Notice 2009-85: Deferred Compensation
Deferred Compensation Items & Notice 2009-85 at Expatriation: When a U.S. Person is a covered expatriate, they will have to perform the covered expatriate analysis, in accordance with the IRS Mark-to-Market analysis at the time of expatriation. But, mark-to-market (MTM) is not the only analysis the an expatriate is required to perform.
The IRS has another way they can hit you with tax, which is through the deemed distribution tax rules.
With deemed distribution, a person is “deemed” to have received a distribution on the day before they expatriate.
There are some very specific rules involving deferred compensation items, which we will explore below:
Deferred Compensation & Deemed Distributions
The general rule is that if there is deferred compensation, it is not subject to the mark-to-market analysis, but rather a deemed distribution.
Rather, if it is eligible deferred compensation (401K), it will be distributed when appropriate to covered expatriate, and 30% withheld (no treaty benefits are applicable).
If it is ineligible deferred compensation (foreign retirement), it is deemed distributed on the day before expatriation.
“A. In general (Deferred Compensation)
Section 877A(c)(1) provides that the tax under the mark-to-market regime provided in section 877A(a) does not apply to any deferred compensation item, as defined below. Instead, alternative tax regimes apply to “eligible deferred compensation items” and “ineligible deferred compensation items.”
In the case of an “eligible deferred compensation item,” section 877A(d)(1)(A) provides generally that the payor must deduct and withhold a tax equal to 30 percent of any taxable payment to a covered expatriate with respect to such an item.
In the case of “ineligible deferred compensation items,” section 877A(d)(2)(A) provides that a covered expatriate generally is subject to taxation on the ineligible deferred compensation item as if received by the covered expatriate on the day before the expatriation date.
Sections 5.B(2) and 5.B(3) of this notice provide definitions for “eligible deferred compensation items” and “ineligible deferred compensation items,” respectively. Sections 5.C and 5.D of this notice provide guidance on the taxation of “eligible deferred compensation items” and “ineligible deferred compensation items,” respectively.”
What is Deferred Compensation for Expatriation?
Deferred compensation essentially includes any compensation which is deferred, such as a 401(k) and 403(a) which is similar, but issued by nob-profits and government agencies. It also includes certain annuities and foreign pension plans
Definitions (Deferred Compensation)
The following definitions apply for purposes of section 877A and this notice.
(1) Deferred compensation item means:
- Any interest in a plan or arrangement described in section 219(g)(5), which means:
- a plan described in section 401(a) that includes a trust exempt from tax under section 501(a),
- an annuity plan described in section 403(a),
iii. a plan established for its employees by the United States, by a State or political subdivision thereof, or by an agency or instrumentality of any of the foregoing, but excluding an eligible deferred compensation plan (within the meaning of section 457(b)),
- an annuity contract described in section 403(b),
- a simplified employee pension (within the meaning of section 408(k)),
- a simplified retirement account (within the meaning of section 408(p)), or
vii. a trust described in section 501(c)(18);
- Any interest in a foreign pension plan or similar retirement arrangement or program;
- Any item of deferred compensation, as defined in section 5.B(4) of this notice; or
- Any property, or right to property, that the individual is entitled to receive in connection with the performance of services to the extent not previously taken into account under section 83 or in accordance with section 83. Until further guidance is issued, a deferred compensation item described in this section 5.B(1)d means property that has been transferred (as defined in § 1.83-3(a)) to the covered expatriate, or a right to property that the covered expatriate, as of the expatriation date, has a legally binding right to receive, in connection with the performance of services (whether or not such property or right to property is substantially vested), but only to the extent the covered expatriate has not taken such item into account under, or in accordance with, section 83. For this purpose, the following generally constitute property or a right to property: statutory and nonstatutory stock options (see sections 421 through 424 and § 1.83-7); stock and other property; stock-settled stock appreciation rights; and stock-settled restricted stock units. A covered expatriate will be considered to have taken property or a right to property into account under section 83 or in accordance with section 83 to the extent that:
(A) on or before the expatriation date, there has been a transfer of property to or on behalf of the covered expatriate in connection with the performance of services with respect to such property or right to property within the meaning of section 83(a) and the regulations thereunder;
(B) on or before the expatriation date, either (i) such transferred property has become substantially vested or (ii) the covered expatriate has made a valid election under section 83(b) with respect to such transferred property; and
(C) the covered expatriate has filed a Federal income tax return for the appropriate taxable year or years accurately reporting the full amount (if any) includible in such covered expatriate’s income with respect to such transferred property for such year or years and has paid all taxes due with respect to such return or returns, or, if such tax return is due after the expatriation date, the income with respect to such transferred property has been subject to appropriate tax withholding.
What makes Deferred Compensation Eligible?
When a deferred compensation is eligible, it means it is eligible to avoid immediate taxation – but of course, it comes with some requirements. The main issue is that treaty benefits are waived.
Therefore, if for example, Scott is a covered expatriate in a foreign treaty country that offers 5% reduced tax on pension plan payments from the treaty country (US) – he is not eligible for the reduced tax.
He will be taxed as an NRA (Non-Resident Alien) at the 30% FDAP Rate.
Notice should be within 30-days of the expatriating act.
(3) Ineligible deferred compensation item means any deferred compensation item that is not an eligible deferred compensation item. See section 8 of this notice for the applicable filing and reporting requirements.
Eligible Deferred Compensation
“(2) Eligible deferred compensation item means any deferred compensation item with respect to which:
(i) the payor is either a U.S. person or a non-U.S. person who elects to be treated as a U.S. person for purposes of section 877A(d)(1) and
(ii) the covered expatriate notifies the payor of his or her status as a covered expatriate and irrevocably waives any right to claim any withholding reduction under any treaty with the United States.
See section 8 of this notice for the applicable filing and reporting requirements.
Separate guidance will be issued under section 877A(d)(3)(A) providing rules for a non-U.S. person to elect to be treated as a U.S. person for purposes of section 877A(d)(1).”
What Happens to Ineligible Deferred Compensation?
The IRS includes it as part of the covered expatriates exit tax. Instead of a mark-to-market, it is deemed distributed on the day before expatriation.
Further Clarification about what is an Item of Deferred Compensation
(4) Item of deferred compensation means any amount of compensation if, under the terms of the plan, contract, or other arrangement providing for such compensation (compensation arrangement), the covered expatriate:
- Has a legally binding right as of the expatriation date to such compensation; and
- The compensation has not been actually or constructively received on or before the expatriation date (note: does not require substantial vesting)
Pursuant to the compensation arrangement the compensation is payable to (or on behalf of) the covered expatriate on or after the expatriation date, but such term does not include any deferred compensation item that is described in section 5.B(1)a, 5.B(1)b, or 5.B(1)d of this notice; and
- An item of deferred compensation generally includes an amount (other than a deferred compensation item described in sections 5.B(1)a, 5.B(1)b, or 5.B(1)d of this notice), whether or not substantially vested, that constitutes nonqualified deferred compensation for purposes of section 404(a)(5) (determined without regard to § 1.404(b)-1T, Q&A 2), including:
- a cash-settled stock appreciation right
- a phantom stock arrangement
- a cash-settled restricted stock unit
- an unfunded and unsecured promise to pay money or other compensation in the future (other than such a promise to transfer property in the future), and an interest in a trust described in section 402(b)(1) or (4) (commonly referred to as a secular trust).
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