57 th UIA CONGRESS Macau / China October 31 November 4, 2013 IMMIGRATION AND NATIONALITY LAW Saturday, November 2, 2013 GLOBAL TRENDS ON CITIZENSHIP AND NATIONALITY UIA 2013 THE TAX ISSUES PROMOTING, AND INVOLVED IN, LOSS OF U.S. CITIZENSHIP Clayton E. Cartwright, Jr. The Cartwright Law Firm, LLC 1921 Whittlesey Road, Suite 210 Columbus, Georgia 31909 USA +1 (706) 494-1701 (Tel.) / +1 (706) 494-1702 (Fax) ccartwright@lawcart.com
The United States is one of the few countries in the world that imposes an income tax on the basis of citizenship regardless of whether the subject individual actually is resident in the United States. 1 While this is not a new development, recent U.S. efforts to dramatically increase the enforcement of its citizenship-based income tax system reached a new pinnacle with the 2010 enactment of the Foreign Account Tax Compliance Act (FATCA). 2 Thus a U.S. citizen residing outside the United States (known herein as Overseas USC ) faces not only compliance with the U.S. income tax system but also the reactions of overseas businesses that are trying to minimize their exposure to FACTA. As a result, Overseas USC often struggles with both (I) the U.S. income tax system and (II) financial institutions that are severing their ties to U.S. citizen clients due to the increasing cost of doing business because of FACTA. This report discusses five issues of the U.S. income tax system that are particularly challenging for Overseas USC and accordingly give him 3 an incentive to free himself from this system by renouncing his U.S. citizenship. To the extent that Overseas USC renounces his U.S. citizenship, this report analyzes the final challenging issue of U.S. tax residency: the U.S. exit tax regime. FIVE U.S. TAX ISSUES PARTICULARLY CHALLENGING FOR OVERSEAS USC While Overseas USC theoretically is subject to the same U.S. income tax system as a U.S. citizen who actually resides in the United States, Overseas USC is more suspect to be challenged with the following five tax issues due to the fact that his overseas residence significantly increases his exposure to these issues: Passive Foreign Investment Companies Controlled Foreign Corporations Foreign Partnerships U.S. Department of the Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (commonly known as the Foreign Bank Account Report or the FBAR ) Internal Revenue Service (IRS) Form 8938, Statement of Specified Foreign Financial Assets Passive Foreign Investment Companies The passive foreign investment company (PFIC) tax regime is quite troublesome for Overseas USC, given (1) the regime s low threshold to be triggered upon Overseas USC and (2) the punitive taxation that is imposed on Overseas LPR if a PFIC is not identified timely. A PFIC is any foreign corporation if (a) 75 percent of its gross income for its taxable year is passive income or (b) the average percentage of its assets that produce passive income or held for the production of passive income is a minimum of 50 percent. 4 The PFIC tax regime applies to any U.S. person who is a shareholder, irrespective of his percentage of stock ownership in the PFIC. 5 As a result, Overseas USC who has a miniscule ownership interest in the PFIC is subject to the PFIC tax regime immediately upon acquisition of said interest. 1 The U.S. income tax system applies to U.S. citizens and U.S. resident aliens, with both terms mutually exclusive of each other. That is, a U.S. citizen is subject to U.S. taxation on worldwide income regardless of actual residency or domicile in the United States. See U.S. Treasury Regulations ( Treas. Reg. ) 1.1-1(b). Under the U.S. Internal Revenue Code (the Code or IRC ), a U.S. citizen is defined as every person born or naturalized in the United States, with deference on acquisition and loss of U.S. citizenship given to the U.S. Immigration and Nationality Act. See Treas. Reg. 1.1-1(c). 2 U.S. Public Law 111-147, 511-513. 3 For purposes of this paper, the use of masculine pronouns is intended to be gender-neutral. 4 U.S. Internal Revenue Code (IRC) 1297(a). 5 See IRC 1291(a)(1). 1
