U.S. Exit Tax & the IRS

U.S. Exit Tax & the IRS

What is U.S. Exit Tax?

U.S. Exit Tax: The Exit tax occurs from U.S. persons at the time of expatriation from the United States. If a person is a U.S. Citizen or Long-Term Resident covered expatriate, the exit tax calculations kick-in. At that time, the covered expatriate will evaluate their potential tax liability had they sold all of their assets on the day before expatriation. Most of the calculations are handled on a Mart-to-Market basis, with some exceptions. Depending on what the total gain is, if the gain exceeds the exemption amount (currently $725,000), the expatriate may have to pay a U.S. Exit Tax, or apply for a bond (which can be very expensive).

What does the IRS Require?

The most important aspect of determining a potential exit tax, if the person is a covered expatriate. Presuming the person who expatriates qualifies as a covered expatriate, they will have to conduct an exit tax analysis using Form 8854.

As provided by the IRS:

If you are a covered expatriate in the year you expatriate, you are subject to income tax on the net unrealized gain in your property as if the property had been sold for its fair market value (FMV) on the day before your expatriation date (“mark-to-market tax”). This applies to most types of property interests you held on the date of your expatriation. But see Exceptions, later

 Gains from deemed sales are taken into account without regard to other U.S. internal revenue laws. Losses from deemed sales are taken into account to the extent otherwise allowed under U.S. internal revenue laws.

However, section 1091 (relating to the disallowance of losses on wash sales of stock and securities) doesn’t apply.

For 2019, the net gain that you otherwise must include in your income is reduced (but not below zero) by $725,000.

What Does it Mean to Pay U.S. Exit Tax?

It means that is a person is a covered expatriate (which includes U.S. citizens and certain Legal Permanent Residents), then they have to file a Form 8854 at the time of expatriation. If the person meets either of the three covered expatriate tests, they may become subject to an exit tax, unless an exception or exclusion applies.

In order to determine if there is an exit tax:

  • The covered expatriate must determine their basis in each asset
  • Then they must determine the FMV on the day before expatriation
  • Each asset is then calculated as if it was sole on the day before expatriation (aka deemed sale)
  • Up to $725,000 of the deemed gain is excluded.

Taxation Under Section 877A

If you are a covered expatriate in the year you expatriate, you are subject to income tax on the net unrealized gain in your property as if the property had been sold for its fair market value (FMV) on the day before your expatriation date (“mark-to-market tax”). This applies to most types of property interests you held on the date of your expatriation. But see Exceptions, later.

Gains from deemed sales are taken into account without regard to other U.S. internal revenue laws. Losses from deemed sales are taken into account to the extent otherwise allowed under U.S. internal revenue laws. However, section 1091 (relating to the disallowance of losses on wash sales of stock and securities) doesn’t apply. For 2019, the net gain that you otherwise must include in your income is reduced (but not below zero) by $725,000.

Exceptions.

The mark-to-market tax does not apply to the following.

1. Eligible deferred compensation items.

2. Ineligible deferred compensation items.

3. Specified tax deferred accounts.

4. Interests in nongrantor trusts.

Instead, item (1) is subject to withholding at source provided that you properly make an irrevocable waiver on your initial filing of this form of any right to claim any reduction in withholding under an applicable treaty between the United States and a foreign country and timely notify the payor on Form W-8CE. To timely notify the payor on Form W-8CE you must file the Form W-8CE with the payor on the earlier of:

• The day prior to the first distribution on or after the expatriation date, or

• 30 days after the expatriation date.

Item (4) is also subject to withholding at source, and you are treated as having waived any right to claim any reduction in withholding under an applicable treaty between the United States and a foreign country, unless you elect to be treated as having received the value of your entire interest in the trust by obtaining a ruling from the IRS to that effect. See Section C—Property Owned on Date of Expatriation under Part II.

In the case of item (2), you are treated as receiving the present value of your accrued benefit as of the day before the expatriation date and you should include this amount on your Form 1040 or 1040-SR for the year that includes your expatriation date.

In the case of item (3), you are treated as receiving a distribution of your entire interest in the account on the day before your expatriation date and you should include this amount on your Form 1040 or 1040-SR for the year that includes your expatriation date. See paragraphs (d), (e), and (f) of section 877A.

Deferral of the Payment of U.S. Exit Tax

You can make an irrevocable election to defer the payment of the mark-to-market tax imposed on the deemed sale of property. If you make this election, the following rules apply.

1. You make the election on a property-by-property basis.

2. The deferred tax on a particular property is due on the return for the tax year in which you dispose of the property.

3. Interest is charged for the period the tax is deferred.

4. The due date for the payment of the deferred tax cannot be extended beyond the earlier of the following dates.

a. The due date of the return required for the year of death.

b. The time that the security provided for the property fails to be adequate. See item (6) below.

5. You make the election in Part II, Section D—Deferral of Tax.

6. You must provide adequate security (such as a bond).

7. You must make an irrevocable waiver of any right under any treaty of the United States that would preclude assessment or collection of any tax imposed by section 877A.

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