Is Changing Citizenship Really Worth It?

Cannon Insights June 2012 – Is Changing Citizenship Really Worth It?.

Taxes—Is Changing Citizenship Really Worth It?

You’ve probably seen the recent reports that one of Facebook’s founders, Eduardo Saverin, who now lives in Singapore, renounced his U.S. citizenship last September, presumably in an effort to save U.S. income taxes.

Few Advisors have the opportunity to advise a client as wealthy as Saverin, who’s four percent interest in Facebook is expected to be worth about $4 billion following the Facebook IPO (give or take a few hundred million), yet it makes sense to understand the dynamics of his planning and the upside potential. As it turns out, Saverin’s name is just one on a long list of individuals recently giving up (or otherwise losing) their U.S. citizenship.

Renouncing US Citizenship
As a general rule, U.S. citizens are subject to U.S. income taxes on worldwide income from whatever source derived. Thus, the only way for a U.S. citizen to legally avoid US income taxation is to renounce his or her citizenship.

Section 349(a)(5) of the Immigration and Nationality Act (INA) is the applicable law. That section provides that a person wishing to renounce his or her U.S. citizenship must voluntarily and with intent to relinquish U.S. citizenship:

• Appear in person before a U.S. consular or diplomatic officer in a foreign country (normally at a U.S. Embassy or Consulate); and
• Sign an oath of renunciation

Renunciations that do not meet the conditions described above have no legal effect. Because of the provisions of Section 349(a)(5), Americans cannot effectively renounce their citizenship by mail, through an agent, or while in the United States.

Clients intending to renounce U.S. citizenship should be aware that, unless they already possess a foreign nationality, they may be rendered stateless and, thus, lack the protection of any government. They may also have difficulty traveling as they may not be entitled to a passport from any country. Even if they were not stateless, they would still be required to obtain a visa to travel to the United States, or show that they are eligible for admission pursuant to the terms of the Visa Waiver Pilot Program (VWPP). If found ineligible for a visa or the VWPP to come to the U.S., a renunciant could be barred from entering the country.

Saverin, age 30, was born and raised in Brazil and moved to the United States in 1992. He became a U.S. citizen in 1998 and has spent the last four years living in Singapore.

Tax Consequences
IRC Section 877A imposes an “expatriation tax,” also referred to as an “exit tax” on individuals renouncing their U.S. citizenship.

For individuals expatriating after June 16, 2008, IRC Section 877A applies if any of the following apply:

• The individual’s average annual net income tax for the five years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($145,000 for 2009 and 2010, $147,000 for 2011, and $151,000 for 2012).
• The individual’s net worth is $2 million or more on the date of your expatriation or termination of residency.
• The individual fails to certify on Form 8854 that he or she has complied with all U.S. federal tax obligations for the five years preceding the date of his or her expatriation or termination of residency.

IRC 877A(g)(4) provides that a citizen will be treated as relinquishing his or her U.S. citizenship on the earliest of four possible dates:

• The date the individual renounces his or her U.S. nationality before a diplomatic or consular officer of the U.S., provided the renunciation is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State;
• The date the individual furnishes to the U.S. Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an act of expatriation specified in paragraph (1), (2), (3), or (4) of section 349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(1)-(4)), provided the voluntary relinquishment is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State;
• The date the U.S. Department of State issues to the individual a certificate of loss of nationality; or
• The date a U.S. court cancels a naturalized citizen’s certificate of naturalization.

IRC Section 877A imposes a mark-to-market regime, which generally means that all property of a covered expatriate is deemed sold for its fair market value on the day before the expatriation date. IRC Section 887A further provides that any gain arising from the deemed sale is taken into account for the taxable year of the deemed sale notwithstanding any other provisions of the Code.

In Saverin’s case, his cost basis in his Facebook stock is assumed to be at or near zero. The value of his pre-IPO Facebook stock remains uncertain, but in any event should have been considerably less than its post-IPO value. Not only did the exit tax value lack the value associated with the IPO buzz and anticipated pop, presumably Saverin should have enjoyed a discount at least for his minority ownership. Thus, although Saverin was subject to IRC Section 877A’s exit tax, the amount of capital gains tax on the deemed sale was presumably considerably less than the tax associated with a sale of Saverin’s post-IPO Facebook stock.

Good Deal or Not
Experts vary in their opinions as to whether Saverin’s renunciation strategy was a good deal or not. Even assuming discounts dropped the value of his pre-IPO Facebook stock to $3 billion, a 15 percent tax on $3 billion translates into about $450 million in current taxes. On the other hand, that’s a fraction of the capital gains tax he’d likely pay on post-IPO sale of his Facebook stock, especially if capital gains taxes increase to 20 percent in 2013 as they are set to do unless Congress acts to change the law between now and the first of the year. Furthermore, Saverin should be able to sell a fraction of or borrow against his post-IPO stock to pay the exit tax. Note that Singapore does not have a capital gains tax although it does impose a tax on income earned in the city-state.

Saverin’s expatriation and the related potential U.S. tax avoidance has stirred up controversy and has even generated proposals for legislation to prevent such activities in the future. Furthermore, the Foreign Account Tax Compliance Act (FACTA) goes into effect in 2013. This law, enacted in 2010 requires financial institutions based outside the U.S. to obtain and report information about income and interest payments accrued to the accounts of American clients. That means additional compliance costs for banks and fewer investment options for all U.S. citizens living abroad.

Bottom Line
Expatriation seems like an extreme step to avoid or minimize taxes, but if the numbers are large enough and it makes sense taking into account the client’s overall situation, it is certainly worth considering. Saverin already resides in Singapore and reportedly intends to make it his home. He joins 1,780 former Americans who renounced citizenship last year and is at least the second billionaire to give up his U.S. citizenship in the last 20 years.