Under the PFIC tax regime, a deferred tax amount is charged to Overseas USC to the extent that he received excess distributions from the PFIC or that he disposed of stock in the PFIC. 6 The deferred tax amount is a calculation of (a) the tax that Overseas USC would have owed had the PFIC distributed income currently and (b) the interest due to the delay in payment of that tax. 7 However, this deferral tax amount will not be charged to Overseas USC if he elects to treat the PFIC as a qualified electing fund (QEF), 8 which treats him as receiving annually a deemed taxable distribution of the PFIC s earnings and profits (known herein as the QEF Election ). 9 Additionally, this deferred tax amount will not be charged if Overseas USC s stock in the PFIC is marketable stock and he elects to include the appreciation in the stock s value in his U.S. gross income for each taxable year (known herein as the Mark-to-Market Election ). 10 Reporting Requirements In addition to the punitive PFIC tax regime for Overseas USC, he also must ensure that he satisfies the filing requirements associated with his ownership of interests in PFICs. Specifically, he must file IRS Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, for each PFIC annually if any one of the following events occurs concerning his interest in that PFIC: He receives certain direct or indirect distributions from the PFIC. He recognizes gain on a direct or indirect disposition of PFIC stock. He makes certain elections concerning his interest in the PFIC, including the QEF Election and the Mark-to-Market Election. 11 Controlled Foreign Corporations Overseas USC s ownership interest in a foreign corporation could cause that corporation to be classified as a controlled foreign corporation (CFC). A CFC is any foreign corporation that is more than 50 percent owned, by vote or value, by United States shareholders during the corporation s taxable year. 12 A United States shareholder is a U.S. person, which includes a U.S. tax resident 13 such as Overseas USC, who owns, by vote, at least ten percent of the corporation. 14 Subpart F Income For the taxable year in which the CFC s taxable year ends, Overseas USC who is a United States shareholder, generally is required to include his pro rata portion of the CFC s Subpart F income 15 in his U.S. gross income. 16 For Overseas USC who is a United States shareholder, the most applicable component of Subpart F income usually is foreign base company income (FBCI). 17 When determining the CFC s Subpart F income, there are three important general rules. First, if the CFC s FBCI (not including deductions) for the taxable years exceeds 70 percent of the CFC s gross income, 6 See IRC 1291(a)(1) and (a)(2). 7 IRC 1291(c). 8 IRC 1291(d)(1). 9 See generally IRC 1293. 10 IRC 1296(a)(1). 11 Instructions, Internal Revenue Service (IRS) Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, December 2012, p.1. 12 IRC 957(a). 13 IRC 957(c); IRC 7701(a)(30)(A). 14 IRC 951(b). 15 See generally IRC 952 (defining Subpart F income). 16 See IRC 951(a). 17 See IRC 952(a)(2) (stating that foreign base company income is a component of Subpart F income). 2
then all of the CFC s gross income is FBCI. 18 Second, and overriding the first exception, FBCI does not include any item of income if such income was subject to an effective tax rate greater than 90 percent of the highest U.S. corporate income tax rate. 19 Third, if the CFC s FBCI (not including deductions) is less than the lesser of (a) five percent of its gross income or (b) $1,000,000, then none of the gross income is classified as FBCI. 20 FBCI includes (a) foreign personal holding company income (FPHCI), (b) foreign base company sales income, and (c) foreign base company services income. 21 FPHCI includes, among other items, dividends, interest, royalties, rents, and annuities. 22 There are three common exceptions to inclusion of these items as FPHCI. First, FPHCI excludes rents and royalties that are derived from the active conduct of a trade or business and that are not received by the CFC from a related person. 23 Second and failing the first exception, rents and royalties are excluded if they are received from a related-person corporation for the use of property within the country where the CFC was organized. 24 Third, dividends and rents are excluded if they are received from a related-person corporation (i) organized in the same country as the CFC and (ii) having a substantial part of its trade or business assets located in that same country. 25 The second and third exceptions do not apply if the payment of such items reduces the Subpart F income of the payor or another CFC. 26 In order for an item of income to be foreign base company sales income, it must satisfy three strict requirements. First, the income must be derived by the CFC based upon the purchase of personal property from, or the sale of personal property to, a related person. 27 Second, such personal property is manufactured or otherwise produced outside the CFC s country of organization. 28 Third, such personal property is sold for use outside the CFC s country of organization. 