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DEVELOPING A STRATEGY TO NAVIGATE THE EXPATRIATION PROCESS 

DEVELOPING A STRATEGY TO NAVIGATE THE EXPATRIATION PROCESS 

INTRODUCTION – WHY EXPATRIATE? 

Americans tend to be a relatively patriotic group, even when life’s journey takes them overseas to live. However, as many Americans become settled over time in a new country, it is only natural that they adapt to the culture, the language, the environment, etc., and adopt a new country as their “home.” Many of our expat clients acquire dual citizenship after spending significant time in a new residence country, or they are able to acquire a second passport even faster due to the nationality of their parents or grandparents. 

Unfortunately, and quite unfairly, the retention of U.S. citizenship often then becomes a special burden to them, because of the unique laws of the United States that base income tax residency on citizenship, not on actual residency. Accordingly, the U.S. “dual national,” who may feel the ties to the U.S. ever fading, is also a “dual tax resident,” meaning that they are also subject to income taxation on worldwide income, from all sources, in both their new “home” country and the United States. Moreover, should they choose to gift wealth during their lifetime, or bequeath their wealth to others at death, the gift, estate, and/or inheritance tax laws of both countries may stake a claim to tax these wealth transfers.

COMPLICATIONS FOR LONG-TERM U.S. RESIDENTS

There is another, larger group of U.S. taxpayers that may find themselves in this same situation: long-term U.S. residents. These are noncitizens that held a U.S. green card and lived in the United States for eight years in any 15-year period. Once you become a long-term resident, U.S. tax residency permanently follows you when you leave the United States, whether the long-term resident returns to their home country or elsewhere. They may let their green card expire, but the tax residency is not so easily shed.

SEVERING TIES WITH U.S. TAX RESIDENCY

There is a way out for both the U.S. citizen abroad and the U.S. long-term resident abroad that wants to sever ties with their burdensome U.S. tax residency: Formal expatriation, first through immigration filings renouncing long-term resident status (Form I-407) or citizenship (State Department Form 4079, Form 4080, Form 4081, and Form 4082), followed thereafter in a final U.S. tax resident form 1040 filing, accompanied with special expatriation tax filing form IRS Form 8854 (the Expatriation Statement). 

As a financial advisor who has had many client and prospective client discussions regarding the tax consequences, formal tax process, and tax-minimization strategies concerning expatriation, I will focus on the tax aspects of expatriation rather than get into the less familiar weeds of the surrendering of green cards or passports. I have only one point to emphasize on initiating the process through an expatriating act (Form I-407 or Forms 4079-4082): Do NOT go through with this until you have worked out the details of the tax filings and statements associated with expatriation, discussed below, and conclude that t

FORM 8854 AND “COVERED EXPAT” STATUS

Form 8854 is, essentially, a declaration of the expatriate’s complete balance sheet as of that day before they formally expatriated (the “valuation date”). It must include all the items that would be considered to be in their taxable estate if they were to have died on the day before they formally expatriated. Valuations of assets ranging the gamut, including real estate, art and jewelry, private business ownership interests, etc. must be attested to by licensed appraisers, while pensions, retirement accounts, and brokerage accounts must be listed, with their market values as of that same date. In addition to itemized valuations as of the valuation date, cost basis information must also be provided, for reasons that will be made clear below. Moreover, the expatriating individual must also make an attestation that they made full, complete, and accurate tax filings to the U.S. Department of Revenue for the last five years.

The expatriation statement, tax returns over the preceding five years, and personal attestation of complete transparency and accuracy will help determine the most critical element of expatriation, namely, whether the expatriating individual will be deemed to be a covered expatriate. This status will largely determine the financial consequences of expatriation, now and into the future. If covered expat status is avoided, the expatriating individual will pay their last U.S. federal tax bill as a tax resident (reporting worldwide income) for the year (or partial year) before expatriating and then, thereafter, would only be liable for U.S. taxes on U.S. source income, and subject to the U.S. tax withholding rules that apply to non-U.S. persons. 

