Notice 2009-85 issued by the Internal Revenue Service
(IRS) on 9 November 2009 provides helpful guidance to practitioners
advising clients who wish to give up their US citizenship. By
relinquishing citizenship, clients avoid further US tax compliance,
as well as US 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. That Act added new
s877A and s2801 to the US Internal Revenue Code (Code),
effective for individuals relinquishing US citizenship or ceasing
to be lawful permanent residents of the US on or after 17 June
2008. For those individuals, Code s877A 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
advise clients properly regarding their exposure to the US exit
tax.
Are you a citizen or lawful permanent
resident of the US?
The exit tax of Code s877A is potentially applicable not only to
US citizens, but also individuals who have resided in the US for at
least eight out of 15 taxable years (long-term resident). The
15-year period ends with the year in which the individual ceases to
be a lawful permanent resident of the US or becomes a resident of a
non-US jurisdiction under the provisions of a tax treaty between
the US and the other country.
What is your net worth? What is your annual
US income tax liability?
These questions provide an initial screen to determine which
clients are subject to the exit tax imposed by Code s887A. Unless
the taxpayer’s net worth exceeds USD2 million (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 USD124,000 amount set forth in Code s887(a)(2)(A), as
adjusted for inflation (USD147,000 for individuals expatriating in
2011) (the tax liability
test) the exit tax imposed by the statute does not apply. Any US
citizen or long-term resident who satisfies the net worth test or
the tax liability test is characterised 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 US tax returns
for the last five years?
To avoid the exit tax, the taxpayer who is expatriating must
also be US tax-compliant: that is, all US tax returns (including
income, 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.
Notice 2009-85 clarifies that US 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 US 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 to confirm US
compliance obligations have been satisfied for the prior five
years. Failure to file Form
8854 or to sign the return under penalties of perjury not only
subjects the person who is expatriating to a USD10,000 penalty, it
also 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.
How did you become a US citizen?
There are a variety of ways in which someone may acquire US
citizenship, but the most common are either to be born in the US or
to have a parent who is a US citizen. Code s877A(g)(1)(B) creates a
loophole for individuals who become dual citizens at birth.
Have you ever lived in the US?
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 US 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 US citizen residing in Canada
at the time Mr Smythe was born. As a result, Mr Smythe has dual
Canadian-US citizenship. Although his net worth is in excess of
USD2 million, if Mr Smythe has been a US resident for ten or fewer
years during the 15-year period ending with the taxable year during
which expatriation occurs, he can avoid the exit tax.
How old are you? How long did you live in
the US?
A further exception to the exit tax exists for individuals with
a net worth in excess of USD2 million or average annual tax
liabilities in excess of USD147,000 if US citizenship is renounced
before age 18 and a half. In this case, the
taxpayer must not have been resident in the US for more than ten
taxable years before relinquishing citizenship.
How do you plan to relinquish US
citizenship?
Section 1481 of title 8 of the United States Code (USC)
describes seven ways in which a US citizen can lose their
nationality, including committing an act of treason. However,
treason and most of the other acts described in s1481 are
insufficient to enable an individual who is a US citizen or
long-term resident to expatriate effectively for US income tax
purposes. The one act within the scope of s1481 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’. The author
understands it is the practice in most US embassies to insist upon
submission of Form DS-4079, ‘Questionnaire: Information for
Determining Possible Loss of US Citizenship’ and a ‘Statement of
Understanding Concerning the Consequences and Ramifications of
Relinquishment or Renunciation of US Citizenship’, along with a
copy of the individual’s passports (both from the US and from the
second country of the individual’s nationality).
Code s877A(g)(4) provides that citizenship will be lost on the
earliest of:
(1) the date the taxpayer renounces their US nationality before
a diplomatic or counsellor officer in a foreign embassy
(2) the date the taxpayer furnishes the US Department of State
with a signed statement of voluntary relinquishment of US
nationality confirming either:
(a) naturalisation in non-US jurisdiction
(b) taking an oath or making an affirmation or other formal
declaration of allegiance to a non-US jurisdiction
(c) serving in the armed forces of a non-US jurisdiction, or
(d) accepting employment by the government of a non-US
jurisdiction
(3) the date the US Department of State issues a certificate of
loss of nationality to the taxpayer, or
(4) the date a court of the US cancels a naturalised citizen’s
certificate of naturalisation.
