Tax attorney Seth Entin has fielded about a dozen calls since Jan. 1 from individuals or companies thinking about exiting the U.S. or moving assets abroad.
“I don’t think I’ve ever gotten more calls in this particular area,” said Entin, who focuses on international tax at Miami-based Greenberg Traurig. “A fair amount of the time I wind up telling people that it’s easier said than done, and if they try to do it, they may wind up in a worse situation.”
Exit taxes and other costs make it prohibitive for most high-income taxpayers and small-business owners to leave the U.S., though they may want to go because of higher taxes at the federal level and in states such as California. Those who expatriate must renounce their citizenship to avoid U.S. taxes and navigate several sets of Internal Revenue Service rules when setting up a foreign corporation.
A high-income couple worth $100 million whose assets have $50 million in gains may have a $10 million tax liability if they decided to leave this year, said Henry Christensen, a partner at Chicago-based McDermott Will & Emery who manages the firm’s international private client practice.
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While the number of people giving up their U.S. passports has been higher in the past few years than in the previous decade, the numbers are a small portion of the population. About 932 people gave up their U.S. citizenship in 2012, IRS data show. That compares with 1,781 in 2011 and 742 in 2009.
The U.S. taxes citizens on their worldwide income even if they live in another country. That’s why people give up their passports to avoid the IRS’ reach.
Top earners will incur higher taxes this year. Congress raised the maximum tax rate to 39.6 percent from 35 percent on taxable income exceeding $400,000 for individuals and $450,000 for married couples.
The increase is coupled with higher levies on capital gains and dividends for top earners of as much as 23.8 percent compared with 15 percent in 2012. States including California also have raised taxes on top earners. California’s tax on income of $1 million or more was boosted to 13.3 percent, the highest in the nation.
The U.S. government generally imposes an exit tax on high earners to discourage them from expatriating as a way of avoiding taxes.
For 2013, individuals with a net worth of more than $2 million, or with average annual income taxes exceeding $155,000 for the past five years, must pay taxes on the value of assets such as homes and stocks as if they were sold the day before they expatriated, according to the IRS. They can benefit from an exclusion of $668,000.
“If someone was timing an exit, you would want to do it before your assets appreciated,” said Suzanne Shier, director of wealth planning and tax strategist at Chicago-based Northern Trust Corp.
Eduardo Saverin, the billionaire co-founder of Facebook, renounced his U.S. citizenship before the company’s initial public offering last year to reside in Singapore. Saverin also had citizenship in Brazil, where he was born. He says that he didn’t renounce his U.S. citizenship for tax reasons.
The U.S. ranked 20th last year of 34 countries on a list of top statutory personal income-tax rates at 41.9 percent, according to the Organization for Economic Cooperation and Development (OECD). The ranking considered federal, state and local levies, said Maurice Nettley, head of tax statistics in the center for tax policy and administration at the OECD. Denmark led the ranking at 60.2 percent while the Czech Republic was 34th at 15 percent.
A family’s wealth may still be subject to U.S. taxes after expatriation, which is another deterrent to exiting, Shier said. If parents move to another country and leave money upon death to their children — who remained U.S. citizens — levies similar to the estate tax apply, Shier said.
Some deferred-compensation plan money and irrevocable nongranter trusts may be taxed when distributions are made in the future, she said.
The exit tax keeps people from giving up their passports and also limits how much time they can spend in the U.S. after they leave without having to pay further taxes, said Entin, of Greenberg Traurig. Several sets of IRS rules can have severe tax consequences for those setting up a business outside of the U.S.
If the owner of a limited-liability company establishes a foreign corporation conducting business in the U.S., it may have to pay several layers of U.S. income tax. Those include a top 35 percent corporate tax, a 30 percent so-called branch profits tax and as much as 43.4 percent tax on non-qualified dividends distributed to a shareholder, Entin said.
That would, in a worst-case scenario, bring after-tax earnings on $100 to $25.80, excluding state taxes, he said.
Stay and pay
By comparison, if executives kept the business in the U.S. and participated in it, they would pay a top rate of 39.6 percent on $100 of earnings, leaving them with $60.40, he said.
“That’s the most common showstopper I encounter,” he said. “There are real situations where it works and you can get a real benefit, but there are a lot of hoops and vetting to get through.”
It’s too early to tell whether higher tax rates Congress passed for this year along with added levies from the health-care law will motivate more top earners to turn in their passports, said Shier, of Northern Trust.
In the past most clients who renounced citizenship were green-card holders, dual citizens or those who had been living abroad for many years, Christensen said.
While people are talking about moving because of higher taxes, most are considering crossing state borders from high-tax states such as California or New York to places like Texas, Washington and Florida that don’t have state income taxes, Christensen said.
“It’s really not worthwhile for most people to give up their passports,” he said.