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Advising U.S. Citizens and Long-Term Residents on Expatriating

Critical
Questions to Provide Good Advice

Notice 2009-85 issued by the Internal
Revenue Service on November 9, 2009 provides helpful guidance to practitioners advising clients who wish to give up their U.S. citizenship.  By relinquishing citizenship, clients avoid further U.S. tax compliance, as well as U.S. taxation on worldwide income. The Notice answers many questions left open by the statute adopted as part of the Heroes Earnings Assistance and Relief Tax Act of 2008[1].  That Act added new Code sections 877A and 2801 effective for individuals relinquishing U.S. citizenship or ceasing to be lawful permanent residents of the United States on or after June 17, 2008.  For those individuals, Internal Revenue Code section 877A creates an exit tax regime.  This article sets forth the questions practitioners should ask their clients who have an interest in expatriating.  These questions will allow the practitioner to elicit information necessary to properly advise clients regarding their exposure to the U.S. exit tax.
Are you a citizen or lawful permanent resident of the United States?

The exit tax of Code Section 877A is potentially applicable not only to U.S. citizens, but also individuals who have resided in the United States for at least eight out of fifteen taxable years (“Long-Term Resident”).  The fifteen-year period ends with the year in which the individual ceases to be a lawful permanent resident of the United States or becomes a resident of a non-U.S. jurisdiction under the provisions of a tax treaty between the United States and the other country[2].

 

What is your net worth?  What is your annual U.S. income taxliability?
These questions provide an initial screen to determine which clients are subject to the exit tax imposed by Code section 887A.  Unless the taxpayer’s net worth exceeds $2 million dollars (the  Net Worth Test”) or the taxpayer’s average annual net income tax liability for the five preceding taxable years prior to the year of expatriation exceeds the $124,000 amount set forth in Code Section 887(a)(2)(A), as adjusted for inflation ($147,000 for individuals expatriating in 2011[3]) (the “Tax Liability Test”) the exit tax imposed by the statute does not apply.  Any U.S. citizen or Long-Term Resident who satisfies the Net Worth Test or the Tax Liability Test is characterized as a “covered expatriate” and subject to the exit tax.  However, the converse is not necessarily true.  That is, a taxpayer who does not satisfy either of these tests is not necessarily exempt from the exit tax.

 

Have you filed all required U.S. tax returns for the last five years?
In order to avoid the exit tax, the taxpayer who is expatriating must also be U.S. tax compliant: that is, all U.S. tax returns (including employment, gift tax, and information returns) must have
been filed by the individual for each of the five taxable years preceding the taxable year in which expatriation occurs and all relevant tax liabilities, interest, and penalties must have been paid.[4]

Notice 2009-85 clarifies that U.S. tax compliance includes filing all information returns.  This includes Form TDF 90-22.1 Report of Foreign Bank and Financial Accounts, as well as all other information returns required by U.S. persons owning foreign accounts, entities, and other assets.

Whether or not a taxpayer who intends to expatriate is a covered expatriate, the taxpayer must file Form 8854.[5]  Failure to file Form 8854 or to sign the return under penalties of perjury will cause an individual who does not satisfy either the Net Worth Test or the Tax Liability Test to nonetheless be treated as a covered expatriate and subject to the exit tax.  Failure to file the Form 8854 not only subjects the person who is expatriating to a $10,000 penalty, it also subjects the person expatriating to the same exit tax as a covered expatriate.[6]

How did you become a U.S. citizen?
There are a variety of ways in which someone may acquire U.S. citizenship, but the most common are either to be born in the United States or to have a parent who is a U.S. citizen. Code Section 877A(g)(1)(B) creates a loophole for individuals who become dual citizens at birth.

Have you ever lived in the United States?
Even if an individual meets the Tax Liability Test or the Net Worth Test, the individual may still avoid the exit tax if the expatriate became a U.S. citizen and a citizen of another country at birth and has continued to be a citizen and taxed as a resident of that other country.

Example.   Mr. Smythe’s mother was a U.S. citizen residing in Canada at the time Mr. Smythe was born.  As a result, Mr. Smythe has dual Canadian-U.S. citizenship.  Although his net worth is in excess of $2 million dollars, if Mr. Smythe has been a U.S. resident for ten or fewer years during the fifteen year period ending with the taxable year during which expatriation occurs, he can avoid the exit tax.[7]

How old are you?  How long did you live in the United States?

A further exception to the exit tax exists for individuals with a net worth in excess of $2 million dollars or average annual tax liabilities in excess of $147,000 if U.S. citizenship is renounced before age 18 ½.[8]  In this case, the taxpayer must not have been resident in the United States for more than ten taxable years before relinquishing citizenship.[9]

How do you plan to relinquish U.S. citizenship?

