During the first half of 2013 alone, the number of people who formally renounced their American citizenship reached 1,809, topping the previous annual high of 1,781 set in 2011. If this trend continues, 2013 will have more than double the national record for renunciations in a single year. Tax professionals point to the IRS’s crackdown on undeclared foreign assets as central to this escalating trend.Renouncing one’s citizenship might seem like an extreme countermeasure to avoid prosecution under the federal tax code, but some tax professionals believe that a number of wealthy Americans have chosen to “jump ship” in order to avoid the federal agency’s reach.
In the years following the September 11 terrorist attacks, the IRS has scaled up its enforcement of undeclared foreign assets. This includes the renewed enforcement of long-neglected foreign asset laws, as well as the creation of new laws aimed at leveraging steep penalties against tax delinquents in the United States and abroad.
Since the IRS began its campaign of aggressive enforcement, it has collected more than $6 billion in tax penalties from banks and individuals who knowingly concealed vast sums of money from the U.S. government. This includes the oldest bank in Switzerland, Wegelin & Co., which was found to have hidden more than $1.2 billion for American taxpayers. After pleading guilty to the charges leveled against it, Wegelin & Co. was forced to shut down. The IRS expects to collect an additional $5 billion in the coming years.
Still, the IRS has an uphill battle in front of it. Out of more than 7.2 million U.S. citizens living abroad and 13.3 million green card holders in the United States, the IRS has received only 825,000 foreign account reports in the past year. Many of these individuals remain unaware of the illegal status of their tax filings within the United States and may be forced to take measures to avoid prosecution in the near future. It is unlikely, however, that a majority of these individuals see renunciation as a viable option.
The thrust of the renunciation movement appears to be driven by wealthy Americans who stand to lose large sums of money or face imprisonment should the IRS turn its attention their way. In a high-risk balancing act, it might be possible for these individuals to shift their assets to a trust to reduce the overall impact of the exit tax. These individuals can then use the trust assets to buy a life insurance policy that would allow the transfer of those funds to heirs without special inheritance taxes. In this way, expatriation could be to their advantage.
Another way in which wealthy Americans might be able to avoid the IRS’s clutches is by transferring assets to a single individual. Once that individual expatriates, he or she can then redistribute the funds back to citizens within the United States tax-free by taking advantage of a foreign grantor trust. This is a risky endeavor, however, as the person who expatriates will have complete control of the combined assets in the trust, including the ability to revoke it and pocket the assets.
As the increases in expatriation continue, we expect to see an ongoing stream of wealth leave the country, out of the reach of the IRS and the U.S. government.