Consider the estate tax planning implications before relocating
Suppose you’re contemplating a bold move — literally: pulling up stakes and moving to a foreign country. There are many possible reasons for this drastic change of scenery. For example, you may be enticed by a new career opportunity, looking to retire to a warmer climate or wanting to live closer to loved ones.
Regardless of whether you’re targeting a move “across the pond” or to a tropical paradise or elsewhere, be aware of the estate tax planning implications.
Income and estate tax ramifications
The main thing to know is that you’ll still owe U.S. income tax if you’re a U.S. citizen, even if you’re earning the money abroad. The reason: The United States taxes you on your worldwide income, not just your U.S. income. Because you’ll likely also owe income tax to the foreign country where you reside, you’re effectively facing a double tax hit.
At least you can usually offset some U.S. income tax with a credit for taxes paid to a foreign country. Furthermore, you may qualify for a foreign earned income exclusion of $108,700 in 2021. To qualify, you must spend at least 330 days out of the country during a 12-month period. Further, you may be eligible for a foreign housing exclusion. And, if the country where you’re residing has a binding treaty with the United States, you may benefit from a reduced tax rate there.
Similarly, you can’t avoid gift and estate tax consequences just by moving abroad. As with income tax, your worldwide assets are still subject to federal gift and estate tax. So, if you buy a home abroad and suddenly die, the home is included in your taxable estate. Again, depending on the law of the foreign country, it’s a double tax whammy.
Renouncing your citizenship
One possible way to avoid double taxation is to renounce your citizenship. This isn’t a decision to be made lightly, especially if you envision returning full-time to the United States at some point. But it does put you in position to obtain some tax relief.
When you become an expatriate, you no longer have to pay income tax on worldwide income. Your U.S. tax obligations are limited to earnings from sources within or connected to the United States. This may reduce your overall income tax exposure. Comparable rules apply to your taxable estate. But you don’t simply get a free pass if you’re treated as a “covered expatriate” for tax purposes.
Notably, you’ll be assessed an exit tax if you’re still earning a living and you were a U.S. citizen or permanent resident for at least eight of the last 15 years. For 2021, the exit tax applies to an expatriate who:
- Has had, for the last five years, an average income tax liability exceeding $172,000,
- Has a net worth of $2 million or more, and
- Fails to certify compliance with all U.S. tax obligations for the preceding five years.
Briefly stated, covered expatriates are treated as if they’d sold all their worldwide assets at fair market value. It’s as if you passed away just before moving day. This can result in significant tax liability, especially when you add in the value of retirement accounts.
Saving grace: There are several key exceptions to the exit tax. The most prominent is a generous inflation-indexed exclusion on unrealized gain ($744,000 for 2021).
Finally, if you renounce your citizenship, you forfeit the benefit of the gift and estate tax exemption. For 2018 through 2025, the exemption is $10 million, indexed for inflation ($11.7 million in 2021). Instead, you’re stuck with a relatively paltry $60,000 exemption for non-residents.
Renouncing your citizenship may have other implications unrelated to or tangential to taxes. Depending on the jurisdiction, a will created and executed in the United States may no longer be legally binding in a foreign country. Plus, other estate planning documents might be affected by foreign laws, defeating your intentions. This could also have an impact on gift and estate taxes.
Another potential consequence is that trusts often don’t travel well. For instance, in some countries trusts may be taxed at both the recipient and trust levels. Accordingly, you may need to investigate alternative planning opportunities such as use of direct gifts, 529 plans or other vehicles suitable to the particular jurisdiction.
Don’t make any rash decisions
Conduct a thorough review of your assets — including earnings, real estate, retirement accounts and other holdings — and determine the repercussions of a move abroad. Contact your estate planning advisor for assistance.