About IRC Sections 877 and 877A
Further to our telephone conversation today, below is a brief review of expatriation tax provisions we discussed. The discussion below scratches only the surface of the myriad requirements of legislation, case studies, revenue rulings and recent financial disclosure requirements. Please also note this memo is not intended to be legal and/or tax advice of any nature or form whatsoever. A further evaluation of state and local laws in the country of expatriation will be necessary as you begin to finalize your expatriation strategy.
When expatriation occurs (that is a US citizen renounces citizenship or a US permanent resident renounces his/her residency) a special tax regime popularly called “expatriation tax” kicks in. The expatriation tax provisions apply to U.S. citizens who have renounced their citizenship and long-term residents who have ended their residency. The rules that apply are based on the dates of expatriation
• Expatriation before June 4, 2004.
• Expatriation after June 3, 2004, and before June 17, 2008.
• Expatriation after June 16, 2008.
For this purpose, a long term resident is an individual who was a lawful permanent resident of the United States in at least 8 of the last 15 tax years ending with the year your residency ends. In determining if the individual meets the 8-year requirement, you do not count any year that the individual is treated as a resident of a foreign country under a tax treaty and the individual does not waive treaty benefits.
Expatriation Before June 4, 2004
In this case, the expatriation tax applies if one of the principal purposes of expatriation was the avoidance of U.S. taxes. A person is presumed to have tax avoidance as a principal purpose if:
- Individuals’ average annual net income tax for the last 5 tax years ending before the date of his/her action to relinquish citizenship or terminate residency was more than $100,000 (adjusted for inflation), or
- his/her net worth on the date of the action (renounce or relinquish citizenship/residency) was $500,000, (adjusted for inflation) or more.
Generally speaking if the expatriation tax applies, the tax is imposed on an individual’s U.S. source gross income and gains on a net basis at the graduated rates applicable to individuals (with allowable deductions under section 877). A higher 30% tax may apply on income not connected with a U.S. trade or business. There are nuances to the deductions allowed and what is included in the income. That’s not where it ends. If the expatriation tax applies, the individual is required to file a Form 8854 for a period of 10 years following the date of expatriation. The form is required to be filed whether or not the individual owes any taxes in the U.S. Penalties for non-filing are hefty.
Expatriation after June 3, 2004 and before June 17, 2008
In this case expatriation tax applies if,
(1) the individual’s average annual income for the five tax years ending before the date of expatriation or termination of residency was more than $124,000 for 2004 termination,……… to $139,000 for 2008 termination, or
(2) the individual’s net worth was $2 million or more on the date of expatriation or residency termination, or
(3) the individual failed to certify on form 8854 that he/she has complied with all U.S. federal tax obligations for the five tax years preceding the date of expatriation or termination of residency.
Generally speaking if the expatriation tax applies, the tax is imposed on the individual’s U.S. source gross income and gains on a net basis at the graduated rates applicable to individuals (with allowable deductions under section 877). A higher 30% tax may apply on income not connected with a U.S. trade or business. There are nuances to the deductions allowed and what is included in the income. That’s not where it ends. If the expatriation tax applies, the individual is required to file a Form 8854 for a period of 10 years following the date of expatriation. The form is required to be filed whether or not the individual owes any taxes in the US. Penalties for non-filing are hefty.
Expatriation after June 16, 2008
For expatriation tax to apply for the years after June 16, 2008, the individual expatriating must be a “covered expatriate”. An “expatriate” for this purpose means
(1) any U.S. citizen who relinquishes his/her citizenship, or
(2) any long term resident of the US (lawful permanent resident of the U.S. in at least 8 tax years during the period of 15 tax years that includes the expatriation date) who ceases to be a permanent resident of the US.
Generally speaking, and there is more than this in code section 877A, covered expatriate means an expatriate who,
(1) has an average annual net income tax liability for the five preceding taxable years ending before the expatriation date that exceeds a specified amount (indexed for inflation) (The “tax liability test”), or
(2) has a net worth of $2 million or more as of the expatriation date, (the “net worth test”) or
(3) fails to certify (on Form 8854) compliance with all U.S. federal tax obligations (including income tax, employment tax, gift tax, information return, obligation to pay all tax liabilities including interest and penalties, etc. for the five taxable years preceding the taxable year that includes the expatriation date (the “certification test”) .
Generally speaking, if the expatriation rules apply the individual is subject to the mark-to-market expatriation tax regime. Without going into details, in the year the individual expatriates he/she is subject to income tax on the net unrealized gain (or loss) in property as if the property had been sold at its fair market value on the day before the expatriation date. Some deductions are allowed in determining gain in this regards.
I hope the above helps in your evaluation of your expatriation strategy. Let’s chat more as you firm up your situation.
(signed)
(Your Tax Professional)
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