Ever since Americans began making aliyah, it was assumed that they should make sure to obtain US citizenship for their children born in Israel. But while there may be advantages for an Israeli to be a dual-citizen of the US, US tax law presents some significant disadvantages.
An Israeli citizen who is not considered an Israeli resident for the year will not be subject to tax in Israel on income earned in the US. That person will, however, be subject to tax in Israel on income earned in Israel.
Most countries follow a similar formula: residents of the country are taxed on their world-wide income from whatever source, but nonresidents are taxed only on income earned in that country.
The United States is an outlier. It taxes both citizens and residents on their world-wide income from whatever source. Only those who are nonresidents and not citizens of the US are taxed solely on income earned in the US.
Paying US tax - even if you have never been there
Let’s get back to the young Israeli child whose parents made aliyah from the US. Thinking that they are bestowing a tremendous kindness, the parents arrange for the child to become a dual Israeli-US citizen as soon as they can.
Fast forward 25 years or so, and now the child is making a comfortable living working for a hi-tech firm in Israel. Even if that person has never set foot in the US, he is considered to have earned income in the US during each year that he was working in Israel, and is liable to pay federal US income tax on those earnings. He will likely have to file tax returns in the US for each of those years, and will have to pay US income tax, plus penalties on the amounts due.
There is an income tax treaty between Israel and the US that is designed to minimize double taxation where a person is otherwise subject to tax in both countries. However, if the Israeli waits many years before filing back US tax returns, there is a good chance that the benefits of the treaty will no longer be available, and that as a result he will pay double tax on the income.
If you are a dual US-Israeli citizen and have not filed US income tax returns, speak to a US tax lawyer or tax accountant to take care of this problem as soon as possible. And if you are Israeli and are eligible to become a US citizen, make sure that you think through all of the pros and cons before deciding what to do.
Unlike Israel, the US has an estate tax
Another aspect of US tax law for Israelis to consider is the federal estate tax. On death, the estate of a US citizen or resident is subject to tax at a maximum rate of 40% on total assets in excess of $12.92 million located anywhere in the world. Additionally the estate of a non-citizen, nonresident is taxed at a maximum rate of 40% on total real estate and tangible personal property in excess of $60,000 located in the US.
So if an Israeli has a substantial amount of assets outside of the US, and little or no assets in the US, he or she might be much better off not being a US citizen or resident. On the other hand, if an Israeli has substantial assets in the US, he or she will likely be better off as a US citizen. Unlike with income taxes, there is no estate tax treaty between Israel and the US, since Israel does not have an estate tax.
Think carefully about gifts
The US also has a federal gift tax which tracks the estate tax. So a US citizen or resident can make gifts totaling as much as $12.92 million during his or her lifetime without being subject to the gift tax, but this includes gifts made anywhere in the world. A non-resident, non-citizen is subject to gift tax on any gift of real estate or tangible personal property located in the US; gifts of property located outside of the US by non-resident, non-citizens are not subject to the gift tax. As with estates, the maximum rate of tax on gifts is also 40%.
Do you have a Green Card and no longer live in the US?
An additional aspect of US tax law that can affect Israelis relates to Israelis who are not US citizens but who possess a Green Card. Under US immigration laws, a Green Card holder is considered a permanent resident of the US and is allowed to work in the US.
So an Israeli who possesses a Green Card and resides in the US will be treated for income tax purposes in the same manner as a US citizen - he or she will be taxed in the US on their world-wide income. If an Israeli who has a Green Card has concluded that it is no longer in his or her best interests to keep it, he or she can voluntarily abandon that status by filing the appropriate form with the US government.
Renouncing US citizenship
A dual US-Israeli citizen may decide that, because of the tax situation, he or she will be better off renouncing US citizenship. In order to do this, he or she has to appear in person before a US consular or diplomatic officer in a foreign country, sign an oath of renunciation, fill out some paperwork, and pay a fee. As is often the case, there are some tax considerations that need to be considered before expatriating.
A US citizen renouncing his or her citizenship may be subject to an exit tax. This tax will apply if the average tax liability for the five tax years ending before the date of expatriation is above a certain limit ($178,000 for 2022), if his or her net worth is $2 million or more on the date of expatriation, or if he or she fails to certify compliance with all US tax obligations for the five tax years preceding the date of expatriation.
The exit tax is calculated by assuming that all of the person’s assets were sold at fair market value as on the date of expatriation. The government then charges 23.8% capital gains tax on the excess of the gain over an exclusion limit ($767,000 in 2022). If a Green Card holder resided in the US for at least 8 years out of any 15-year period and decides to give up his or her Green Card, he or she is subject to the same expatriation rules that apply to a US citizen.
What if we ignore the US tax authorities?
Some Israelis might take the position that these rules are so cumbersome that it is better to ignore them and rely on the notion that the US Internal Revenue Service (IRS) will most likely not learn about Israelis who violate US tax law provisions, or that the IRS is only interested in pursuing the most highly compensated and wealthiest persons. It would be a grave mistake to take this position, particularly if you are a dual US-Israeli citizen living in Israel.
Over the past decade, the IRS has developed an extremely sophisticated computer system to help detect when persons or businesses located either in the US or abroad might be taking highly aggressive tax positions, such as understating their income, overstating their expenses, or mischaracterizing taxable income as tax-free income.
On the basis of its review of these factors, the IRS will decide which tax returns filed in which years should be audited. For the most part, such audits are handled via email, but they can drag on for a very long time, so compliance is usually far better than playing Russian roulette with the IRS.
Mark H. Hess is a tax attorney licensed in California and Israel.
Published by Globes, Israel business news - en.globes.co.il - on January 15, 2024.
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