While Code s877A(g)(4) recognises four ways in which citizenship
may be relinquished, in most cases the taxpayer will submit two
forms to the US embassy or consulate in the country where the
individual resides: a ‘Statement of Understanding Concerning the
Consequences and Ramifications of Relinquishment or Renunciation of
US Citizenship’ and Form DS-4079 ‘Questionnaire: Information for
Determining Possible Loss of US Citizenship’, along with copies of
the taxpayer’s US and foreign passports.
What assets do you own?
The vast majority of individuals who have dual citizenship with
the US and another country will not be subject to the exit tax of
Code s877A. 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 US was less
than five out of the last 15 years. However, for individuals who
fail to satisfy these requirements or others summarised above,
which allow expatriation on a tax-free basis, the exit tax under
Code s877A must be computed to determine the tax liability the
individual will incur on expatriation.
Generally, the exit tax on expatriation is a tax on the
unrealised income inherent in the covered expatriate’s assets.
Thus, assets the individual owns are deemed to have been sold on
the day before the date of expatriation. Retirement plan assets and
other deferred compensation items are deemed to have been paid to
the covered expatriate on the day before the date of
expatriation.
To determine the extent and value of the covered expatriate’s
assets, US estate tax principles apply. The same
revenue laws that determine the extent of a taxpayer’s gross estate
for US estate tax purposes under Code s2033 to s2046 will apply to
determine the assets included in the covered expatriate’s net
worth. The same principles appearing in US Treasury
Regulations issued under Code s2031 and s2512 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 s2032 and special use valuation under Code s2032A are not
available.) 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.
Have you ever transferred assets to a
trust?
In certain cases a covered expatriate will also be deemed to own
assets that would not be subject to US estate taxation at the
covered expatriate’s death. Although not explicit in the statute,
the technical explanation to the Heroes 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 s671 to s679 will be included in the
tax base on which the exit tax is assessed. Thus, if the covered
expatriate is treated as the owner of the trust for US 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 grantor trust to be converted from a
US to a non-US trust as a result of relinquishment of citizenship
and application of the rules of Code s7701(a)(31)(b) and US
Treasury Regulations s301.7701-7, Notice 2009-85
makes it clear that Code s684 may apply. This Code provision
treats the transfer of appreciated property to a foreign trust as a
gain recognition event unless the transferor
is treated as the owner of the trust for US income tax purposes
under Code s671 to s679. Thus, if (a) expatriation causes the
situs of the trust to change from domestic to foreign, and
(b) 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 s684 apply before the provisions of Code
s877A. As a result, it
would appear that the USD600,000 exclusion of gain under Code
s877A(a)(3)(A) (adjusted to USD636,000 for individuals expatriating
in 2011) would not be
available to reduce or offset gain recognition under Code s684.
Other arrangements that frequently (but not necessarily) involve
the use of trusts will also increase a covered expatriate’s net
worth – for purposes of the exit tax. As observed above, US estate
tax principles determine the extent and value of the covered
expatriate’s assets. For example, Code
s2035 to s2038 treat a decedent as owning assets previously
transferred prior to death if the decedent 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. Where control or
income was retained through a trust, the assets held in trust will
be subject to the exit tax computed as if the previously
transferred assets had been sold for an amount equal to their fair
market value on the day before the date of expatriation. No relief
is provided for US gift taxes paid in connection with the initial
transfer to the trust. In contrast, gift tax paid in connection
with the transfer of property subject to inclusion in the gross
estate of a decedent for US estate tax purposes under Code s2035 to
s2038 is credited in the computation of the transferor’s estate tax
liability.
Are you a beneficiary of a trust?
