Reshma Kapadia for Barrons writes: As anxiety rises about the increasing tax burden on the world's richest, some boldface names have taken drastic steps. French actor Gérard Depardieu recently bid adieu to France and accepted Russian citizenship, and Tina Turner is giving up her U.S. citizenship for Switzerland. Golfer Phil Mickelson got an earful after publicly raising the prospects of making "drastic changes" due to California's rising taxes.
Plenty of other Americans are considering similar moves. With the pressure building for Congress to raise takes on high earners, people are lining up to ask their bankers and tax attorneys a once-unthinkable question: Does it make sense to flee the country?
In fact, just about all (legal) avenues of reducing tax liabilities are on the table these days when wealthy clients sit down with their advisors. That's because revenue-hungry governments everywhere are closing escape hatches. "It doesn't seem to be a fad," says Suzanne Shier, director of wealth planning and tax strategy at Northern Trust.
FOR GOOD OR ILL, moving to another country generally won't solve the problem. The idea that leaving these shores will automatically lighten your tax bill is nothing more than an enduring myth. The U.S. is one of the few countries that tax citizens on income earned anywhere in the world -- whether they are living on a yacht in the Caribbean or in a villa in Tuscany.
The biggest exception may come for Americans opening a business in certain countries abroad. Say an American entrepreneur moves to the U.S. Virgin Islands and invests in a local business that creates jobs, or makes certain capital investments that help the local economy; the expat can then exempt 90% of the U.S. tax on that business income, reducing his tax liability, says Lewis Kevelson, international tax partner at Marcum LLP.
But for personal income taxes, the potential savings are limited. Americans living abroad can generally exclude $97,600 from their income this year, paying taxes on anything over that amount if they have been out of the U.S. for 330 full days during a 12 consecutive-month period.
Additionally, expat Americans usually can use a foreign tax credit to offset taxes they owe Uncle Sam with what they have paid overseas. However, if the foreign taxes you've paid are lower than what you would have paid in the U.S., the IRS requires you to fork over the difference.
For most, that rule effectively eradicates the benefits of moving to a foreign tax haven. Furthermore, since American expats are filing and paying taxes in two countries, the legal and accounting costs -- just consider staying compliant with foreign-asset reporting rules -- could eliminate any marginal tax savings accrued by moving abroad.
Which brings us to the emotionally charged step of giving up your U.S. passport. While the headlines may suggest that the wealthy are fleeing in droves, just 932 Americans renounced their citizenship in 2012, down considerably from the 1,781 Americans who did so in 2011. Granted, it's nearly double what it was a decade ago, according to the Federal Register. That increase in renunciations coincided not just with the threat of higher taxes on the wealthy, but also stricter enforcement by U.S. authorities monitoring overseas assets.
SO, DESPITE INCREASED QUERIESabout making such a move, international tax lawyers and wealth advisors say only a handful finally go through with it -- and they usually have little connection to the U.S. to begin with.
In most cases, these expat Americans have been living in a foreign country for decades and, for other reasons, have become full-fledged citizens of their adopted country. "The decision to expatriate is rarely motivated by taxes anymore, because the move is really punitive on that front for many wealthy Americans," says Christian Kalin, a partner in charge of the residence and citizenship practice group at the global consulting firm Henley & Partners.
Why so few takers? Most Americans with a net worth of more than $2 million, or average annual net income for the last five years of more than $151,000, must pay an exit tax. The process involves marking to market all your assets, as if they were sold the day prior to expatriation, and paying taxes on any net unrealized gains over $668,000. That means 39.6% tax on any short-term income gains and IRA distributions; 20% on any long-term capital gains; 3.8% on any net investment income; and 28% on collectibles.
Some dual citizens can avoid the exit tax if they've been citizens of both countries since birth, currently live and pay taxes in the other country, and have not been a resident of the U.S. for 10 of the last 15 years. For everyone else, the better time to expatriate, given the tax, is when assets are suffering a loss -- circa March 2009 -- rather than when they have appreciated.
Part of the expatriation process involves certifying that you have met all federal tax requirements for the past five years -- an obstacle for some "accidental" Americans who may not have owed U.S. taxes because of the tax credits but didn't realize they were still required to report all foreign assets, says Andrew Mitchel, an international tax lawyer who works with high-net-worth clients. Intentionally failing to file triggers a penalty of 50% of the balance of foreign accounts per year, or $100,000, whichever is greater -- not to mention potential criminal prosecution. Penalties for unintentionally not filing start at $10,000 a year per account.
One of the thorniest issues thrown up by the move involves wealth transfers for those who have expatriated but plan to leave money to their children who still are Americans. Typically, the couple's estate would pay the tax upon their death, getting an exclusion of up to $10.5 million free of estate tax this year. But since they have expatriated, upon their death the beneficiary will be taxed at a rate as high as 40%, without the cushion of any exemptions.