However, should the circumstances trigger the key status as a covered expatriate, additional financial obligations ensue. First, the covered expatriate will owe an exit tax, above and beyond ordinary income tax obligations, in the year of expatriation. More details of the exit tax may be the subject of an article focusing on this particular subject, but, to summarize:

  • The exit tax is calculated as if the expatriating individual sold all of their assets provided on Form 8854 the day before expatriating, meaning that all unrealized gains at that time are now, in fact, realized. This is subject to a special exemption on the first $737,000 of realized gains (2020, adjusts annually); and

  • For retirement accounts, the exit tax is calculated as if the expatriating individual took full distribution of the pension, deferred compensation plan, retirement plan, or IRA account. As this is ordinary income to the expatriate, the capital gains exemption above does not reduce taxes owed from these implied distributions. For qualified retirement plans like 401(k)s, but not IRAs, there is an ability to defer the tax from this implied distribution to when actual distributions are made, subject to special conditions, including application of the 30% withholding tax on each distribution and the waiver of the future right to reduce this withholding rate by tax treaty.

The burdens do not stop with the exit tax, either. Additionally, the covered expat will be deterred in the future from gifting or bequeathing assets to U.S. tax residents, such as family members that do not expatriate. Gifts and bequests from a covered expatriate are not entitled to a gift or estate tax exemption and are taxed at the maximum tax rate by law on the entirety of the gift or bequest (currently 40%, or even 80% on generation-skipping gifts or bequests). This tax is paid by the beneficiary/recipient U.S. tax resident.

COVERED EXPAT STATUS “TEST”

By now, given the punitive taxation that accompanies the covered expat status, it is obviously critical to understand the test for acquiring this unfortunate status and the exceptions that otherwise prevent the triggering of covered expat status. Basically, the covered expat status is triggered by any one of three tests – fail any of the there following tests, and the expatriating individual shall be deemed a covered expat:

  • The Compliance Test – As mentioned above, the expatriating person must certify they have been compliant with federal tax laws over the past five years. Failure to certify and/or failure to submit adequate evidence to substantiate compliance will result in covered expat status. Expect extra scrutiny of these tax forms during the process.

  • High Income Tax Liability Test – Looking at those past five years of tax returns, the expatriating individual will be deemed a covered expatriate if their average federal income tax liability over the five-year period exceeds $172,000 (2021, adjusted annually). Do not confuse this with annual income or adjusted gross income – the standard is an actual tax liability on average per year exceeding $172,000, which implies high earnings and/or significant capital gains realization during part or all of those five years.

  • High Net Worth Test – Looking at the balance sheet of the individual taxpayer, as submitted in Form 8854, including substantiation of the valuation of assets and liabilities, if the expatriating person’s net worth on the valuation date exceeds $2 million, the expatriate shall be deemed a covered expat. Remember, joint assets should be apportioned between individuals, so this is an individual net worth threshold, not a joint threshold. Unlike the high-income tax liability test, the $2 million threshold does not adjust to account for inflation.

It should come as little surprise that this third test, high net worth, is more often the test that triggers covered expat status, especially considering that net worth covers every item that would fall within the expatriating person’s taxable estate. However, getting around either of those tests’ thresholds may be a matter of timing, or, especially in the case of the high net worth test, a matter of strategically repositioning family wealth among family members.

There are a couple of important exceptions for those that would otherwise fail the covered expat tests:

  • Dual nationals from birth (oftentimes considered “accidental Americans”), who have lived in the U.S. less than 10 of the previous 15 years before the year of expatriation, who continue to be citizens and tax residents of that other country for which they hold citizenship; and

  • Citizens who expatriate before the age of 18 ½, who were resident of the United States for less than 10 years.

Remember that all expatriating persons must still file Form 8854 and go through the tax process of expatriation, even though these two groups may do so without fear of being deemed a covered expatriation.

To generally recap the tax rules regarding expatriation – the procedure for eliminating tax residency based on citizenship or long-term residency status – the expatriating person must commit an expatriating act and complete the tax filing and certification process outlined above. For the citizen, this will involve forms and procedures to formally terminate citizenship, e.g., surrendering the U.S. passport. For a long-term tax resident, this might involve voluntarily surrendering your green card. Letting a green card expire without renewal, by itself, may not be an expatriating act. Therefore, the completion of Form I-401, entitled “Record of Abandonment of Lawful Permanent Resident Status,” is critical to establish intent to expatriate for long-term residents. This will then trigger the obligation to complete Form 8854 and certify compliance with U.S. federal tax laws. 

