Allocation of the Exclusion Amount 877A Calculating Exit Tax: When it comes time for expatriation from the United States, some U.S. persons who are considered a covered expatriate may have to compute the exit tax. And, when it comes time to compute the exit tax, one important aspect is the exclusion of a certain portion of the mark-to-market unrealized gain.
When a person computes the exit tax, it involves unrealized gain on the “pretend” sale of certain assets on the day before expatriation. With the allocation, some of the pretend gain may be pretend exempted. But, the IRS does not allow the covered expatriate to pick the type of assets to apply the exclusion to — it must be applied evenly over the different mark-to-market assets.
For example, the expatriate cannot decide to apply the full exclusion to Ordinary Dividends or Short-Term Capital Gains instead of Qualified Dividends and Long-Term Capital Gain.
And, the exclusion does not apply to deemed distributions of deferred tax and/or deferred compensation)
Allocation of the Exclusion Amount 877A & Calculating Exit Tax
The Allocation of the Exclusion Amount 877A Calculating Exit Tax rules are complex.
As provided by Notice 2009-45:
- “The exclusion amount, as described in section 877A(a)(3), must be allocated among all built-in gain property that is subject to the mark-to-market regime and is owned by the covered expatriate on the day before the expatriation date, regardless of whether the covered expatriate makes an election to defer tax with respect to any such property pursuant to section 877A(b).
- Specifically, the exclusion amount must first be allocated pro-rata to each item of built-in gain property (“gain asset”) by multiplying the exclusion amount by the ratio of the built-in gain with respect to each gain asset over the total built-in gain of all gain assets.
- The exclusion amount allocated to each gain asset may not exceed the amount of that asset’s built-in gain. If the total section 877A(a) gain of all the gain assets is less than the exclusion amount, then the exclusion amount that can be allocated to the gain assets will be limited to the total section 877A(a) gain.”
Impact on the IRC 877A Allocation of the Exclusion Amount
Sometimes it helps to break the complex world of exit tax into bite-sized pieces
- Section 877A involves the expatriation tax.
- Section 877A(a)(3) involves the exclusion.
- The Notice 2009-45 explains how to apply the exclusion.
Pursuant to Notice 2009-45, the exclusion is applied pro-rata to each item of built-in gain by computing a ration analysis.
Then, the covered expatriate must apply the gain evenly to each asset. If the total gain is below the exclusion amount (it increases each year or so based on inflation), there would be no gain.
*There may still be an exit tax based on the exceptions to the mark-to-market, which are deemed distributed, including:
- Deferred Compensation Expatriation Tax Treatment
- Specified Tax Deferred Account Expatriation Tax Exception
Lifetime Exclusion is Only One per Person
Each person is only entitled to one lifetime exemption.
Therefore, if you happened to be a covered expatriate, submitted expatriation documents, and then years later are in the same boat – you don’t get to restart the exclusion amount. But, you do get the chance to utilize the remainder of the unallocated exclusion.
If you used it all up already, you will not be entitled to any exclusion amount.
As provided by Notice 2009-45:
- Each individual is eligible for only one lifetime exclusion amount. Thus, if a covered expatriate becomes a U.S. citizen or long-term resident, and then loses such citizenship or ceases to be a lawful permanent resident and thereby becomes a covered expatriate subject again to section 877A, the exclusion amount with respect to the individual on a second expatriation is limited to the unused portion of his or her exclusion amount remaining (if any) after the first expatriation, as adjusted for inflation.
- For example, if a covered expatriate used one third of the exclusion amount for the first expatriation, he or she will have two thirds of the exclusion amount available, as adjusted for inflation, in the event of a second expatriation.
- After allocating the appropriate amount of the exclusion amount among the gain assets, the covered expatriate must report gains and losses on the appropriate Schedules and Forms depending upon the character of each asset.
- Losses may be taken into account only to the extent permitted by the Code, except that the wash sale rules of section 1091 do not apply. Thus, for example, losses are subject to the limitations of section 1211(b).
A very common situation in the past few years has been when a U.S. Citizen or Long-Term Resident wants to expatriate, but is out of international offshore reporting compliance. In this scenario, the client is unable to certify that they have been 5-years compliance.
Therefore, we develop a strategy to both get the client into offshore compliance and complete the expatriation process.
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