The first tax expatriation rules were enacted in 1966. The rules were created because Congress instituted a flat 30% tax on U.S.-sourced investment income for nonresident alien individuals. At the time, the top graduated rate for individuals was 70%. Congress was concerned that high income individuals would move abroad and renounce their U.S. citizenship so that they could be taxed at a flat 30% rate on their U.S. investment income.
The special expatriation rules required that the individual file U.S. tax returns for 10 years after expatriating, and the individual was subject to an “alternative tax regime.” To be subject to the special rules, the individual had to have expatriated for tax avoidance purposes.
In 1996, Congress created a presumption that the expatriation was for tax avoidance purposes if certain objective criteria were met (a net worth test and an average tax liability test). Also in 1996, Congress expanded the expatriation rules to long-term green card holders, and required that the IRS publish the names of the expatriates in the Federal Register.
In 2004, Congress eliminated the tax purpose presumption and eliminated the tax purpose test altogether. Instead, the special expatriation rules applied only if one or more of three objective criteria were met (a net worth test, an average tax liability test, or a failure to certify [tax compliance] test).
In 2008, Congress eliminated the 10 year tax return filing requirement and instituted in its place an “exit” tax. Under the exit tax, if the individual meets any of the objective criteria, he or she is deemed to have sold their worldwide assets for fair market value on the day prior to expatriating.
Also in 2008, Congress added special gift and estate taxes for gifts or inheritances received by U.S. persons from covered expatriates. Normally, gift and estate taxes are imposed on the person making the transfer and not on the recipient. However, under these special expatriate gift and estate rules, the recipient of the gift or inheritance is obligated to pay the tax.
These exit tax rules continue to be in place today. The first $744,000 of the deemed gain is exempt from tax. This amount is adjusted for inflation each year. In addition, special rules apply to deferred compensation, deferred tax accounts, and nongrantor trusts.