It has taken awhile, but the IRS issued extensive guidance this week on the operation of the revised expatriation rules under Code Section 877A.
Some highlights and items covered:
Some highlights and items covered:
-The Code requires expatriates to recognize gain or loss as if they sold all their assets for fair market value on the day before expatriation. A $600,000 exemption against gain is provided (adjusted for inflation). The guidance confirms that the expatriate gets a full adjustment in basis for the gain or loss to be used in regard to future gain or loss computations for those owned assets, even for assets whose gain is reduced under the exemption. Losses will reduce basis (apparently even if losses are not deductible under the Code).
-The guidance confirms that assets owned under the grantor trust rules will be subject to the deemed sale rules.
-The $600,000 exclusion is allocated among all gain assets pro-rata to the built-in gain of such assets.
-Only one lifetime $600,000 exclusion will apply (that is, if an expatriate becomes a U.S. taxpayer in the future and then a covered expatriate again).
-Coordination with Section 367(a) gain recognition agreements is provided.
-The guidance warns about the application of Section 684 gain on trust assets if the expatriation converts the trust from a domestic to a foreign trust.
-Federal estate tax rules are invoked to determine what assets an expatriate is deemed to own (and thus have subject to the deemed sale) and for computing fair market value. Essentially, assets that would have been included in the expatriate's gross estate if he or she had died the day before expatriation are subject to the deemed sale rules. One has to wonder if there is some overeaching involved in this definition. There are policy reasons for including assets in a decedent's gross estate (e.g., under Code Section 2036-2038) where the decedent no longer owns a direct interest - those rules do not apply for income tax purposes so it should be inappropriate to tax them under the income tax rules upon expatriation. Further, the guidance provides that a taxpayer is deemed to own beneficial interests in trust that are not included in his or her gross estate under certain circumstances. To the extent that the guidance seeks to impose, under these extended ownership rules, an expatriate's interest in assets of a nongrantor trust, these rules should be invalid since the Committee Reports to Section 877A make clear that such trust assets are not subject to the deemed sale rules.
-Distributions from a nongrantor trust to the expatriate are subject to a 30% withholding tax post-expatriation to the extent the distribution would have been taxable if the expatriate was still a U.S. taxpayer. The trustee is liable for the tax - if not withheld, the taxpayer is liable for it. A conversion of a nongrantor trust to a grantor trust will result in a deemed distribution of the trust assets to the expatriate grantor. These rules will impose the 30% withholding tax even on capital gain income included in distributed fiduciary accounting income. The 30% tax will not apply if the expatriate is taxed as a U.S. person at the time of distribution. Reporting and notice rules are provided. For example, expatriates may need to provide a Form W-8CE to trustees of trusts of which he or she is a beneficiary.
-Persons becoming a resident may step-up their basis in assets owned for this purpose at the time they become a U.S. resident. The guidance provides exceptions, however, for U.S. real property interests and U.S. trade or business property. Query whether the IRS has the statutory authority for these exceptions.
-A procedure is provided for obtaining deferral of the tax on the deemed sale until the sale of the applicable asset. Interest is charged and security must be provided.
-Taxpayers report their deemed gain by filing a "dual status return" - that is, by filing a Form 1040NR for the period of the year after expatriation, with an attachment of a Form 1040 for the preexpatriation period. Such a dual status return will not be needed if the taxpayer expatriates on January 1 of a year.
-Expatriates will continue to file Forms 1040NR in future years, except if all of their U.S. source income is withheld at the source and they have no effectively connected income.
-Form 8854 is the principal expatriation filing that is filed with the Form 1040NR relating to the year of expatration. The Form is loaded with applicable elections and disclosures. Expatriates who are not "covered expatriates" by reason of not surpassing the threshold income or asset holdings requirements must still file the Form 8854 to make the required certification that they have complied with U.S. tax return filing requirements for the preceding five years - failure to make that certification will result in the expatriate being deemed to be a covered expatriate.
-The reporting requirements and taxes relating to estate and gift tax transfers are deferred, pending issuance of subsequent guidance.