Section 1481 of Title 8 of the United States Code describes seven ways in which a U.S. citizen can lose his nationality, including committing an act of treason.  However, treason and most of the other acts described in Section 1481 are insufficient to enable an individual who is a United States citizen or long term resident to effectively expatriate for U.S. income tax purposes.  The one act within the scope of Section 1481 which is effective is “making a formal renunciation of nationality before a diplomatic or counselor officer of the United States in a foreign state in such a form as may be prescribed by the Secretary of State”.[10]  The author understands it is the practice in most U.S. embassies to insist upon submission of Form DS-4079 Questionnaire Information for Determining Possible Loss of U.S. Citizenship and a Statement of Understanding Concerning the Consequences and Ramifications of Relinquishment or Renunciation of U.S. Citizenship, along with a copy of the individual’s passports (both from the United States and from the second country of the individual’s nationality).

Code Section 877A(g)(4) provides that citizenship will be lost on the earliest of

(1)        the date the taxpayer renounces his or her U.S. nationality before a diplomatic or counselor officer in a foreign embassy;

(2)     the date the taxpayer furnishes the United States Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming either

(a)   naturalization in non-U.S. jurisdiction,

 

(b)
taking an oath or making an affirmation or other formal declaration of
allegiance to a non-U.S. jurisdiction,

 

(c)   serving in the armed forces of a
non-U.S.          jurisdiction, or

 

(d)  accepting employment by the government of a
non-U.S. jurisdiction;

 

(3)        the date the U.S. Department of State
issues a certificate of loss of nationality to the taxpayer; or

 

(4)
the date a court of the United States cancels a          naturalized citizen’s certificate of
naturalization.

 

While Code Section 877A(g)(4)
recognizes four ways in which citizenship may be relinquished, in most cases
the taxpayer will submit two forms to the U.S. embassy or consulate in the
country where the individual resides: A Statement of Understanding Concerning
the Consequences and Ramifications of Relinquishment or Renunciation of U.S.
Citizenship and Form DS-4079 Questionnaire Information for Determining Possible
Loss of U.S. Citizenship along with copies of the taxpayer’s U.S. and foreign
passports.

 

 

 

What assets do you own?

The vast majority of individuals who
have dual citizenship with the United States and another country will not be
subject to the exit tax of Code Section 877A.
Many of these taxpayers will not satisfy the Tax Liability Test or the
Net Worth Test.  Others will not be
treated as covered expatriates because their citizenship arises as an accident
of birth and the time the individual was present in the United States was less
than eleven out of the last fifteen years.
However, for individuals who fail to satisfy these requirements or
others summarized above which allow expatriation on a tax free basis and thus
are treated as covered expatriates, the exit tax under Code Section 877A must
be computed in order to determine the tax liability the individual will incur
on expatriation.

 

Generally, the exit tax on
expatriation is a tax on the unrealized income inherent in the covered
expatriate’s assets.  Thus, assets the
individual owns are deemed to have been sold on the date of expatriation.  Retirement plan assets and other deferred
compensation items are deemed to have been paid to the covered expatriate on
the date of expatriation.

 

To determine the extent and value of
the covered expatriate’s assets, U.S. estate tax principles apply.[11]  The same revenue laws which determine the
extent of a taxpayer’s gross estate under Code Sections 2033 through 2046 will
apply to determine the assets included in the covered expatriate’s net
worth.  The same principles appearing in
U.S. Treasury Regulations issued under Code Sections 2031 and 2512 apply to
measure the value of the assets the covered expatriate owns or is deemed to
own.  (In this regard, the alternate
valuation date election under Code Section 2032 and special use valuation under
Code Section 2032A are not available.[12]
Contractual arrangements, such as options or other transactions
involving family members, will generally be ignored if these arrangements have
the effect of depressing the value of an asset.[13]

 

 

 

Are
you a beneficiary of a Trust?

In addition to assets owned directly
by an expatriate, included in the tax base on which the exit tax is assessed is
the beneficial interest held by the expatriate in a trust.  The Notice provides that the value of the
beneficial interest is determined under the rules of Section III of Notice
97-19, 197-1 C.B. 394.[14]  Notice 97-19
values the beneficial interest of the covered expatriate based on the gift tax
principals of Code Section 2512 of the regulations thereunder (without regard
to any prohibitions or restrictions on such interest).[15]  The nature and extent of the covered
expatriate’s beneficial interest in the trust will be determined in comparison
with the beneficial interest of other beneficiaries “based on all relevant
facts and circumstances, including the terms of the trust instrument, letter of
wishes (and any similar documents), historical patterns of trust distributions,
and any functions performed by a trust protector or similar adviser.”[16]  Notice 97-19 goes on to provide that in
default of an allocation based upon facts and circumstances, beneficial
interests will be allocated “under the principals of intestate
succession.”[17]  Illustrating this
concept, Notice 97-19 describes a trust with respect to which income and corpus
is distributable in the trustee’s discretion among two beneficiaries.  Each beneficiary is deemed to own one-half of
the assets of the trust.