29 Foreign base company services income is defined as any compensation derived from services provided to a related person outside the CFC s country of organization. 30 Reporting Requirements A common misperception is that, if the foreign corporation of which Overseas USC is a shareholder is not a CFC, or if the CFC, of which Overseas LPR is a shareholder, does not have Subpart F income, then Overseas USC has no reporting obligation concerning the foreign corporation. In fact, Overseas USC can have a U.S. income tax reporting obligation in relation to a foreign corporation, in which he has no ownership interest whatsoever. The primary form on which Overseas USC reports an interest in a foreign corporation is IRS Form 5471, Information Return With Respect to Certain Foreign 18 IRC 954(b)(3)(B). The term insurance income also is included as a portion of the 70 percent in this determination. However, this term is left out of the text because it is unlikely that the typical Overseas USC will encounter such income with this provision. 19 IRC 954(b)(4). See IRC 11(b)(1)(D) (stating that the current maximum corporate income tax rate is 35 percent, which places the 90-percent effective tax rate threshold at 31.5 percent). 20 IRC 954(b)(3)(B). 21 IRC 954(a)(1)-(a)(3). 22 IRC 954(c)(1)(A). 23 IRC 954(c)(2)(A). 24 IRC 954(c)(3)(A)(ii). 25 IRC 954(c)(3)(A)(i). 26 IRC 954(c)(3)(B). 27 IRC 954(d)(1). A related person, for purposes of the definition of FBCI, is defined, in relation to a CFC, as an individual or entity that controls, or is controlled by, the CFC ( parent-subsidiary relationship ) or an individual or entity that is controlled by the same persons that control the CFC. Control is defined as possessing more than 50 percent of the total voting power of a corporation or more than 50 percent of the value of the beneficial interests of a partnership, trust or estate. IRC 954(d)(3). 28 IRC 954(d)(1)(A). 29 IRC 954(d)(1)(B). 30 IRC 954(e)(1). 3
Corporations. If Overseas USC is any one of the following four categories of filers, he must file Form 5471 with his annual U.S. income tax return: Category 2. Overseas USC is an officer or director of a foreign corporation in which a U.S. person (which does not have to be Overseas USC) (i) has become a ten-percent shareholder, by vote or by value, of the corporation or (ii) has acquired an additional ten percent, by vote or by value, of the stock of the corporation. 31 Category 3. Overseas USC (i) has become a ten-percent shareholder, by vote or by value, of the corporation, (ii) has acquired an additional ten percent, by vote or by value, of the stock of the corporation, 32 or (iii) disposed of sufficient stock in the foreign corporation to reduce his interest, by vote or by value, to less than ten percent. 33 Category 4. Overseas USC generally is a Category 4 filer if he controls a foreign corporation for an uninterrupted period of at least thirty days during the corporation s annual accounting year ending with or within his U.S. tax year. 34 Control means Overseas USC owns stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of the foreign corporation. Category 5. Overseas USC who is a United States shareholder automatically is a Category 5 filer. 35 Foreign Partnerships Overseas USC who is a partner of a foreign partnership has U.S. filing requirements vis-à-vis the partnership, even if the partnership is not engaged in a U.S. trade or business or otherwise has no U.S.-source income. 36 This filing requirement is satisfied by IRS Form 8865, Return of U.S. Persons With Respect To Certain Foreign Partnerships. Overseas USC does not necessarily have to file Form 8865 annually. Rather, he must file the form separately each year for each foreign partnership only to the extent that a reportable event occurs for that partnership. 37 The reportable events are distinguished among four categories, as explained below. Category 1 Overseas USC is a Category 1 filer if he is a partner of the foreign partnership who controls the partnership at any time during the partnership s taxable year. 38 Control, for this purpose, is defined as (a) ownership of more than 50 percent of the partnership s capital, (b) ownership of more than 50 percent of the partnership s profits, or (3) ownership of an interest in the partnership to which more than 50 percent of the partnership s losses or deductions are allocated. 