At least 12% of Americans have thought about living abroad in retirement, according to a study by the Aegon Center for Longevity and Retirement. If that's part of your retirement plan — or you're already living outside the United States — it's important to know that your country of residence could affect your estate and tax planning. To avoid potential penalties and other adverse events, take some time now to address these issues.
U.S. citizens and permanent residents (green card holders) generally are subject to taxes on their worldwide income, even if they're living and working abroad. This raises concerns about double taxation of the same income by the United States and a foreign country. Depending on the country, you may be able to claim a credit against U.S. taxes for taxes you pay to a foreign jurisdiction. Also, some countries have tax treaties with the United States that entitle you to a reduced foreign tax rate.
There may be tax planning strategies you can use to minimize your overall tax bite. For example, the United States provides exclusions from income for a certain amount of foreign earned income and foreign housing expenses. But, depending on the foreign country's income tax rate, you may be better off forgoing these exclusions and applying foreign tax credits to your total income.
As with income taxes, U.S. citizens and permanent residents are subject to gift and estate taxes on their worldwide assets. That means that a home or other assets you acquire in a foreign country may be subject to U.S. gift and estate taxes. Again, this can trigger double taxation, depending on the foreign jurisdiction's tax laws and any applicable tax treaties.
One potential strategy for reducing U.S. taxes is to renounce your U.S. citizenship or permanent resident status. The advantage of doing so is that, rather than being taxed on your worldwide income and assets, you'll be subject to U.S. income, gift and estate taxes on only your U.S.-source income and U.S.-situs assets. However, renouncing citizenship raises your risk of being assessed an "exit tax."
The United States imposes exit taxes to prevent "covered expatriates" from escaping taxes on appreciated assets. A covered expatriate is a U.S. citizen (or permanent resident who's held that status for at least eight of the previous 15 years) who: 1) can claim a net worth of $2 million or more, 2) has an average annual net income tax liability for the preceding five years that exceeds $178,000 for 2022 or 2023, or 3) fails to certify compliance with all U.S. tax obligations for the preceding five years.
Covered expatriates are treated as if they'd sold all their worldwide assets at fair market value on the day before they became an expatriate. There are some exceptions — for example, there's an exemption ($767,000 for 2022) of any unrecognized gains. But the tax liability is determined by calculating the value of the estate as though the person had died on that day. One consequence is that any retirement accounts are deemed to have been distributed on the day before the person became an expatriate.
If you plan ahead, you may be able to reduce, or even eliminate, the impact of any exit tax. For example, you might:
Expatriation can also lead to some costly gift and estate tax traps. As previously noted, expatriates are subject to U.S. gift and estate taxes on only their U.S.-source assets. But they're allowed a significantly reduced exemption compared to the exemption that citizens and permanent residents enjoy. If you own a significant amount of real estate or other assets in the United States, expatriation could increase, rather than decrease, your gift and estate tax liability. Consult with your tax advisor about your situation.
Living abroad in retirement can provide a less expensive cost of living, among other benefits. But if you don't plan for tax and estate issues, your expatriate life could, in fact, cost you more in the long run.
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