Confronting the New Expatriation Tax:
Advice for the U.S. Green Card Holder
by John L. Campbell, Cincinnati, Ohio, and
Michael J. Stegman, Cincinnati, Ohio*
Editor’s Synopsis: The authors examine the intricacies involved in planning for Green Card holders, as
well as U.S. citizens who formally expatriate, to avoid
or at least minimize the impact of the new expatriation
tax. Among the solutions discussed are steps and
strategies to steer clear of covered expatriate status or,
failing that, using an expatriation trust to keep assets
outside the reach of the mark-to-market tax. The article
concludes with checklists of things to do and not to do.
Introduction
Many practitioners in the wealth planning field
advise foreign executives who are on an extended
assignment in the U.S. and have become, or will
become, Green Card holders as permanent U.S. residents. The foreign executive and spouse, however,
may plan to leave the U.S. and return home upon
retirement with the expectation of abandoning lawful
permanent residence status in order to terminate the
ongoing tax reporting required of a U.S. resident.
When advising the foreign executive, the advisor
should assume that any foreign executive who is not
actively pursuing U.S. citizenship may, at some future
time, abandon lawful permanent residence status.
Upon abandoning such status, the foreign executive
will likely face the new expatriation tax, which
became law on June 17, 2008.1
The expatriation tax regime, which also applies to
U.S. citizens who formally expatriate, can impose
immediate and onerous income taxes on the “expatriating” long-term resident under new Internal Revenue
Code (“I.R.C.”) Section 877A (collectively, the “exit
tax”).2 The flagship exit tax of the new regime is an
* Copyright 2010 by John L. Campbell and Michael J.
Stegman. All rights reserved.
1
The new regime became law on June 17, 2008 as part of the
Heroes Earnings Assistance and Relief Tax Act of 2008, P.L. 110245 (2008). The former regime still applies to expatriations before
that date.
2
The primary immediate income taxes are a mark-to-market
tax on deemed gains (discussed further in note 3 below) and taxes on
IRA’s, 529 Plans and HSA’s (which are taxed at ordinary rates). Tax
is deferred on some other assets, such as qualified retirement plans.
3
I.R.C. § 877A(a). The mark-to-market tax is on the unrealized gain in all assets worldwide, to the extent the gain exceeds a
threshold of US$600,000 in 2008, $626,000 in 2009, and $627,000
35
ACTEC Journal 266
(2009)
immediate “mark-to-market” tax on the unrealized
gain within all of the expatriate’s worldwide assets to
the extent the deemed gain as of the day before the
expatriation date exceeds an inflation-adjusted threshold ($627,000 in 2010).3 In addition to the exit tax
upon departure, if the expatriating executive later
makes gifts or testamentary dispositions to children
who have remained in the U.S., the expatriation tax
regime will impose an expensive inheritance-type
transfer tax on the recipients under new I.R.C. Section
2801 (the “inheritance tax”).4
The purpose of this article is to propose practical
advice for the expatriating executive who faces the
consequences of the new expatriation tax. The key to
the advice is either to take steps to avoid applicability
of the new regime or, if non-applicability cannot be
achieved or is inconsistent with the executive’s overall
objectives, to manage the negative tax impact of the
new regime so as to eviscerate it effectively.
Avoiding Classification as a “Covered Expatriate”
Similar to the alternative tax regime that applies to
expatriations before June 17, 2008, the new regime on
subsequent expatriations looks to certain criteria in
determining whether the person is a “covered expatriate” and is therefore subject to its taxes. Before considering income, net worth or tax compliance criteria,
the regime first looks to whether the expatriating executive is a “long-term resident.”
A long-term resident is a person who has been a
lawful permanent resident of the U.S., i.e., a Green
Card holder, during eight of the previous fifteen
years.5 This is often referred to as the “8-of-15 Test.”
in 2010, as further adjusted for inflation in future years. The rates
of tax differ with the type of asset involved. Long-term capital gain
assets and portfolio income would receive preferential rates under
current U.S. law. The unrealized gain in a life insurance contract,
for example, would be taxed at ordinary rates.
4
The 2010 rate on the transfer tax is 35% (equal to the highest gift tax rate under I.R.C. § 2502(a)) with a US$13,000 exemption per year, per recipient (equal to the annual exclusion amount
under I.R.C. § 2503(b)). It applies to receipts by U.S. citizens or
residents and by domestic trusts from a covered expatriate, and to
distributions from foreign trusts to U.S. citizens or residents that
are traceable to the expatriate. I.R.C. § 2801.
5
I.R.C. §§ 877A(g)(5), 877(e)(2).
© 2010 The American College of Trust and Estate Counsel. All Rights Reserved.
It is noteworthy that, for purposes of this test, any part
of a tax year in which the person is a Green Card holder counts as a year.6 For example, if the executive
obtains the Green Card on December 30, 2002 and
holds it until January 2 , 2009, the countable years are
considered to be eight (2002-2009, inclusive).
To trigger the taxes of the new regime, the longterm resident must “expatriate.” Expatriation can be
the result of an affirmative action, or, in the regime’s
hidden trap, it can occur unintentionally.
An affirmative expatriation would normally occur
when the long-term resident voluntarily gives up the
Green Card.7 The unintended expatriation will ensnare
the long-term resident executive who moves to one of
the over sixty countries which has an income tax treaty
with the U.S. and dutifully files his or her U.S. income
tax return8 and, on that return, takes a treaty-based
position providing tax relief. If this occurs, the person
is deemed to have expatriated for purposes of the
regime.9 To avoid unintentional expatriation, the foreign executive would continue to file his or her U.S.
income tax return and not take advantage of a treaty.10
In a confusing twist of the regime, the foreign
executive who has not yet met the 8-of-15 Test and
who is now a resident of a treaty country may toll the
accrual of years under the 8-of-15 Test by filing a U.S.
income tax return and in fact taking advantage of treaty
relief.11 Although doing so would trigger expatriation
for the foreign executive who had already met the 8-of15 Test, the treaty-based return position for the not-yet
long-term resident living abroad serves to toll accrual
of years under the Test. This person would then be free
to give up the Green Card whenever desired during the
tolling period and avoid the expatriation tax.
As long as the executive who meets the 8-of-15
Test has not statutorily expatriated, he or she may be
Treas. Reg. § 301.7701(b)-1(b)(1).
This can be accomplished by the filing with the U.S. Citizenship and Immigration Services (“USCIS”) (formerly the Immigration and Naturalization Service) or a U.S. consular officer of an
application for abandonment of lawful permanent residence status
or of a letter stating intent to abandon with the individual’s Permanent Resident Card (“Green Card”) enclosed (USCIS Form I-407).