39 31 IRC 6046(a)(1)(A) and (a)(2); Instructions, IRS Form 5471, Information Return With Respect to Certain Foreign Corporations, December 2012, p.1 ( Form 5471 Instructions ). There is no Category 1, as that category related to foreign personal holding companies, the tax regime for such companies having been repealed by the American Jobs Creation Act of 2004. Form 5471 Instructions, p.1. 32 IRC 6046(a)(1)(B), (a)(2); Form 5471 Instructions, p.1. Unlike the Category 2 filer, Overseas USC who is a Category 3 filer is deemed to constructively own stock through other foreign corporations and foreign partnerships in which he owns interests and through family members. Treas. Reg. 1.6046-1(e)(4)(iii)-(iv), (i). 33 Form 5471 Instructions, p.2. 34 IRC 6038(a)(1) (a)(2); Treas. Reg. 1.6038-2(a). 35 IRC 6038(a)(4). 36 IRC 6046A. 37 Treas. Reg. 1.6046A-1(a)(1). 38 Instructions, IRS Form 8865 (2012), Return of U.S. Persons With Respect to Certain Foreign Partnerships, December 6, 2012, p.2 ( Form 8865 Instructions ). 39 Form 8865 Instructions, pp.2 and 4. 4
Category 2 Overseas USC is a Category 2 filer if, during the foreign partnership s taxable year, both of the following conditions are satisfied: He owned at least ten percent of the partnership s capital or profits, or is allocated at least ten percent of the partnership s losses and deductions 40 (known hereunder as a United States partner ). More than 50 percent of the capital or profits of the partnership is owned by, or more than 50 percent of the losses and deductions of the partnership is allocated to, United States partners. 41 Category 3 Overseas USC is a Category 3 filer if he transferred property to the foreign partnership during the year and one of the following conditions applies: He owns at least ten percent of the partnership s capital or profits, or is allocated at least ten percent of the partnership s losses and deductions, immediately after the transfer. The value of all property contributed by Overseas USC and any related person to Overseas USC exceeds $100,000 for the 12-month period ending on the date of the above-referenced transfer. In addition, Overseas USC is a Category 3 filer if the foreign partnership, in a year in which Overseas USC remains a partner, disposes appreciated property that was initially transferred by Overseas USC in a transaction that classified him as a Category 3 filer. 42 Category 4 Overseas USC is a Category 4 filer if any of these reportable events occurs during the year concerning the foreign partnership in which he owns an interest: He acquired an additional direct ownership interest in the partnership such that his direct ownership interest in the partnership increased from less than ten percent to at least ten percent. He increased his direct ownership interest in the partnership by at least ten percent since the last year he had a reportable event. He disposed of a direct ownership interest in the partnership such that his direct ownership interest in the partnership decreased from at least ten percent to below ten percent. He decreased his direct ownership interest in the partnership by at least ten percent since the last year he had a reportable event. His direct ownership interest in the partnership otherwise increased or decreased by at least ten percent since the last year he had a reportable event. 43 40 Form 8865 Instructions, p.2. 41 Form 8865 Instructions, pp.2 and 4. 42 Form 8865 Instructions, p.2. 43 Form 8865 Instructions, pp.2-3. 5
U.S. Department of the Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts U.S. Department of the Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (commonly known as the Foreign Bank Account Report or the FBAR ), is filed with the U.S. Department of the Treasury, as opposed to the IRS, but its timely filing is enforced by the IRS. As a result, while the FBAR technically is not a tax issue, its enforcement is so intertwined with income tax enforcement that its preparation usually is done in conjunction with U.S. income tax preparation services. The FBAR must be filed by Overseas USC annually to the extent he has a financial interest in, or signature authority or other authority, over any financial account in a foreign country if the aggregate value of the accounts exceeds $10,000 at any time during the calendar year. 44 The FBAR discloses the foreign interest or account and does not impose a tax, although failure to file it can incur penalties. A non-willful failure to file the FBAR may be penalized by up to $10,000 per violation, unless the failure was due to reasonable cause. 45 A willful failure to file can be subject to a higher civil penalty (up to $100,000 or 50 percent of the balance of the foreign account, whichever is greater) and criminal penalties. 