Human Rights Law and the Taxation Consequences for Renouncing Citizenship
William Thomas Worster*
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Very few states in the world, including the United States, impose a tax on persons who renounce their nationality, and this practice implicates the human right of expatriation. While one might think that a person who gives up his nationality would no longer have any tax obligations to his former state of nationality, this expatriation tax, or “exit tax,” imposes a tax event and potentially continuing tax obligations for years to follow. It might even chill the practice of renunciation as a tax avoidance scheme. However, international human rights law provides that every person has a right to leave any country, including his own, and to renounce and change his nationality. This Paper will examine whether the U.S. exit tax regime violates the international human right of expatriation.
I. U.S. EXIT TAX REGIME
A U.S. citizen may renounce nationality and upon expatriation, the former U.S. national incurs a taxation consequence. When a person ceases to be a U.S. national, he or she also usually ceases to be a U.S. tax person, and thus the former national would no longer be subjected to taxation on his or her worldwide income, only U.S. source income, and would enjoy a lower rate on U.S.-source income. In an effort to reduce the attractiveness of renouncing nationality for tax savings, Congress has passed a number of tax measures specifically aimed at U.S. citizens renouncing nationality, including the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), the American Jobs Creation Act of 2004 (“AJCA”), and the Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART Act”).
The rules specially designed for expatriates subjected these former U.S. citizens to ten years of additional U.S. tax compliance. In those years, the former nationals were required to pay the higher of the regular tax regime or the special expatriate tax regime, which taxes U.S.-source income and income “effectively connected” with a U.S. trade or business, including investment portfolio income, interest, and capital gains from U.S. stocks and bonds. There was also a special estate tax on U.S.-situs assets and a gift tax on U.S.-situs intangible property.
These rules applied if the expatriate’s “principle purpose” in renouncing nationality was to avoid taxation. Initially, the burden of proving this purpose fell on the IRS, but the AJCA abolished entirely the need to prove any purpose for the expatriation. Following this change, any “wealthy” person who renounced nationality would have an objective intent to avoid taxes. “Wealthy” was defined as a person with an average annual tax of $124,000 for the previous five years or a net worth of $2,000,000. However, there are some exceptions for dual citizens from birth who have not had substantial contacts with the United States or were merely U.S. citizens by birth with neither parent being a U.S. citizen. These exceptions were lost, however, if the individual could not prove that he or she had been in full compliance with the Internal Revenue Code during the preceding five years or had been present in the United States for more than thirty days during any of the ten calendar years preceding expatriation and following the expatriation.
In 2008, Congress also enacted the HEART Act to impose a “mark-to-market” tax on citizens renouncing citizenship so that expatriates would continue to pay normal U.S. income taxes on all unrealized gains that exceeded $600,000 on their worldwide assets. In addition, the IRS would now tax distributions from certain retirement plans at any time, not limited to ten years following expatriation. There are similar exceptions for dual citizens with minimal connections to the United States.
*Lecturer, International Law, The Hague University of Applied Sciences, The Hague, The Netherlands; LL.M. (Adv.) in Public International Law, cum laude, Leiden University, Faculty of Law, Leiden, The Netherlands; J.D., Chicago-Kent College of Law, Illinois Institute of Technology, Chicago, Illinois; B.A., Modern European History, University of Kansas, Lawrence, Kansas.