4 Important Tax Considerations for Expatriates
There are a variety of reasons why a U.S. citizen or long-term permanent resident may want to formally expatriate from the United States.
For example, the U.S. tax system somewhat uniquely imposes taxation based on citizenship, not residency. By expatriating, former citizens can avoid this complexity and the potential for double taxation.
Additionally, U.S. permanent residents (green card holders) may want to move abroad, but it’s very difficult to maintain a green card in those circumstances. Long-term U.S. permanent residents who have held a green card for more than eight years also need to formally expatriate when they give up their U.S. residency.
The expatriation process requires that you formally renounce your citizenship by forfeiting your U.S. passport and filing Form 8854 as part of your final tax filing. Note that if you have personal wealth of more than $2 million, have a high taxable income or are non-compliant on your previous tax returns, you may be subject to exit tax. See our article on this topic for more details.
Once you’ve completed these steps, that means you won’t need to pay any U.S. taxes going forward, right?
Not so fast.
If you continue to maintain a U.S.-based bank account, brokerage account, 401(k), IRA, etc., then you may still be subject to U.S. tax withholding. Read on to learn what you need to know about holding U.S.-based assets as a non-citizen.
#1 – Once you expatriate, you’re considered a nonresident alien by the U.S. tax system.
From a tax perspective, the downside of this status is that the United States will want to collect tax on any U.S.-based assets before they’re sent overseas. The responsibility for withholding taxes then falls on the U.S. financial institution that holds your assets. If the institution fails to withhold the proper taxes, it’s responsible for paying the difference.
To protect themselves against this financial risk, most financial institutions automatically withhold a flat 30% on any IRA distributions, dividends, pension payments and other U.S.-based income sent overseas. They may also withhold a percentage of any taxable brokerage sales.
#2 – Completing Form W-8BEN may allow you to lower your U.S.-based tax exposure.
Form W-8BEN — technically the “Certificate for Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting” — is an IRS form that allows non-U.S. citizens to declare foreign status and claim any applicable tax treaty benefits. It also provides safe harbor for U.S.-based financial institutions, which can’t be penalized by the IRS for failing to withhold taxes as long as a client has filed the form.
There are several potential tax benefits of completing the W-8BEN:
- No default 30% withholding –To protect themselves from potential tax liabilities, most financial institutions automatically withhold 30% from any IRA distributions, pension payments or dividends before distributing those funds to non-citizens. A W-8BEN allows you to provide your financial institution with the information it needs to prove to the IRS that it qualifies for safe harbor. As a result, the institution can withhold less than 30% on your distributions. This could reduce your tax withholding to as low as 0%.
- No tax on bank interest – The United States typically doesn’t tax bank interest; however, banks generally withhold taxes on interest earned by non-citizens. Completing the W-8BEN can help ensure your bank interest remains tax-free.
- No capital gains tax – Most non-citizens are exempt from U.S. capital gains tax. However, your financial institution will need to have a Form W-8BEN on file for you to get this benefit. Otherwise, they may withhold a portion of the entire sale.
#3 – It’s important to understand the provisions of any tax treaties between your current country and the United States.
Form W-BEN allows you to declare your foreign status and inform your withholding agent (typically your bank or investment firm) that you’re eligible for the tax benefits afforded by any existing tax treaty between the United States and your current country of residence. That’s why it’s important to understand if a tax treaty exists and, if so, what benefits it offers.
The IRS provides a list of existing tax treaties on its website. However, it’s wise to work with a qualified international wealth manager who understands the ins and outs of your country’s treaty provisions. Doing so can help you optimize any existing tax benefits in order to reduce your tax exposure.
#4 – Not all U.S. financial institutions will work with foreign citizens.
One of the biggest financial challenges you may face as a U.S. expat is finding a U.S.-based financial institution that’s willing to continue working with you once you’re no longer a U.S. citizen or green card holder. Due to the added complexities of complying with foreign countries’ tax laws, in-depth reporting requirements and the tax liabilities that come with serving non-citizens, many financial institutions simply refuse to work with people outside the U.S.
Fortunately, there are still a handful of financial institutions that will work with advisory firms, such as Creative Planning International, to service investment accounts on the behalf of their clients.
Could you use help navigating the financial challenges you face after expatriation? Creative Planning International is here for you. We work with Americans abroad and cross-border families to help maximize their wealth and avoid costly mistakes, especially when it comes to U.S. expat investments. We understand the complex interaction of multi-jurisdiction tax and regulatory regimes and take into account currency, diversification, tax and other portfolio considerations as we help you plan and invest for the future.