Section 3A of the Notice is confusing in stating ‘a covered
expatriate is deemed to own his or her beneficial interest(s) in
each trust (or portion of a trust) that would not constitute part
of his or her gross estate…’ This blanket statement appearing in
s3A of the Notice is contradicted by both the statute and s7A of
the Notice. Code s877A(c)(3) expressly excludes application of the
mark-to-market rules of Code s877A(a)(2) to ‘any interest in a
non-grantor trust (as defined in subsection (f)(3))’. A non-grantor
trust is defined by Code s877A(f)(3) as any portion of a trust with
respect to which the settlor is not considered to be the owner
under Code s671 to s679. This determination is made immediately
before expatriation.
The relief from the exit tax provided by Code s877A(c)(3) and
s7A of the Notice to a covered expatriate’s beneficial interest in
a non-grantor trust may prove to be ephemeral. The unrealised gain
inherent in the assets held by a non-grantor trust will be
recognised if the non-grantor trust subsequently becomes a grantor
trust after the covered expatriate’s expatriation. The Notice provides
the assets held by the trust with respect to which the covered
expatriate is treated as the owner will be deemed to have been
distributed under Code s877A(f)(1) to the covered expatriate.
Although the covered expatriate’s beneficial interest in a
non-grantor trust is not included in the tax base on which the exit
tax is assessed, the covered expatriate will be subject to 30 per
cent withholding on distributions from
the trust. Generally, treaty
relief is not available to reduce or eliminate such withholding. If
the distribution takes the form of appreciated property, the trust
will recognise gain as if the distributed property had been sold to
the expatriate at fair market value. The covered expatriate must
file Form W-8CE with the trustee of the non-grantor trust annually
to notify the trustee of the covered expatriate’s status and that
the covered expatriate has waived any applicable tax treaty
benefits. The covered
expatriate must also file Form 8854 each year to report either the
receipt or absence of distributions from the trust.
Do you own any life insurance or annuity
contracts?
Assets such as annuities and life insurance policies are also
included in applying the net worth test and in computing the exit
tax if the taxpayer who relinquished US citizenship is determined
to be a covered expatriate. Annuities and life insurance policies
are generally valued at their replacement cost.
Have you ever transferred assets to a non-US
corporation?
Generally, gain is required to be recognised on contribution of
appreciated property to a non-US corporation. However, the gain
realised may be deferred by entering into a gain recognition
agreement satisfying the requirements of US Treasury
Regulations issued under Code s367(a). These regulations also
provide that if an individual US transferor loses US citizenship or
ceases to be a lawful permanent resident of the US, 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 recognised on the date of
expatriation.
Again, the Notice is explicit: the gain that was deferred by the
gain recognition agreement is recognised and taxed before
application of Code s877A. The result of the
ordering rule of the Notice is to make the USD600,000 exclusion
under Code s877A(a)(3)(A) unavailable to reduce or offset gain
recognition under Code s367(a).
Do you own any individual retirement
accounts, do you participate in employer provided retirement plans,
or are you eligible for any other form of deferred compensation
benefit?
Computation of the exit tax under Code s877A 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 recognised under Code s877A. 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
realised as if the deferred compensation were received. In each
case, the practitioner should ask questions necessary to identify
the types of property s877A seeks to tax.
Do you participate in any retirement
plans?
For those individuals subject to Code s877A, expatriation
generally 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, potentially subject to acceleration, but the
expatriate’s interest in any individual retirement account (IRA),
Government 403(b) plans, simplified employee pensions described in
Code s408(k), and simplified retirement accounts described in Code
s408(p) will become immediately taxable. 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 s877A(g)(4).
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.
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.’ 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 s83(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 s877A.
Do you have any Registered Retirement
Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs),
or similar retirement savings arrangements?
