EXPATRIATION | ULTIMATE OPT OUT? HASSLE? BOTH?

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Jason B. Freeman

Jason B. Freeman

Managing Member

214.984.3410
Jason@FreemanLaw.com

Mr. Freeman is the founding member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney.

Mr. Freeman has been named by Chambers & Partners as among the leading tax and litigation attorneys in the United States and to U.S. News and World Report’s Best Lawyers in America list. He is a former recipient of the American Bar Association’s “On the Rise – Top 40 Young Lawyers” in America award. Mr. Freeman was named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas for 2019 and 2020 by AI.

Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service. He has previously been recognized by Super Lawyers as a Top 100 Up-And-Coming Attorney in Texas.

Mr. Freeman currently serves as the chairman of the Texas Society of CPAs (TXCPA). He is a former chairman of the Dallas Society of CPAs (TXCPA-Dallas). Mr. Freeman also served multiple terms as the President of the North Texas chapter of the American Academy of Attorney-CPAs. He has been previously recognized as the Young CPA of the Year in the State of Texas (an award given to only one CPA in the state of Texas under 40).

Every few years, it seems, there’s a story about someone giving up his or her U.S. citizenship or legal residency to save on U.S. taxes. Given the peculiarities of the U.S. tax system, expatriation may make sense, sort of the ultimate opt-out. But there are some hassles involved.

The United States is unique as virtually the only country to use citizenship as a basis for taxation. Generally, the federal income tax is imposed on the worldwide income of U.S. citizens (and certain resident aliens) regardless of whether such persons currently live in the United States. Nonresident aliens are subject to tax only on U.S.-source income and income effectively connected with a U.S. trade or business.

And the discrepancy in tax treatment between citizens and nonresident aliens doesn’t end with the income tax. For instance, the U.S. estate tax defines the gross estate of a citizen or resident alien to include all property held at death wherever situated, while the gross estate of a nonresident alien includes only property situated in the United States. Citizens and certain resident aliens also may be required to report foreign bank accounts and assets to the United States, while nonresident aliens are not subject to those requirements.

So there are reasons why expatriating may seem like a good idea.

But here’s where the hassles come in. Since 1966, Congress has implemented several regimes to dissuade citizens from tax-motivated expatriation. The most recent regime is found principally in Section 877A of the Internal Revenue Code. Section 877A makes the renunciation of U.S. citizenship or the cessation of long-term lawful permanent residency by certain covered expatriates into a taxable event. A “covered expatriate” means any expatriate:

(1) whose average net income tax for the period of 5 taxable years ending before the date of loss of U.S. citizenship is greater than $124,000;

(2) whose net worth as of such date is $2,000,000 or more; or

(3) who fails to file a Form 8854 certifying under penalty of perjury that he or she has met the requirements of Internal Revenue Code for the five preceding taxable years or fails to submit such evidence of such compliance as may be required.

The above amounts are subject to a cost-of- living adjustment for years after 2004. However, the definition of a covered expatriate does not include any individual who was born a citizen of both the United States and another country, continues to be a citizen of and taxed as a resident of this other country as of the expatriation date, and has not been a resident of the United States for more than 10 taxable years during the 15-taxable year period ending with the expatriation date.

Section 877A treats all property of a covered expatriate (subject to certain narrow exceptions) as having been sold at fair market value on the day before the expatriation date. All gains and losses from this deemed sale are recognized and included in the expatriate’s gross income for the taxable year of the deemed sale to the extent that this aggregate includible amount exceeds $600,000 (subject to a cost-of- living adjustment for years after 2008).

A covered expatriate may elect to defer payment of tax on any property deemed to have been sold until after he or she actually disposes the property if he or she provides the United States with adequate security for the deferred tax (as well as applicable interest) and waives any right under any treaty that would prevent the assessment or collection of the tax imposed by Section 877A. Expatriates who elect to defer also must file a Form 8854 every year after expatriation until the tax imposed by reasons of Section 877A (as well as applicable interest) is paid off.

It’s no picnic after expatriation either. For starters, an expatriate has to make sure not to be present in the United States a sufficient number of days to qualify as a U.S. resident under the substantial presence test in Section 7701(b) of the Internal Revenue Code, or subject again to U.S. tax on a worldwide basis. In addition, Section 2801 of the Internal Revenue Code, with certain exceptions, imposes a succession tax at the highest applicable rate on U.S. citizens and residents who receive from a covered expatriate gifts or bequests exceeding the federal gift tax annual exclusion for any given year.