During this tax process to conclude expatriation, a critical factor determining the real cost to get out of U.S. tax residency will be whether covered expat status is triggered. Because the consequences of that status can be so punitive in the present (exit tax) and thereafter to the American beneficiaries or heirs, it seems only logical to suggest that the expatriating person get some meaningful tax and financial advice well in advance of committing the expatriating act. In particular, if there is any real possibility that the three tests for covered expatriation could be met, and the two exceptions for covered expats will not apply, then developing and implementing a comprehensive strategy for expatriation with experienced financial and tax professionals may prove pivotal to navigating this process without creating unnecessary tax burdens for the expatriating person and their American families. 

HOW WE CAN HELP

At Walkner Condon, our international team of financial advisors is here to help guide clients that want to consider the possibility of expatriation. The first step of the process may be to determine what real tax advantage would flow from successfully expatriating. This requires an analysis of both U.S. and resident country tax laws and whatever tax treaties or compacts may factor in the distribution of tax payments by the client to each country. 

If there may be financial relief to be gained through expatriation, then an evaluation of whether the client would meet the covered expat criteria, or, importantly, whether there are steps necessary before expatriation to either (a) avoid covered expatriate status, (b) at least reduce the exit tax consequences, or (c) modify estate plans to reduce the gift and/or estate tax consequences flowing from the decision to expatriate. 

Ultimately, if a general strategy map toward expatriation is formulated, we’ll make sure that clients also get the tax and legal expertise needed to successfully implement that strategy and successfully navigate the complex rules of formal expatriation. It begins with a conversation, and we’re here to provide knowledge, support, and advice that is helpful and impactful. 

 

Note: We are not CPAs. Please consult a tax professional if you have any tax questions specific to your situation.

ABOUT THE AUTHOR

Stan Farmer, CFP®, J.D.

Financial Advisor

Stan Farmer is a member of Walkner Condon’s team of U.S. expat-focused advisors. He is a fee-only, fiduciary financial advisor who works with Americans abroad, wherever life takes them.

WEBINAR: Moving to Portugal as an American

WEBINAR: Moving to Portugal as an American

Let’s dive into financial life in Portugal as an American.

When people reach out to our team of US expat financial advisors, there’s a good chance they’re either living or planning a move to a certain place – Portugal. And it’s not just something we’ve seen. It’s something the Wall Street Journal & LA Times have written about, too.

So as Portugal continues to grow in its popularity for Americans moving abroad, we’re focusing in on the key components of such a move from a finance & investing lens. After all, those areas will impact your experience in Portugal, whether it’s two years or for the duration of your retirement.

Our team of advisors – Stan Farmer, CFP®, J.D; Syl Michelin, CFA; and Keith Poniewaz, Ph.D. – present and then answer questions in the second portion of the webinar. Questions before or after watching the webinar? Send us an email at [email protected].

You can watch the full replay below or on Walkner Condon Financial Advisors’ YouTube channel.

If you have any questions, we’d encourage you to submit them ahead of time using the button below.

Moving to Spain as an American: Financial Factors to Know

Moving to Spain as an American: Financial Factors to Know

When it comes to top destinations abroad for Americans and U.S. expats, Spain is certainly one of the favorite choices. There are roughly 40,000-50,000 Americans residing in Spain, depending on the source you reference.

For Americans moving to Spain, or thinking about such a move – whether it’s for temporary work for a U.S. company, a job that is based in Spain, or retirement – there are many financial components to consider. It’s not just as simple as leaving your U.S. finances behind when you board the plane.

Walkner Condon’s Keith Poniewaz, Ph.D., walks you through several of the key financial considerations to be aware of if you’re planning a move or even just thinking about one.

A financial advisor who works with U.S. expats, Keith covers Foreign Earned Income Exclusion (FEIE), trusts and inheritance, why the location of your investments matters, and more.

Is relocation from the U.S. to Spain in your future? You can schedule a meeting to discuss your details more in-depth with our team of U.S. expat financial advisors below.

American Abroad and Accounts Being Closed by Fisher Investments

American Abroad and Accounts Being Closed by Fisher Investments

We’ve recently heard from a handful of Americans abroad who had either moved outside of the United States or updated their U.S. address to an international one, resulting in Fisher Investments closing their accounts (or informing of the intent to close their accounts). 

Now, this closing of accounts is nothing new when it comes to Americans moving abroad and trying to seamlessly move their investments with them. But this is the first we’ve heard of the account issues with Fisher Investments for U.S. expats. However, regardless of the brokerage, we’ve helped seek out solutions for U.S. expats in similar situations. 

Below, we outline some of the key points of the conversations we have related to this topic. 

