Denaturalization could open the door to the U.S. 'Exit Tax'

America is poised to enforce denaturalization of some citizens in unprecedented numbers. Some of these residents may face the U.S. exit tax.

According to the Migration Policy Institute, there are 24.5 million naturalized Americans in the U.S. Until recent years, the U.S. Department of Justice (DOJ) filed only a handful of denaturalization cases annually, a number that did increase slightly under President Biden and increased much more in the first term of President Trump (who created an office specifically to scrutinize denaturalization).

With denaturalization, the government files a lawsuit to strip one’s U.S. citizenship after they have become citizens, turning them back into noncitizens who can be deported. Historically, observers say, the U.S. has reserved denaturalization for individuals who committed serious crimes, including war criminals and funders of terrorist groups. More recently, using false IDs to procure naturalization or even underreporting income on a tax return have become reasons for the federal government to challenge one’s naturalization.

What are the tax implications of denaturalization?

Long simmering, now boiling

Denaturalization occurs when the U.S. government revokes citizenship of a naturalized immigrant. (Denaturalization is different from deportation, which removes noncitizens from the country.) This can happen because of:

• “Sufficient evidence,” a lower burden of proof than “beyond a reasonable doubt,” for naturalization fraud (aka “deliberate deceit on the part of the person” in failing to disclose or misrepresenting a material fact that would have influenced awarding U.S. citizenship, such as a past crime).

  
  

• Illegal past procurement of naturalization because the person does not meet or fails to comply with such requirements for naturalization as residence, physical presence, lawful admission for permanent residence, good moral character and attachment to the U.S. Constitution.

  
  

• Membership or affiliation with a terrorist or other hostile organization.

The burden of proof is on the federal government, but a person may voluntarily renounce U.S. citizenship.

In June, a DOJ Civil Division memo specifically moved denaturalization to the front burner. “The Civil Division shall prioritize and maximally pursue denaturalization proceedings in all cases permitted by law and supported by the evidence,” the memo reads, establishing categories of priorities for denaturalization cases against naturalized U.S. citizens who:

1. Pose a potential danger to national security, including those with a nexus to terrorism, espionage, or the unlawful export from the United States of sensitive goods, technology, or information raising national security concerns;

   
   

2. Engaged in torture, war crimes, or other human rights violations;

   
   

3. Further or furthered the unlawful enterprise of criminal gangs, transnational criminal organizations, and drug cartels;

   
   

4. Committed felonies that were not disclosed during the naturalization process;

   
   

5. Committed human trafficking, sex offenses, or violent crimes;

   
   

6. Engaged in various forms of financial fraud against the United States (including Paycheck Protection Program (“PPP”) loan fraud and Medicaid/Medicare fraud);

   
   

7. Engaged in fraud against private individuals, funds or corporations; and

   
   

8. Acquired naturalization through government corruption, fraud, or material misrepresentations, not otherwise addressed by another priority category.

The memo also gives the Division latitude to pursue other cases. Some denaturalization procedures, unclear to begin with, are potentially casting a wider net for naturalized citizens who have committed more minor crimes. Clearly, denaturalization is becoming more possible for more taxpayers.

‘Exit tax’ threat

As we’ve discussed before, voluntarily surrendering a green card if pressured at a U.S. port of entry can expose a holder to the American expatriation tax, or exit tax, which applies to American citizens who have renounced their citizenship and long-term residents who end their U.S. resident status. The tax is designed to prevent taxpayers simply moving aboard to avoid U.S. taxes.

Only “long-term permanent residents” might have to pay exit tax, meaning those who have held LPR status in at least part of eight out of the last 15 years. For those who expatriate now or in the near future, the tax applies if your average annual net income tax for the five years ending before the date of expatriation or termination of residency exceeds a specified amount (adjusted for inflation). These amounts are $171,000 for 2020, $172,000 for 2021, $178,000 for 2022, $190,000 for 2023, $201,000 for 2024 and $206,000 for 2025.

