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Many US citizens that have considerable wealth or that are just "retired" move overseas in an attempt to avoid having to pay US income tax. Some revoke their US citizenship and some just move without notifying anybody. The plan is to take advantage of the tax treaties with foreign countries and pay less income tax. If you follow the law, you will find out that it doesn't work, because the deck is stacked against you.
US citizens are taxed on their worldwide income and living in a foreign country is not going to give you relief from US taxation. You will be required to file a tax return, just as you did when you lived in the US.
US citizens revoking their US citizenship that have annual incomes of $100,000 or a net wealth of $500,000 will be presumed to have moved to avoid US tax, regardless of their actual motivation. This invokes the "penalty tax" under Internal Revenue Code 877. The burden is on the taxpayer to overcome this rebuttable presumption, and the Internal Revenue Code Section 877 alternative tax would then apply to them for the next 10 years. Yes, even though you have revoked your citizenship, if 877 applies to your facts and circumstances, you will be required to file a US tax return for ten years after leaving the country. Foreign source income is usually excluded from this section 877 tax.
What about the tax treaty of the foreign country? Well, most treaties reserve to the US, the right to tax its citizens without regard to the treaty and a "citizen" defined in these treaties usually includes former citizens.
US citizens losing citizenship are also required to file a statement with the State Department or Federal Court, providing financial information relating to net worth, residency, citizenship, and other personal financial information. If you don't file the required disclosures, you are presumed to be within the regime of section 877 and will be subject to the tax.
Hey, i'll just transfer my assets to a foreign corporation and avoid this mess, will that work? First of all, don't be duped by these tax planning kits that teach people how to avoid paying US tax, the IRS has already been there. Former US citizens that contribute property to a foreign corporation within 10 years after expatriation and 5 years before, will be taxed as if the taxpayer still owned the property under section 877.
The risks of innocent costly mistakes are high when dealing with offshore accounts and trusts especially after the recent passage of the Heroes Assistance and Relief Act “HEART” of 2008. If you are considering expatriating in the near future or are living abroad and gifting to children within the US, you most likely will fall under the provisions of this new legislation. You should familiarize yourself with the FBAR rules concerning foreign account disclosures, and the rules under IRC 877 dealing with expatriation to avoid us taxation.
If you have overseas bank account(s) that have combined balances of over $10,000 at anytime within the calendar year, then you must file a form TD F 90-22.1 (FBAR) by June 30 of the following year to: Department of the Treasury Post Office Box 32621 Detroit, MI 48232-0621. Extensions to file this form are not granted and the filing of this form is not related to the filing of your tax return.
So, can transferring assets offshore protect you from paying taxes? Not even remotely, the IRS
can make you disclose your off-shore accounts and trusts, by forcing you to sign waivers to allow the
IRS to obtain financial records from foreign banks and institutions. If you don’t sign, you go to jail
until you change your mind, U.S. v. Spearbeck, 80 AFTR 2d. In Spearbeck, a U.S. District Court
found there was no right to privacy, and ordered the taxpayer to sign several consent directives,
allowing the IRS to obtain their financial records from foreign institutions. A foreign jurisdiction's
secrecy laws are of little protection against the IRS.
The reporting and disclosure rules concerning offshore accounts and trusts are ominous to say
the least, requiring disclosure filings for the settlor, fiduciary, beneficiary and responsible parties
connected to the offshore trusts and accounts.
What happens if I have an offshore bank account that has no income, what can the IRS do for
failing to disclose the account? Well, the IRS can seize the account and levy 30% of the account
balance as a penalty under the law. The IRS can prosecute you for tax evasion, or they can assess penalties and interest for failure to file the required disclosure forms, which can be significant. Additionally, if the account pays interest and you have a credit
card attached to the account, you may have violated criminal provisions of the Federal Code and
your name may be on the list along with hundreds of thousands of other US citizens that the IRS
recently acquired from offshore banking institutions. Aside from this, there are jeopardy provisions in
the IRS code that suspend your due process rights in situations where taxpayers under investigation, transfer or possesses assets offshore which indicate to the IRS that there is a collection risk, allowing for streamlined seizure and levy action.
If you own foreign property, you may have an interest in a foreign entity that you are also required to disclose under the law.
Internal Revenue Code Section 911 (IRC Sec 911) allows for an election to be made, to exclude up to $91,500 in foreign earned income for the 2010 tax year. You must file a form 2555 with your tax return, claiming the election. Although the election is supposed to be made pursuant to a timely filed tax return with extensions (form 2350), there is a provision within the Treasury Regulations that permit late filings to be accepted. Regulation Section 1.911-7 describes the procedures necessary to file the form 2555 with your delinquent tax return to obtain relief. The total earned income is reported on line 7 of your form 1040 and the exclusion amount is then subtracted as a negative number on line 21.
Not all income will be excludible under IRC 911, because the some income, such as income earned from US Government entities, is not excludible. There are other restrictions and tax benefits to working overseas as well, such as housing allowance exclusions and
a person considering working overseas should read section 911 to become familiar with the rules. See Working Overseas.
Do I have any other option if my election is denied? Yes, you can claim the foreign income taxes that may have been withheld from your foreign wages as a credit or deduction against your US income tax. File form 1116 to obtain the credit and file it with your income tax return, listing the credit on line 47 of your form 1040 tax return.
The Internal Revenue Service publication 54 has valuable information regarding the filing requirements for individuals working and living overseas.