Why Exactly Are My Fisher Investments Accounts Being Closed? 

In the case of Fisher Investments, it’s unclear whether the accounts are being closed based specifically on the country of residence or if it’s being done for all Americans abroad. Though, as we’ve mentioned, this is a common obstacle for U.S. expats with many of the main brokerages, including Wells Fargo, UBS, and others. Simply put, this issue tends to boil down to compliance and the costs, and other burdens, inherent in maintaining that compliance in an international landscape. The Foreign Account Tax Compliance Act, or FATCA, along with many other financial regulations related to anti-money laundering have played a role in this higher compliance environment. If you’re looking for more in-depth information on the subject, we wrote extensively about the difficulties of opening accounts as a U.S. expat in this whitepaper

And it’s not just the financial component. As privacy regulations continue to tighten abroad, it’s also become increasingly more challenging to advertise and acquire new clients that live outside of the U.S. Not only is the cost of doing business more onerous, but the cost of growing that business is also compounded by compliance. 

What Brokerage Should I Use Now?

Unfortunately, there’s no one-size-fits-all solution when it comes to a brokerage for Americans abroad. It’s a vast landscape from a regulatory standpoint, so some brokerages serve certain areas while others choose not to. Charles Schwab, Interactive Brokers, and TD Ameritrade all provide services to U.S. expats, though it can vary by country. We dive more into the various brokerage options, and their pros and cons, for Americans aboard in this piece

How Walkner Condon Can Help

Our team of financial advisors – Stan Farmer, CFP®, J.D.; Syl Michelin, CFA®; and Keith Poniewaz, Ph.D. – works with U.S. expats and understands the intricacies of financial planning for Americans abroad. They help our clients with wealth management, guiding them through hurdles of currency, taxation, and country-specific regulations and building investment portfolios attuned to their specific needs and risk tolerance. You can learn more about the various subjects impacting U.S. expats in our Expat Investment Guide

If you have any questions, don’t hesitate to send us an email here or book an appointment with one of our advisors.

Five Things for Americans to Know Before Moving to the United Kingdom

Five Things for Americans to Know Before Moving to the United Kingdom

With our historical links and common language, it is no surprise that hundreds of thousands (at least 200,000) American citizens reside in the United Kingdom. London has long been a truly international city and many Americans live and work in the greater metropolitan area. In my professional experience, more U.S. expats in the United Kingdom choose to remain in the UK than may be the case in any other foreign country. In fact, many clients come to identify as Brits and hold U.S./UK dual citizenship. 

However, whether you are considering a short, intermediate, or long-term move to the United Kingdom, there are a variety of planning topics that are best considered prior to making the move. In this blog, I discuss five key issues, but there are many, many more unique tax, estate planning, and investment issues that Americans in the United Kingdom may have to deal with once they become a resident in the United Kingdom. Each one of these issues below would merit a separate article, so consider this a cursory examination of these five topics that hopefully lead to further inquiry and discussion with your accountants, attorneys, and/or financial planners.

UNDERSTAND THE DIFFERENCE BETWEEN REMITTANCE BASIS AND ARISING BASIS TAXATION

Unlike the United States tax policy of taxing its citizens on their global income regardless of where they reside, most countries, including the UK, subject only those who are tax residents of that country to income taxes on both their country-sourced and non-country-sourced income (i.e., their worldwide income). To attract affluent foreigners and foreign companies to the UK, the UK has created a temporary tax status for non-UK nationals who chose to become residents of the UK called the “remittance-based” election. 

Accordingly, during the first seven years of UK tax residency, a non-UK national may elect the remittance basis on their UK income tax return, and thereby pay UK income tax only on two types of income: (1) UK-sourced income, and (2) non-UK-sourced income that is remitted to the United Kingdom. Remitting generally means that the funds are physically moved to the UK or used to pay UK obligations or purchase goods, services, or other assets in the United Kingdom. This election can be freely made for the first seven years; but, there are substantial fees/taxes paid to the HMRC (Her Majesty’s Revenue & Customs) to extend that privilege for a limited period (up to eight more years) thereafter. For those that do not elect the remittance basis, or for those whose remittance-basis term has expired, UK taxes income on the “arising basis,” meaning simply that all income from all sources (foreign and abroad) is taxed in the year in which it is received by the taxpayer.