The tax might also apply if your net worth is $2 million or more on the date of expatriation or termination of residency or you fail to certify on Internal Revenue Service Form 8854 that you have complied with all U.S. federal tax obligations for the five years preceding.

The exit tax is a mark-to-market regime, which generally means that all property of a covered expatriate is deemed sold for its fair market value on the day before the expatriation. Tax-deferred retirement accounts, trusts and certain types of deferred income can add to the taxed amount.

This year, the first $890,000 is excluded (also an amount annually indexed for inflation); the remaining amount of assets incurs the U.S. capital gains tax.

Does this tax apply right to those who are involuntarily denaturalized – or, in other words, has such a person become a “covered expatriate” for American tax purposes?

The IRS says only that expatriation tax provisions under Internal Revenue Code (IRC) sections 877 and 877A apply to U.S. citizens who have renounced their citizenship and long-term residents (as defined in IRC 877(e)) who have ended their U.S. resident status for federal tax purposes.

At this point, observers say no express requirement differentiates a taxpayer who voluntarily renounces citizenship and one forced to denaturalize. An involuntary denaturalization could still incur the exit tax, observers say, under similar logic by which the IRS requires domestic taxpayers to report criminal income on their U.S. tax return.

For now, the best rule is that cancelation or revocation of naturalization means a taxpayer is no longer a U.S. citizen. If they then become a covered expatriate, they may become subject to exit taxes.

 

Preparing

If you think you face denaturalization, plan mitigation measures for the exit tax:

·        Transferring or gifting assets and restructuring trusts before expatriation to reduce net worth, if you have time before expatriation.

·        Professionally valuating assets.

·        Rolling over or distributing retirement accounts before expatriation, though this must be done carefully or it could make the exit tax higher.

·        Examining details of U.S. income tax treaties with other nations that may mitigate or exit tax components.

Post-expatriation U.S. federal tax obligations include filing a U.S. Form 8854 with a timely filed tax return that includes the date of expatriation and filing for any U.S. taxes still owed on U.S.- source earnings and accounting for U.S. taxes owed on distributions from retirement accounts, among others.

Failure to comply with exit tax and expatriate U.S. federal tax obligations can result in substantial penalties and potential criminal liability.

The threat of denaturalization looms larger than ever for naturalized citizens in the U.S., igniting tax risks and obligations that may not be recognized until too late. Those who feel threatened by the new American administration’s actions against immigrants would be wise to start tax planning for all the eventualities of having to leave the U.S. involuntarily.

Alicea Castellanos, the CEO and Founder of Global Taxes LLC

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Please note: This content is intended for informational purposes only and is not a replacement for professional accounting or tax preparatory services. Consult your own accounting, tax, and legal professionals for advice related to your individual situation. Any copy or reproduction of our presentation is expressly prohibited. Any names or situations have been made up for illustrative purposes — any similarities found in real life are purely coincidental.

Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high-net-worth families and their advisors. Alicea has more than 20 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm. Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates, and foundations that have a U.S. connection.

Alicea also specializes in foreign investment in U.S. real estate property and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, and foreign companies wanting to do business in the U.S. Alicea is fluent in Spanish and has a working knowledge of Portuguese.

Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPA), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).

Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA Forty Under 40 Award. She was selected as someone that has notable skills and is visibly making a difference in the accounting profession. Alicea has also been recognized as a leading expert for tax advice and she has been invited to join Advisory Excellence, as their exclusively recommended tax expert in the USA.

In 2021 and 2022, Alicea won Gold and Silver in Citywealth's Powerwomen Awards for USA - Woman of the Year - Business Growth (Boutique). In 2023, she received Gold for Company of the Year - Female Leadership (Boutique) and was listed in the Global Elite Directory, an exclusive directory of top wealth advisors.

In 2024, Alicea was named to Citywealth's Top 50 Tax Professionals, shortlisted for the Magic Circle Awards, peer-nominated as a Non-Legal Adviser, and appointed as a judge for the Citywealth Powerwomen Awards USA. She is also certified as an International Business Advisory Firm by AuditTrust International and a proud STEP member for 2024/2025.