In recent years, a large number of Americans living abroad — or planning to do so — have renounced their U.S. citizenship to avoid U.S. taxes. Expatriation can provide a tax advantage over the long term: U.S. citizens and residents generally pay U.S. taxes on their worldwide income, while expatriates are taxed only on their U.S.-source income.
If you’re contemplating this strategy, consider the “exit tax.” The tax applies if you’ve been a U.S. citizen or resident for at least eight of the last 15 years and your average annual net income tax liability for the preceding five years exceeds a certain threshold ($161,000 for 2016), and your net worth is $2 million or more. Last, the tax applies if you fail to certify compliance with your U.S. tax obligations for the preceding five years.
If the tax applies, you’d be treated as if you’d sold all of your assets at fair market value on the day before expatriation. You’d also be taxed on the hypothetical gain to the extent it exceeds a certain threshold ($693,000 for 2016). But if you start planning early, certain strategies can minimize the exit tax, such as gradually liquidating appreciated assets or taking advantage of limited partnerships.
Undo your Roth IRA conversion?
For many people, converting a traditional IRA to a Roth IRA provides long-term tax advantages, but these advantages come at a short-term tax cost: When you convert, you must pay taxes on all of the contributions you previously deducted and on the account’s earnings. In addition, a Roth conversion may push you into a higher tax bracket.
If you did a Roth conversion last year, but the value of your IRA has since declined, consider undoing the conversion. Generally, you have until October 15, 2016, to undo a 2015 conversion. Then, so long as you wait at least 30 days, you can redo the conversion at a lower tax cost. Keep in mind that there’s a risk that the value of your IRA will rebound during the waiting period, resulting in even higher taxes.
No tax on identity protection services
Organizations that experience data breaches often provide identity protection services, free of charge, to their employees, customers or others whose personal information is at risk. These services may include credit reporting and monitoring, identity theft insurance and identity restoration services.
In a recent announcement, the IRS clarified that individuals whose personal information may have been compromised in a data breach needn’t include the value of such identity protection services in their gross income.