 

 

Despite
subjecting the covered expatriate’s beneficial interest in a trust to inclusion
in the tax base on which the exit tax is assessed (in such a case, the
beneficiary typically has no basis for the beneficiary’s interest), the covered
expatriate will be subject to 30% withholding on distributions from the
trust.[18]  Further, if the distribution
takes the form of appreciated property, the trust will recognize gain as if the
distributed property had been sold to the expatriate at fair market value.  Further, treaty relief is not available to
reduce or eliminate such withholding.[19]

 

 

 

Have you ever transferred assets to
a trust?

Even if the covered expatriate is not
a beneficiary of a trust, property previously transferred to a U.S. trust may
also fall within the scope of assets the expatriate is deemed to own.  Although not explicit in either the statute
or Notice 2009-85, the technical explanation to the Hero’s Earnings Assistance
and Relief Tax Act of 2008 confirms that the assets with respect to which the
covered expatriate is treated as the owner under the grantor trust rules of
Code Sections 671 through 679 will be included in the tax base on which the
exit tax is assessed.[20]  Thus, if the covered
expatriate is treated as the owner of the trust for U.S. income tax purposes,
the assets of the trust will be treated as owned by the covered expatriate for
purposes of computing the exit tax.  If
expatriation causes the U.S. trust to be converted to a non-U.S. trust as a
result of relinquishment of citizenship and application of the rules of Code
Section 7701(a)(31)(b) and Treasury Regulations Section 301.7701-7, Notice
2009-85 makes it clear that Code Section 684 may apply.[21]  This Code provision treats the transfer of
appreciated property to a foreign trust as a gain recognition event.[22]  Finally, even if expatriation does not cause
the situs of the trust to change from domestic to foreign, if expatriation
causes the covered expatriate to no longer be treated as grantor of the trust,
Notice 2009-85 confirms that the assets of the trust will be deemed to have
been sold.  With regard to these
circumstances, the Notice is explicit that the provisions of Code Section 684
apply before the provisions of Code Section 877A.[23]  As a result, it would appear that the
$600,000 exclusion of gain under Code Section 877A would not be available to
reduce or offset gain recognition under Code Section 684.

 

Other arrangements which frequently
(but not necessarily) involve the use of trusts will also increase a covered
expatriate’s net worth.  Code Sections
2035-2038 will treat the covered expatriate as owning assets previously
transferred by the expatriate if the expatriate retained control over the
transferred property or the income therefrom, unless the retained control or
income was relinquished more than three years prior to expatriation.[24]  As a result, the assets held in trust will be
subject to exit tax computed as if the previously transferred assets had been
sold for an amount equal to their fair market value on the date of
expatriation.  No relief is provided for
U.S. gift taxes, paid in connection with the initial transfer to trust.  In contrast, gift tax paid in connection with
the transfer of property subject to inclusion in the gross estate under Code
Sections 2039-203F is credited in the computation of the transferor’s estate
tax liability.[25]

 

 

 

Do you own any life insurance or
annuity contracts?

Assets
such  as  annuities and life insurance policies are
generally valued at their replacement cost.[26]

 

 

 

Have you ever transferred assets to
a non-U.S. corporation?

Generally, gain is required to be
recognized on contribution of appreciated property to a non-U.S.
corporation.  However, the gain realized
may be deferred by entering into a gain recognition agreement satisfying the
requirements of U.S. Treasury Regulations issued under Code Section
367(a).  These Regulations also provide
that if an individual U.S. transferor loses U.S. citizenship or ceases to be a
lawful permanent resident of the United States, the individual will be treated
as having disposed of all of the stock of the foreign corporation to which the
appreciated property was transferred.  As
a result, the gain that was deferred as a result of the gain recognition
agreement will be accelerated and recognized on the date of expatriation.

 

 

 

Do you own any individual retirement
accounts, participate in employer provided retirement plans, or are eligible
for any other form of deferred compensation benefit?

Computation of the exit tax under Code
Section 877A begins with analysis of the assets the covered expatriate owns or
is deemed to own.  Once these assets are
identified, special rules apply to determine the income required to be
recognized under Code Section 877A.  In
the case of personal and investment assets owned directly by the expatriate,
these assets are marked to market as if they had been sold for fair market
value on the date of expatriation.  In
the case of other assets such as deferred compensation items, income will be
realized as if the deferred compensation were received. In each case, the
practitioner should ask questions necessary to identify the types of property
Section 877A seeks to tax.