Treas. Reg. § 301.7701(b)-1(b)(3). Loss of lawful permanent resident status can also occur through the issuance of a final administrative or judicial order of exclusion or deportation or the issuance
of a final administrative order of abandonment, if the USCIS or a
consular officer initiates a determination of abandonment, or upon
a final judicial order of abandonment in the event a U.S. federal
court grants an appeal of the final administrative order. Treas. Reg.
§ 301.7701-1(b)(2), (3).
8
A lawful permanent resident, regardless of where he or she
resides, is subject to U.S. income tax as any citizen would be, subject to relief that may be available under various income tax
treaties.
9
I.R.C. § 7701(b)(6) – flush language, which provides: “An
individual shall cease to be treated as a lawful permanent resident
of the United States if such individual commences to be treated as
a resident of a foreign country under the provisions of a tax treaty
between the United States and the foreign country, does not waive
the benefits of such treaty applicable to residents of the foreign
country and notifies the [U.S. Treasury] Secretary of the commencement of such treatment.” This statute seems to have two
main operative parts. First, the person must become a resident of a
treaty country. Second, the person must not waive the benefits of
the treaty, which would be the case if the taxpayer affirmatively
takes advantage of a treaty provision on a U.S. income tax return.
As a corollary to this second component, the taxpayer notifies the
Treasury Secretary of the benefits claim, which again happens
when he or she files the return. See Treas. Reg. § 301.7701(b)7(a)(1). For a discussion of what would constitute the “expatriation date” under these circumstances (and therefore the date as of
which assets would be valued for purposes of the mark-to-market
tax and other components of the exit tax), see Michael J. Stegman,
Breaking Up is Harder to Do: the New Alternative Tax Regime on
U.S. Expatriates, PROBATE LAW JOURNAL OF OHIO, September/
October 2009. A link to this article can be found at www.kplaw.
com/profiles/mjs.html.
10
The following will serve as three examples of treaty benefit
to the U.S. resident living abroad: (1) The taxpayer, filing as a nonresident, claims exemption of interest income on U.S.-source publicly traded debt instruments. See Treas. Reg. § 301.7701(b)-7(e),
ex. 3. (2) Many treaties will exempt from U.S. tax any salary paid
by his or her foreign employer even though the services are partly
performed in the U.S., so long as the taxpayer is not physically present in the U.S. for any part of 183 days or less in any twelve month
period or in the calendar year, and the income is not attributable to
a permanent establishment or fixed base the foreign employer
maintains in the U.S. In this way, double taxation of the part of the
income earned in the U.S. is avoided, since the U.S., under its
internal revenue law absent the treaty, would have taxed the portion
of the income attributable to services performed in the U.S. I.R.C.
§ 861(a)(3). See, e.g., Convention for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with respect to Taxes
and Capital, U.S.-Fr., Aug. 31, 1994, 1963 U.N.T.S. 67, art 15. (3)
If the foreign executive resides in a treaty country such as Mexico
with lower personal income tax rates, the treaty will exempt all of
the income of the foreign employer from U.S. tax so long as the
same 183-day rule is not violated and no income is derived from
the employer’s fixed establishment in the U.S. See, e.g., Convention for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion with respect to Taxes on Income, U.S.-Mex., Sept.
18, 1992, art. 14.
11
I.R.C. § 877(e)(2), which provides: “an individual shall not
be treated as a lawful permanent resident for any taxable year if
such individual is treated as a resident of a foreign country for the
taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of
such treaty applicable to residents of the foreign country.” If the
taxpayer cannot find a treaty benefit to take advantage of, then the
question becomes how to “not waive the benefits of such treaty.”
The authors have no advice in this regard.
6
7
35
ACTEC Journal 267
(2009)
able to employ certain strategies so as not to meet the
other criteria for classification as a covered expatriate
upon subsequent expatriation. Meeting any one of
three criteria will suffice to turn an executive who is a
long-term resident into a covered expatriate upon
expatriation. They are: (1) having failed to certify full
compliance with all U.S. tax obligations over the preceding five years (the “certification test”);12 (2) having
incurred average annual U.S. net income tax for the
preceding five tax years in excess of US$145,000 (for
expatriations in 2010, as subsequently further adjusted
for inflation) (the “tax liability test”);13 and (3) having
a net worth of US$2,000,000 or more (not indexed for
inflation) (the “net worth test”).14
Strategies for avoiding covered expatriate status
under each of these criteria will be discussed in turn.
Certifying Full Compliance with all U.S. Tax
Obligations
The alternative tax regime will always ensnare the
expatriating executive who fails under the certification
test to fully comply with U.S. tax obligations. Given
that most foreign executives are provided with return
preparation by international accounting firms, noncompliance is unlikely. If, however, the executive
knows of some failure, he or she should file amended
returns and come into full grace with the Internal Revenue Service (“IRS”).
Keeping Under the Average Net Income Tax
Threshold
Under the tax liability test, the new law considers
the average U.S. income tax incurred by the individual
over the five years prior to expatriation.15 For expatri-
12
I.R.C. § 877(a)(2)(C). See also IRS Form 8854 – Expatriation Information Statement (2008), Part B, Line 6.
13
I.R.C. § 877(a)(2)(A); Rev. Proc. 2009-50, 2009-45 I.R.B.
617. For expatriations in 2009, it was also an average of $145,000
of tax over five years. Rev. Proc. 2008-66, 2008-45 I.R.B. 1107.
For 2008 expatriations, it was $139,000. Rev. Proc. 2007-66, 200745 I.R.B. 970.
14
I.R.C. § 877(a)(2)(B). The $2,000,000 threshold considers
all assets worldwide. IRS Form 8854 – Expatriation Information
Statement (2008) contains a list of possible assets for purposes of
comprising a balance sheet. Of particular interest are pensions
from services performed outside the U.S., assets held in grantor
trusts where the taxpayer is the deemed owner, and beneficial interests in nongrantor trusts. See Schedule A of Form 8854.
15
Some IRS guidance exists on calculating net income tax.
The guidance was issued under the old alternative tax regime, but it
still applies to the new regime, which relies on the same net income
tax test. See I.R.S. Notice 2009-85, 2009-45 I.R.B. 598, Section
35
ACTEC Journal 268
(2009)
ations in 2010, the average tax must exceed
US$145,000. It would not be unusual for the executive to have earned income and other income sufficient
to produce a tax liability of this magnitude. It may be
possible to come under the threshold through greater
use of deferred compensation, stock options in lieu of
cash compensation, and investment in tax-free bonds
and non-dividend-paying stocks. The particulars of
these approaches are beyond the scope of this article.
Reducing Net Worth to Below US$2,000,000
The net worth test presents perhaps the most planning opportunities. If the long-term resident executive
has complied with tax laws and does not meet the tax
liability test, then he or she can avoid covered expatriate status by reducing net worth to below
US$2,000,000 before the expatriation date. Possible
strategies for doing so are set forth below.