Then there are the non-tax hassles associated with expatriation. For instance, Section 6039G of the Internal Revenue Code requires the names of all persons who have lost U.S. citizenship in each calendar quarter to be posted in the federal register. In addition, a former citizen may be barred from reentering the United States if it is determined that the renunciation of citizenship was tax-motivated. However, this latter provision does not seem to have ever been enforced.

 

The primary I.R.C. tax statute is set forth below:

26 U.S. Code § 877A.Tax responsibilities of expatriation

(a) General rulesFor purposes of this subtitle—

(1) Mark to market

All property of a covered expatriate shall be treated as sold on the day before the expatriation date for its fair market value.

(2) Recognition of gain or lossIn the case of any sale under paragraph (1)—

(A) notwithstanding any other provision of this title, any gain arising from such sale shall be taken into account for the taxable year of the sale, and
(B) any loss arising from such sale shall be taken into account for the taxable year of the sale to the extent otherwise provided by this title, except that section 1091 shall not apply to any such loss.
Proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the preceding sentence, determined without regard to paragraph (3).

(3) Exclusion for certain gain

(A) In general

The amount which would (but for this paragraph) be includible in the gross income of any individual by reason of paragraph (1) shall be reduced (but not below zero) by $600,000.

(B) Adjustment for inflation

(i) In generalIn the case of any taxable year beginning in a calendar year after 2008, the dollar amount in subparagraph (A) shall be increased by an amount equal to—

(I) such dollar amount, multiplied by
(II) the cost-of-living adjustment determined under section 1(f)(3) for the calendar year in which the taxable year begins, by substituting “calendar year 2007” for “calendar year 2016” in subparagraph (A)(ii) thereof.

(ii) Rounding

If any amount as adjusted under clause (i) is not a multiple of $1,000, such amount shall be rounded to the nearest multiple of $1,000.

(b) Election to defer tax

(1) In general

If the taxpayer elects the application of this subsection with respect to any property treated as sold by reason of subsection (a), the time for payment of the additional tax attributable to such property shall be extended until the due date of the return for the taxable year in which such property is disposed of (or, in the case of property disposed of in a transaction in which gain is not recognized in whole or in part, until such other date as the Secretary may prescribe).

(2) Determination of tax with respect to property

For purposes of paragraph (1), the additional tax attributable to any property is an amount which bears the same ratio to the additional tax imposed by this chapter for the taxable year solely by reason of subsection (a) as the gain taken into account under subsection (a) with respect to such property bears to the total gain taken into account under subsection (a) with respect to all property to which subsection (a) applies.

(3) Termination of extension

The due date for payment of tax may not be extended under this subsection later than the due date for the return of tax imposed by this chapter for the taxable year which includes the date of death of the expatriate (or, if earlier, the time that the security provided with respect to the property fails to meet the requirements of paragraph (4), unless the taxpayer corrects such failure within the time specified by the Secretary).

(4) Security

(A) In general

No election may be made under paragraph (1) with respect to any property unless adequate security is provided with respect to such property.

(B) Adequate securityFor purposes of subparagraph (A), security with respect to any property shall be treated as adequate security if—

(i) it is a bond which is furnished to, and accepted by, the Secretary, which is conditioned on the payment of tax (and interest thereon), and which meets the requirements of section 6325, or
(ii) it is another form of security for such payment (including letters of credit) that meets such requirements as the Secretary may prescribe.

(5) Waiver of certain rights

No election may be made under paragraph (1) unless the taxpayer makes an irrevocable waiver of any right under any treaty of the United States which would preclude assessment or collection of any tax imposed by reason of this section.

(6) Elections

An election under paragraph (1) shall only apply to property described in the election and, once made, is irrevocable.

(7) Interest

For purposes of section 6601, the last date for the payment of tax shall be determined without regard to the election under this subsection.

(c) Exception for certain propertySubsection (a) shall not apply to—

(1) any deferred compensation item (as defined in subsection (d)(4)),
(2) any specified tax deferred account (as defined in subsection (e)(2)), and
(3) any interest in a nongrantor trust (as defined in subsection (f)(3)).