 

 

 

Do you participate in any retirement
plans?

For those individuals subject to Code
Section 877A, expatriation triggers the acceleration of the covered
expatriate’s account balance in a wide variety of retirement plans.  Not only are employer provided retirement
plans such as 401(k) and pension and profit sharing plans subject to
acceleration, but the expatriate’s interest in any individual retirement
account, government 403(b) plans, simplified employee pensions described in
Code Section 408(k), and simplified retirement accounts  described in Code Section 408(p) will become
immediately taxable.[27]  In addition,
“any interest in a foreign pension plan or similar retirement arrangement or
program” is included within the definition of a “deferred compensation item”
for purposes of Code Section 877A(g)(4).
This would appear to include RRSPs, as well as other retirement savings
arrangements common in Canada.  Further,
amounts payable under non-qualified deferred compensation arrangements, such as
trusts or other arrangements in which the “covered expatriate has a legally binding
right as of the expatriation date to such compensation…not…actually or
constructively received on or before the expatriation date…” will be deemed
to have been paid.[28]

 

Finally, deferred compensation items
also include “any property, or right to property, which the individual is
entitled to receive in connection with the performance of services to the
extent not previously taken into account under Section 83 or in accordance with
Section 83.”[29]  This includes statutory
and non statutory stock options, stock appreciation rights, restricted stock
units with respect to which income recognition has been deferred because the
property is either subject to a substantial risk of forfeiture or
non-transferable.  However, if the
property has been the subject of an election under Code Section 83(b) resulting
in its fair market value having been taken into income by the covered
expatriate, it will not be treated as a deferred compensation item for purposes
of Code Section 877A.[30]

 

 

 

Were any of the services giving rise
to the deferred compensation benefit performed outside of the United States?

An exception is provided by Code
Section 877A(d)(5) for deferred compensation items attributable to services
performed outside the United States while the covered expatriate was not a
citizen or resident of the United States.
These items fall outside the scope of the exit tax imposed by Code
Section 877A.[31]  This would most
commonly arise in the case of an individual who is not a U.S. citizen but
became subject to Code Section 877A as a result of satisfying the definition of
a Long Term Resident.  Notice 2009-85
provides that taxpayers may use “any reasonable method” to determine what
portion of a deferred compensation item is attributable to services performed
outside the United States while the covered expatriate was not a citizen or
resident, as distinguished from that portion attributable to services performed
while the covered expatriate was a resident of the United States.[32]

 

 

 

When did you become a U.S. resident?

For those individuals who become
subject to the exit tax of Code Section 877A as a result of characterization as
a Long-Term Resident (that is, a lawful permanent resident of the United States
for at least eight taxable years during the fifteen year period ending with the
taxable year in which residency ceases), an exception to the scope of the exit
tax arises.  Gain inherent in the assets
owned by the covered expatriate at the time the individual first became a
resident of the United States will be ignored.[33]  Residency for these purposes is determined on
the basis of the tests found in Code Section 7701(b).  Thus, residency could commence on the date
the individual first

 

(1)     became a lawful permanent resident of the
United States (that is, a “green card” holder),

 

(2)
satisfied the substantial presence test of Code Section 7701(b)(3), or

 

(3)     elected to be treated as a U.S. resident
pursuant to Code Section 7701(b)(4).

Property owned by the covered
expatriate on the residency starting date is deemed to have a basis for
purposes of computing gain or loss under Code Section 877A equal to the fair
market value of the property on that date.[34] This basis adjustment is
automatic unless the covered expatriate elects out of these rules.  Such an election may be appropriate in the
case of a covered expatriate whose gain recognition is sufficiently limited so
as to be sheltered by the $600,000 exclusion provided by Code Section
877A(a)(3)(A) (adjusted to $636,000 for individuals expatriating in 2011)[35]
or who owns a U.S. real property interest with respect to which the individual
prefers to recognize gain otherwise excluded as a result of Code Section
877A(h)(2), perhaps because of lower capital gain rates applicable to the year
of expatriation.[36]  Notice 2009-85
provides that the basis step-up allowed by Code Section 877A(h)(2) will not be
available in the case of a U.S. real property interest held in connection with
the conduct of a U.S. trade or business on the date the covered expatriate
first became a resident of the United States unless the U.S. trade or business
was not carried on through a permanent establishment in the United States as a
result of a tax treaty between the United States and the country in which the
covered expatriate resided prior to U.S. residency.[37]

 

 

 

Are you willing to give away assets?

