Renouncing US citizenship is on the rise, driven by tax burdens, bureaucratic hurdles, and unique challenges for “accidental Americans.”
As recent data shows, nearly 6,000 Americans gave up their citizenship in the first half of 2020, marking a sharp increase.
This trend highlights the complicated tax policies and legal requirements that make holding onto US citizenship difficult for some, particularly those with dual nationality who reside abroad.
For the ultra-wealthy and accidental Americans alike, renunciation may appear an appealing solution to escape double taxation and complex financial reporting requirements.
Why citizenship renunciation is on the rise
Americans living abroad face an uphill struggle with double taxation rules, which require them to file and potentially pay taxes in both the US and their country of residence.
The US remains one of the few nations enforcing citizenship-based taxation, a system that demands worldwide income reporting.
While credits and exclusions reduce actual tax payments for many, the compliance costs and penalties loom large, leading some to explore renunciation.
According to government data, the number of US citizens renouncing their citizenship surged tenfold in early 2020.
These individuals face a long process involving costly paperwork, high fees, and potential loss of access to the US.
This rise is driven in part by “accidental Americans” who inherited US citizenship by birth but have little to no connection to the country.
Accidental Americans and tax pressures
Accidental Americans are a unique group of US citizens who might be unaware of their American status until informed by financial institutions.
Many foreign banks, fearing compliance with US tax law under the Foreign Account Tax Compliance Act (FATCA), decline services to American clients.
FATCA requires all foreign banks to report accounts held by US citizens, adding layers of complexity and compliance for banks and clients alike.
For accidental Americans with limited or no ties to the US, renunciation seems a practical solution.
The cost, estimated at $2,350, alongside an exit tax for those with significant assets, makes renunciation financially challenging.
The ultra-wealthy explore global options
High-net-worth individuals are also seeking alternatives to US citizenship.
Faced with high tax obligations on income, estate, and capital gains, some are renouncing citizenship as a tax strategy.
Wealth advisors report that the ultra-wealthy are increasingly investing in secondary citizenships in tax-friendly jurisdictions.
Programmes in Portugal, Malta, and the Caribbean allow for second citizenship by investment, offering these individuals an escape from US taxation without fully severing ties with the country.
The exit tax is particularly stringent for the wealthy, applying to those with a net worth over $2 million or an average annual income above set thresholds.
All assets, including retirement accounts, are taxed to ensure compliance before the IRS allows renunciation.
While acquiring a second passport can help, wealthy renunciants must carefully consider the consequences, as some may face re-entry restrictions to the US.
How FATCA and compliance costs fuel renunciations
Introduced in 2010, FATCA has been a significant factor in citizenship renunciations.
Intended to combat tax evasion, FATCA mandates extensive reporting on foreign accounts by both individuals and institutions.
Americans abroad have increasingly struggled with FATCA’s requirements, as it complicates even basic financial activities like obtaining a mortgage or opening a bank account.
Many foreign banks, deterred by reporting requirements, deny services to Americans, viewing them as high-risk clients.
For US citizens abroad, the administrative burden of annual tax filings, combined with the risk of penalties for non-compliance, adds further incentive for renunciation.
Process and pitfalls of renouncing citizenship
Renouncing US citizenship is a multi-step process. Individuals must secure citizenship in another country, make a formal renunciation at a US embassy, and pay both outstanding taxes and a fee (expected to drop from $2,350 to $450 soon).
For high-net-worth individuals, the IRS applies an exit tax on global assets, including IRAs.
Renunciation is a decision with lasting implications, including potential bans from re-entering the US.
While some may gain a second passport from countries with favourable agreements, others, especially those with passports from investment programmes, may face hurdles entering the US in the future.
While renouncing citizenship is an option for those seeking to escape US tax burdens, the trend remains niche, particularly among accidental Americans and the ultra-wealthy.
The broader issue lies in US tax policy, which imposes costly obligations on citizens living abroad.
Until there is a shift from citizenship-based taxation to residence-based models, experts predict that the number of Americans relinquishing citizenship will continue to grow, albeit incrementally.
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