Specified Tax Deferred Account Expatriation Tax Exception: The Specified Tax Deferred Account Expatriation Tax Exception (IRS 877A) is complicated. In general, when a person expatriates from the U.S., and they are considered a covered expatriate, then they are subject to U.S. tax on the unrealized gain – using a Mark-to-Market calculation. As with anything dealing with the IRS, there are exceptions, and more exceptions. One of the main exceptions to this rule is when the expatriate has ownership of a Specified Tax Deferred Account Expatriation Tax Exception.
Specified Tax Deferred Account Expatriation Tax Exception (IRC 877A)
The The Specified Tax Deferred Account Expatriation Tax Exception is one of several exceptions under IRC 877A. It is an exception to the mark-to-market tax rules for expatriation.
Unfortunately, the exception is for the benefit of the U.S. government, not the expatriate.
What does the IRC 877A (e) provide?
According to IRC 877A (e):
(e) Treatment of Specified Tax Deferred Accounts
(1) Account treated as distributed: In the case of any interest in a specified tax deferred account held by a covered expatriate on the day before the expatriation date
(A) the covered expatriate shall be treated as receiving a distribution of his entire interest in such account on the day before the expatriation date,
(B) no early distribution tax shall apply by reason of such treatment, and
(C) appropriate adjustments shall be made to subsequent distributions from the account to reflect such treatment.
(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).
What is a Specified Tax Deferred Account?
Let’s first look at the referenced code sections:
7701(a)(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).
Section 408 is very long, here is the crux of it.
(a) Individual retirement account
For purposes of this section, the term “individual retirement account” means a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries, but only if the written governing instrument creating the trust meets the following requirements…
Exceptions to the Specified Tax Deferred Account
- 408 (k): Simplified Employee Pension
- 408 (p) Simple Retirement plan
- 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).
Tax Treatment of a Specified Tax Deferred Account
How is the Specified Tax Deferred Account treated for tax purposes?
Account Treated as Distributed
Tax Deferred accounts lose their tax deferred status up to the day before expatriation. In other words, the expatriate must determine the value of the account on the day before expatriation. Then, the expatriate takes that value and is considered to have received a distribution of the entire interest in the account on the day before the expatriate.
*In other words, there is no mark-to-market (MTM) analysis for tax deferred accounts. Rather, the expatriate must report it as income.
Early Distribution Penalty
When a person withdraws tax deferred money early, they are usually hit with a penalty for doing so. In accordance with these expatriate tax rules under IRC 877A, any early distribution penalty (as if the deemed distribution is not penalty enough) does not apply.
Appropriate Adjustments Shall be made to Subsequent Distributions
Just because the account has a “deemed distribution” does not mean there is actually any distribution. Therefore, if the account continues to grow, then at that time, the expatriate should have some tax credit available, to avoid double taxation.
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