The obvious planning opportunity to
avoid status as a covered expatriate is to give assets away prior to
expatriation so as to avoid the Net Worth Test.
If the asset transfers reduce the taxpayer’s Net Worth below the $2
million threshold, the exit tax may be avoided.
(The taxpayer will also have to fail to satisfy the Tax Liability Test
in order to avoid status as a covered expatriate.)  Gifts prior to expatriation will qualify for
the gift tax exemption of Code Section 2505.[38]

 

In order to be effective to reduce the
net worth of the taxpayer who is contemplating expatriation below the $2
million threshold of the Net Worth Test, conveyances do not need to take the
form of direct gifts.  Transfers in trust
will qualify so long as the conveyance is a completed gift prior to the date of
expatriation.  Such trusts would have to
run the gauntlet of the rules discussed above regarding the circumstances in
which assets held in trust will be considered to comprise part of the asset
base to which the Net Worth Test is applied: generally a non-grantor trust with
respect to which the taxpayer has no beneficial interest.  The taxpayer could nonetheless act as trustee
of such a trust as long as the trustee’s discretion to make distributions were
limited by an ascertainable standard[39] or the beneficial interests in the
trust were administered as separate shares.[40]

 

 

Do you wish to incur the exit tax in
the year of expatriation or take advantage of opportunities for its deferral?

 

Computation of the exit tax.  In order to intelligently determine whether
the exit tax should be deferred, it is necessary to first compute the covered
expatriate’s tax exposure under Code Section 877A.  Unless the taxpayer’s expatriation date is
January 1, the covered expatriate will file a “dual status return” for the year
in which expatriation occurs.[41]  The
dual status return requires preparation of both Form 1040NR and Form 1040
attached as a schedule.[42]  With the
dual status return, the covered expatriate must provide a statement which
includes the information required by Code Section 6039G: generally, the covered
expatriate’s income, assets, and liabilities.
This information will be used to compute the gain realized as a result
of the deemed sale of the covered expatriate’s assets and the income realized
as a result the deemed payment of the covered expatriate’s deferred
compensation items.  Notice 2009-85
provides examples illustrating how the $600,000 exclusion provided by Code
Section 877A(a)(3)(A) will be allocated among the assets with respect to which
gain is realized.  The Notice resolves
two unanswered questions or ambiguities present in the language of the
statute.  First, loss realized as a
result of marking-to-market the covered expatriate’s assets will be applied to
offset gains.  Second, the resulting
basis adjustment will take into account gain sheltered as a result of the
$600,000 exclusion.

 

Example.   Mr. Smythe owns one asset with a basis of
$200,000 and a fair market value of $2 million.
As a result of his expatriation, the asset is marked to market and
deemed to be sold for $2 million.  Of the
$1.8 million of deemed realized gain, $600,000 is sheltered as a result of the
exclusion provided by Code Section 877A(a)(3)(A).  Mr. Smythe will pay a tax on the remaining
$1.2 million of unsheltered gain.  Notice
2009-85 makes clear that the basis which Mr. Smythe takes in his U.S. real
property interest is $2 million, despite the $600,000 exclusion.[43]

 

 

Deferral of income recognition from
deemed sales.  There are two
opportunities to defer the exit tax.
First, in the case of any asset subject to the mark-to-market regime a
deferral election is available under Code Section 877A(b).  Elective deferral is available on an
asset-by-asset basis.[44]  As a result of
the deferral election, the exit tax will be deferred until the asset is
sold.  In the interim, interest will
accrue on the deferred tax liability at the underpayment rate established under
Code Section 6621 from the due date of the covered expatriate’s U.S. income tax
return determined without extensions for the taxable year that includes the day
before the expatriation date.[45]  That
is, April 15 of the year after the year in which the expatriation date occurs,
unless the expatriation date occurs on January 1, in which case interest will
accrue starting on April 15 of the year in which the expatriation date
occurs.[46]

 

In order to qualify for the deferral
election, the covered expatriate must

 

(1)
waive  any  treaty
benefits   which   would
preclude assessment or collection of the exit tax by filing Form 8854
with the covered expatriate’s U.S. income tax return for the taxable year that
includes the day before the expatriation date;

 

(2)
provide adequate security,
described  by the Notice  as either

 

(a)     a bond meeting the requirements of Code
Section 6325 or

 

(b)    another form of security acceptable to the
U.S. Secretary of the Treasury such as a letter of credit;

 

(3)
enter into a tax deferral agreement with the Internal Revenue Service
conforming to the template provided as Appendix A to Notice 2009-85; and

 

(4)
appoint a U.S. person to act as the covered expatriate’s agent for
purposes of receiving correspondence from the IRS relating to the tax deferral
agreement by entering into a binding agreement substantially similar to the
form of the agreement provided as Appendix B to Notice 2009-85.