46 On January 9, 2012, the IRS reopened its Offshore Voluntary Disclosure Program indefinitely to encourage U.S. persons to come into compliance with their reporting and tax requirements concerning offshore assets, with a general reduced penalty of 27.5 percent (up from 25 percent from the 2011 program). 47 IRS Form 8938, Statement of Specified Foreign Financial Assets Effective for all tax years commencing after March 18, 2010 (2011 being the first such year in most cases) pursuant to FATCA, 48 Overseas USC must file IRS Form 8938, Statement of Specified Foreign Financial Assets, with his annual U.S. income tax return if the aggregate value of all of his foreign financial assets exceeds $50,000 at the end of the tax year or $75,000 at any time during the tax year. 49 These thresholds are increased to as high as $400,000 and $600,000, respectively, depending upon whether Overseas USC files a joint income tax return and is eligible to claim the foreign earned income exclusion. 50 NAVIGATING THE U.S EXIT TAX REGIME FOR OVERSEAS USC WHO RENOUNCES HIS U.S. CITIZENSHIP Overseas USC, who is a citizen of another country, can be free of all of the above challenging U.S. income tax issues if he renounces his U.S. citizenship. Renunciation also means that he is subject to the U.S. exit tax regime. However, just because such Overseas USC is subject to the U.S. exit tax regime does not mean that the U.S. exit tax (the Exit Tax ) will be imposed on him. Who Is Affected by the Exit Tax The Exit Tax only affects Overseas USC who is an Expatriate, which definition under the U.S. exit tax regime includes any U.S. citizen who relinquishes his citizenship. 51 Therefore the first area of emphasis is how and when U.S. citizenship is relinquished for purposes of the Exit Tax. 44 31 Code of Federal Regulations 1010.306(c) and 1010.350(a). 45 31 United States Code 5321(a)(5)(B). 46 31 United States Code 5321(a)(5)(C)-(a)(5)(D) and 5322(a). 47 See generally IRS News Release 2012-5 (Jan. 9, 2012). 48 See generally IRC 6038D. 49 Treas. Reg. 1.6038D-2T(a)(1). 50 See Treas. Reg. 1.6038D-2T(a)(2)-(4). 51 IRC 877A(g)(2). 6
How and When U.S. Citizenship Is Relinquished Overseas USC becomes an Expatriate and is deemed to relinquish his citizenship once the earliest of the following four events occurs, creating an Expatriation Date : 52 Overseas USC renounces his U.S. nationality before a U.S. diplomatic or consular officer under Section 349(a), paragraph (5), of the Immigration and Nationality Act (the INA ), by making a formal renunciation of nationality before a U.S. diplomatic or consular officer in a foreign state with the intention of relinquishing his U.S. nationality. 53 While the date of the renunciation is the Expatriation Date for Overseas USC, he will not be deemed to have relinquished his citizenship, for purposes of the Exit Tax, unless his renunciation subsequently is approved by the issuance of a Certificate of Loss of Nationality (CLN) to him by the U.S. Department of State (DOS). 54 Overseas USC furnishes to DOS a signed statement of voluntary relinquishment of U.S. nationality confirming he performed an act of expatriation under paragraph (1), (2), (3), or (4) of Section 349(a) of the INA. 55 While the date of the voluntary relinquishment is the Expatriation Date for Overseas USC, he will not be deemed to have relinquished his citizenship unless his voluntary relinquishment subsequently is approved by the issuance of a CLN to him by DOS. 56 DOS issues a CLN to Overseas USC. 57 A U.S. court cancels the Certificate of Nationalization for Overseas USC who is a naturalized U.S. citizen. 58 Classification of Expatriate as a Covered Expatriate Subject to the Exit Tax Relinquishment of U.S. citizenship only triggers the application of the Exit Tax if Overseas USC who is Expatriate is classified as a Covered Expatriate. He will be classified as a Covered Expatriate if he fails any one of the following three objective threshold tests: 59 Tax Liability Test. Expatriate s average annual U.S. income tax liability for the period of five taxable years ending before his Expatriation Date is greater than an amount adjusted for inflation annually 60 ($155,000 for an Expatriation Date occurring in 2013). 61 The calculation of the annual U.S. income tax liability under this Test allows an offset for the U.S. foreign tax credit. 62 Net Worth Test. Expatriate s net worth as of his Expatriation Date is at least $2,000,000. 63 The Net Worth Test requires Expatriate to value all of his interests in property on his 52 IRC 877A(g)(3); Notice 2009-85, 2.A. 53 8 United States Code 1481(a)(5). 54 IRC 877A(g)(4) (flush text). 55 IRC 877A(g)(4)(B). 56 IRC 877A(g)(4) (flush text). 57 IRC 877A(g)(4)(C). 58 IRC 877A(g)(4)(D). 59 IRC 877A(g)(1) (cross-referencing IRC 877(a)(2)). Failure, under the below-referenced tests, is defined as having a high average tax liability, having a high net worth, or failing to certify U.S. tax compliance. 60 IRC 877A(g)(1)(A) (incorporating IRC 877(a)(2)(A)); IRC 877(a)(2) (flush text). 61 IRS Revenue Procedure 2012-41, 2012-45 I.R.B. 539 (November 5, 2012) ( Revenue Procedure 2012-41 ), 3.15. 62 IRC 877(a)(2)(A) (cross-referencing IRC 38(c)(1)). 63 IRC 877A(g)(1)(A) (incorporating IRC 877(a)(2)(B)). 7
