By: (Eli Doron, Adv; Yaron Tikotzky, Adv, (C.P.A); Dr.Slomo Nass, Adv, (C.P.A
During the past few years, a growing number of Americans who are living outside the U.S are renouncing their U.S. citizenship. This phenomenon receives a new angle considering Israel's tax reform which went into effect recently (hereafter referred to as "The Israeli tax reform"), and has broadened significantly the tax breaks given to returning residents and new immigrants to Israel. This local legislation, alongside of the US sub-prime crisis that has led the IRS to tighten the enforcement on American citizens who are living outside the U.S, led the trend of American citizens who decide to immigrant or to return to Israel as residents, and simultaneously renounce their American citizenship, what makes Israel an ultimate tax haven for them.
Why should I renounce my American citizenship?
The U.S. is one of the few countries of the world which imposes taxes on the world-wide income of citizens and resident aliens, regardless of whether they live in the country or abroad. Thus, for example, an American citizen who lives in Israel since his childhood and hasn't been in his homeland for decades still has to meet the rigid requirements of the American tax law, which are enforced by the IRS. These laws require that American citizens living in Israel must report their annual income and assets in Israel, or in any other country, to the IRS. Furthermore, in the event that the tax liability of the American citizen in Israel is lower that his tax liability in the U.S, he must pay the tax difference to the IRS.
As if this was not enough, the complex tax system in the U.S makes it difficult for the American citizen to understand completely all his tax liabilities, including the sanctions that apply to him. It is important to emphasize that the civil penalty may cost up to 50% of the total amount of a citizen's unreported bank account. There's no need to mention that a citizen who have failed to comply with his tax liabilities might find himself wanted in the U.S for tax crimes, and even find himself facing a charge sheet.
Why should I renounce my American citizenship now, more than ever?
In the past few years, the IRS chose not to invest many resources in enforcing the laws that require every American citizen all over the world to submit a detailed report of his annual income during the year. This policy has changed since the US sub-prime crisis, when the need to increase the U.S revenues from taxation brought a severe change in the IRS's approach. The economic fluctuations in the U.S led the IRS to make a few significant steps in order to enforce the tax liabilities on American citizens living outside the U.S. These steps include a series of treaties which the U.S singed with a list of countries that are known tax havens, and an agreement with Swiss banks in which the names of every American citizen who have deposited money in the banks will be transferred to the IRS. Another agreement, which is broader than the others and more crucial for American citizens living in Israel, states that starting from 2013, most of the banks in the world, including every bank in Israel, will be required to report to the IRS about every account that is held or opened in the bank by an American citizen.
Even so, in June 2011 the IRS has announced an amnesty program, which gives American citizens who live outside the U.S and hold offshore accounts a window of opportunity: during the program, which will end at August 2011, the American citizen can file tax returns disclosing his income from his country of residence without criminal enforcement measures being taken against him, and pay a reduced penalty in the amount of 25% of the total amount held in his offshore accounts. Furthermore, in the case that the income of the American citizen is less that 10,000$ a year, he has the possibility to pay a reduced fine of only 5% of the money in his offshore bank account. Starting from September 2011 the IRS is expected to take even severe measures against citizens who chose not to report the IRS about their income in their resident country and not to take advantage of the amnesty program.
Alongside of the toughening measures that are taken by the IRS, an amendment to the American expatriation rules, which went into effect in June 2008, chose to ease on American citizens interested in renouncing their citizenship: the amendment declared that the IRS can no longer pursue former citizens for up to 10 years in order to collect U.S. taxes on U.S. source income. The meaning is that once an American citizen expatriate, all of his future income from non-U.S. sources will not be subject to U.S. taxes. Furthermore, assets that were outside the U.S. would be free of U.S. estate taxes.
What are the changes made by the Israeli tax reform which made the option to immigrate or return to Israel as a resident and simultaneously renounce my American citizenship a preferable option?