"After spending a lot of money in legal and accounting fees to get the tax benefit of expatriation, the benefit could be undone when assets are passed either as gifts or at death to U.S. taxpayer beneficiaries," says Jay Rosenbaum, an international tax attorney and partner at Nixon Peabody in Boston. The fees to just renounce your citizenship could easily start at five figures, he says.
WHEN DOES IT PAY? An American who owns a foreign company with a big payout a couple years away, or that makes a product that could be developed and launched much more quickly overseas, could save millions by settling in a country with lower taxes -- about 20% on the expected increase in the company's value, Kevelson says.
Along those lines, Facebook co-founder Eduardo Saverin notoriously saved a bundle by expatriating to Singapore before Facebook went public -- even though he publicly claimed that taxes had nothing to do with the move. For those who have an inheritance coming due, consider using a foreign trust or setting up in a country with no estate or inheritance tax, such as Singapore or St. Kitts, before dropping your U.S. citizenship.
But few people come in looking to go to the lowest-tax jurisdiction, lawyers and advisors say. For starters, a 1996 law permanently bars re-entry to any person who renounces his citizenship for the purpose of avoiding taxation, even though proving such motivation has made enforcement difficult.
The logistical and lifestyle hassles are, in contrast, very real. Anyone who renounces his citizenship won't be able to re-enter the country without a visa; they'll have to stand in the long lines at JFK for noncitizens, a fact one lawyer says was enough to dissuade a client who would have saved millions by expatriating. Expatriates then have to be mindful of the days they spend in the U.S. If the total of all the days in the current year, one-third of the days in the prior year, and one-sixth of the days in the year prior to that exceeds 183, the ex-pat runs afoul of "substantial presence" language, and the IRS can tax them again.
It's self-evident but probably worth stating that you first have to have established residency or citizenship elsewhere before dropping your U.S. citizenship, since being stateless essentially means not being able to board a plane and even come back to the U.S., which is why it's good to know that there are countries out there that offer residency in return for investments in property or local businesses.
The Caribbean island federation of St. Kitts and Nevis actually offers citizenship through investments of at least $400,000 in designated local real estate and the resulting taxes and fees, in the nation, or alternatively at least $250,000 in charitable contribution to its Sugar Industry Diversification Foundation. Processing time is usually about three months, but islands like these -- or even tax-friendly countries like Panama or Costa Rica -- are typically not the best fit for ultrahigh-net-worth clients used to a certain lifestyle, Kalin says.
Instead, some wealthy Americans move north to Canada, which offers a five-year tax exemption on non-Canadian income and citizenship as quickly as in three years. That was such a sweet deal, Canada had to stop accepting new residency applications for this fast-track immigrant-investor program, as it tries to deal with the backlog and reassess how it handles the interest, Kalin says.
The United Kingdom also has been an attractive destination for the world's millionaires looking for just residency rather than citizenship; the U.K. allows its "nondomicile residents" to live, say, in London, while not paying tax on any income earned outside the U.K. The offer is a little less sweet after the rules changed a few years ago; such residents must now either pay an annual remittance of 30,000 to 50,000 pounds ($45,786 to $76,310), based on length of residency, or pay taxes on worldwide income, says Michael Davis, a partner at international accounting firm HW Fisher & Co. in London.
More of these thousand-cuts to tax loopholes are popping up even in island havens, which are also looking to trim their fiscal deficits and raise revenue. St. Kitts and Nevis recently instituted a value-added tax, and a tax overhaul could be in the cards for the Bahamas. Few expect wealthy foreigners to be the target of these changes, but remember: We all live in a deficit-driven world. Capturing income from tax havens is seen as a win-win situation for revenue-hungry countries across the globe, creating one of the most volatile times for tax policy in decades, says Ronen Palan, head of the department of international politics at the City University London.
Given the uncertainty and logistics, maybe it's wiser to follow the stream of sports celebrities and hedge-fund executives heading to Florida. After all, it's sunny, there's no state income tax or estate tax -- and you get to keep your passport.
Best of the Havens
While Americans are taxed on worldwide income, and overseas tax advantages have been squeezed, there are still a few havens that offer sweet deals in certain circumstances. Americans with a big payday from an overseas company coming due can cut their taxes by first moving abroad and dropping U.S. citizenship.
| Top Resident | | Sales/ | | | | |
| Individual Income | Capital | Value | Inheritance/ | |
| Country | Tax Rate | Gains | Added Tax | Estate Tax | Comment | | |
| Bahamas | 0% | No | No | No | A sales/property tax possibly on the table |
| St. Kitts/Nevis | 0 | 20% on assets within country | 17% | No | Citizenship for investment. No residency requirement |
| Singapore | 20 | No | 7 | No | Visas for minimum $2.5 million investment |
| Monaco | 0 | No | 17 | In some cases where local property involved | Expensive. Citizenship hard, but residency quickly available |
| Costa Rica | 15% for salary; 25% on business income generated within country | No, but some exceptions | 13 | No | Not the best match for wealthy lifestyles |
| Panama | 25% on income generated within country | 10% | 7 | No | Poor infrastructure/services for the wealthy |
| Source: Marcum LLP/Henley& Partners |