Many US citizens in Canada want to be rid of their citizenship to avoid being subject to American tax rules.

Let’s use an example. John is a Canadian citizen who lives in Ottawa. His mother was American, so John is a US citizen too. He keeps reading in the paper that as a US citizen living in Canada, he’s subject to US tax rules. Having lived in Canada all of his life, he’s annoyed that he has to file extra tax returns. So he marches down to the American Embassy, pays the $2350 (the current fee) and renounces his US citizenship.

Before deciding to wave goodbye to the USA, John should know that Uncle Sam will want to try and collect one last income tax before letting John leave. This “exit tax” is levied on the difference between John’s basis in all of his assets (essentially what he paid for them) and their current value. The precise way that the exit tax is calculated is quite complicated, but the bottom line is that John might find it very expensive to renounce his American citizenship.

John has to pay the exit tax if a) the average US tax he owes exceeded USD $160,000 a year over the past 5 years, or b) his total assets on the date he gave up his citizenship exceed USD $ 2 million, or c) he hasn’t been tax compliant for five years.

If John was a dual US/Canadian citizen at birth, he could avoid the exit tax, regardless of his total assets, if he files US tax returns for the last five years. In short, John has to come clean with the IRS to get out of the US tax system. John can file three years of past US tax returns under the streamlined program that was discussed in an earlier column. He would then file tax returns for two future years. With this, John would be tax compliant for five years and may be able to avoid the exit tax.

For John, the advantages of giving up his citizenship are obvious — no more tax problems. But there are also downsides. John can no longer vote in US elections, rely on US consular services abroad, or live and work freely in the US. John might also be subject to future problems at the border. The 1996 Reed amendment gives the US Attorney General the power to deny entry to former US citizens who have renounced their citizenship for tax reasons. This law has rarely been applied, but it remains on the books. Some US lawmakers have tried, without success, to pass harsher versions of it. It’s hard to say what future laws will look like.

Some Americans who have renounced their citizenship tell stories of being hassled at the US-Canada border, but the vast majority report no problems. They simply enter on their Canadian passport like the millions of other Canadians who enter the US every year.

Written by Max Reed