It has been more than three years since the enactment of Sec. 877A, which introduced a mark-to-market tax on U.S. persons expatriating on or after June 16, 2008.
Official records indicate that, although still relatively small, there is an increasing number of U.S. persons who have renounced, or are in the process of renouncing, their U.S. citizenship or are terminating their long-term residency.
The decision to expatriate is deeply personal but in many cases can be tax motivated. This is particularly the case for U.S. citizens and green card holders living overseas where they remain subject to U.S. tax (albeit net of applicable credits and exclusions) on their worldwide income and gains and, ordinarily, their worldwide estate. The situation has been exacerbated by recent legislation that has made it increasingly burdensome for U.S. persons to open and maintain offshore bank accounts and work with offshore trustees, and who tend to have limitations on investment choices by virtue of their status as U.S. taxpayers. In addition, U.S. persons with foreign interests are subject to extensive and invasive reporting of such ownership interests and related income on federal forms such as the FBAR (for foreign accounts), IRS forms 3520 (for trusts), 8621 and 5471 (for foreign entities) and for the 2011 tax year, the new Form 8938 for foreign accounts holding more than $50,000. As such, U.S. persons residing overseas or contemplating a permanent move are giving greater consideration to these issues and to expatriation as a potential solution.
The introduction of Sec. 877A has also made a significant impact on the decisions of many to attain a green card or citizenship in the first place. It can be costly for wealthy individuals to become a covered expatriate (as described below) and, consequently, taking steps to avoid becoming a covered expatriate has become a fundamental part of pre-immigration planning.
Who Is Subject To Sec. 877A?
Expatriation simply includes the act of relinquishing U.S. citizenship or terminating long-term residency. Some limited exceptions apply with regard to citizens who meet certain tests related to minors and dual nationals. A long-term resident (LTR) is defined in Sec. 877(e) as someone who was a lawful permanent resident (green card holder) for eight of the past fifteen years ending with the year their LTR status ends. In theory, this could be as short as six years and two days if, for example, one were in the United States with a green card on December 31, 2004, and terminated LTR status on January 1, 2011.
Sec. 877A is only applicable to covered expatriates where:
- average annual net income tax for the five years ending before the date of expatriation or termination of residency is more than $147,000 (for 2011); or
- net worth is $2 million or more on the date of expatriation or termination of residency; or
- there is failure to certify on Form 8854 that one has complied with all U.S. federal tax obligations for the five years preceding the date of expatriation or termination of residency.
What Is Taxed Under 877A?
Sec. 877A provides that all property of a covered expatriate shall be treated as sold on the day before the expatriation date for its fair market value. To the extent the taxable gain exceeds an exclusion amount of $636,000 (for 2011) the covered executive would have a tax liability. Certain exceptions exist with regard to deferred compensation items and interests in non-grantor trusts. In calculating the taxable gain, LTRs may be able to receive a step-up in basis to the fair market value of assets when they first became a U.S. resident so it can be important to value and record assets at that time. The payment of tax can be deferred until gains are actually realized, but this can be cumbersome, requires posting a security bond and incurs an interest charge.
Sec. 877A should mean that, for the most part, you pay the tax and you’re effectively done. However, this is not necessarily so. When it comes to the estate and gift tax, the law also provides that gifts or bequests from covered expatriates to U.S. persons are subject to transfer taxes at the highest rate, which is currently 35 percent. This could mean that for someone who expatriates with a net worth of $10 million who has only U.S. heirs and dies 20 years later worth $200 million, the entire $200 million would be subject to tax at the highest rates. It is the U.S. recipient, including a U.S. trust, who is liable for the tax. This would be reportable on a new Form 708 except for the fact that, more than three years after the law was changed it is yet to be published. As such, transfers are not currently reportable until such form and associated guidance is available.
Opportunities exist for planning. For example, low current asset values may make it a good time to expatriate, especially where income tax rates are set to rise. The current $5 million gift tax exemption could also provide a window for reducing net worth below the $2 million level. Or simply selling one's principal residence prior to expatriation would allow one to benefit from the Sec. 121 exemption ($250,000 for individuals), which may otherwise be lost if taxed under Sec. 877A.
For someone with a green card, non-immigrant visa status or just contemplating a move to the United States, the best planning could be to simply avoid becoming a LTR by giving up one's green card before meeting the eight year test or to avoid getting a green card altogether. Of course, a taxpayer’s immigration status will be largely informed by the personal objectives of the taxpayer and his or her family, so any tax planning should be coordinated with any non-tax immigration goals.
Published December 19, 2011.
