Tax Treatment for Persons Giving Up U.S. Citizenship to Avoid Taxation

Internal Revenue Code - Section 877A

Image - Tax Effect of Renouncing U.S. CitizenshipThe Heroes Earnings Assistance and Relief Tax Act of 2008 (P.L. 110-245) fundamentally changed the rules aimed at preventing expatriations in order to avoid U.S. tax by passing Code Sec. 877A. Unlike the old regime, which tracked an expatriate's U.S. source income for ten years, the new rules generally subject "covered expatriates" to a one time mark to market tax as if they sold all of their property for its fair market value on the day before their "expatriation date". The mark-to-market tax is imposed on the property's net unrealized gain to the extent it exceeds $690,000. Exceptions exist for certain deferred income items and interests in certain trusts. In addition, the expatriate can defer any tax owed under the new regime by posting adequate security. The rules apply to individuals with expatriation dates on or after June 16, 2008.

What is a "Covered Expatriate"?

A person giving up U.S. citizenship or relinquishing long term residence (applies to persons who have held a green card for over seven years) will be considered a "covered expatriate" if any of the following statements apply:

1.  The average annual income TAX LIABILITY for the five years ending before expatriation exceeds:

  • $139,000 for 2008;
  • $145,000 for 2009 and 2010;
  • $147,000 for 2011;
  • $151,000 for 2012;
  • $155,000 for 2013;
  • $157,000 for 2014;
  • $160,000 for 2015.

2.  Net worth exceeds $2 million as of the date of expatriation.  (Please contact us to determine the treatment of jointly owned assets.)

3.  You have not complied with all U.S. federal tax obligations in the 5 tax years before expatriation; or

4.  You expatriated before 2015 and have deferred the payment of tax, have an item of eligible deferred compensation or have an interest in a non grantor trust.

Exceptions to the rules classifying a person as a covered expatriate apply for dual citizens who became a U.S. citizen and the citizen of another country at birth and who have not spent over 10 years in the U.S. in the 15 years prior to expatriation, or to persons who expatriate prior reaching 18 1/2 years of age and have not lived in the U.S. for more than 10 years prior to expatriation.

Tax Effect of Expatriation from the U.S.

Upon expatriation, a "covered expatriate" is subject to tax on any net unrealized gain exceeding $690,000 assuming that all capital property was sold at fair market value as of the date of expatriation.  Under certain conditions an election may be made on an asset by asset basis to defer the payment of the expatriation tax by lodging security satisfactory to IRS.

Travel to the U.S. After Expatriation:

Subject to certain exceptions, a person who is present in the U.S. for any reason in the 10 years after expatriation for more than 30 days in any calendar year will be treated as a U.S. citizen, and will be subject to reporting worldwide income and all other federal tax reporting obligations.

In addition, U.S. recipients of gifts or bequests from "covered expatriates" may be subject to a special expatriate transfer tax of Code Sec. 2801.

IRS Guidance:

The IRS has issued extensive guidance for expatriating taxpayers subject to the new mark-to-market regime of Code Sec. 877A and the corresponding reporting rules under Code Sec. 6039G.  The guidance, which includes multiple examples, is divided into nine sections each discussed below.

Section 1 provides background regarding the general application of Code Sec. 877A.

Section 2 provides rules for determining whether an individual is a "covered expatriate" and, thus, subject to Code Sec. 877A. In particular, taxpayers are directed to Section III of Notice 97-19, 1997-1 C.B. 394, to determine whether an individual meets the tax liability test or the net worth test of Code Sec. 877A(g)(1)(A).

Section 3 explains the operation of the mark-to-market regime. For purposes of computing the tax liability under Code Sec. 877A, a covered expatriate owns any property that would be taxable as part of his or her gross estate for Federal estate tax purposes under Code Secs. 2001 through 2210 without regard to Code Secs. 2010 through 2016. In addition, a covered expatriate owns his or her beneficial interest(s) in each trust that would not be included in their Federal gross estate. Such beneficial interest(s) are determined under the special rules set forth in section III of Notice 97-19. When computing the tax liability, a covered expatriate must use the fair market value of each interest in property as determined (generally) under the Federal estate tax rules as if the covered expatriate had died as a citizen or resident of the United States on the day before they expatriated. Specific rules are also provided for allocating the exemption amount of Code Sec. 877A(a)(3). And, the Notice states that an individual only has one exemption per lifetime; so, if a covered expatriate used one third of the exclusion amount for a first expatriation, he or she will have two thirds of the exclusion amount available, as adjusted for inflation, in the event of a second expatriation. Section 3 also provides rules for:

Section 4 addresses the interaction of Code Sec. 877A and other Code provisions, including the prior expatriation rules under Code Sec. 877 and Code Secs. 367(a), 684, and 897.

Section 5 explains the application of Code Sec. 877A to deferred compensation items. In particular, definitions and operating rules are provided for "eligible deferred compensation items" (items which avoid the mark-to-market tax) and "ineligible deferred compensation items" (items subject to the tax).

Section 6 explains the application of Code Sec. 877A to specified tax deferred accounts (Code Sec. 7701(a)(37) individual retirement plans, Code Sec. 529 qualified tuition plans, Code Sec. 530 Coverdell education savings account, Code Sec. 223 health savings accounts, and Code Sec. 220 Archer MSAs).

Section 7 explains the application of the special rules for interests in nongrantor trusts under Code Sec. 877A(f).

Section 8 describes the filing and reporting requirements under Code Sec. 6039G and provides an overview of changes to Form 8854 (Expatriation Information Statement) as well as an introduction to new Form W-8CE (Notice of Expatriation and Waiver of Treaty Benefits).

Section 9 states that future guidance will address gifts and bequests subject to a transfer tax under new Code Sec. 2801.