At 2008, as part of the 168 amendment (hereafter referred to as "The Amendment") of the Israeli tax law, a broad tax reform, which granted tax benefits to individuals that were Israeli residents for the first time and for individuals that are defined by the Israeli law as senior returning residents, was approved. The amendment is based on a broad program, which was designated in order to achieve immigration absorption, returning human assets back to Israel and encouraging investors with financial potential to make Israel their center of life and invest in Israel's economic strength.
The amendment has compared the status of a senior returning resident to the status of an immigrant, concerning the various tax benefits that are mentioned in the Israeli tax law. It's important to emphasize that a "new immigrant" is defined In the Israeli law as an individual that has become an Israeli resident for the first time in his life, whereas a "senior returning resident" is defined as an individual that has returned to Israel after being a resident outside Israel for 10 consecutive years.
Among the tax benefits granted to a senior returning resident, the following are included:
- An exemption from taxes on income that was produced or accrued outside of Israel for a period of 10 years.
- An exemption from taxes on capital gains tax from an asset sold outside of Israel.
- An exemption from taxes on income gained from a foreign company that is managed and controlled by a first time Israeli resident.
- • An "adaptation year" for a person who immigrated to Israel for the first time, in which one can enjoy full tax exemption from income gained or accrued outside of Israel, and exemption from tax liabilities that apply only on Israeli residents.
- An exemption from taxes on theoretical dividend gained by holdings in a Controlled Foreign Company.
- An exemption from the duty to report about income gained outside of Israel.
- An exemption from taxes on income from interest on a foreign currency bank deposit in Israel.
- Reduction of tax on pension that its source is outside of Israel and is received by a personץ
who immigrated to Israel, for his work in a Foreign Country.
How can you renounce your citizenship?
In order to renounce your U.S. citizenship, you must voluntarily and with intent to relinquish U.S. citizenship:
- appear in person before a U.S. consular or diplomatic officer,
- in a foreign country (normally at a U.S. Embassy or Consulate); and
- Sign an oath of renunciation.
Renunciations that do not meet the conditions described above, have no legal effect.
What are the shortcomings in renouncing my American citizenship?
The substantial obstacle facing the expatriate is the new expatriation tax: The expatriation tax applies to U.S citizens who have renounced their citizenship, and long-term residents who have ended their US resident status for federal tax purposes. The rule applies to citizens who follow any of the following statements apply:
- Their average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($139,000 for 2008; $145,000 for 2009 and 2010).
- Their net worth is $2 million or more on the date of their expatriation or termination of residency.
- They've failed to certify on Form 8854 (the Initial and Annual Expatriation Statement) that they have complied.
with all U.S. federal tax obligations for the 5 years preceding the date of their expatriation or termination of residency.
The new rule imposes a mark-to-market regime, which generally means that every asset of a covered expatriate (Stock portfolios, art, real estate etc.) will be taxed on the day of the expatriation as if it was sold at it's fair market value on the day before the expatriation date.
However, you can elect to defer the exit tax until you actually sell the property, and leave the U.S without triggering immediate tax- as long as the IRS is assured that it will collect the tax in the future. In order to defer the exit tax effectively, you must provide a bond or other adequate security for the tax liability.
Except of the expatriation tax, another disadvantage one must keep in mind is that an American citizen that is found by the IRS as a citizen that has renounced his citizenship in order to avoid tax liability might be denied entry to the U.S.
In conclusion, the deterrent enforcement procedures described so far, along with an certain ease by the IRS's approach towards American citizens who chose to renounce their citizenship, is used as an accelerating factor for many American citizens to cross the Rubicon, renounce their American citizenship and immigrate to Israel or to return as a resident. Thus, these Americans achieve two goals: the first- removal of the deterring enforcement of the IRS, and the second- gaining many benefits from the new Israeli tax reform, that eases the taxation on the income of new immigrants and returning residents.