Meghan Markle, an American actress, is set to marry Prince Harry of Great Britain in May 2018 and will become a member of the British Royal Family. Even when she moves across the pond and becomes a permanent bona fide resident in one of several royal palaces, Ms. Markle will still be expected to file annual returns and pay taxes to the Internal Revenue Service of the United States. Boris Johnson, Great Britain's current Secretary of State for Foreign and Commonwealth Affairs and former Mayor of London, was born in Manhattan to British parents and has not lived in the United States since he was five years old. Yet, Mr. Johnson, a U.S. citizen by virtue of his birthplace, still continues to file annual returns and pay taxes to the IRS. How can this be?
The United States is one of two countries in the world (the other one being Eritrea) that taxes its citizens on the basis of citizenship, not residency. As long as you possess U.S. citizenship, you still be expected to pay U.S. taxes on all global income no matter where you reside in the world. This situation is based on an archaic law from the Revenue Act of 1862 that intended to punish men leaving the country to avoid military service in the American Civil War. This law persists to this day. No matter how high in British society that Ms. Markle and Mr. Johnson will rise, they cannot retain their U.S. citizenship without continuing to honor their tax liabilities.
Foreign assets and income create increased burdens on U.S. citizens for tax reporting purposes. If you have foreign financial accounts that had an aggregate amount of $10,000.00 at any time during the tax year, you must file FinCEN 114, Report of Foreign Bank and Financial Accounts (known as "FBAR") with the Department of Treasury by April 15th each tax year. Additional, you will also have to file Form 8938, Statement of Specified Foreign Financial Assets, each year if you live outside the U.S. and specified foreign financial assets are more than $200,000.00 on the last day of the tax year (or $300,000.00 at any point during the year). Certainly, the British Royal Family must be concerned about the prospect of Ms. Markle having to report royal financials and other secrets to the United States government. More likely than not, a diplomatic solution between the two countries will be reached should a tax issue with Ms. Markle arise. Most other U.S. citizens abroad will not be so lucky.
Fortunately, foreign income is subject to some tax breaks in the Internal Revenue Code. U.S. citizens are generally entitled to a credit against U.S. tax for amounts paid as taxes to foreign governments. Additionally, U.S. citizens living and working outside the U.S. may also be eligible for a foreign earned income exclusion that can exclude up to $104,100.00 in 2018 of earned amounts (e.g. wages and salaries) from taxable income. Furthermore, you may also be able to claim an exclusion from gross income of housing amounts if you meet certain criteria for maintaining a domicile in a foreign country.
So can I just renounce my U.S. citizenship to get out of my tax liabilities? Sure, but the Internal Revenue Service gets at least one more shot at you on the way out. If your average income for the previous five years was $162,000 or more in 2017, or your net worth is $2 million, or you fail to certify that you have complied with all federal tax obligations in the last five years, then you will be a "covered expatriate" subject to an "exit tax" on your property. Essentially, you will be subject to income tax on the unrealized net gain of all of your property as if you had sold it all at fair market value the day that you renounce your citizenship. It is similar to paying estate and gift taxes on your estate while you are still alive. The expatriation tax is required to be reported and paid with Form 8854 and a $10,000.00 penalty applies for failing to do so. Leaving the United States behind for good comes with a price.
If you are considering a permanent departure from the U.S., be sure you are fully advised on the federal tax consequences before making rash choices based on legal misconceptions.