 

The deferral request the covered
expatriate is required to provide in order to elect to defer the exit tax must
include

 

(1)     two signed copies of the tax deferral
agreement,

 

(2)     a description of the assets with respect to
which elective deferral applies,

 

(3)
an attachment showing the calculation of the tax attributable to each of
the assets computed in the manner required by Notice 2009-85,

 

(4)
documentation of the security offered by the covered expatriate for
deferral of the tax,

 

(5)     a copy of the agreement with the U.S.
agent, and

 

(6)     a copy of the covered expatriate’s U.S.
income tax return for the taxable year that includes the day before the
expatriation date.

 

In addition, the covered expatriate
must include a copy of the deferral request with his tax return for the taxable
year that includes the day before the expatriation date.  The Notice makes clear that the covered
expatriate may file the deferral request simultaneously with this tax
return.[47]

 

 

Deferral of income recognition from
deemed payment of deferred compensation items.
Deferral is also available with respect to deferred compensation items
which satisfy the definition of an eligible deferred compensation item under
Code Section 877A(g)(3).  Despite
expatriation, eligible deferred compensation items are not subject to U.S.
taxation until actually paid to the covered expatriate.  In order to satisfy the requirements of the
statute, the deferred compensation must be payable by a United States person or
a person who elects to be treated as a United States person for purposes of the
statute.  The covered expatriate must
notify the payor of the taxpayer’s status as a covered expatriate and waive
reduced withholding provided by any applicable tax treaty.[48]  The Notice requirement is satisfied by filing
form W-8CE with the payor within thirty days of the expatriation date or prior
to the first distribution on or after the expatriation date if less than thirty
days.[49]   As a result of the treaty
waiver, payment of the deferred compensation to the covered expatriate will be
subject to 30% withholding under Code Section 877A(d)(1).  Until the eligible deferred compensation
items are paid, the covered expatriate must also file Form 8854 annually to
avoid imposition of a $10,000 penalty for failure to file.

 

Anything that is not an eligible
deferred compensation item is characterized by the Notice as an “ineligible
deferred compensation item.”[50]  These
items will be fully taxable in the taxable year of the covered expatriate which
includes the day before the expatriation date.
The Notice requires the covered expatriate to provide Form W-8CE to the
payor of the deferred compensation item.
Within sixty days of receipt of Form W-8CE “the payor must provide a
written statement to the covered expatriate setting forth the present value of
the covered expatriate’s accrued benefit on the day before the expatriation
date.”[51]

 

Generally in the case of ineligible deferred
compensation items, the amount included in income is the covered expatriate’s
account balance on the day before the expatriation date.[52]  However, in the case of a defined benefit
plan, the present value of the covered expatriate’s accrued benefit will be
determined using the methodology set forth in Section 4.02 of Revenue Procedure
2004-37, 2004-1C.B.1099.  In the case of
ineligible deferred compensation items which represent interests in foreign
pension plans or similar retirement arrangements or items of deferred
compensation payable by a non-U.S. employer, (such as non-qualified deferred
compensation), the present value of the covered expatriate’s accrued benefit
will be determined by applying the principles set forth in Proposed Treasury
Reg. Section 1.409A-4.  In the case of an
ineligible deferred compensation item which takes the form of property subject
to Code Section 83, the fair market value of the property interest will be
determined as of the day before the expatriation date without regard to any
risk of forfeiture as if the item were fully transferrable by the covered
expatriate (reduced by the amount, if any, paid by the covered expatriate for
the property).[53] With respect to stock appreciation rights or restricted
stock units, the Notice provides that these interests will be treated as
substantially vested as of the day before the expatriation date and valued by
reference to the “cash equivalency doctrine.”[54]

 

Early distribution taxes and penalties
will not apply in computing the tax liability for ineligible deferred
compensation items subject to the exit tax.[55]

 

 

 

Do you own any interest in an IRA, 529
plan, Coverdell saving account, health savings account, or Archer medical
savings account?

 

Although not explicitly stated in
Notice 2009-85, accounts of the covered expatriate that fall within the
definition of “specified tax deferred accounts” under Code Section 877A(e)(2)
are not eligible for deferral.  Although
no early distribution penalties or taxes will apply to the account balance in
the specified tax deferred account, the entire account balance on the day
before the expatriation date will be treated as distributed to the covered
expatriate.  Specified tax deferred
accounts are defined by the statute to include any individual retirement plan
as defined by Code Section 7701(a)(37) (that is, individual retirement accounts
and individual retirement annuities, other than simplified employee pension
plans described in Code Section 408(k) and simple retirement accounts described
in Code Section 408(p), qualified tuition programs described in Code Section
529, Coverdell education savings accounts described in Code Section 530, health
savings accounts described in Code Section 223, and Archer medical savings
accounts described in Code Section 220).

