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Jul 2007
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In Brief:
On 18 July 2007 the US House of Representatives introduced H.R. 3056, the "Tax Collection Responsibility Act of 2007," which includes a proposed "exit tax" or "mark-to-market" tax provision for individuals who expatriate from the United States. The proposal is similar to previous exit tax proposals, the most recent of which was introduced in June's military tax relief bill. Several key provisions of the proposal are discussed below. |
Individuals subject to the mark-to-market tax
The proposed law would apply to US citizens who relinquish their citizenship and long-term residents who terminate their permanent residence status (known as "expatriation"). An individual is a long-term resident if they were a lawful permanent resident in at least eight out of the fifteen taxable years ending with the year in which the residency termination occurs. The mark-to-market tax would apply to any US citizen who relinquishes citizenship and any long-term resident who terminates US residency if the individual:
- Has an average annual net income tax liability for the five preceding years ending before the date of expatriation that exceeds $136,000 (2007 amount, adjusted annually for inflation);
- Has a net worth of $2 million or more on the date of expatriation; or
- Fails to certify under penalties of perjury that he or she has complied with all US federal tax obligations for the preceding five years or fails to submit such evidence of compliance as the Secretary may require.
Certain exceptions apply to individuals born with dual citizenship and those who relinquish US citizenship prior to age 18.5 (provided certain requirements are met).
Date of expatriation
The bill sets forth rules for establishing the date of expatriation. In the most common cases, this will be the date the individual swears or affirms their oath of renunciation in front of a consular officer and witnesses or files Form I-407 terminating permanent residence status. Long-term residents would also be treated as expatriating when utilizing residency 'tie-breaker' provisions of income tax treaties to be treated as US nonresident aliens despite their permanent residency status.
Note that the rule in the current law, which provides that an individual continues to be taxed as a US citizen or long-term resident for US federal tax purposes until Form 8854 is filed, would be repealed under the proposal.
Mark-to-market tax imposed
The proposal subjects expatriating individuals to tax on the net unrealized gain on their property as if such property were sold for fair market value on the day before the expatriation date. Gain from the deemed sale is taken into account at that time without regard to other tax code provisions; any loss from the deemed sale generally would be taken into account to the extent otherwise provided in the code. The value of property held when an individual first became a US resident will be taken into account for purposes of determining the gain, unless the individual makes an irrevocable election for basis to be calculated under general US tax principles.
Deemed sale of property upon expatriation
The deemed sale rule generally applies to all property interests held by the individual on the date of expatriation. Special rules apply in the case of trust interests. The bill generally does not apply to US real property interests, which remain subject to US tax to nonresident noncitizens.
The proposal indicates that certain deferred compensation items are not subject to mark-to-market treatment upon expatriation. In general, stock option rights, restricted stock units, multi-year long term performance awards, pension rights (qualified or non-qualified) may be regarded as deferred compensation items for these purposes and not subject to mark-to-market treatment. Where this treatment applies, the individual who expatriated remains subject to US taxation on US source income when the compensation is realized or otherwise taxable under general US tax principles as long as:
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The individual expatriate notifies the payor of the deferred compensation amount of his status as a covered expatriate; and
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Irrevocably waives any right to claim any reduction in withholding on such item under a treaty with the US.
In this situation, the payor must deduct and withhold US tax from any taxable payment of an eligible deferred compensation item at a rate equal to 30%. Where the payor is not a US person, the payor must elect to be treated as a US person for purposes of the withholding requirement, and must meet such requirements as the Secretary may provide to ensure that withholding will be effected. In cases where the withholding tax does not apply, the present value of the expatriate's accrued benefit is treated as having been received by the expatriate on the date before expatriation as a distribution under the plan (though no early distribution tax applies at such time). For purposes of these provisions, deferred compensation attributable to services performed outside the US while the expatriate was not a citizen or resident of the US should not be taken into account.
Any net gain on the deemed sale is recognized to the extent it exceeds $600,000 ($1.2 million in the case of married individuals filing a joint return, both of whom relinquish citizenship or terminate residency). The $600,000 amount is increased by a cost of living adjustment factor for calendar years after 2007.
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Observation: Though gains from the sale of US real property would not be subject to the exit tax, gains from the sale of property outside the US would. This may include property such as principal residences, vacation homes, rental properties, etc. in the individual's home country. General stock investments worldwide would be considered as well. |
Gift tax provisions The proposal includes a transfer tax on "covered gifts or bequests" received by a US citizen or resident from a covered expatriate. The tax is calculated at the higher of the highest marginal estate tax rate or the highest gift tax rate.
Due date of tax
The mark-to-market tax would be due on the 90th day after expatriation.
Individuals would be permitted to make an irrevocable election to defer payment of the mark-to-market tax on a property-by-property basis, which would include an interest charge during the deferral period. The individual would generally be required to provide a bond to the Secretary in order to make this election.
Effective date
The new law would take effect on the date enacted, and the exit tax would apply to individuals who expatriate on or after the enactment date. The gift tax provisions in the proposal would apply to all gifts and bequests received from covered expatriates on or after the enactment date, regardless of the expatriation date. Individuals who expatriate prior to the enactment date continue to be covered by the existing expatriation rules for income tax purposes.
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"The Bottom Line"
Individuals who are considering relinquishing their US citizenship or permanent residency should consider the possibility of the latest mark-to-market tax provision, which would be effective immediately if enacted. | Note: This bulletin is designed for the information of readers. Whilst every effort has been made to ensure accuracy, information contained in this bulletin may not be comprehensive or may not yet be passed into law. Recipients should not act upon it without seeking professional advice.
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