advised investor this is the result).

Example:  Eduardo owned 100 shares of Facebook stock that he bought for $100 at founding.  He cancels his citizenship and pays his $900 tax as described above.  The company goes IPO.  Now the stock is worth $500 per share.  His holdings are worth $50,000.  He sells.  Pays no capital gain tax.

This means that the total capital gain tax that he paid, as a founder of Facebook, was $900.

And if the price per share goes to $1,000, he has $100,000 in his pocket, on which he paid $900 of tax.

Etc.

I don’t know the true numbers

I don’t know the true numbers that apply to him.  But that’s the tax game he played.  He only gets taxed on the capital gain up to the value of the stock on the day before he expatriated.  All future appreciation in value is forever tax-free to him.

I approve.

EDIT:  I’m quoted in an article on abc.com about this situation.

Eduardo Saverin, a Facebook co-founder, renounced his U.S. citizenship last year.

Only an elected official would fail to predict such events.

(There are other utterly predictable events from Federal tax policy that somehow fail to register on the Congressional Richter Scale).

It is also utterly predictable that some politician somewhere will rant about this.  And it is also utterly predictable that the recommended remedy is more regulation, higher penalties, and higher taxes.

The beatings will continue until morale improves, apparently.

EDIT:  Bloomberg reports on the same story.

Atlas Shrugged, apparently.

Here is a simple explanation of how it works.  If you’re just starting to think about giving up your U.S. citizenship or green card, this is the place to start.

Disclaimer, warning shot, weasel-words, pre-emptive strike

Sorry.  Have to do it . . .

- This is not legal advice to you.

- This explanation is like giving me a map of Europe when I ask you to recommend a good Thai restaurant in Zurich.  It is extremely simplified.  There are exceptions and special rules all over the place.

- In other words, if blog posts were art, this is a doodle on a napkin, not the Mona Lisa.

With that out of the way, here is the explanation.

Two tasks when you expatriate

There are two things you need to accomplish when you give up your U.S. citizenship.  You need to convince the Department of State that you are no longer a citizen, and you need to convince the IRS that you are no longer a U.S. taxpayer.

Log out of the citizenship system

The first (and easier) part is to terminate citizenship. You do some paperwork (look for Form DS-4079 on the internet; there is other stuff too that the Embassy will want). You show up at the Embassy or Consulate for an interview.

Your citizenship is terminated effective that day but it typically takes about 4 months to get the confirmation paperwork. I recently had two different clients (on opposite sides of the world) get their paperwork back in a matter of days, however.  I blame global warming for that astonishing efficiency.

Log out of the tax system

The harder job is to log out of the tax system.

This job is either paperwork only (if you are “poor”) or it is paperwork plus pay some tax (if you are “rich”).

“Rich” for exit tax purposes

You are “rich” and therefore have to pay tax when you leave if you satisfy one of two financial tests.

The first test is a simple balance sheet test. Is your net worth (assets minus liabilities) $2 million or more?

The second test is based on the amount of Federal income tax paid over five years before you terminate citizenship. Is the average Federal tax liability over those five years $151,000 or more? For someone who terminates citizenship in 2012, that means we look at 2007-2011, and calculate the average based on those years.  The $151,000 amount is indexed for inflation so next year it will be higher.

If you satisfy EITHER of these tests, you are “rich” and therefore you will pay tax when you leave the United States. Plus you do the paperwork, of course.

If you satisfy NEITHER of these tests, you only have some paperwork ahead of you but you do not have to pay any tax.

Income calculation for someone who is “rich”

For a rich person who terminates citizenship, there is a “mark-to-market” event in the person’s life. Pretend that all assets are sold on the day before you went to the Embassy to cancel your citizenship, at market prices. The first $651,000 of profit is tax free. Everything above that is taxable, at the normal tax rates that would apply.

There are special rules if you are a beneficiary of a trust, or if you have a pension.  There are a few other odds and ends that can cause taxation.

But the most important thing is this “pretend that you sold everything and pay real money taxes on the pretend profits.”

This is done for all assets worldwide.

The exit tax paperwork

The tax paperwork filed is a complex income return for the year you terminate your citizenship.  You file it according to the normal filing deadlines.  For someone who terminates citizenship in 2012, you will be filing your tax return in 2013.

The tax return has a component that is part-year reporting as a citizen of the United States, another component which is part-year reporting as a nonresident of the United States, and (this is the important one) Form 8854, which is the form the government wants to see to log you out of the tax system.

Prior five years are clean

In order to do this right, your U.S. tax paperwork and tax payments must be up to date for the prior five years. For someone who will terminate citizenship in 2012, that means the 2007-2011 tax returns must be filed, and must be correct.

“Thar be dragons!”

Can I tell you again that there is a lot of other stuff that is important, tax-wise?  Get smart before you make that appointment to terminate your citizenship. 

Shameless self-promotion

We do a lot of this stuff.  

We will walk you through the early stages so you can make a well-informed decision:  how to do it, how long it takes, what the estimated tax hit (if any) will be, what can be done to reduce or eliminate taxes.  

Then if you hire us, we do everything.  In our experience the “get out of the citizenship” part is straightforward but the tax stuff is not.  We do the pre-expatriation tax planning.  We do the exit year tax returns for you and the following year as well because there is usually some strange stuff going on in the year after you leave the United States.  It is rare that people can get their financial affairs arranged so that their U.S. finances are completely wrapped up by the time they leave.

I travel frequently (the upcoming trip is Switzerland from 20-27 May, Beirut from 27-30 May, and Dubai from 30 May to 03 June) so we can meet outside the USA.  Or we can meet in my office or talk via phone or Skype.

http://mobile.bloomberg.com/news/2012-05-08/u-s-millionaires-told-go-away-as-tax-evasion-rule-looms.html

Congress imagines itself to be the Borg. Resistance is futile. Submit and be assimilated.

In fact America is declaring itself irrelevant. And the rest of the world agrees. Add to this the way it is being done — in a schoolyard bully style — and is it any wonder that we are entering the American Pariah Era?

Where I am about to talk about RRSPs.

You go, IBS.