Expatriation Date. An interest in property includes money or other property, regardless of whether it produces any income or gain. 64 Certification Test. Expatriate did not certify under penalty of perjury that he has satisfied his U.S. tax requirements for the preceding five taxable years and did not submit any evidence of such compliance as may be required. 65 The certification is made using IRS Form 8854, Initial and Annual Expatriation Statement ( Form 8854 ), which is filed with Expatriate s U.S. income tax return for the taxable year that includes the date before the Expatriation Date. 66 Exemptions from the Tax Liability and Net Worth Tests There is no universal exemption from all of the three tests stated above for classification as a Covered Expatriate. Specifically, the Certification Test always will apply. As a result, Expatriate, by the time that he files Form 8854 for the taxable year that includes the day before the Expatriation Date, must have his U.S. tax affairs for the previous five taxable years in order. Otherwise, Expatriate will not be able to certify compliance on said Form 8854 and will be subject to the Exit Tax, even if neither the Tax Liability Test nor the Net Worth Test applies to him. There are two exemptions from both the Tax Liability Test and the Net Worth Test for Expatriate who is classified as either a dual status citizen or an expatriating minor, as set forth below: Dual Status Citizen Exemption. Under this exemption, Expatriate, at birth, must have become a U.S. citizen and a citizen of another country, and currently remains a citizen and an income tax resident of that other country. 67 Additionally, Expatriate must have been a U.S. income tax resident under the Substantial Presence Test 68 for not more than ten taxable years during the period of 15 taxable years ending with the taxable year he has been deemed to have expatriated for purposes of the Exit Tax. 69 Expatriating Minor Exemption. Under this exemption, Expatriate (i) must relinquish U.S. citizenship before attaining age 18½ 70 and (ii) has been a U.S. income tax resident under the Substantial Presence Test for not more than ten taxable years before the date he relinquishes his U.S. citizenship. 71 Imposition of the Exit Tax on Covered Expatriate Covered Expatriate is subject to the Exit Tax on his worldwide property, which generally is treated as being sold for its fair market value on the day before his Expatriation Date (the Deemed Sale ). 72 To the extent that Covered Expatriate s gross income is increased due to the Deemed Sale, that increase is reduced by $600,000 but only to the extent that the increase is eliminated (the Deemed Sale 64 IRS Notice 97-19, 1997-1 C.B. 394, III. 65 IRC 877A(g)(1)(A) (incorporating IRC 877(a)(2)(C)). 66 IRS Notice 2009-85, 2009-45 I.R.B. 598 (November 9, 2009) ( Notice 2009-85 ), 2.A. 67 IRC 877A(g)(1)(B)(i)(I). 68 U.S. income tax residents include U.S. citizens and resident aliens. See supra note 1. The term resident alien, for purposes of the Code, is defined generally in Code Section 7701(b). Two (2) main categories of resident aliens are (a) U.S. lawful permanent residents (said test of U.S. income tax residency being known as the Lawful Permanent Resident Test ) and (b) certain individuals (deemed to satisfy the Substantial Presence Test ) who, for each taxable year, are present in the United States for at least 183 days (or satisfy a special three-year averaging test that generally classifies an individual as a resident alien if he averages four months or more of presence for each taxable year in the United States). IRC 7701(b)(1) and (b)(3). 69 IRC 877A(g)(1)(B)(i)(II). 70 IRC 877A(g)(1)(B)(ii)(I). 71 IRC 877A(g)(1)(B)(ii)(II). 72 IRC 877A(a)(1). 8
