The TAX Corner

18 Dec 2019 5:06 PM | Deleted user

The Expatriation Tax (Part Three)


Covered expatriates face the prospect of being forced to pay tax in return for being allowed to escape the U.S. tax system’s worldwide tax net. The general principles are easy to understand:

  • Pay tax as you receive income. If the IRS can rely on tax withholding rules to assure full collection of income tax, the covered expatriate pays tax at a 30% rate on U.S. source income as it is received.
  • Pay tax on everything now. If the IRS cannot be assured of timely collection of tax at the source, the usual tax fiction of a deemed sale or deemed distribution (from an IRA, for instance) forces immediate recognition and taxation of unrealized income and capital gain while the individual is still a U.S. taxpayer.

The IRC lays this out by identifying three categories of income for which special exit tax rules have been written. Everything else is subjected to a mark-to-market system that causes a deemed sale of assets at fair market value.

Specified Tax-Deferred Accounts Specified tax-deferred accounts are things like IRAs or Health Savings Accounts: tax-advantaged creatures of congressional creation.

If the covered expatriate has any of these accounts, he or she is deemed to have received a full distribution on the day before expatriation. Early distribution penalties are not applied.

Deferred Compensation Deferred compensation means pensions as well as other deferred compensation arrangements. If the covered expatriate has any of these, expatriation will trigger tax liability.

Some deferred compensation arrangements are taxed on a “pay as you go” arrangement. As the covered expatriate receives distributions, tax is withheld. These are “eligible” deferred compensation arrangements. “Eligible” deferred compensation plans are those where the payor is a U.S. person.

There is a simple reason why the government is willing to collect 30% as benefits are paid. A U.S. plan administrator means that there is a U.S. withholding agent. If a withholding agent mistakenly does not withhold tax, it is personally liable to the IRS for the tax that should have been withheld, but was not. The government cannot lose: Tax will be collected from the taxpayer (if withholding is done correctly) or from the U.S. pension plan administrator (if tax withholding is done incorrectly).

“Ineligible” deferred compensation arrangements are those where the payor is not a U.S. person. A foreign pension plan is a simple example of this. Now, the IRS cannot rely on a withholding agent to act, in effect, as a guarantor of tax payments.

A foreign pension plan administrator, making a pension distribution to a foreign person (the covered expatriate) might not feel any particular compunction to satisfy an IRS request for tax withholding compliance. For ineligible deferred compensation arrangements, a covered expatriate is treated as having received a lump sum distribution on the day before expatriation equal to the present value of the accrued plan benefits.

Covered expatriates who are beneficiaries of non-grantor trusts must pay 30% tax on the taxable portion of trust distributions they receive.

Everything that falls outside of those three special categories will be taxed according to mark-to-market principles. All assets are deemed sold on the day before expatriation, at fair market value. Capital gain or loss is computed in the normal way. An exemption amount ($699,000 for expatriations in 2017; this amount is indexed for inflation) is applied, and any net capital gain above the exemption amount is taxed using the usual capital gain tax rates.

Predictably, the exit tax rules have spawned special-purpose tax forms.

  • Form 8854. Form 8854 is the main tax form. This form is due on the normal income tax filing deadline for the year of expatriation. Both covered and noncovered expatriates file this form. It captures all of the information that the IRS needs to determine whether the taxpayer is a covered expatriate or not. For covered expatriates, it provides the details of the taxable income triggered by the event of expatriation, and where that income is reflected on the income tax return.
  • Form W-8CE. A special member of the W-8 family exists, just for covered expatriates. The covered expatriate gives this form to retirement plan administrators, pension and deferred compensation plan administrators, and trustees of nongrantor trusts where the covered expatriate is a beneficiary. This notifies the payor of taxable income of the recipient’s covered expatriate status, so the correct tax withholding can be applied. The recipient is also required to provide specified information to assist the covered expatriate’s calculation of the exit tax. For instance, an IRA custodian must report the value of an IRA on the day before expatriation, so the covered expatriate can treat that amount as a deemed distribution prior to expatriation.
  • Form 708. This form has not yet been published. Form 708 will be filed by recipients of gifts or bequests from a covered expatriate. The recipients pay tax at the highest gift tax rate on amounts received from covered expatriates. There are only a few exceptions. Proposed Regulations have been published to interpret and implement IRC section 2801, which imposes this tax.

DISCLAIMER

This communication is not intended to be tax advice and should not be treated as such. Readers should contact your tax professional to discuss your specific situation.

DISCLAIMER 
This communication is not intended to be tax advice and should not be treated as such. Readers should contact your tax professional to discuss your specific situation. 

Oscar Eduardo Mary is a founding member of RCBM, an international tax and business consulting firm headquartered in Buenos Aires, Argentina and with a branch office in Carrollton, Texas. RCBM assists companies that want to operate in Argentina and / or United States. You may contact him at o.mary@rcbmgroup.com 


Comments

  • 30 May 2020 5:02 PM | Qui aut
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