Outright Gifts to Reduce Net Worth
If the executive is still residing in the U.S.,
such that the U.S. gift tax laws apply,16 there are a few
options.
First, the executive could use the
US$1,000,000 lifetime gift tax exclusion and the
$13,000 annual exclusion per donee to make gifts to
family members. In this regard, transfers by gift of
non-voting interests in a closely-held business or limited liability company may allow the donor to transfer
a portion of wealth while retaining control of the entity in which the wealth is held and generated.17 When
transferring hard-to-value assets, the expatriating
executive must establish the value of the assets, which
is best achieved through formal appraisal, accompanied by appropriate U.S. gift tax reporting upon the
2.B. Most importantly, the guidance under the old regime instructed that, in the case of a joint return, the net income tax must reflect
the total liability of both spouses. I.R.S. Notice 97-19, 1997-1 C.B.
395.
16
I.R.C. § 2501(a)(1). Residency for U.S. transfer tax purposes is defined in Treas. Reg. §§ 20.0-1(b) and 25.2501-1(b). For
these purposes, residency is defined in a manner that equates to
domicile under the Anglo-American common law concept. Thus, a
person becomes a domiciliary in a place by living there, even if for
a brief period, with no present intention of leaving there, and a later
intention to change domicile will not be effective unless the person
actually leaves. The definition differs substantially from the
income tax tests of residency under I.R.C. §7701(b).
17
The use of a Subchapter S corporation would not be acceptable for this purpose as the expatriating executive will not qualify
as a Subchapter S shareholder after expatriation. I.R.C. §
1361(b)(1)(C).
completion of the gift. Upon expatriation, the executive must report the value of assets on IRS Form
8854.18
If the executive’s spouse is a U.S. citizen, there is
an unlimited marital deduction that the executive can
use to shed assets. In the case where the spouse is a
non-citizen, the executive is limited to an inflationadjusted annual marital deduction of US$134,000 in
2010.19 If the spouse is also expatriating, however,
these marital gifts can be used only to the extent that
they do not cause the spouse to become a covered expatriate. Furthermore, such inter-spousal gifting may be
unnecessary if the marital assets are subject to a community property regime typical of civil law countries
and some U.S. states.20 As a further caveat, the law of
the couple’s country of nationality may impose a
“forced heirship” regime that could be ultimately violated by transfers to a spouse. Germany serves as an
example in this regard.21 When the couple moves out of
the U.S., the law of the new domiciliary country (such
as France) may also impose such a regime.22
The best gifting opportunity may occur after
the executive has departed the U.S. Although as a
Green Card holder he or she remains a U.S. resident
for income tax purposes, the result may be different
for U.S. transfer tax purposes. Under the U.S. transfer
tax laws, a person becomes a domiciliary in a place by
living there, even if for a brief period, with no present
intention of leaving there.23 If the expatriating executive settles decisively in the new country, with no current intention of moving on, the executive will become
a domicile of the new country and will cease to be a
resident of the U.S. for gift tax purposes.24 At this
point, the executive will not incur U.S. gift tax on a
transfer to spouse or children, unless the asset in question is real estate or tangible personal property having
a situs in the U.S.25 These gifts must be made, of
course, before expatriation, whether the expatriation is
effected by formally turning in the Green Card or by
filing an income tax return and taking a treaty-based
return position, as discussed above.
The practitioner should be careful to engage
18
See note 14. IRS Form 8854 – Expatriation Information
Statement is the form to be used by individuals who expatriate on
or after June 4 2004, to provide information required by Internal
Revenue Code Section 6039G. In order to withstand inclusion of
the entire interest in the company, including the transferred interests, in the valuation of the expatriating executive’s assets on IRS
Form 8854, the expatriating executive must have a legitimate nontax purpose for forming the entity and must manage the entity with
the appropriate formalities.
19
I.R.C. § 2523(i); Rev. Proc. 2009-50, 2009-45 I.R.B. 617.
For 2009, it was $133,000. Rev. Proc. 2008-66, 2008-45 I.R.B.
1107. For 2008, it was $128,000. Rev. Proc. 2007-66, 2007-45
I.R.B. 970. A marital deduction for a transfer to a Qualified
Domestic Trust is not available for gifts.
20
American courts follow the general rule that rights in property acquired during marriage are governed by the law agreed to by
the couple. RESTATEMENT (SECOND) OF CONFLICTS OF LAW § 258
(1971). In the absence of an agreement, interests of spouses in personal property acquired during marriage are determined by the law
of the state with the most significant relationship to the spouses and
the property (usually the state of the couple’s domicile), and interests in land are determined by the law in which land is situated. Id.
at §§ 258(2), 234.
21
German forced heirship law follows the nationality of its
citizens and is not circumvented by a change of domicile. With the
exception of real estate not situated in Germany, the forced heirship
rights guarantee a minimum portion of the estate to the closest relatives and the spouse of the deceased person. The forced heirship
rights exist if the closest relatives and/or the spouse are left with a
lower share of the estate than half of their respective statutory portion or if, under the Will, they are burdened by the appointment of
a reversionary heir. The forced heirship right is a monetary claim
against the estate and not a right in rem. Although a German
national is free to make gifts to third persons inter vivos (if he is not
bound by a German contract of inheritance or a German joint testa-
ment of spouses) that do not comply with the forced heirship
regime, a gift made within ten years before the testator’s death will
give rise to the right of the aggrieved relative to sue the recipients
for his or her compulsory portion. BÜRGERLICHES GESETZBUCH
[BGB] [CIVIL CODE] art. 2303 et seq. (F.R.G.).
22
Successions of personal property will be governed by
French law if the deceased’s last domicile was in France. In this
jurisdiction, inter vivos gifts which ultimately prove to violate the
French forced heirship regime are subject to an unlimited clawback
period, such that the rightful heirs of the affected portion (or their
creditors) have a claim against the recipients. Code civil [C. Civ.]
[Civil Code] art. 843, 922, 1166 (Fr.).
23
See supra note 16.
24
Once an executive who holds U.S. permanent resident status establishes a domicile abroad and no longer has any intention of
returning to live in the U.S., the U.S. immigration authorities take
the position that the executive has abandoned his permanent resident status and that, although his permanent resident card is unexpired, it would be unlawful for the executive to use his card to reenter the United States. Instead of the executive attempting to use
the card, the U.S. authorities expect the permanent resident to complete a formal abandonment process and relinquish the permanent
resident card either to a U.S. Embassy or to U.S. Customs and Border Protection. Abandonment would mean that the executive would
then become like any other "alien" who would need to obtain a
U.S. visa (or if from a qualifying country, use the Visa Waiver program) to enter the U.S. for business trips or for personal reasons.
Given the significance of abandoning the hard-to-achieve status of
U.S. permanent residence, the executive should always consult
with U.S. immigration counsel before finalizing a decision to take
up residence abroad. The authors wish to thank Douglas J. Halpert,
Esq. of the law firm of Dinsmore & Shohl, Cincinnati, Ohio, for his
input in this regard.
