01 Dec USA Expatriation, Experience Matters -Treasury Reg. 1.409A, Internal Revenue Code 877A, 2801 & IRS Forms 8854, W-8CE
Call me naive but the immigration “problem” in the USA is rooted in the fact that the country offers the absolute best Social Security and Medicare systems on the planet. It is remarkable that millions of people, mostly good people in all other regards, are so willing to commit the crime of residing in the USA without proper documentation in pursuit of a ‘better life’ for themselves and their progeny.
On the one hand thinking about and planning for multiple generations at a time is what seems to lead to measurable advancements in humanity. But on the other hand one must ask whether being in the USA without proper documentation is worth it at any cost. Evidently the answer is a resounding and problematic yes. That is why expatriating from the USA, a country with countless millions of undocumented aliens, has been one of those frustrating conundrums that causes many to pause.
Up until recently it seemed that in order to even consider expatriating from the USA one would have to be either disgustingly rich or extraordinarily pissed off, and probably both. Not necessarily so is the lesson learned as I have now helped a few people in these regards and can share with you my experiences to date. The following are the 10 most salient and resonating points to ponder in advance of embarking on any journey down this conflicting path of expatriation:
- If you have truly resigned yourself to expatriation you are best served proceeding with careful deliberation as the ramifications are profound.
- Specifically and most notably you are eligible for only one lifetime exclusion amount.
- The first option worth consideration is to make pre-expatriation gifts to reduce net worth until you are under the applicable net worth threshold subsequently preventing application of the rules in the first place.
- Americans, permanent residents and long term green card holders expatriating are taxed on their accumulated un-taxed wealth prior to leaving the United States, along with their future earned income that has at the time of expatriating not been paid.
- Additionally, the United States will tax expatriating Americans that die owning United States Estate Tax and that make significant gifts subject to the “Gift Tax” even after relinquishing United States citizenship.
- If you are a covered expatriate generally you are under a mandate to treat all owned property as though it was sold on the day before the expatriation date for its fair market value. Any gain from the “deemed sale” is used to calculate income tax for the taxable year even if you chose to not sell the asset.
- BEFORE expatriating be sure to have an ENROLLED AGENT scrutinize your tax return making sure to compare it in line item detail to your IRS Wage and Income Transcripts as well as your IRS Record of Account AND get your foreign bank account reporting in order with the US Treasury
- When confused be sure to get the advice from an enrolled agent experienced navigating the troubled waters of Internal Revenue Code 877-A.
- IRS Form 8854 – Annual Statement of Expatriation for tax year 2014 and its instruction set has not been updated as of the publishing of this post.
- You have the option to elect to defer payment of tax attributable to property deemed sold in most all regards except most deferred compensation items including specified tax deferred accounts and interests in a non-grantor trust, if you were a beneficiary on the day before the expatriation date.
You are a covered expatriate if you are a U.S. citizen or long term resident who relinquishes citizenship. A long term resident is a permanent resident of the United States in possession of a “Green Card” for at least 8 of 15 taxable years.
You are not a covered expatriate if:
- you had a second citizenship due to birth; and
- on the expatriation date continue to be a citizen and tax resident of that other country, and
- have been a U.S. resident for no more than 10 of the previous 15 taxable year period prior to expatriation, or
- you became at birth a U.S. citizen of another country and, as of the expatriation date, continue to be a taxed citizen of the other country, and have been a U.S. resident for not more than 10 of the 15 taxable years from the expatriation date.
There is a minimum wealth and income requirement that must be met before being subject to expatriation taxes. Any one of the following three factors will result in taxation.
- You must have an average annual net income tax liability that for the five preceding taxable years exceeds $124,000 per year, adjusted for inflation
- You have a net worth of $2 Million or more as of the expatriation date (the “net worth test”)
- You do not certify under penalties of perjury that you have been in compliance with all U.S. Federal tax obligations for the preceding five taxable years.
