Tax Treatment for Persons Giving Up U.S. Citizenship to Avoid Taxation
Internal Revenue Code – Section 877A
The Heroes Earnings Assistance and Relief Tax Act of 2008 (P.L. 110-245) fundamentally changed the rules aimed at preventing expatriations in order to avoid U.S. tax by passing Code Sec. 877A. Unlike the old regime, which tracked an expatriate’s U.S. source income for ten years, the new rules generally subject “covered expatriates” to a one time mark to market tax as if they sold all of their property for its fair market value on the day before their “expatriation date”. The mark-to-market tax is imposed on the property’s net unrealized gain to the extent it exceeds $600,000. Exceptions exist for certain deferred income items and interests in certain trusts. In addition, the expatriate can defer any tax owed under the new regime by posting adequate security. The rules apply to individuals with expatriation dates on or after June 17, 2008.
In addition, U.S. recipients of gifts or bequests from “covered expatriates” may be subject to a special expatriate transfer tax of Code Sec. 2801.
The IRS has issued extensive guidance for expatriating taxpayers subject to the new mark-to-market regime of Code Sec. 877A and the corresponding reporting rules under Code Sec. 6039G. Future regulations incorporating this guidance will apply to individuals expatriating on or after October 15, 2009. Until these regulations are issued, such individuals may rely on these rules. In addition, individuals whose expatriation date is on or after June 17, 2008, and before October 15, 2009, may also rely on the new guidance. The guidance, which includes multiple examples, is divided into nine sections each discussed below.
Section 1 provides background regarding the general application of Code Sec. 877A.
Section 2 provides rules for determining whether an individual is a “covered expatriate” and, thus, subject to Code Sec. 877A. In particular, taxpayers are directed to Section III of Notice 97-19, 1997-1 C.B. 394, to determine whether an individual meets the tax liability test or the net worth test of Code Sec. 877A(g)(1)(A).
Section 3 explains the operation of the mark-to-market regime. For purposes of computing the tax liability under Code Sec. 877A, a covered expatriate owns any property that would be taxable as part of his or her gross estate for Federal estate tax purposes under Code Secs. 2001 through 2210 without regard to Code Secs. 2010 through 2016. In addition, a covered expatriate owns his or her beneficial interest(s) in each trust that would not be included in their Federal gross estate. Such beneficial interest(s) are determined under the special rules set forth in section III of Notice 97-19. When computing the tax liability, a covered expatriate must use the fair market value of each interest in property as determined (generally) under the Federal estate tax rules as if the covered expatriate had died as a citizen or resident of the United States on the day before they expatriated. Specific rules are also provided for allocating the exemption amount of Code Sec. 877A(a)(3). And, the Notice states that an individual only has one exemption per lifetime; so, if a covered expatriate used one third of the exclusion amount for a first expatriation, he or she will have two thirds of the exclusion amount available, as adjusted for inflation, in the event of a second expatriation. Section 3 also provides rules for:
Section 4 addresses the interaction of Code Sec. 877A and other Code provisions, including the prior expatriation rules under Code Sec. 877 and Code Secs. 367(a), 684, and 897.
Section 5 explains the application of Code Sec. 877A to deferred compensation items. In particular, definitions and operating rules are provided for “eligible deferred compensation items” (items which avoid the mark-to-market tax) and “ineligible deferred compensation items” (items subject to the tax).
Section 6 explains the application of Code Sec. 877A to specified tax deferred accounts (Code Sec. 7701(a)(37) individual retirement plans, Code Sec. 529 qualified tuition plans, Code Sec. 530 Coverdell education savings account, Code Sec. 223 health savings accounts, and Code Sec. 220 Archer MSAs).
Section 7 explains the application of the special rules for interests in nongrantor trusts under Code Sec. 877A(f).
Section 8 describes the filing and reporting requirements under Code Sec. 6039G and provides an overview of changes to Form 8854 (Expatriation Information Statement) as well as an introduction to new Form W-8CE (Notice of Expatriation and Waiver of Treaty Benefits).
Section 9 states that future guidance will address gifts and bequests subject to a transfer tax under new Code Sec. 2801.