25
I.R.C. §§ 2501, 2511.
35
ACTEC Journal 269
(2009)
As an alternative to outright gifting of assets,
the executive could create and fund an irrevocable selfsettled nongrantor U.S. discretionary trust for the benefit of the executive and his or her spouse and descendants (an “Expatriation Trust”).29 There are several
considerations to examine in regard to this structuring.
First, the Expatriation Trust must be settled
under the laws of a jurisdiction that has asset protection legislation in place for self-settled discretionary
trusts. If this is not the case, the IRS would certainly
take the position that all trust assets are countable
under the net worth test. The asset protection jurisdictions provide an advantage in that the trust assets
would not be includible in the estate of the settlor for
U.S. estate tax purposes.30 Elsewhere in the alternative
tax regime, the IRS employs this analysis of estate tax
inclusion in determining what constitutes “property”
for purposes of the mark-to-market tax.31 It would
likely argue the same under the net worth test for covered expatriate classification.
Regardless of whether the Expatriation Trust is
settled in an asset protection jurisdiction, the IRS will
still attempt to value and include the grantor’s retained
“beneficial interest” in the trust.32 In valuing a beneficial interest, the IRS employs a vague facts and circumstances test. In so doing, it considers the terms of the
trust instrument, any letter of wishes submitted by the
grantor, historical patterns of trust distributions, and the
powers of any trust protector or advisor.33 While the
terms of the executive’s Expatriation Trust will include
him or her as only one of a class of potential recipients
of distributions along with children or other objects of
bounty, there should be no distributions to the settlor
and spouse. The longer the existence of the Expatriation Trust without distributions to the executive and
spouse, the greater is the likelihood that the IRS will
agree that there is no or little value to the settlor’s beneficial interest. If the Expatriation Trust is structured
such that the approval of other beneficiaries (such as
adult children of the settlor) is required before a distribution can be made to the settlor or spouse, the noninclusion argument becomes stronger.
If a “beneficial interest” cannot be allocated to
the settlor under the facts and circumstances test, the
IRS will allocate the interest based on the intestate succession rules under the Uniform Probate Code, with the
settlor as the party assumed to have died.34 Where the
expatriate is the settlor, the rules of intestate succession
would allocate nothing to the settlor of the Expatriation
Trust. The spouse, however, would have an interest,
the size of which would depend on various factors.35
26
CAPITAL ACQUISITIONS TAX CONSOLIDATION ACT 2003,
§§ 50, 70 and Schedule 2 (Ir.). The s542,544 is the 2009 exemption.
27
ESTATE AND GIFT DUTIES ACT OF 1968 (N.Z.).
28
INHERITANCE TAX ACT OF 1984, § 3a (U.K.).
29
Excluding the executive as a beneficiary would be preferable, but it is assumed that this would be unpalatable. The foreigner is going to have a hard enough time comprehending that he or
she has to set up anything to avoid a tax that will likely be viewed
as nonsensical.
30
Rev. Rul. 77-378, 1977-2 C.B. 347; PLR 200944002 (October 30, 2009). The practitioner should be aware that all state asset
protection statutes are not alike. For purposes of achieving gift
completion and estate non-inclusion, the statutes should be
reviewed carefully. See Jonathan G. Blattmachr, et al., IRS Rules
that Self-Settled Alaska Trust Will Not Be in Grantor’s Estate,
ESTATE PLANNING JOURNAL, January 2010.
31
See infra note 52.
32
I.R.S. Notice 97-19, 1997-1 C.B. 394, Section III.
Although this Notice was issued under the old alternative tax
regime, the new regime relies on the same net worth test (and tax
liability and certification tests) as found in I.R.C. § 877(a)(2) of the
old regime. Notice 2009-85, which was issued under the new
regime, incorporates the guidance issued in Notice 97-19 for purposes of the net worth and tax liability tests. I.R.S. Notice 200985, 2009-45 I.R.B. 598, Section 2.B. The term “covered expatriate,” however, is unique to the new regime. I.R.C. § 877A(g)(1)(a).
33
Id. The corresponding form is I.R.S. Form 8854 – Expatriation Information Statement, Schedule A, line 10. See also the
Instructions for Form 8854 (2008), p. 5.
34
Id. Cf. National Conference of Commissioners on Uniform
State Laws, Uniform Probate Code (http://www.law.upenn.edu/
bll/archives/ulc/upc/2008final.htm).
35
Uniform Probate Code, §§ 2-102, 2-102A (2004, revised
2008). See supra note 34.
foreign advisors on the law of the new jurisdiction.
Aside from the succession law issues found in some civil
law countries as discussed above, the transfer could trigger the new country’s inheritance or gift tax. In Ireland,
for example, although there is no tax on gifts between
spouses, gifts to children are taxed at 20% to the extent
that all gifts to children exceed a cumulative exemption
of s542,544 (circa US$800,000).26 In New Zealand,
gifts by a person domiciled in New Zealand or gifts of
property sited in New Zealand made to one or multiple
individuals, the total value of which exceeds NZ$27,000
(circa US$20,000) in any given year, will be taxed at a
rate of at least 5% and up to as much as 25% for gifts
over NZ$72,000 (circa US$53,000).27 Under the law of
the United Kingdom, however, an outright gift is not taxable so long as the donor survives for seven years.28
Once the net worth is below US$2,000,000,
the executive can safely turn in his Green Card. In the
meantime, the executive must be sure to file his or her
U.S. income tax return in full compliance with U.S.
tax laws and not take any treaty relief.
Using an Expatriation Trust to Reduce Net
Worth
35
ACTEC Journal 270
(2009)
A second consideration in structuring the
Expatriation Trust is to preclude classification as a
“grantor trust” for U.S. income tax purposes under
I.R.C. Sections 671-679. The IRS takes the position
that the entire value of a grantor trust is includible for
purposes of the net worth test, however tenuous this
position may be.36 In order to prevent grantor trust status, the terms of the Expatriation Trust must provide
that no income or principal can be distributable to the
settlor without the consent of an adverse party.37 For
these purposes, the settlor’s spouse is not adverse;38
the approval would have to come from other beneficiaries who are adverse parties, such as children or other
objects of bounty.
Furthermore, to insure that the Expatriation
Trust is not a grantor trust under I.R.C. Section 679, the
Expatriation Trust should not be a “foreign trust” for
U.S. income tax purposes.39 A “foreign trust” is any
trust over which a U.S. court is not able to exercise primary jurisdiction or does not have a “U.S. Person” controlling all substantial decisions, either as trustee or as a
trust advisor or protector.40 A U.S. Person in this context is a domestic corporation or a citizen or resident of
the U.S. Therefore, the expatriating executive must
take particular care to insure that the trustees, as well as
the persons with power to remove a trustee and the
adverse parties who will control distributions from the
Expatriation Trust to the settlor, are at all times U.S.