There is also an exclusion for the first $600,000 adjusted for inflation. The exclusion amount must be allocated among all built in gain. The exclusion amount must first be allocated pro rata to each item of built in gain property by multiplying the exclusion amount by the ratio of the built-in gain with respect to each gain on the specific asset over the total built in gain of all gain assets. The exclusion amount allocated to each asset’s gain may not exceed the amount of that asset’s built-in gain.
Your expatriation date is the date you relinquish U.S. citizenship or, in the case of a long term resident of the United States, the date on which you cease to be a lawful permanent resident of the United States. You will be treated as relinquishing your U.S. citizenship on the earliest of these possible dates:
- The date you renounce your U.S. nationality before a diplomatic or consular officer of the United States pursuant the Immigration and Nationality Act
- The date you furnish to the United States Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an act of expatriation specified in the Immigration and Nationality Act.
- If you are a naturalized citizen, the date the United States cancels your certificate of naturalization
Covered expatriates are deemed to have sold any interest in property that is considered to be “owned” with certain exceptions. A covered expatriate is considered to own any interest in property that would be taxable as part of his or her gross estate for Federal estate tax purposes, as if he or she had died on the day before the expatriation date as a citizen or resident of the United States. This also includes beneficial interest(s) in each trust (or portion of a trust), that would not constitute part of his or her gross estate.
In computing the tax liability under the mark-to-market method, you must use the fair market value of each interest in property as of the day before the expatriation date in accordance with the valuation principles applicable for purposes of the Federal estate tax code.
The tax may be deferred until the taxable year you actually sell the property in question. The deferral cannot extend beyond the due date of the return for the taxable year in which the tax return is due or you cease to exist in human life form. There are a number of conditions on the availability and cost of the deferral
- Interest will accrue on the deferred tax at the underpayment of tax rate;
- Security must be provided with respect to the Property.
- You must make an irrevocable waiver of any right under any tax treaty that would preclude assessment or collection of the tax; and a “designated agent” must be appointed.
The irrevocable election to defer taxes applies only to the specifically identified property with “adequate security” and a Tax Deferral Agreement. The term “adequate security” means a bond that is furnished to, and accepted, that is conditioned on the payment of the tax (and interest thereon) or in certain circumstances any other form of security for such payment including letters of credit deemed acceptable.
A deferral agent can be any U.S. person you designate to act as your limited power of attorney solely for purposes of accepting communication related to the tax deferral agreement from the IRS your behalf.
Compensation is considered to be either “eligible deferred compensation” or “ineligible deferred compensation”. The mark to market method applies to un-taxed gains on property or essentially a tax on unrealized and unrecognized increases in your wealth but does not apply to deferred compensation items.
Deferred compensation items include interests in retirement plans and compensation for services that are subject to tax deferral. For eligible deferred compensation items there is a 30% tax that is withheld when paid. Deferred compensation is any amount of compensation pursuant to a compensation arrangement, that you have a legally binding right as of the expatriation date to and the compensation has not been actually received on or before the expatriation date. The entity that pays you the “eligible deferred compensation item” must deduct, withhold and tender a tax equal to 30 percent of any taxable payment.
Any amount of deferred compensation that is attributable to services performed outside the United States while you are not a citizen or resident of the United States is not subject to this tax. In the case of certain defined contribution plans, until further guidance is issued, the present value of the covered expatriate’s accrued benefit is the account balance.
“Deferred compensation” items include:
- any interest in a plan or arrangement described in Section 219(g)(5);
- any interest in a foreign pension plan or similar retirement arrangement or program;
- any item of deferred compensation; and
- any property or right to property, which you are entitled to receive in connection with the performance of services to the extent not previously taken into account under Section 83
“Specified tax-deferred accounts” include:
- an individual retirement plan, other than any arrangement described in Section 408(k) or (p);
- a Section qualified tuition program;
- a Section 530 Coverdell education savings account;
- a Section 223 health savings account; and
- a Section 220 Archer MSA.
