Is there a Roth IRA Tax When Relinquish US Citizenship or Green Card

Roth IRA for Covered Expatriates

Roth IRA for Expatriates

Roth IRA for Expatriates: When it comes to expatriation, one of the biggest concerns for U.S. Citizens and Long-Term Lawful Permanent Residents (Long-Term Residents) is what happens to their tax deferred/tax exempt assets and investments in the United States. If the expatriate is considered a Covered Expatriate, then they have to do a deep-dive into their financial world to determine if they have any Mark-to-Market Gain or income tax consequences for their Tax Deferred Investments, Deferred Compensation and/or ownership of Trusts. One common investment that many taxpayers have is an IRA. And, some taxpayers have a Roth IRA — which grows tax free, but what happens when the expatriate no longer resides in the US —

In other words, what happens to the Roth IRA from a tax perspective at the time of expatriation?

Roth IRA – What is it?

A Roth IRA is a type of tax deferred account. In accordance with 26 USC 408A — a Roth IRA is treated as an individual retirement plan for purposes of this analysis.

IRC 877A & Roth IRA for Covered Expatriates

A Roth IRA is a type of tax deferred account. For purposes of expatriation, it is referred to as a “Specified Tax Deferred Account.”

26 USC 877A (c)(2)

• • • (2) Specified tax deferred account For purposes of paragraph (1), the term “specified tax deferred account” means an individual retirement plan (as defined in section 7701(a)(37)) other than any arrangement described in subsection (k) or (p) of section 408, a qualified tuition program (as defined in section 529), a qualified ABLE program (as defined in section 529A), a Coverdell education savings account (as defined in section 530), a health savings account (as defined in section 223), and an Archer MSA (as defined in section 220).

26 USC 7701(a)(37)

• • • (37) Individual retirement plan The term “individual retirement plan” means— (A) an individual retirement account described in section 408(a), and (B)an individual retirement annuity described in section 408(b).

408(a)/408(A)

• (a) General rule

  • • • Except as provided in this section, a Roth IRA shall be treated for purposes of this title in the same manner as an individual retirement plan.

• (b) Roth IRA

  • • • For purposes of this title, the term “Roth IRA” means an individual retirement plan (as defined in section 7701(a)(37)) which is designated (in such manner as the Secretary may prescribe) at the time of establishment of the plan as a Roth IRA. Such designation shall be made in such manner as the Secretary may prescribe.

How is the Roth IRA Taxed at Expatriation?

Roth IRA Contributions vs Growth

An important difference is contributions and growth:

Contributions

Your Contributions are post-tax.

You can withdraw them at any time and the IRS does not re-tax you just because you are exiting the US.

Growth/Earnings

A much more complicated analysis:

Notice 2009-85 Roth IRA

Notice 2009-85 provides a good summary on how expatriates are taxed at exit from the U.S. Let’s focus on the Roth IRA — which is a Specified Tax Deferred Account.

How is a Specified Tax Deferred Account Taxed?

• • 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.

No Early Distribution Penalty

• • Section 877A(e)(1)(B) provides that no early distribution tax will apply by reason of the tax imposed by section 877A(e)(1)(A). Section 877A(g)(6) provides that the term “early distribution tax” means any increase in tax imposed under sections 72(t), 220(e)(4), 223(f)(4), 409A(a)(1)(B), 529(c)(6), or 530(d)(4).

26 USC 408A

(d) Distribution Rules

For purposes of this title—

(1) Exclusion

• • • Any qualified distribution from a Roth IRA shall not be includible in gross income.

(2) Qualified distribution For purposes of this subsection—

• • • (A) In general The term “qualified distribution” means any payment or distribution—

      • (i) made on or after the date on which the individual attains age 59½,

      • (ii) made to a beneficiary (or to the estate of the individual) on or after the death of the individual,

      • (iii) attributable to the individual’s being disabled (within the meaning of section 72(m)(7)), or

      • (iv) which is a qualified special purpose distribution.

(B) Distributions within non-exclusion period

A payment or distribution from a Roth IRA shall not be treated as a qualified distribution under subparagraph

• • • (A) if such payment or distribution is made within the 5-taxable year period beginning with the first taxable year for which the individual made a contribution to a Roth IRA (or such individual’s spouse made a contribution to a Roth IRA) established for such individual.

What does this Mean?

Generally, if you are 59 1/2 then your Roth IRA distribution is not taxable unless you withdraw it before 5-years after the first year contribution.

Exit Tax on the Roth IRA for Covered Expatriates

Here is the overall impact on expatriation:

Roth IRA Under 59 ½ Years Old

• • • If the expatriate is under 59 1/2 then the earnings are taxable (the exceptions listed above are usually inapplicable to expatriation).

    • If 59 1/2 or over, the Covered Expatriates meet the first prong and is part way in the clear.

*Even if you’re under 59 1/2  you do not get penalized under section 72(t) and 26 USC 4974(c).

5-Year Rule

• • • In addition to reaching 59 1/2, the covered expatriate must wait until five years after the initial contribution into the Roth IRA before withdrawing it (even for make believe expatriation purposes). In other words, it is deemed distributed at expatriation.

    • So, if it is deemed distributed for US tax purposes before the expatriate meets the 5-year rule, it is not considered qualified and it results in tax implications for the covered expatriate  — 

The Roth IRA for Covered Expatriates Analysis Complicated

In conclusion, expatriation can be complicated and the exit tax even more so — but oftentimes covered expatriates with IRAs may be able to limit or minimize the tax liability depending on the value and the portion that is contributions vs growth.

The age and the length of the Roth IRA investment will impact the tax rules — but no early withdrawal penalty would apply.

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