Notice 2009-85 (Section 1)
IRS Notice 2009-85: When certain persons expatriate from the U.S., they may become subject to IRS exit tax. This will depend on whether they are covered expatriates, and if they have sufficient unrealized capital gain that exceeds the exclusion amount. In addition, if the expatriate has ineligible deferred compensation, tax deferred investments, or ownership of certain non-grantor foreign trusts — they may still owe an exit tax.
Previously the Internal Revenue Service issued Notice 2009-85 to assist Taxpayers.
We will provide our summaries and insights to help shed some light on the process of expatriation, who may be a covered expatriate, and what exceptions, exclusions and limitations may apply.
We will post multiple several posts to help individuals isolate each issue contained in each section of the notice.
This summary will focus on Notice 2009-85 (Section 1: Overview).
IRS Notice vs. Revenue Procedure
While an IRS Notice does not the same authority as a Revenue Procedure, it does hold some weight.
As provided by the IRS:
“A notice is a public pronouncement that may contain guidance that involves substantive interpretations of the Internal Revenue Code or other provisions of the law. For example, notices can be used to relate what regulations will say in situations where the regulations may not be published in the immediate future.”
So essentially, you can kinda sorta rely on it, but it is not per se binding on the IRS.
Notice 2009-85 (Section 1) Overview
Notice 2009-85 (Section 1) overview is the introduction to the purpose behind Notice 2009-85.
“Section 877A(a) generally imposes a mark-to-market regime on expatriates who are covered by section 877A, providing that all property of a covered expatriate is treated as sold on the day before the expatriation date for its fair market value.
Section 877A further provides that any gain arising from the deemed sale is taken into account for the taxable year of the deemed sale notwithstanding any other provisions of the Code. Any loss from the deemed sale is taken into account for the taxable year of the deemed sale to the extent otherwise provided in the Code, except that the wash sale rules of section 1091 do not apply.
Under section 877A(a)(3), the amount that would otherwise be includible in gross income by reason of the deemed sale rule is reduced (but not to below zero) by $600,000, which amount is to be adjusted for inflation for calendar years after 2008 (the “exclusion amount”). For calendar year 2009, the exclusion amount as adjusted for inflation is $626,000. The amount of any gain or loss subsequently realized will be adjusted for gain and loss taken into account under the mark-to-market regime without regard to the amount excluded. Pursuant to section 877A(b), a taxpayer may elect to defer payment of tax attributable to property deemed sold.”
Section 877(a): Treatment of Expatriates
The key takeaway from this section, is simply that a Covered Expatriate under 877A is subject to the mark-to-market sale exercise on unrealized capital gain for certain assets held the day before expatriation.
It is referred to as a “deemed sale.” In addition, there is an exclusion (currently $725,000) in which reduces the gain.
The exclusion cannot work to reduce the gain to below zero.
Therefore, if you are a covered expatriate, and you have certain assets, they will be deemed sold the day before expatriation. You can then exclude a portion of the gain, and after the exclusion is applied, you may or may not have gain sufficient to require an exit tax.
“Section 877A(c) provides that the mark-to-market regime does not apply to deferred compensation items, specified tax deferred accounts, and interests in a nongrantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date.
If the covered expatriate is treated as the owner of any portion of a trust under the grantor trust rules (sections 671 through 679) on the day before the expatriation date, the assets held by that portion of the trust are subject to the mark-to-market regime (but see section 4 of this notice concerning coordination with section 684).”
Section 877A(c): Treatment of Expatriates
Not all property is subject to the mark-to-market exercise.
Rather, some items are instead treated as if they were deemed distributed the day before expatriation. This may cause a significant impact to the covered expatriate, especially in situations involving foreign pension plans, which are usually categorized as ineligible deferred compensation.
The mark-to-market analysis does not apply to:
(1) any deferred compensation item (as defined in subsection (d)(4)),
(2) any specified tax deferred account (as defined in subsection (e)(2)), and
(3) any interest in a nongrantor trust (as defined in subsection (f)(3)).
“Section 877A(d) provides alternative tax regimes that apply to “eligible deferred compensation items” and to other deferred compensation items (“ineligible deferred compensation items”).
In the case of “eligible deferred compensation items,” section 877A(d)(1)(A) provides generally that the payor must deduct and withhold from any taxable payments to a covered expatriate with respect to such items a tax equal to 30 percent of the amount of those taxable payments.
In the case of “ineligible deferred compensation items,” section 877A(d)(2)(A) provides that a covered expatriate generally is treated as having received an amount equal to the present value of the covered expatriate’s accrued benefit on the day before the expatriation date.”
“Section 877A(e)(1)(A) provides that if a covered expatriate holds any interest in a specified tax deferred account on the day before the expatriation date, such covered expatriate is treated as having received a distribution of the covered expatriate’s entire interest in such account on the day before the expatriation date.”
Section 877A(d)(1)(A) and (e)(1)(A):
Section 877A(d) and (e) further breaks down the treatment of property owned by the covered expatriate, which is not subject to the mark-to-market analysis.
When it comes eligible deferred compensation (401K for example), there is no deemed distribution the day before expatriation, BUT there is a 30% withholding at the time of distribution (presuming the administrator was timely notified of the expatriation) and the covered expatriate has waived treaty rights.
Other ineligible deferred compensation and tax deferred accounts, the covered expatriate is: “treated as having received a distribution of the covered expatriate’s entire interest in such account on the day before the expatriation date.“
“Section 877A(f) provides that in the case of any direct or indirect distribution of property to a covered expatriate from a nongrantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date, the trustee must deduct and withhold from the distribution an amount equal to 30 percent of the taxable portion of the distribution.
If the fair market value of the property distributed exceeds its adjusted basis in the hands of the trust, gain shall be recognized to the trust as if the property had been sold by the trust and the proceeds distributed to the covered expatriate.”
Section 877A(f): Special Rules for Non-Grantor Trusts
We have a separate article dealing specifically with the complexities of non-grantor trusts.
But essentially, if the covered expatriate receives a distribution from trust, of which they were a beneficiary prior to expatriation, then the administrator is supposed to withhold 30%.
There are further complexities involving deemed ownership percentage prior to expatriation, distributions of property, and making a form 8854 election to preserve potential treaty rights at a future date.
Additional Regulations May be Coming
The IRS can always issue additional and clarifying regulations, but have not yet finalized them.
“Section 877A(i) provides that the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of section 877A. The Treasury Department and the Internal Revenue Service (IRS) expect to issue regulations to incorporate the guidance set forth in this notice. Until such regulations are issued, taxpayers may rely on the guidance set forth in this notice.”
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