Deemed Distribution & Exit Tax at Expatriation: The deemed distribution & exit tax at expatriation analysis is complicated. The reason is primarily because when people consider IRS tax and expatriation, they focus on mark-to-market. But, in addition to mark-to-market, there is another aspect of exit tax which is referred to as a deemed distribution. With deemed distribution, a person is “deemed” to have received a full distribution of the money on the day before expatriation.
While this does not mean that the distribution is actually distributed out of the account, it does mean the income is deemed received by the covered expatriate.
Expatriation Deemed Distribution Example
Let’s take a look at a basic example with a common issue involving how a deemed distribution works with an ineligible foreign retirement plan.
David is a Green Card Holder and has been for 30 years.
Therefore, he is considered a Long-Term Resident and will file a Form 8854.
He has been working for a foreign employer who has been funding his foreign retirement since becoming a U.S. person. (aka there is no issue with pre-U.S. person basis). He was unaware that he was required to pay income tax on the portion being set aside for retirement.
David had a net-worth of $5 Million.
Therefore, David is considered a Covered Expatriate.
Computing the Exit Tax
David was smart, and handled his exit tax planning timely.
Therefore, David planned for his expatriation and therefore, he is all cash. As such, he does not have any mark-to-market issues. That does NOT mean he will escape U.S. exit tax, because David has a foreign ineligible deferred compensation plan.
Unlike a 401K which can escape deemed distribution, a foreign retirement account is deemed distributed on the day before the expatriation.
David’s foreign retirement is worth $900,000, and he has not tax basis in it (since it is all pre-taxed dollars).
Therefore, David is deemed to have received the full amount of the retirement on the day before expatriation. Since it is a foreign retirement plan with a foreign plan administrator, it would not qualify as an eligible plan.
*Eligible deferred compensation plans, such as a 401K can escape deemed distribution rules, presuming the proper procedures (Such as filing the W-8CE timely) – but all [potential] future treaty benefits at the time when income is distributed are waived.
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