Guidance is needed regarding the proper characterisation of
RRSPs, RRIFs, and other retirement savings arrangements common in
Canada. In certain respects, these savings arrangements would seem
to not be properly characterised as deferred compensation items
inasmuch as they do not seem to fit easily under the rubric
‘foreign pension plan or similar retirement arrangement or program’
because the RRSP or RRIF is linked to a particular employee not to
a particular employer. In this respect, the RRSP would seem to be
more analogous to an individual retirement account, which is
characterised by Code s877A(e)(2) as a ‘specified tax deferred
account’ instead of a deferred compensation item. However, unlike
an IRA, there are no penalties for early withdrawals of amounts
from RRSPs and the tax deferral (for US income tax purposes) is
limited to the accrual of funds held in the plan or fund, not the
contributions. Deferral of accruals is provided by para 7 of
Article XVIII of the Convention between the US of America and
Canada with Respect to Taxes on Income and on Capital
(US-Canada Tax Treaty). The relief provided by Article XVIII of the
US-Canada Tax Treaty extends to accruals under ‘a trust, company,
organisation or other arrangement… operated exclusively to provide
pension, retirement or employee benefits…’ Revenue
Procedure 2002-23 explicitly recognises RRSPs and RRIFs as
within the scope of arrangements covered by para 7 of Article XVIII
of the US-Canada Tax Treaty, but did not characterise these savings
arrangements as ‘pension plans’. Finally,
Notice 2003-25 and 2003-57 characterised RRSPs
and RRIFs as trusts subject to the reporting requirements of Code
s6048.
If RRSPs and RRIFs and other similar retirement savings
arrangements are regarded as trusts, they are clearly grantor
trusts because of the access and control the covered expatriate has
over the assets of the plan or fund. As explained above, the assets
of a grantor trust are treated as owned by the covered expatriate
and marked to market. As such, the difference between the
contributions made by the covered expatriate to the plan or fund
and the fair market value of the assets in which those
contributions were invested as of the day before the date of
expatriation will be recognised and subject to the exit tax to the
extent not sheltered by the exclusion of Code s877A(a)(3)(A). In
contrast, Code s877A(d)(2)(A)(i) treats deferred compensation item
as having been ‘received’ by the covered expatriate and Code
s877A(e)(1)(A) treats the covered expatriate ‘as receiving the
entire interest in such account’. Characterisation of the RRSP,
RRIF or similar retirement savings arrangement as a deferred
compensation item requires the custodian to ‘deduct and withhold
from any taxable payment to a covered expatriate with respect to
such item a tax equal to 30 per cent thereof.’ As such, the Notice
requires the untaxed income of the plan or fund to be included in
the final return of the covered expatriate or – if the item of
deferred compensation qualifies as ‘eligible deferred compensation
– subject to 30 per cent withholding when paid.’ Because the
market-to-market regime does not apply to either items of deferred
compensation or tax deferred accounts, the USD600,000 exclusion of
Code s877A(a)(3)(A) does not apply.
Were any of the services giving rise to the
deferred compensation item performed outside of the US?
An exception is provided by Code s877A(d)(5) for deferred
compensation items attributable to services performed outside the
US while the covered expatriate was not a citizen or resident of
the US. These items fall outside the scope of the exit tax imposed
by Code s877A. This would most
commonly arise in the case of an individual who is not a US citizen
but became subject to Code s877A 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 US 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 US.
When did you become a US resident?
A special exception is available to those individuals who become
subject to the exit tax of Code s877A as a result of
characterisation as a long-term resident (that is, a lawful
permanent resident of the US for at least eight taxable years
during the 15-year period ending with the taxable year in which
residency ceases). Gain inherent in the assets owned by the covered
expatriate at the time the individual first became a resident of
the US will be ignored. Residency for these
purposes is determined on the basis of the tests found in Code
s7701(b). Thus, residency could commence on the date the individual
first:
(1) became a lawful permanent resident of the US (that is, a
‘green card’ holder)
(2) satisfied the substantial presence test of Code s7701(b)(3),
or
(3) elected to be treated as a US resident pursuant to Code
s7701(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 s877A equal to the fair market value of the
property on that date. 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 USD600,000 exclusion provided by Code
s877A(a)(3)(A) or who owns a US real property interest with respect
to which the individual prefers to recognise gain otherwise
excluded as a result of Code s877A(h)(2), perhaps because of lower
capital gain rates applicable to the year of
expatriation. Notice
2009-85 provides that the basis step-up allowed by Code
s877A(h)(2) will not be available in the case of a US real property
interest held in connection with the conduct of a US trade or
business on the date the covered expatriate first became a resident
of the US unless the US trade or business was not carried on
through a permanent establishment in the US as a result of a tax
treaty between the US and the country in which the covered
expatriate resided prior to US residency.