At first blush, remittance basis sounds like a proverbial no-brainer for any expatriate that will derive any income from outside of the UK, whether that income is earned through business conducted outside of the UK, earned through passive investments in real estate, stocks, bonds, etc., or otherwise is characterized as non-UK-sourced income. However, the decision to elect the remittance basis in any of those initial seven years of UK tax residency is one that should be very carefully considered. Without going into considerable detail (and the rules surrounding remittance taxation contain meticulous details) the remittance basis can create accounting headaches, perhaps even nightmares, whenever funds are eventually remitted to the UK and the UK taxes come due on that part of the remitted funds that are attributable to income earned during the period in which remittance basis was claimed. The process of attribution involves what has come to be known as the “clean capital ordering rules,” and pitfalls abound when trying to track and trace the underlying UK tax characteristics of offshore funds (in particular investment accounts) when some of those resources are remitted to the UK. 

Accordingly, there are circumstances where remittance basis makes perfect sense. To the extent that:

  • The U.S. expat is confident that the UK stay will not evolve into something longer-term or even permanent, and/or;
  • The U.S. expat has considerable non-UK-sourced income (e.g., from a very large investment within a U.S. taxable brokerage account, or perhaps through partnership income in a global concern where only a fraction of earned income is attributed to UK sources);

then remittance basis should be very seriously considered to lessen the UK income tax burden. Conversely, where the U.S. expat has modest income from non-UK sources or where the UK tax residency may become longer-term or even permanent, then the calculus may well favor UK income taxation on the arising basis from the onset of becoming a UK tax resident. In all cases, this is a decision facing all Americans moving to the UK and should be carefully contemplated with the advice of experienced professionals.

PFIC AND UK TAX RULES FOR “OFFSHORE FUNDS”

It is fundamental that American expats, who obviously live and transact outside of the United States, understand the perils of “offshoring” their taxable investments. By offshoring, I mean owning foreign-registered pooled investments, such as ETFs that are not registered with the SEC and trade predominantly on foreign securities exchanges, mutual funds that are registered with foreign financial regulators and are not subject to U.S. laws and regulations, as well as foreign private equity funds and hedge funds (both of which are usually organized as limited partnerships). The IRS has created special regulations regarding the tax treatment of such foreign pooled investments, known as the “passive foreign investment company” (or “PFIC”) rules. 

A detailed discussion of how these offshore funds are taxed in the U.S. is beyond the scope of this article. For our purposes, it is simply important to understand that “offshore” funds lose their capital gains character because of the PFIC rules, and, therefore, all gains are taxed as ordinary income. That’s for starters – with income recharacterization to prior years in the holding period, interest, and penalties, the tax rate could be 50% and, in some cases, even higher! The bottom line: buying foreign mutual funds, ETFs and other pooled investments outside of a treaty-recognized foreign pension is usually tax toxic to U.S. tax residents.

So an American living in the UK would do well to avoid the temptation to “go native” and open brokerage accounts in the UK and invest in non-U.S.-registered funds. Can the American expat then avoid offshore tax rules by just keeping their investments in the U.S. and purchasing U.S. mutual funds or ETFs? For the American expat in the UK, the answer is usually “NO,” because the UK has similar tax rules with regards to offshore funds and, from a UK perspective, U.S. mutual funds and ETFs are offshore funds. The general HMRC tax rules in the UK therefore would deprive gains on the sale of these offshore funds of the lower and more favorable capital gains rates and instead levy taxes on realized gains at ordinary income tax rates, which tend to be higher than U.S. ordinary income tax rates. What a mess the U.S. expat investor might find themselves in trying to navigate the offshore funds rules of two different national tax authorities!

One way the U.S. expat might avoid these onerous tax rates would be to avoid “pooled” investments by just buying individual securities and building a fund-free portfolio of individual stocks and bonds. Naturally, this may be an imperfect solution at best for investors that don’t have the capital to adequately diversify such a portfolio. Moreover, even with ample capital to do so, most investors have their own careers, families, and social lives to manage and don’t want to be their own portfolio managers. 

Fortunately, the HMRC’s offshore funds tax rules do provide an important exception: where the foreign fund provides adequate accounting through reports sent annually to the HMRC, investors in these offshore “reporting funds” will be exempted from the special tax rules and will be entitled to capital gains treatment on gains generated from these reporting funds. Although the vast majority of U.S. mutual funds and U.S. ETFs do not qualify as reporting funds in the UK, there are enough decent U.S. funds that are in fact UK reporting funds that a fairly quality, low cost, and well-diversified portfolio can in fact be constructed. The main challenge is scouring the HMRC’s spreadsheet with thousands of reporting funds and identifying those that are indeed U.S.-registered. Beware the foreign “clones” of U.S.-registered funds that carry the same names of their U.S. counterparts but are, in fact, PFICs!