Persons. A U.S. Person must hold all other relevant
powers under the terms of the Expatriation Trust.41
The third consideration in structuring an
Expatriation Trust concerns avoiding U.S gift taxes. If
the executive is still resident in the U.S. when funding
the Expatriation Trust, he or she would owe gift tax on
the value of the transfer that exceeds the cumulative
US$1,000,000 exemption. If the executive has remaining U.S. gift tax exemption and a transfer to an Expa-
triation Trust within the remaining exemption amount
would suffice to reduce net worth to below
US$2,000,000, then the gift to the trust could be structured as complete. If this is not the case, in order to
accomplish both the goal of gift tax avoidance and the
overriding objective of non-inclusion for net worth test
purposes, the gift, when made to the Expatriation
Trust, must be incomplete. After the executive is no
longer a U.S. resident for gift tax purposes, the executive must take a further step to complete the gift. The
process of making an incomplete gift and later completing the gift is discussed immediately below.
With respect to the initial incomplete nature of
the gift to the Expatriation Trust when the executive
has no remaining exemption, the most reliable way to
achieve incompleteness in this context is for the settlor
to retain a limited testamentary power of appointment
over the trust estate.42
The essential further step is to complete the
gift to the Expatriation Trust by renouncing the
retained limited testamentary power of appointment.
The executive will take this step after establishing permanent residence abroad but before expatriating. If
the renunciation does not occur before expatriation,
the IRS would count the trust asset for purposes of the
net worth test. As discussed above, the IRS would take
the position that the value of the trust assets should be
included among the assets of the expatriate under the
net worth test,43 as the gift to the trust was never completed. In fact, the IRS would further argue that, if the
renunciation occurred within three years of the expatriation date, the parallel principles of U.S. estate taxation of its citizens and residents would keep the underlying Expatriation Trust assets in the taxable estate
under I.R.C. Sections 2035 and 2038. Therefore, a
period of three years should elapse between the renunciation of the power and the expatriation.44, 45 Since the
36
See I.R.S. Form 8854 – Expatriation Information Statement
(2008), Schedule A, line 9. See also the Instructions for Form 8854
(2008), p. 5. This position of the Service is not reflected in Notice
97-19, supra note 32.
37
I.R.C. §§ 674, 677.
38
I.R.C. § 672(e).
39
I.R.C. § 679(a)(1). A foreign trust is considered as a
grantor trust under I.R.C. § 679(a)(1) if such foreign trust is established by a U.S. person and a U.S. person is one or more of the beneficiaries. Such will be the case if the settlor, a U.S. person, is a
discretionary beneficiary.
40
I.R.C. § 7701(a)(31)(B).
41
I.R.C. § 7701(a)(31), (a)(30)(E)(ii). It is fortunate that residency for these purposes is as defined for income tax purposes,
such that the holding of a Green Card by a child suffices to
cause that child to be a U.S Person for these purposes. I.R.C.
§ 7701(a)(30)(A), (b)(1)(A)(i). Otherwise, if the executive affirmatively moves abroad and takes all non-citizen children along, a
residency definition for estate and gift tax purposes would render
them all nonresidents. See supra note 16.
42
Rev. Rul. 77-378, supra note 30.
43
See supra note 31.
44
Mention should be made here of a parallel concept of the
estate tax regime applicable to nonresident-noncitizens of the U.S.
Under I.R.C. § 2104(b), the U.S. will tax the U.S.-sited assets
transferred to a trust during life (even if converted to non-situs
assets prior to death) or held in the trust at death if, at the time of
the death of the taxpayer, the trusts assets would have been includible in the estate of a U.S. citizen or resident under I.R.C. §§ 20352038. Accordingly, if the nonresident foreigner dies within three
years after renunciation of the limited testamentary power of
appointment, his or her estate will be subject to U.S. estate taxation
on the U.S.-sited assets transferred to the Expatriation Trust (again,
without relief for subsequent conversion to non-U.S. assets) or
remaining in it at time of death. Furthermore, under the same U.S.
estate tax regime applicable to nonresident-noncitizens, other U.S.-
35
ACTEC Journal 271
(2009)
IRS’ Instructions for Form 8854 require the executive
to list significant changes in assets and liabilities for
the period that began five years prior to expatriation,46
the executive must disclose a completed gift of assets
into the Expatriation Trust made within such five-year
period. As a result, the executive should expect IRS
scrutiny of the funding of the Expatriation Trust or
should be willing to wait to expatriate until five years
has elapsed since he or she renounced the retained limited testamentary power of appointment.
Furthermore, the technique of making an
incomplete gift while in the U.S. and then completing
the gift, once permanently resident in the new country,
may have the further effect of escaping transfer tax in
the new country, since the new country’s fiscal authority may not impose an inheritance tax on the beneficiary of an Expatriation Trust upon the settlor’s renunciation of a power. Foreign counsel would need to be
consulted for a definite answer.
If the executive decides to employ the mechanism of an Expatriation Trust for the purpose of reducing net worth to below $2,000,000, he or she may wait
until taking up residence abroad before doing so. If
this is the case, many of the same considerations
apply: (1) settle the trust under the laws of a U.S. state
offering asset protection; (2) establish and fund the
trust at least three years before expatriating; (3) require
adverse parties to approve any distributions to the
grantor or spouse; (4) make sure the trust will not be
classified as a foreign trust under U.S. law; and (5)
forego any distributions from the trust to the executive
or spouse prior to expatriation. If the executive’s move
to the foreign country is of such definiteness that he or
she is no longer a U.S. resident for gift tax purposes,47
the executive may make a completed transfer of certain intangible assets into the Expatriation Trust, since
the U.S. gift tax laws will not apply. If this approach is
used, it is still advisable to allow significant time to
elapse between the creation of the Expatriation Trust
and the date of expatriation. The lapse of time will
serve to ripen the executive’s foreign domicile and
thus frustrate the IRS in claiming gift taxes on the theory that the executive was still a U.S. resident for
transfer tax purposes.