(d) Treatment of deferred compensation items

(1) Withholding on eligible deferred compensation items

(A) In general

In the case of any eligible deferred compensation item, the payor shall deduct and withhold from any taxable payment to a covered expatriate with respect to such item a tax equal to 30 percent thereof.

(B) Taxable payment

For purposes of subparagraph (A), the term “taxable payment” means with respect to a covered expatriate any payment to the extent it would be includible in the gross income of the covered expatriate if such expatriate continued to be subject to tax as a citizen or resident of the United States. A deferred compensation item shall be taken into account as a payment under the preceding sentence when such item would be so includible.

(2) Other deferred compensation itemsIn the case of any deferred compensation item which is not an eligible deferred compensation item

(A)

(i) with respect to any deferred compensation item to which clause (ii) does not apply, an amount equal to the present value of the covered expatriate’s accrued benefit shall be treated as having been received by such individual on the day before the expatriation date as a distribution under the plan, and
(ii) with respect to any deferred compensation item referred to in paragraph (4)(D), the rights of the covered expatriate to such item shall be treated as becoming transferable and not subject to a substantial risk of forfeiture on the day before the expatriation date,
(B) no early distribution tax shall apply by reason of such treatment, and
(C) appropriate adjustments shall be made to subsequent distributions from the plan to reflect such treatment.

(3) Eligible deferred compensation itemsFor purposes of this subsection, the term “eligible deferred compensation item” means any deferred compensation item with respect to which—

(A) the payor of such item is—

(i) a United States person, or
(ii) a person who is not a United States person but who elects to be treated as a United States person for purposes of paragraph (1) and meets such requirements as the Secretary may provide to ensure that the payor will meet the requirements of paragraph (1), and

(B) the covered expatriate

(i) notifies the payor of his status as a covered expatriate, and
(ii) makes an irrevocable waiver of any right to claim any reduction under any treaty with the United States in withholding on such item.

(4) Deferred compensation itemFor purposes of this subsection, the term “deferred compensation item” means—

(A) any interest in a plan or arrangement described in section 219(g)(5),
(B) any interest in a foreign pension plan or similar retirement arrangement or program,
(C) any item of deferred compensation, and
(D) 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.

(5) Exception

Paragraphs (1) and (2) shall not apply to any deferred compensation item to the extent attributable to services performed outside the United States while the covered expatriate was not a citizen or resident of the United States.

(6) Special rules

(A) Application of withholding rules

Rules similar to the rules of subchapter B of chapter 3 shall apply for purposes of this subsection.

(B) Application of tax

Any item subject to the withholding tax imposed under paragraph (1) shall be subject to tax under section 871.

(C) Coordination with other withholding requirements

Any item subject to withholding under paragraph (1) shall not be subject to withholding under section 1441 or chapter 24.

(e) Treatment of specified tax deferred accounts

(1) Account treated as distributedIn the case of any interest in a specified tax deferred account held by a covered expatriate on the day before theexpatriation date—

(A) the covered expatriate shall be treated as receiving a distribution of his entire interest in such account on the day before the expatriation date,
(B) no early distribution tax shall apply by reason of such treatment, and
(C) appropriate adjustments shall be made to subsequent distributions from the account to reflect such treatment.

(2) Specified tax deferred account

For purposes of paragraph (1), the term “specified tax deferred account” means an individual retirement plan (as defined in section 7701(a)(37)) other than any arrangement described in subsection (k) or (p) of section 408, a qualified tuition program (as defined in section 529), a qualified ABLE program (as defined in section 529A), a Coverdell education savings account (as defined in section 530), a health savings account (as defined in section 223), and an Archer MSA (as defined in section 220).

(f) Special rules for nongrantor trusts

(1)In generalIn the case of a distribution (directly or indirectly) of any property from a nongrantor trust to a covered expatriate

(A) the trustee shall deduct and withhold from such distribution an amount equal to 30 percent of the taxable portion of the distribution, and
(B) if the fair market value of such property exceeds its adjusted basis in the hands of the trust, gain shall be recognized to the trust as if such property were sold to the expatriate at its fair market value.

(2) Taxable portion

For purposes of this subsection, the term “taxable portion” means, with respect to any distribution, that portion of the distribution which would be includible in the gross income of the covered expatriate if such expatriate continued to be subject to tax as a citizen or resident of the United States.

(3) Nongrantor trust

For purposes of this subsection, the term “nongrantor trust” means the portion of any trust that the individual is not considered the owner of under subpart E of part I of subchapter J. The determination under the preceding sentence shall be made immediately before the expatriation date.