Again you are required to treat these accounts as being entirely distributed on the day before the date of the expatriation, thus terminating the accounts. However, no premature distribution penalty is to apply by reason of this treatment.
“Rather than being deemed sold or distributed, a grantor trust interest treated as owned by the expatriate, is subject to withholding and payment by the trust of a 30% tax on the “taxable portion” of actual distributions when they occur. The determination of whether and how much of a trust is not treated as a grantor trust is made immediately before the date of expatriation and the taxable portion of the each distributing is the portion that would be included in your gross income if you continued to be a U.S. citizen or resident.”
Estate and Gift Taxation under IRC 877A
“If a U.S. citizen or resident receives property directly or indirectly either by or from, or by reason of the death of, a person who at the time of the acquisition or death was a covered expatriate, then the transfer is subject to a tax equal to the value of the property multiplied by the highest rate of tax for federal estate tax or federal gift tax purposes. The tax is payable by the recipient.”
For purposes of IRC Section 2801, there are reductions in the value for a gift in the amount of the annual gift tax exclusion although there is no unified credit amount in the case of a transfer by reason of death. There are, however, also exceptions for transfers reported on a timely filed return and otherwise subject to federal estate or gift tax and for a transfer to a spouse or charity that would qualify for a deduction if the donor or decedent were a U.S. person. The amount of the tax is also subject to reduction for any gift or estate tax paid to a foreign country with respect to the property transfer.
Finally, there are special rules treating a domestic trust as a U.S. citizen for this purpose (with the tax being payable by the trust) and treating distributions from a foreign trust as a U.S. citizen or resident as taxable (with an election available to the foreign trust as treated as a domestic trust).
With respect to any ineligible deferred compensation item not described in section of this notice, until further guidance is issued, the present value of the covered expatriate’s accrued benefit is determined by applying principles Treas. Reg. Section 1.409A-1. Where such proposed regulations provide for a determination to be made as of the end of the taxable year, such determination shall be made as of the day before the expatriation date. The present value of your accrued benefit is determined without regard to any substantial risk of forfeiture.
FILING AND REPORTING REQUIREMENTS
You absolutely must have filed the proper income tax returns the day before the expatriation date.
Initial filing obligations for the year of expatriation.
You must file a dual status return if you were a U.S. citizen or long term resident for only part of the taxable year. A dual status return requires you to file IRS Form 1040NR with a Form 1040 attached as a schedule. If your expatriation date is January 1, then you will not be required to file a dual status return.
You must file IRS Form 1040 NR unless the covered expatriate tax is fully withheld upon at source for a particular taxable year and you have no income effectively connected with the conduct of a trade or business in the United States for that year, then you will not be required to file IRS Form 1040NR for those years.
IRS Form W-8CE Notice to Payor
If you have a deferred compensation item, a specified tax deferred account or an interest in a non-grantor trust you must file Form W-8CE with the relevant paying party on the earlier of the day prior to the first distribution on or after the expatriation date or 30 days after your expatriation date.
In the case of an eligible deferred compensation item, the Form W-8CE provides notice to the paying party that you are a covered expatriate who has waived treaty benefits with respect to the eligible deferred compensation item, with the result that taxable payments will be subject to 30% tax.
Ineligible deferred compensation item and specified tax deferred accounts IRS Form W-8CE provides notice to the paying party that you are a covered expatriate who is to be treated as receiving an amount equal to the present value of his or her accrued benefit on the day before the expatriation date.
Within 60 days of receipt of Form W-8CE, the paying must provide a written statement to you setting forth the present value of your accrued benefit on the day before the expatriation date.
In the case of an interest in a non-grantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date, Form W-8CE provides notice to the trustee that the individual is a covered expatriate. The covered expatriate will be deemed to have waived treaty benefits with respect to future distributions from the trust unless the covered expatriate checks a box on Form W-8CE certifying that he or she will elect on IRS Form 8854 to pay tax currently on the value of his or her interest in the trust.