Exclusion ). 73 The Deemed Sale Exclusion is adjusted for inflation for taxable years after 2008, 74 and for 2013, is $668,000. 75 Covered Expatriate is not subject to this mark-to-market Deemed Sale in two ways. The first way is his election to defer tax on items that otherwise would be included in the Deemed Sale. Second, the Exit Tax sets forth items that automatically are not included in the Deemed Sale. This second way is not necessarily relief from the Exit Tax. Rather, in the cases of certain Deferred Compensation Items and of Specified Tax Deferred Accounts, it could trigger immediate U.S. taxation under the Exit Tax for Covered Expatriate, without a benefit similar to the Deemed Sale Exclusion or the election to defer tax from the Deemed Sale. Election to Defer Tax from the Deemed Sale Covered Expatriate can make an irrevocable election on Form 8854 for any item of the property treated as sold in the Deemed Sale. This election defers the time for payment of the additional tax attributable to such property item until the due date for his U.S. income tax return for that taxable year in which such property item actually was sold. 76 The additional tax attributable to such property item is computed based upon the ratio of the gain attributable to the elected property item to the gain attributable to all property treated as sold in the Deemed Sale. 77 Items Automatically Excluded from the Deemed Sale The Deemed Sale automatically excludes (a) property that is a Deferred Compensation Item, (b) a Specified Tax Deferred Account or (c) an interest in a nongrantor trust. 78 These automatic exclusions are not exclusions for purposes of the Exit Tax. Rather, they set forth two significant and additional layers of complexity of U.S. tax compliance for Covered Expatriate. First, Covered Expatriate file must IRS Form W-8CE, Notice of Expatriation and Waiver of Treaty Benefits ( Form W-8CE ), with the payor of any of the above-listed property items. The filing deadline for Form W-8CE is the earlier of the day prior to the first distribution of a Deferred Compensation Item on or after Covered Expatriate s Expatriation Date or 30 days after his Expatriation Date. 79 Second, Covered Expatriate, to extent that he wishes to claim tax treaty relief on a distribution of an Eligible Deferred Compensation Item or on a distribution from a nongrantor trust, must file a U.S. nonresident income tax return for the taxable year at issue, as the Exit Tax prohibits him from claiming a treaty exemption on withholding. As a result, Covered Expatriate who is subject to such withholding may be filing U.S. nonresident income tax returns for many taxable years after the year of expatriation. Deferred Compensation Item. A Deferred Compensation Item, for purposes of the Exit Tax, includes any of the following items: Any interest in a Internal Revenue Code ( Code ) Section 401(a) qualified retirement plan; Code Section 403(b) annuity plan; a retirement plan established for U.S. federal, state and local employees or employees of any agency or instrumentality thereof; a Code 403(b) 73 IRC 877A(a)(3)(A). 74 IRC 877A(a)(3)(B). 75 Revenue Procedure 2012-41, 3.16. 76 IRC 877A(b)(1); IRC 877A(b)(6). 77 IRC 877A(b)(2). 78 IRC 877A(c). 79 Notice 2009-85, 8.D. 9
annuity contract; a Code Section 408(k) simplified employee pension; and a Code Section 408(p) simple retirement account. 80 Any interest in a foreign pension plan. 81 Any item of deferred compensation. 82 Any property, or right to property, that Covered Expatriate is entitled to receive pursuant to his performance of services that is governed by Code Section 83. 83 An Eligible Deferred Compensation Item is eligible (i) if its payor is a U.S. person, or a person electing to be treated as a U.S. person for this purpose, and (ii) if Covered Expatriate notifies this payor, by filing Form W-8CE with this payor, that Covered Expatriate is subject to the Exit Tax and that Covered Expatriate irrevocably waives any claim to reduce U.S. tax withholding pursuant to a tax treaty. 84 As for an Eligible Deferred Compensation Item, the payor is required to impose a 30 percent withholding tax on any taxable payment of such item to Covered Expatriate. 85 For a Deferred Compensation Item that is not an Eligible Deferred Compensation Item (an Ineligible Deferred Compensation Item ), Covered Expatriate is deemed to have received a distribution equal to the present value of his accrued benefit under such a plan on the day before his Expatriation Date, and is taxed on said deemed distribution. 86 Specified Tax Deferred Account. A Specified Tax Deferred Account includes any of the following items: An individual retirement plan, other than a Code Section 408(k) plan or a Code Section 408(p) plan. A Code Section 529 qualified tuition program. A Code Section 530 Coverdell education savings account. A Code Section 223 health savings account. 