(4) Special rules relating to withholdingFor purposes of this subsection—

(A) rules similar to the rules of subsection (d)(6) shall apply, and
(B) the covered expatriate shall be treated as having waived any right to claim any reduction under any treaty with the United States in withholding on any distribution to which paragraph (1)(A) applies unless the covered expatriate agrees to such other treatment as the Secretary determines appropriate.

(5) Application

This subsection shall apply to a nongrantor trust only if the covered expatriate was a beneficiary of the trust on the day before the expatriation date.

(g) Definitions and special rules relating to expatriationFor purposes of this section—

(1) Covered expatriate

(A) In general

The term “covered expatriate” means an expatriate who meets the requirements of subparagraph (A), (B), or (C) of section 877(a)(2).

(B) ExceptionsAn individual shall not be treated as meeting the requirements of subparagraph (A) or (B) of section 877(a)(2) if—

(i) the individual—

(I) became at birth a citizen of the United States and a citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country, and
(II) has been a resident of the United States (as defined in section 7701(b)(1)(A)(ii)) for not more than 10 taxable years during the 15-taxable year period ending with the taxable year during which the expatriation date occurs, or

(ii)

(I) the individual’s relinquishment of United States citizenship occurs before such individual attains age 18½, and
(II) the individual has been a resident of the United States (as so defined) for not more than 10 taxable years before the date of relinquishment.

(C) Covered expatriates also subject to tax as citizens or residents

In the case of any covered expatriate who is subject to tax as a citizen or resident of the United States for any period beginning after the expatriation date, such individual shall not be treated as a covered expatriate during such period for purposes of subsections (d)(1) and (f) and section 2801.

(2) ExpatriateThe term “expatriate” means—

(A) any United States citizen who relinquishes his citizenship, and
(B) any long-term resident of the United States who ceases to be a lawful permanent resident of the United States (within the meaning of section 7701(b)(6)).

(3) Expatriation date The term “expatriation date” means—

(A) the date an individual relinquishes United States citizenship, or
(B) in the case of a long-term resident of the United States, the date on which the individual ceases to be a lawful permanent resident of the United States (within the meaning of section 7701(b)(6)).

(4) Relinquishment of citizenshipA citizen shall be treated as relinquishing his United States citizenship on the earliest of—

(A) the date the individual renounces his United States nationality before a diplomatic or consular officer of the United States pursuant to paragraph (5) of section 349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(5)),
(B) the date the individual furnishes to the United States Department of State a signed statement of voluntary relinquishment of United States nationality confirming the performance of an act of expatriation specified in paragraph (1), (2), (3), or (4) of section 349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(1)–(4)),
(C) the date the United States Department of State issues to the individual a certificate of loss of nationality, or
(D) the date a court of the United States cancels a naturalized citizen’s certificate of naturalization.
Subparagraph (A) or (B) shall not apply to any individual unless the renunciation or voluntary relinquishment is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the United States Department of State.

(5) Long-term resident

The term “long-term resident” has the meaning given to such term by section 877(e)(2).

(6) Early distribution tax

The term “early distribution tax” means any increase in tax imposed under section 72(t), 220(f)(4), 223(f)(4), 409A(a)(1)(B), 529(c)(6), 529A(c)(3), or 530(d)(4).

(h) Other rules

(1) Termination of deferrals, etc.In the case of any covered expatriate, notwithstanding any other provision of this title—

(A) any time period for acquiring property which would result in the reduction in the amount of gain recognized with respect to property disposed of by the taxpayer shall terminate on the day before the expatriation date, and
(B) any extension of time for payment of tax shall cease to apply on the day before the expatriation date and the unpaid portion of such tax shall be due and payable at the time and in the manner prescribed by the Secretary.

(2) Step-up in basis

Solely for purposes of determining any tax imposed by reason of subsection (a), property which was held by an individual on the date the individual first became a resident of the United States (within the meaning of section 7701(b)) shall be treated as having a basis on such date of not less than the fair market value of such property on such date. The preceding sentence shall not apply if the individual elects not to have such sentence apply. Such an election, once made, shall be irrevocable.

(3) Coordination with section 684

If the expatriation of any individual would result in the recognition of gain under section 684, this section shall be applied after the application of section 684.

(i) Regulations

The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.

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