UNDERSTAND THE INTERPLAY OF U.S. AND UK RULES REGARDING RETIREMENT ACCOUNTS, INCLUDING THE INCOME TAX TREATY

There are some advantageous and truly cooperative nuggets in the income tax treaty (and the technical explanation thereof) between the United States and the United Kingdom, particularly in the area of retirement accounts or “pensions.” For example, because of the treaty, distributions from a U.S. Roth IRA in retirement will enjoy the same tax-free qualities for a UK tax resident (expat or otherwise) as they do for domestic American taxpayers. Additionally, those horrid PFIC and Reporting Fund rules discussed in the previous section will be irrelevant to investments in retirement accounts in either country so long as the treaty benefit is claimed. There are other special rules regarding the special tax-free 25% lump-sum distribution from a UK pension that may benefit a former U.S. expat that participated in a UK pension scheme but thereafter returns to the U.S. before taking the lump-sum distribution. It is critical to work with advisors that can help the U.S. expat position their accounts to truly navigate the tax rules and take full advantage of these types of beneficial treaty provisions.

Unfortunately, for high-net-worth individuals, there have been severe limits put in place in the UK in recent years on how much can be contributed in tax-advantaged pension schemes. These newer rules tend to severely limit the contributions by and on behalf of higher earners in the UK to their company pension and even personal pension (SIPP) accounts. Interestingly, these rules will also dramatically affect the tax deductibility on UK tax returns of contributions to U.S. qualified retirement plans as well. Therefore, for Americans working and earning in the United Kingdom, it is particularly crucial to get the input of a UK tax accountant to assist in determining how much should or can be contributed to retirement plans and pensions regardless of where they are held for each and every UK tax year. Moreover, U.S. retirement contribution eligibility rules, rules on the deductibility of retirement plan contributions, and so forth require the U.S. expat to also discuss all (not just domestic) retirement plan contributions with their U.S. accountant to ensure that the investor’s strategy is tax optimal under U.S. tax rules, too. 

“COMMON LAW?” – CAUTION WHEN BRINGING A U.S. TRUST WITH YOU TO THE UK

Trusts, like most estate planning issues and tools, are a creature of local law. It is a common folly of many expats, and even domestic U.S. attorneys, to believe that an estate plan carefully crafted under the laws of a particular state in the U.S. can be taken abroad and continue to operate as intended. It usually won’t, and, in some instances, a good domestic estate plan may well backfire spectacularly when the family, or one or more of its members, moves abroad. That’s a very broad and general statement, but consider it is based on my experiences as an expat advisor who has witnessed the unintended consequences materialize from a domestic estate plan when the legal and tax issues unfold in the cross-border/expat environment. To put it bluntly: when you move somewhere else, new rules apply, and it is highly unlikely that the original estate plan was crafted with any of the new rules in mind.

Another broad and general statement can be made about trusts: The more sophisticated an estate plan, the more likely that it will backfire in the cross-border environment and the more costly the unintended consequences that will materialize. However, we’re talking about moving to the United Kingdom – the birthplace of trust instruments– and one might think that a U.S. trust would always work just as well in the UK as it would in the domestic U.S. scenario, but one could pay a dear price for such an innocent assumption. 

For example, a U.S. expat family has utilized trusts that provide that one or more of the expat family members who serve as trustee. If the trustees of a U.S. trust become UK tax residents, the trust becomes a UK tax resident. From the UK perspective, the trust has been “on-shored” so to speak, and the trust is now a UK tax resident. Things can get even more complicated from there: what if the trustee(s) returns to the United States thereafter? From the UK legal and tax perspective, this could represent an “off-shoring” of the trust – the trust will no longer be characterized as a UK domestic trust, but as an offshore trust. The tax implications that flow from offshoring a trust are usually that an “exit tax” must be paid, which means that all unrealized gains from trust property are thereby realized and capital gains from the recognition of gain are now owed to the HMRC. 