Once established as a resident of the foreign
country, the executive will have to consider the new
jurisdiction’s gift and inheritance tax laws when making the transfer to the Expatriation Trust. Many civil
law jurisdictions do not recognize trusts, and, as a
result, a transfer to a trust is assigned an unfavorable
category (and resultant tax rate) for purposes of assessing such jurisdiction’s gift/inheritance tax. An example is Germany. Under its inheritance tax laws, the
transfer to the Expatriation Trust may be taxed under
its least-favorable Class III category.48 Furthermore,
distributions made from the Expatriation Trust during
its existence and at its termination may also be taxed.49
France may be an exception among the civil law jurisdictions as to the taxation of the initial transfer to the
Expatriation Trust.50
Furthermore, for Expatriation Trusts settled in
2010 only, new subsection (c) of I.R.C. Section 2511
appears to foreclose an incompleted gift to a nongrantor trust. Thus, at least during that year, the mechanism of making an initially incomplete gift to a
nongrantor trust will not work. In this situation, the
executive can wait until establishing domicile in the
foreign country before creating the trust, as discussed
immediately above. In the alternative, the executive
can make an incompleted gift to a grantor trust while
in the States and, after settling in the foreign land and
completing the gift through renunciation of the limited
power of appointment, the independent trustee may be
able to then decant the trust under applicable state law
so as to add a provision that renders it a nongrantor
trust. If this additional step is taken before the expatriation date, then the IRS may respect its status as a nongrantor trust as of expatriation.
sited assets not held in trust (such as U.S real estate and stock in
domestic corporations) will be subject to estate tax. In this case,
the U.S. estate tax exemption will be only US$60,000, instead of
the US$3,500,000 exemption currently enjoyed by U.S. citizens
and residents for deaths occurring in 2009.
45
Instead of granting a limited testamentary power of appointment, the trust instrument could contain a power by which the other
beneficiaries may transfer the assets of the Expatriation Trust into a
new trust that does not give the settlor a limited testamentary power
of appointment or any other control. This approach would obviate
the need for the subsequent renunciation of the power by the settlor.
But, the children or other adverse parties may fail to exercise the
power or may exercise it in a way that excludes the settlor from further benefit. Furthermore, the IRS would likely maintain that there
was a prior arrangement in place with the children. In another possible alternative, the trustee could exercise a decanting power under
local law to create a new trust which would not include a limited
testamentary power of appointment in favor of the settlor.
46
See I.R.S. Instructions for Form 8854 (2008), p. 4: Schedule A – Balance Sheet, Note.
47
See supra note 16.
48
ERBSCHAFTSSTEUR-UND SCHENKUNGSSTEUERGESETZ [ERBSTG] [INHERITANCE AND GIFT TAX ACT] §§ 3, 7 (F.R.G.).
49
Id. at § 7.
50
See Jean-Marc Tirard, “Trusts and French Gift Tax: The
Decision of the French Cour De Cassation of 15 May 2007,”
TRUST LAW INTERNATIONAL, Vol. 22, No. 1, 2008, pp. 3 et seq.
35
ACTEC Journal 272
(2009)
Using an Expatriation Trust to Keep Assets
Outside the Reach of the Mark-to-Market Tax
The expatriating executive may not be able to
avoid classification as a covered expatriate under the
net income tax or the net worth test such that the executive may be taxable under the new expatriation tax
upon renunciation of the Green Card. If this is the
case, the executive can make transfers to an Expatriation Trust to keep certain assets outside of the reach of
the mark-to-market income tax.
The mark-to-market tax imposes a deemed sale on
all “property” of the covered expatriate, with certain
exceptions.51 To date, the only IRS guidance on defining “property” has come in Notice 2009-45 and in the
Instructions to the 2008 Form 8854. The definition of
“property” in this Notice and these Instructions would
exclude the assets of a trust if the trust would not be
includible in the gross estate of the taxpayer for U.S.
estate tax purposes, assuming he or she died on the
day before the expatriation date as a citizen or resident
of the U.S.52 In this case, none of the Expatriation
Trust assets would be considered property of the expatriating executive.
A properly structured Expatriation Trust should
avoid inclusion as property under this definition. The
structuring would involve principles already discussed
above: (1) establish a discretionary U.S. domestic trust
in a state having asset protection legislation for self-settled discretionary trusts; (2) do not reserve trustee
removal powers or retain other powers that would run
afoul of U.S. estate inclusion principles; (3) structure
the trust so as to be a nongrantor trust for U.S. income
tax purposes; and (4) if the initial transfer to the Expa-
51
I.R.C. § 877A(a). The exceptions are taxed independently
of the mark-to-market tax (I.R.C. § 877A(c)). These exceptions
include qualified plans and other “deferred compensation items”
(I.R.C. § 877A(d)) and IRA’s and other “specified tax deferred
accounts” (I.R.C. § 877A(e)).
52
Notice 2009-85, 2009-45 I.R.B. 598, Section 3.A; I.R.S.
Instructions for Form 8854 (2008), p. 7. The Instructions include
the assets of a grantor trust under the net worth test for determining
whether covered expatriate status exists, but do not include grantor
trust assets as property for mark-to-market tax purposes unless the
trust would be includible for estate tax purposes or the expatriate’s
beneficial interest in the trust can be valued (see note 36 supra).
The Notice, in an introductory section, would seem to include
grantor trust assets as property under the mark-to-market tax, but in
the section of the Notice dealing specifically with property, does
not automatically include such assets and instead subjects such
trusts to the estate tax inclusion analysis and the beneficial interest
analysis. See Sections 1 (“Introduction”) and 3.A (“Mark-to-Market Regime: Identification of a covered expatriate’s property and
determination of fair market value”) of Notice 2009-85.
53
Although the deemed gain on the assets outside of the
triation Trust is structured as an incomplete gift so as to
avoid U.S. gift tax inclusion while the expatriating
executive is still a U.S. resident for transfer tax purposes, then complete the gift after establishing residency in
the new country by means of renouncing the limited
testamentary power of appointment and allow at least
three years to elapse prior to expatriation. If the Expatriation Trust is structured and executed in this manner,
the mark-to-market tax should not apply to its assets.
In the case where the expatriating executive is willing to transfer significant assets to an Expatriation Trust,
but wants to retain sufficient assets to meet liabilities
and living needs, the executive could fund the Expatriation Trust with only low-basis assets, retaining his or her
high-basis property. Upon expatriation, the Expatriation Trust assets are not counted as property, and the
gain on deemed sale of the retained high-basis property
may fall within the US$627,000 exemption.53 Upon
actual realization of gains, however, the Expatriation
Trust will pay U.S. capital gains tax at the trust level
because, as a domestic trust, it is a U.S. taxpayer.54
There is, however, a drawback to the use of a nongrantor Expatriation Trust to remove assets from the
definition of property. Under the exit tax provisions of
the new expatriation tax regime that is an exception to
the mark-to-market tax, the Internal Revenue Code
imposes a tax on distributions to the covered expatriate
from a trust which, as of a time immediately before the
expatriation date, is a nongrantor trust.55 Pursuant to
this part of the regime, the trustee must withhold 30%
of the “taxable portion” of each distribution, as determined under normal tax accounting principles applicable to trusts and as if the covered expatriate were still a
U.S. citizen or resident.56 Thus, the trustee would
Expatriation Trust may fall within the exemption or may be taxed
at favorable U.S. capital gain rates (currently 15% for capital assets
held for more than one year), the expatriate may face the capital
gains tax of the new country upon actual sale of the assets. This
may result in a double tax, as the new country’s laws may not grant
a basis equal to the deemed sale price under the U.S. mark-to-market tax.