 

 

 

Do you own any U.S. real property
interests, stock of any U.S. corporation, or assets used in a U.S. trade or
business?

 

U.S. real property interests, stock of
U.S. corporations, or assets used in U.S. trade or business are examples of
U.S. situs property.  Nonresident aliens
are subject to U.S. estate taxation on U.S. situs assets.[56]  Further, these assets will also be subject to
U.S. gift taxation if transferred prior to the death of the nonresident
alien.  Unlike a nonresident alien, a
U.S. citizen or resident has the benefit of a significant U.S. gift tax
exemption.  For transfers made after
December 31, 2010 and before January 1, 2013, a U.S. citizen or resident may
transfer up to $5 million in assets without incurring a U.S. gift tax
liability.[57]  Because of the adverse
gift and estate tax treatment imposed on U.S. situs assets if transferred by a
nonresident alien while alive or at death, these assets should be transferred
prior to expatriation.  (Nonresident
alien decedents receive the benefit of only a $60,000 U.S. estate tax
exemption.[58]

 

 

 

Do you have any family members to whom
you intend to make gifts during your lifetime or bequests at your death who are
U.S. citizens and may reside in the United States?

 

Code Section 2801 imposes a U.S.
transfer (gift or estate) tax on any gift or bequest made by a covered
expatriate to a United States citizen or resident.  The tax imposed by Code Section 2801 falls
not on the covered expatriate but rather the U.S. citizen or resident receiving
the gift or bequest from the covered expatriate.[59]  The gift will be reported on a Form 708 which
has yet to be issued by the Internal Revenue Service.  “The due date for reporting, and for paying
any tax imposed on, the receipt of such gifts or bequests has not yet been
determined.”[60]

 

The tax imposed by Code Section 2801
is calculated at the maximum gift or estate tax rate in effect under Code
Section 2001(c).[61]  The tax is applied
to the fair market value of the assets which are the subject of the gift or
bequest.[62]  Value is determined on the
date the transfer occurs.  Although Code
Section 2801(d) provides for a tax credit for “any gift or estate tax paid to a
foreign country”, it is not clear that an income tax on dispositions of capital
assets (such as the tax imposed by Sections 69.1 of 70.5 of the Income Tax Act
on transfers while alive and deemed dispositions at death) will satisfy the
requirements of the statute.  In this
regard, Notice 2009-85 provides that “[s]atisfaction of the reporting and tax
obligations for covered gifts or bequests received will be deferred, pending
the issuance of guidance.”[63]

 

 

 

Have you previously expatriated?

 

Each covered expatriate is allowed one
exclusion under Code Section 877A(a)(3)(A).[64]
If an individual expatriates more than once, any unused portion of the
covered expatriate’s exclusion will be available on subsequent exits.[65]

 

 

 

CONCLUSION

 

While guidance remains pending on
certain matters (particularly as related to the operation of Code Section
2801), Notice 2009-85 fills in many of the gaps left by Code Section 877A and
provides essential guidance regarding compliance procedures for paying the exit
tax and taking advantage of the deferral opportunities provided by the statute.  Perhaps the most essential unanswered
question for advisers to clients residing in Canada is whether Paragraph 7 of
Article XIII of the Convention between Canada and the United States of America
with Respect to Taxes on Income and on Capital (the “Tax Treaty”) may be relied
upon by a covered expatriate.  This
provision of the Tax Treaty appears to offer an opportunity to coordinate the
recognition of gain under the revenue systems of both countries so as to make
the U.S. exit tax creditable against the Canadian tax liability of a covered
expatriate residing in Canada.
Presumably, if Paragraph 7 of Article XIII of the Tax Treaty applies to
allow gain to be recognized and taxed by Canada in the same year the exit tax
under Code Section 877A is imposed by the U.S., there would be a corresponding
basis adjustment for the gain recognized.[66]
Competent authority relief may ultimately be necessary to determine
whether relief from double taxation is available on imposition of the exit tax under
Code Section 877A, as well as the transfer tax imposed by Code Section 2801.

 

[1]
P.L. 110-245

 

[2]
Code Section 877A(g)(5), referring to Code Section 877(e).

 

[3]
Rev. Proc. 2010-40; 2010-46 I. R. B. 663

 

[4]
Code Section 877A(g)(1)(A) cross referencing Code Section 877(a)(2)(c).

 

[5]
See Notice 2009-85, Section 8C.

 

[6]
Notice 2009-85, Section 8C, example 22.

 

[7]
See Notice 2009-85, Section 2A.

 

[8]
Code Section 877A(g)(1)(B)(ii)

 

[9]
Id.

 

[10]
8 USC Section 1481(a)(5)

 

[11]
Notice 2009-85, Section 3A.