Quite often, a few minor (or less minor, depending on the trust) changes to the trust could have been made before the trustee(s) moved to the UK, which may have prevented this issue from ever materializing. If minor changes do not suffice, the trust might need to be dissolved prior to the move. Accordingly, when family wealth is in any manner managed or protected by trusts, some legal advice (i.e., an estate plan review) from an estate planning expert in the future country of residency (in this case, the United Kingdom) can be critically important.

UNDERSTAND UK “DOMICILE” AND IT’S IMPLICATIONS

U.S. and UK income taxes differ in a variety of ways (e.g., the tax liability on the sale of a primary or secondary residence) and there may be a substantial income tax-rate divergence between the two countries for a given U.S. expat living in the United Kingdom, depending on the expat’s current income. However, the taxation of wealth transfers (gifts during your lifetime, or bequests/transfers upon death) should also be considered as the expat accumulates wealth. Like the U.S, the UK may tax gifts made during the life of the donor and will also tax the estate of a decedent before their wealth is transferred via their estate plan. Unlike the U.S., there may be income tax owed by the donor (known as a “deemed disposition”). Here, the opportunity for divergence between U.S. and UK tax exposure can be quite profound, due largely (but not exclusively) to the different exemption levels under the current tax laws of both countries. 

For example, in 2021, the United States provides a very generous lifetime personal exemption for gift and estate taxes of $11.7 million ($23.4 million for a U.S. married citizen couple). In stark contrast, the UK individual estate (IHT) exemption is only £325,000 (£650k for a UK domiciled couple), with possibly an additional allowance of £125,000 for the decedent’s primary residence. That differential puts a tremendous premium on estate tax planning and financial planning in general. 

A crucial part of determining the current and future UK IHT tax exposures for a U.S. expat family centers on whether the family, or individual members thereof, have voluntarily or involuntarily attained the status of a UK domicile. If a person is determined to be domiciled in the UK, then their worldwide estate would be subject to IHT. If tax residency and entrenchment have not yet crossed the threshold of domicile, then only the UK situs property will be subject to potential IHT tax liability. Domicile is a common law term that combines residency and long-term intention. Accordingly, there is a degree of subjectivity when determining whether an American expat has become entrenched in the UK to the point that this key threshold has been breached. 

It can be difficult to ascertain in close cases whether an expat’s behavior demonstrates enough intent to assure an HMRC finding that the expat is a UK domicile. On the one hand, if an expat moves to the UK on a work assignment (secondment) and spends five years living with family in a home that is rented by the company, it is certainly less likely that the status of domicile has been achieved. However, if that expat and family buy a home, apply for citizenship, sell their U.S. home, and effectively cut most ties with their old American community, the probabilities increase dramatically that the family would be considered UK domiciles. 

To combat the efforts for long-term UK tax residents to evade domicile status, the UK has created a “deemed-domicile” status or threshold based on the more objective criteria of how many years an individual has held UK tax resident status. Under the rules that went into effect in 2017, once the expat has held UK tax residency for 15 years of a 20-year period, that expat is thereafter deemed a domicile of the United Kingdom, regardless of any other circumstances. Beyond IHT exposure, this will also mean that the expat can no longer utilize the remittance basis of taxation (which requires substantial payments beyond year seven but is now unavailable at any cost after year 15).

Prior to obtaining domicile, steps can be taken to protect non-UK wealth from IHT exposure, but such planning is going to require retaining very specialized estate planning counsel. Given that the deemed domicile status is, in a temporal sense, the maximum but by no means a minimum time within which domicile can occur, an important first step for such planning would be to have counsel conduct what is sometimes referred to as a “domicile audit,” which may be a series of meetings and/or detailed questionnaires to first determine the current status of an expat, as well as determine what, if any, wealth might be strategically sheltered from the expat’s taxable (IHT) estate.

PLANNING AND INVESTMENT ISSUES ABOUND

Please consider this a very cursory examination of five key issues that should be considered and incorporated into your financial planning and your portfolios before completing the journey to live in the United Kingdom. This is by no means an exhaustive inventory, nor a complete examination of the financial, tax and legal issues within each area. It is our intention at Walkner Condon to enrich the expat communities around the world through sharing knowledge about such topics and to assist Americans who are or may be contemplating a move abroad in the near term or in the future. Through a little pre-move planning and strategic positioning, we believe that the transition to a new home can be less stressful and, ultimately, more rewarding. If you find these issues resonating with your personal situation, I, or one of my team members here at Walkner Condon, would be happy to schedule an introductory meeting with you.

Stan Farmer, J.D., CFP®️

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