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 USD2 million threshold, the exit tax
may be avoided. (The taxpayer will also have to fail to satisfy the
tax liability test to avoid status as a covered expatriate.) Gifts
prior to expatriation will qualify for the gift tax exemption of
Code s2505.
To be effective to reduce the net worth of the taxpayer who is
contemplating expatriation below the USD2 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
will 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 was limited by an
ascertainable standard or the beneficial
interests in the trust were administered as separate
shares.
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
To determine intelligently whether the exit tax should be
deferred, it is necessary first to compute the covered expatriate’s
tax exposure under Code s877A. Unless the taxpayer’s expatriation
date is 1 January, the covered expatriate will file a ‘dual status
return’ for the year in which expatriation occurs. The dual status
return requires preparation of both Form 1040NR and Form
1040 attached as a
schedule. With the dual status return, the covered expatriate must
provide a statement that includes the information required by Code
s6039G: generally, the covered expatriate’s income, assets, and
liabilities. This information will be used to compute the gain
realised as a result of the deemed sale of the covered expatriate’s
assets and the income realised as a result the deemed payment of
the covered expatriate’s deferred compensation items. Notice
2009-85 provides examples illustrating how the USD600,000
exclusion provided by Code s877A(a)(3)(A) will be allocated among
the assets with respect to which gain is realised. The Notice
resolves two unanswered questions or ambiguities present in the
language of the statute. First, loss realised 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 USD600,000
exclusion.
Example: Mr Smythe owns one asset with a basis of USD200,000 and
a fair market value of USD2 million. As a result of his
expatriation in 2011, the asset is marked to market and deemed to
be sold for USD2 million. Of the USD1.8 million of deemed realised
gain, USD636,000 is sheltered as a result of the exclusion provided
by Code s877A(a)(3)(A). Mr Smythe will pay a tax on the remaining
USD1.2 million of unsheltered gain. Notice 2009-85 makes
clear that the basis which Mr Smythe takes in his US real property
interest is USD2 million, despite the USD636,000
exclusion.
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 s877A(b). Elective deferral is
available on an asset-by-asset basis. 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 s6621
from the due date of the covered expatriate’s US income tax return
determined without extensions for the taxable year that includes
the day before the expatriation date. That is, 15
April of the year after the year in which the expatriation date
occurs, unless the expatriation date occurs on 1 January, in which
case interest will accrue starting on 15 April of the year in which
the expatriation date occurs.
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 US 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 s6325, or
(b) another form of security acceptable to the US Secretary of
the Treasury, such as a letter of credit
(3) enter into a tax deferral agreement with the IRS conforming
to the template provided as appendix A to Notice 2009-85,
and
(4) appoint a US 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 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 US agent, and
(6) a copy of the covered expatriate’s US 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 their 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.
Deferral of income recognition from deemed payment of deferred
compensation items. Deferral is also available with respect to
deferred compensation items that satisfy the definition of an
eligible deferred compensation item under Code s877A(g)(3). Despite
expatriation, eligible deferred compensation items are not subject
to US taxation until actually paid to the covered expatriate. To
satisfy the requirements of the statute, the deferred compensation
must be payable by a US person or a person who elects to be treated
as a US person for purposes of the statute. The covered expatriate
must notify the payer of the taxpayer’s status as a covered
expatriate and waive reduced withholding provided by any applicable
tax treaty. The Notice
requirement is satisfied by filing form W-8CE with the payer within
30 days of the expatriation date or prior to the first distribution
on or after the expatriation date if fewer than 30
days. As a result of the
treaty waiver, payment of the deferred compensation to the covered
expatriate will be subject to 30 per cent withholding under Code
s877A(d)(1). Until the eligible deferred compensation items are
paid, the covered expatriate must also file Form 8854 annually to
avoid imposition of a USD10,000 penalty for failure to file.