54
See generally I.R.C. § 641.
55
I.R.C. § 877A(f). The covered expatriate must annually file
IRS Form 8854 to report distributions from a nongrantor trust or to
certify that no distributions have been made. I.R.S. Notice 200985, 2009-45 I.R.B. 598, Section 8.C.
56
I.R.C. § 877A(f)(1)(A) & (2). The covered expatriate may
not claim a reduction in withholding under the provisions of any
treaty. I.R.C. § 877A(f)(1)(B). If the distribution is wholly or partly in-kind, the tax result becomes more complex. In this case, the
property is deemed to have been sold by the trust to the beneficiary
at its fair market value. To the extent that there is deemed gain, the
trust pays the tax on the gain at the normal rates applicable to
trusts. I.R.C. § 877A(f)(1)(B).
35
ACTEC Journal 273
(2009)
withhold on distributions of income earned by the trust
on a worldwide basis. The actual tax to the expatriate,
however, appears to be only on certain items of U.S.source income under the normal rules applicable to
nonresident-noncitizens under I.R.C. Section 871.57 In
any event, the covered expatriate would have to undertake the yearly burden of filing for a refund of the
withheld portion of non-U.S. income. Accordingly,
the best scenario for this Expatriation Trust is if the
assets may not be needed in the future by the executive, such that the trust will be used primarily as a
means of making future gifts to children.58
The problem of the withholding of and tax on subsequent distributions to a covered expatriate from a
nongrantor trust, however, may be avoided. This
would involve establishing the trust in the same manner as set forth above (without attributes that would
cause U.S. estate tax inclusion as if the expatriate had
remained a U.S. resident) but, under this alternate
strategy, to establish it as a grantor trust for U.S.
income tax purposes. Under the definition of property
in IRS guidance to date, the assets of a grantor trust
that otherwise would be excludible for estate tax purposes will nonetheless be counted as property subject
to the mark-to-market tax if the expatriate’s beneficial
interest in the trust assets can be valued.59 At this point,
the IRS employs the same “facts and circumstances”
test and the alternate intestate share test as under the
analysis for inclusion of the trust assets under the net
worth test in determining covered expatriate status. In
order to bolster the non-inclusion of the grantor trust
assets under the mark-to-market tax, care should be
taken, as discussed above, to discourage any distributions by the trustee to the expatriating executive or
spouse prior to the expatriation date and not to leave a
letter of wishes to the trustee as to the personal benefit
of the settlor and spouse.
Under this alternate strategy, the post-expatriation
distributions from this grantor trust will not be subject
to withholding and tax, because the Code only looks to
distributions from nongrantor trusts. Although at the
time of expatriation the status of the grantor trust will
change to a nongrantor trust under the provisions of
I.R.C. Section 672(f), the determination of nongrantor
trust status under I.R.C. Section 877A(f) turns on characterization of the trust “immediately before the expatriation date.”60
If it is determined to create a grantor trust, the
advisor should not employ the mechanism of establishing the trust in a foreign country or with a foreign
trustee so as to achieve the initial classification as a
grantor trust.61 Upon expatriation of the executive, the
trust’s status would change to nongrantor, and I.R.C.
Section 684 would impose a tax on deemed gains.62
Given the impact of the separate deemed gains tax on
transfers to nongrantor foreign trusts under I.R.C. Section 684, the planning to avoid the similar deemed
gains scheme of the mark-to-market exit tax will have
been lost.63
I.R.C. § 877A(f)(4)(A); I.R.S. Notice 2009-85, 2009-45
I.R.B. 598, Section 7.C. The tax should only extend, for the most
part, to U.S.-source dividends and rents. I.R.C. § 871. The covered expatriate may elect to treat his or her entire value in the beneficial trust interest as having been received on the day before the
expatriation date, but only if he or she first receives an IRS letter
ruling as to the value of the interest. Notice 2009-85, Section 7.D.
58
Because the transfer to the trust will have been made before
the expatriation date, subsequent distributions from the trust to a
U.S. citizen or resident will not be subject to transfer tax under new
Internal Revenue Code Section 2801. I.R.C. § 2801(e)(4)(a).
59
See supra note 32.
60
I.R.C. § 877A(f)(3).
61
See supra note 39.
62
I.R.C. § 684(c); Treas. Reg. § 1.684-2(e).
63
The result would be even worse than under the mark-tomarket exit tax on inherent gains under I.R.C. § 877A, because
while that section allows offsetting deemed losses and provides for
an exemption ($627,000 in 2010), Section 684 does neither.
64
I.R.C. § 2801(e)(1).
57
35
ACTEC Journal 274
(2009)
U.S. Inheritance Tax Considerations for the
Covered Expatriate
If the expatriating executive is classified as covered expatriate, he or she would remain forever subject
to the new inheritance tax under I.R.C. Section 2801.
Post-expatriation gifts and bequests to U.S. citizens or
residents, perhaps children who stayed behind, would
be taxed to them at the highest gift or estate tax rate
then in effect, with only the annual exclusion to shelter
them. Subsequent transfers to a U.S. domestic trust
would also be taxed. What can be done here?
If the executive settles the Expatriation Trust prior
to expatriation, subsequent distributions from the trust
to the executive’s children or grandchildren in the U.S.
will not be taxed under the inheritance tax. The inheritance tax is only applicable to a transfer from a person
who is a covered expatriate at the time of transfer to the
trust.64 If the transfer to the Expatriation Trust takes
place prior to the expatriation date, the inheritance tax
will not apply to subsequent transfers from that trust to
the covered expatriate’s children. As a result, the Expatriation Trust is an ideal source of gifts to a covered
expatriate’s children who have remained in the U.S.
If a post-expatriation transfer to a U.S. resident
child occurs and the assets come directly from the
expatriating executive, there may be some relief from
the transfer tax under an estate/gift tax treaty between
the U.S. and the covered expatriate’s country of residence. The U.S. transfer tax laws are subject to bilateral treaties.65 The U.S. has entered into transfer tax
treaties with sixteen countries.66
Before any treaty is consulted for possible relief
from the new inheritance tax, the practitioner should
be aware that the inheritance tax provisions of the new
alternative tax regime provide, as a matter of U.S.
domestic law, for a full credit for any foreign gift or
estate tax imposed on the transfer.67 But where foreign
jurisdictions do not tax the transfer or impose a lower
tax, a treaty may provide relief to the U.S. recipient
from the imposition of the new inheritance tax. The
analysis will be treaty specific.
Consider the example of a covered expatriate who
takes up residence in Germany. More than ten years
after expatriation, the expatriate makes a cash gift of
s300,000 (circa US$445,000) to her U.S. resident son.