80 IRC 877A(d)(4)(A); IRC 219(g)(5). 81 IRC 877A(d)(4)(B). 82 IRC 877A(d)(4)(C). An item of deferred compensation is any compensation amount if, under the arrangement providing for said compensation, Covered Expatriate has a legally binding right to the compensation on the Expatriation Date, the compensation has not been actually or constructively received on or before the Expatriation Date, and the compensation, pursuant to the compensation arrangement, is payable to, or on behalf of, Covered Expatriate on or after the Expatriation Date. An item of deferred compensation does not include any amount classified as a deferred compensation item under one of the other three categories of deferred compensation item. Notice 2009-85, 5.B(4). 83 IRC 877A(d)(4)(D). Such property, or rights to property, includes statutory and nonstatutory stock options, stock, stock-settled stock appreciation rights, and stock-settled restricted stock units. Notice 2009-85, 5.B(1)d. 84 IRC 877A(d)(3); Notice 2009-85, 5.F. 85 IRC 877A(d)(1)(A). 86 IRC 877A(d)(2)(A)(i). Even for an Ineligible Deferred Compensation Item, Covered Expatriate must file Form W-8CE with the payor on the earlier of the day prior to the first distribution of such an item on or after Covered Expatriate s Expatriation Date or 30 days after Covered Expatriate s Expatriation Date. The payor has 60 days after receiving this Form W-8 to provide Covered Expatriate with a written statement disclosing the present value of the Ineligible Deferred Compensation Item on the day before the Expatriation Date. Notice 2009-85, 8.D. 10
A Code Section 220 Archer medical savings account (MSA). 87 Covered Expatriate is deemed to receive a distribution of his entire interest in a Specified Tax Deferred Account on the day before his Expatriation Date, and is taxed on said deemed distribution. 88 Interest in a Nongrantor Trust. A nongrantor trust is (i) an entire trust or (ii) the portion of any trust, of which Covered Expatriate is not the owner on the day before his Expatriation Date. 89 The trustee of a nongrantor trust is required to withhold 30 percent of the taxable portion of any direct or indirect distribution from the trust to Covered Expatriate, 90 if Covered Expatriate was a trust beneficiary on the day before his Expatriation Date. 91 The term taxable portion means the portion of the distribution that would be included in Covered Expatriate s gross income presuming he was U.S. income tax resident. 92 For such distributions subject to this withholding tax, Covered Expatriate is treated as having waived any claim to reduction in U.S. tax withholding pursuant to a tax treaty. 93 CONCLUSION Overseas USC faces several challenges from the U.S. income tax system, such as the PFIC and CFC tax regimes, in order to remain compliant with that system. At the same time, FACTA has buoyed the IRS international tax enforcement efforts such that Overseas USC who is U.S. income tax compliant has difficulties maintaining business relationships with non-u.s. financial institutions, which also are being burdened by FACTA. As a result, there is little wonder why Overseas USC would seek to renounce his U.S. citizenship. However, such renunciation requires him to navigate the U.S. exit tax regime, which imposes its own heavy burdens of (A) the significant transactional costs of engagement of U.S. immigration and tax advisors to guide him through renunciation and (B) the exposure to a potentially sizeable U.S. tax liability resulting from the imposition of the Exit Tax itself. 87 IRC 877A(e)(2). 88 IRC 877A(e)(1)(A). Covered Expatriate must file Form W-8CE with the payor on the earlier of the day prior to the first distribution of a Specified Tax Deferred Account on or after Covered Expatriate s Expatriation Date or 30 days after Covered Expatriate s Expatriation Date. The payor has 60 days after receiving this Form W-8CE to provide Covered Expatriate with a written statement disclosing the present value of the Specified Tax Deferred Account on the day before the Expatriation Date. Notice 2009-85, 8.D. 89 IRC 877A(f)(3). 90 IRC 877A(f)(1)(A). Covered Expatriate must file Form W-8CE with the trustee on the earlier of the day prior to the first distribution from a nongrantor trust (subject to the Exit Tax) on or after the Expatriation Date or 30 days after Covered Expatriate s Expatriation Date. Notice 2009-85, 8.D. 91 IRC 877A(f)(5). 92 IRC 877A(f)(2). 93 IRC 877A(f)(4)(B). 11