Anything that is not an eligible deferred compensation item is
characterised by the Notice as an ‘ineligible deferred compensation
item.’ 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 payer of the
deferred compensation item. Within 60 days of receipt of Form W-8CE
‘the payer 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’. 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. 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 s4.02 of Revenue Procedure
2004-37, 2004-1C.B.1099. Early distribution taxes and penalties
will not apply in computing the tax liability for ineligible
deferred compensation items subject to the exit tax. 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-US 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.
s1.409A-4. In the case of an ineligible deferred compensation item
that takes the form of property subject to Code s83, 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). 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.’
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 s877A(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 s7701(a)(37) (that
is, individual retirement accounts and individual retirement
annuities, other than simplified employee pension plans described
in Code s408(k) and simple retirement accounts described in Code
s408(p), qualified tuition programmes described in Code s529,
Coverdell education savings accounts described in Code s530, health
savings accounts described in Code s223, and Archer medical savings
accounts described in Code s220).
Do you own any US real property interests,
stock of any US corporation, or assets used in a US trade or
business?
US real property interests, stock of US corporations, or assets
used in US trade or business are examples of US situs
property. Non-resident aliens are subject to US estate taxation on
US situs assets. Further, these
assets will also be subject to US gift taxation if transferred
prior to the death of the non-resident alien. Unlike a non-resident
alien, a US citizen or resident has the benefit of a significant US
gift tax exemption. For transfers made after 31 December 2010 and
before 1 January 2013, a US citizen or resident may transfer up to
USD5 million in assets without incurring a US gift tax
liability. Because of the
adverse gift and estate tax treatment imposed on US situs
assets transferred by a non-resident alien while alive or at death,
these assets should be transferred prior to expatriation.
(Non-resident alien decedents receive the benefit of only a
USD60,000 US estate tax exemption.)
Do you have any family members to whom you
intend to make gifts during your lifetime or bequests at your death
who are US citizens and may reside in the US?
Code s2801 imposes a US transfer (gift or estate) tax on any
gift or bequest made by a covered expatriate to a US citizen or
resident. The tax imposed by Code s2801 falls not on the covered
expatriate but rather the US
citizen or resident receiving the gift or bequest from the covered
expatriate. The gift will be reported on a Form 708, which has yet
to be issued by the IRS. ‘The due date for reporting, and for
paying any tax imposed on, the receipt of such gifts or bequests
has not yet been determined.’
The tax imposed by Code s2801 is calculated at the maximum gift
or estate tax rate in effect under Code s2001(c). The tax is applied
to the fair market value of the assets that are the subject of the
gift or bequest. Value is determined
on the date the transfer occurs. Although Code s2801(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 s69.1 to s70.5 of the
Canadian 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’.
Have you previously expatriated?
Each covered expatriate is allowed one exclusion under Code
s877A(a)(3)(A). If an individual
expatriates more than once, any unused portion of the covered
expatriate’s exclusion will be available on subsequent
exits.
CONCLUSION
While guidance remains pending on certain matters (particularly
as related to the operation of Code s2801), Notice 2009-85
fills in many of the gaps left by Code s877A 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 para 7 of Article
XIII of the Convention between Canada and the United States of
America with Respect to Taxes on Income and on Capital 1980–
(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 US exit tax creditable against the
Canadian tax liability of a covered expatriate residing in Canada.
Presumably, if para 7 of Article XIII of the Tax Treaty applies to
allow gain to be recognised and taxed by Canada in the same year
the exit tax under Codes877A is imposed by the US, there would be a
corresponding basis adjustment for Canadian tax purposes for the
gain recognised. Competent authority
relief may ultimately be necessary to determine whether relief from
double taxation is available on imposition of the exit tax under
Code s877A, as well as the transfer tax imposed by Code s2801.