The German inheritance/gift tax regime imposes a
transfer tax on gifts from a German resident to the
recipient,68 and, in this case, the son is considered a
Class I beneficiary.69 For gifts to persons within this
class, there is a seven to thirty percent tax rate70 and a
cumulative exemption over a period of ten years of
s400,000.71 Assume that there is sufficient remaining
exemption to exclude the entire s300,000 gift from
the German inheritance tax. May the U.S. impose its
current 35% inheritance tax on the son for the value of
the gift in U.S. dollars, which would result in a tax of
approximately US$156,000 (.35 x $445,000)?
The U.S.-Germany Estate and Gift Tax Treaty covers German inheritance and gift tax and U.S. federal
estate tax, gift tax and GST tax.72 The treaty further
applies to “any similar taxes on estates, inheritances,
and gifts which are imposed after the date of signature
of the Convention in addition to, or in place of, the
existing taxes.”73 Accordingly, the treaty would cover
the new U.S. inheritance tax. Because in the example
given the covered expatriate is domiciled in Germany
for treaty purposes and makes a gift of property (cash)
that does not fall into a special situs category (such as
U.S. real property), and the gift is made more than ten
years after expatriation, the treaty awards exclusive
taxing rights to Germany.74 Therefore, the U.S. would
be denied the right to tax the transfer. The U.S. residency of the recipient of the gift is irrelevant.
Although like some other transfer tax treaties, the
U.S.-Germany Treaty allows the U.S. to continue to tax
individuals who are former citizens or long-term residents, the period for taxation lasts for only ten years.75
The Treaty was negotiated and concluded while the old
alternative tax regime was in place, which called for
expanded transfer taxation for a period of only ten years
after expatriation.76 Under the new regime, there is no
ten-year restriction; the inheritance tax continues for the
life of the covered executive.77 But the Treaty remains as
it is, and it would bar U.S. taxation in this situation.
65
A treaty is regarded to have primacy over the Internal Revenue Code unless Congress intended that a specific revenue law
override existing treaties. The legislative history of the 2008
HEART Act, which gave us the new alternative tax regime, does
not address the effect on treaties. Therefore, it is reasonable to conclude that the HEART act does not override existing treaties.
66
Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Norway,
South Africa, Switzerland and the United Kingdom.
67
I.R.C. § 2801(d).
68
ERBSCHAFTSSTEUR-UND SCHENKUNGSSTEUERGESETZ [ERBSTG] [INHERITANCE AND GIFT TAX ACT] §§ 1, 2 (F.R.G.).
69
Id. at § 16.
70
Id. at § 19.
71
Id. at § 16. The revised s400,000 exemption came into
effect 1 January 2009.
72
Convention for the Avoidance of Double Taxation with
respect to Taxes on Estates, U.S.-F.R.G., Dec. 3, 1980, 2120
U.N.T.S. 283, art. 2, para. 1.
73
Id. at art. 2, para. 2.
74
Id. at art. 9.
75
Id. at art. 11, para. 1.a. iii.
76
I.R.C. §§ 877, 2501(a)(3), 2511(b), 2107(b).
77
I.R.C. § 2801.
78
I.R.C. § 877A(h)(2). Such an election may be made on a
property-by-property basis. I.R.S. Notice 2009-85, ___ C.B. ___,
Section 3.D.
A Checklist of Things to Do
The expatriating executive should do the following:
1. If reducing net worth below $2,000,000 will
keep the executive from being classified as a
covered expatriate, settle a nongrantor domestic Expatriation Trust in favor of the expatriating executive and family.
2. If the expatriating executive’s status as a covered expatriate is inevitable, settle a domestic
Expatriation Trust in favor of the expatriating
executive and family and fund preferably with
lower basis assets. Use this Expatriation Trust
as a vehicle for later gifting to children who
have remained in the U.S.
3. Keep track of the basis of assets. For purposes
of the mark-to-market tax, the expatriating
executive uses the value of assets as of the day
he or she became a lawful permanent resident,
unless the taxpayer elects otherwise.78 If some
assets will be placed into an Expatriation Trust
35
ACTEC Journal 275
(2009)
and others will be left open to the mark-to-market tax, subject the higher basis assets to the tax
and make use of the $627,000 exemption.
4. If the foreign executive has not yet met the
8-of-15 Test for years as a U.S. Green Card
holder and is living in a foreign country, either
give up the Green Card or toll the accrual of
years by taking a treaty-based return position
on the expatriating executive’s U.S. income
tax return.
5. Come into full compliance and remain in full
compliance with all U.S. internal revenue laws.
A Checklist of Things Not to Do
The expatriating executive should not do the following:
A. If a foreign executive meets the 8-of-15 Test
and takes up residence in a treaty country, do
not file a U.S. income tax return and take
advantage of treaty benefits. The taking of a
treaty-based return position will trigger expatriation under the new regime.
worth for purposes of determining whether the
executive is a covered expatriate. Furthermore,
upon expatriation of the settlor executive, the
trust will become a nongrantor foreign trust,
and the deemed gains tax of I.R.C. Section 684
will apply. If a non-U.S. Person serves as a
trustee or trust protector/advisor, or has the
power to remove the trustee or trust protector
or to appoint a replacement, the Expatriation
Trust will be a foreign trust.
C. Never roll qualified plan assets into an IRA
prior to expatriation. Qualified plans can be
easily placed in the favorable category as “eligible deferred compensation plans,” which are
subjected to a maximum 30% tax as distributions are made over time.79 An IRA is taxed as
if the expatriating executive took a full distribution on the day before the expatriation date.80
Conclusion
B. In employing an Expatriation Trust for purposes of avoiding classification as a covered expatriate under the net worth test, do not establish
the trust as a foreign trust. The transfer of
assets to a foreign Expatriation Trust, with the
expatriating executive as settlor and discretionary beneficiary, will be taxed by the IRS as
a grantor trust and, accordingly, will be included in the calculation of the executive’s net
When advising foreign executives who are on an
extended assignment in the U.S., the advisor should
regard the foreign executive as a potential expatriating executive and make him or her aware of the
applicable expatriation tax provisions which will
apply upon the renunciation of permanent resident
status. Armed with the knowledge of the potential
tax pitfalls, the foreign executive can take the necessary steps to prepare for expatriation, including the
formation and funding of an Expatriation Trust. In
addition, the advisor and the foreign executive should
keep in mind the checklists set out at the end of this
article in the conduct of tax planning, tax preparation
and asset allocation.
I.R.C. § 877A(d)(4). For the plan to be “eligible,” the covered expatriate needs to advise the administrator of his or her status
as such by submitting a Form W-8 CE. In this form, the taxpayer
waives any treaty relief that would lower the payor’s required withholding rate to below 30%.
80
I.R.C. § 877A(e).
79
35
ACTEC Journal 276
(2009)