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Americans who move abroad still have a responsibility to file their taxes with the IRS, sometimes in addition to taxes paid in their place of residence. Unsurprisingly, the thought of renouncing their U.S. citizenship may have crossed their minds at least once.
However, experts advise against the move.
“It typically doesn’t make financial sense, and there’s a few reasons why,” said Italy-based Alex Ingrim, a financial advisor for Chase Buchanan Wealth Management.
While there may be some instances where “the pain of being American” arises in the tax liability, “you’re very rarely double-taxed” as an American, Ingrim said.
Additionally, citizenship renunciation is not an easy process and can be difficult to backtrack on if you change your mind, said certified financial planner Jude Boudreaux, a partner and senior financial planner at The Planning Center in New Orleans.
Therefore, taxpayers looking to move abroad in the coming year may need to plan ahead of time to figure out what their tax residency will look like.
Before you move abroad, make sure what your income situation will be: whether you will be working or will depend on retirement savings.
“The U.S. and the country [of residence] might have an income tax treaty, it might have an estate tax treaty [or] it might have a normalization agreement, which deals with retirement income like Social Security,” said Boudreaux, a CNBC FA Council member. “It all depends on the different rules.”
To that point, some European countries, such as Portugal, tax retirees’ streams of income, so expats’ tax liability under the double taxation agreement is to the foreign country where they reside and not the U.S., Ingrim said.
Under such an agreement, those filing U.S. tax returns can use the credit from what was paid in the other country to extinguish their tax liability back in the States, he added. For example, if Portugal has higher tax rates, it expunges your U.S. liability.
Similarly, if you earn Portuguese income and pay Portuguese income taxes, you will get some credits on your U.S. filing for taxes paid overseas, according to Boudreaux.
“The pain of being American comes when you go to file … and the fact that it costs more money to file your taxes in two different countries,” he said.
Americans who end up rescinding their U.S. citizenship might do so to explore different investment options or really low tax jurisdictions, Ingrim said.
For example: An American moves to a place with little to no taxes, like Monaco or Dubai. However, they still have the U.S. tax liability.
“For those people, it’s a pain, and [they] opt for giving up their citizenship to avoid paying taxes,” Ingrim said.
Others may want to explore investment options, like European mutual funds, exchange-traded funds, savings products and wealth-structuring solutions.
However, “if you buy a mutual fund, you may end up under a really kind of negative set of tax rules,” Boudreaux said.
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The IRS considers these products as passive foreign investment corporations, or PFIC, and the federal agency has rules around the types of structures American taxpayers can invest in, Ingrim said.
“The reporting is extremely onerous and costs a lot of money,” he said. “For people that are just trying to build their savings, it can be really frustrating.”
This may especially apply to Americans making money in euros who do not want to send money back to the U.S. and invest in dollars, or if they want to reap the tax benefits some European mutual funds may offer in certain jurisdictions.
However, despite the hefty guardrails, American citizens still have access to the U.S. financial system, which is something to consider before giving up the passport.
The U.S. financial system is “really is a huge benefit to have, where you can invest, trade and hold your money for almost nothing,” Ingrim said.
Most European banks typically charge high fees for the same services and are constantly trying to sell you new products.
“The U.S. system is more evolved, and if Americans took that view when they live abroad … they’d be a little bit happier about being American,” he added.
Altogether, renouncing your U.S. citizenship is a much bigger process than may be necessary, Boudreaux said.
“It’s not necessarily easy, could be a little expensive and it’s one of those things it’s kind of hard to undo once you’ve done it,” he said.
Additionally, you might owe exit taxes as an expatriate under the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008, Boudreaux added.
“You can’t just expatriate and not pay taxes on things you owned in the U.S. and then went overseas,” he said, “There’s basically no way to get out of not paying U.S. taxes in one form or fashion.”