 

[12]
Id.

 

[13]
Id.

 

[14]
See Notice 2009-85, Section 3A.

 

[15]
See Notice 97-19, Section III.

 

[16]
Id.

 

[17]
Id.

 

[18]
Code Section 877A(f)(1)(A).

 

[19]
Code Section 877A(f)(4)(B).

 

[20]
Technical Explanation of HR 6081- The “Hero’s Earnings Assistance and Relief
Tax Act of 2008,” as Scheduled for Consideration by the House of
Representatives on May 20, 2008, Prepared by the Staff of the Joint Committee
on Taxation, page 43.

 

[21]
See Notice 2009-85 Section 4.

 

[22]
See Code Section 684(a).

 

[23]
See Notice 2009-85, Section 4.

 

[24]
See Notice 2009-85, Section 3A.

 

[25]
See Code Section 2001(b)(2).

 

[26]
Notice 2009-85, Section 3A, referring to Treasury Reg. Section 25.2512-6.

 

[27]
Code Section 877A(g)(4)(A) brings within the scope of Code Section 877A “any
interest in a plan or arrangement described in Section 219(g)(5).”

 

[28]
Notice 2009-85, Section 5B(4).

 

[29]
Code Section 877A(g)(4)(D).

 

[30]
See Notice 2009-85, Section 5B(1)(d).

 

[31]
See Notice 2009-85, Section 5E.

 

[32]
Id.

 

[33]
Code Section 877A(h)(2).

 

[34]
Code Section 877A(h)(2).

 

[35]
Rev. Proc. 2010-40; 2010-46 I.R.B. 663

 

[36]
In this regard, the Tax Relief, Unemployment Insurance Reauthorization, and Job
Creation Act of 2010 extended the 15% rate on capital gains for two years.  Absent further Congressional action the
capital gains reverts to 20% for sales and exchanges after December 31,
2012.  See Pub. L. No. 111-132, Section
102.

 

[37]
See Notice 2009-85, Section 3D.

 

[38]
In this regard, the Tax Relief, Unemployment Insurance Reauthorization, and Job
Creation Act of 2010 increased the gift tax exemption from $1 million for
transfers made in 2010 to $5 million for transfers made in 2011 and 2012.  See Pub. L. No. 111-132, Section 302.  Absent further congressional action, the gift
tax exemption will revert to $1 million for transfers made after December 31,
2012.

 

[39]
See Code Section 674(b)(5)(A).

 

[40]
See Code Section 674(b)(5)(B).  Some
commentators have also suggested that it may be possible to design a trust with
respect to which the settlor retains a beneficial interest.  See Campbell and Stegman, “Confronting the
New Expatriation Tax: Advice for the U.S. Greencard Holder” 35 ACTEC Journal,
266, 270. (Winter, 2009)

 

[41]
Notice 2009-85, Section 8B.

 

[42]
The Notice refers taxpayers to Treasury Reg. Section 1.6012-1(b)(2)(ii)(b),
Treasury Reg. Section 1.871-13, and chapter 6 of IRS Publication 519 for the
requirements for filing a dual status return.

 

[43]
See Notice 2009-85, Section 3C.

 

[44]
See Notice 2009-85, Section 3E.

 

[45]
See Notice 2009-85, Section 3E.

 

[46]
The underpayment rate for the first quarter of 2011 is 30%. Rev. Rul. 2010-31;
2010-52 I.R.B 898.

 

[47]
See Notice 2009-85, Section 8C.

 

[48]
Notice 2009-85, Section 5B(2).

 

[49]
Notice 2009-85, Section 8D.

 

[50]
See Notice 2009-85, Section 5B(3).

 

[51]
Notice 2009-85, Section 8D.

 

[52]
Notice 2009-85, Section 5D.

 

[53]
Notice 2009-85, Section 5D.

 

[54]
Id., referring to Cowden vs. Commissioner, 289 F.2d 20 (5th Cir. 1961).

 

[55]
Code Section 877A(d)(2)(B).

 

[56]
Code Section 2101, 2104(a).

 

[57]
Code Section 2505; Pub. L. No. 111-132, Section 302.

 

[58]
See Code Sections 2102(b)(1), 2001(c).

 

[59]
Code Section 2801(b).

 

[60]
See Notice 2009-85, Section 9.

 

[61]
Code Section 2801(a)(1).

 

[62]
Code Section 2801(a)(2).

 

[63]
Announcement 2009-57, 2009-29IRB158.

 

[64]
See Notice 2009-85, Section 3B.

 

[65]
Id.

 

[66]
Whether any basis adjustment is available for the $600,000 exclusion provided
by Code Section 877A(a)(3)(A) appears doubtful.