Filing and Reporting
Under broad regulatory authority contained in section 6039G, the 2009 Notice expands the reporting that is due from covered expatriates in years following the year of expatriation. Under prior law (in particular, the 2004 AJCA changes), a covered expatriate was required to file annual information returns on Form 8854 for the 10-year post-expatriation period that he remained subject to tax under the alternative tax regime, whether or not he had any income tax liability. In any year that a covered expatriate had U.S. source income on which tax due was not fully withheld at source, a covered expatriate was also required to file a Form 1040NR.
The Notice states that a covered expatriate having eligible deferred compensation items or interests in nongrantor trusts must annually file Form 8854 to certify either that no distributions have been received or to report distributions that have been received. Unlike under prior law, there apparently is no time limit on this obligation. The Notice also confirms that, in accordance with Treas. Reg. section 1.6012-1(b), a covered expatriate having taxable income (i.e., eligible deferred compensation or distributions from nongrantor trusts) for which taxes are not fully withheld at source must file a tax return on Form 1040NR. As foreign fiduciaries are unlikely to withhold and remit a 30% tax on distributions from nongrantor trusts, this creates an affirmative filing obligation for covered expatriates subject to all usual return filing rules. Any covered expatriate who has elected to defer payment of the mark-to-market tax must also file an annual Form 8854 through the year that the deferred tax and all interest is paid.
The 2009 Notice also confirms that a covered expatriate who has a deferred compensation item, a specified tax deferred account, or a beneficial interest in a nongrantor trust generally must file Form W-8CE with the relevant payor on or before the earlier of the day prior to the first distribution on or after the individual's expatriation date or 30 days after the expatriation date. With respect to a distribution of an eligible deferred compensation item or an interest in a nongrantor trust, the form generally provides notice to the payor that the individual has waived any otherwise applicable treaty benefits. However, in the case of a nongrantor trust, if the covered expatriate has indicated on the form that he will request a letter ruling from the IRS as to the value of his beneficial interest on the day before his expatriation date, the trustee is "required" to furnish the individual information necessary to calculate such value.62 In the case of an ineligible deferred compensation item, Form W-8CE is notice to the payor that the individual is a covered expatriate who is treated as receiving an amount equal to the present value of his accrued benefit on the day before his expatriation date. This is also notice to the payor that adjustments may have to be made to future distributions to account for the tax required to be paid by the covered expatriate as a result of his expatriation. Finally, in the case of a specified tax deferred account, Form W-8CE is notice to a payor that the individual is a covered expatriate for whom adjustments may be required on future distributions from the account. Within 60 days of receiving the form, the payor is required to provide a statement to the covered expatriate of the account balance on the day before the expatriation date.
Additional Expatriation Issues Requiring Guidance
As indicated above, the 2009 Notice does not discuss the issues that may arise under section 2801, the succession tax provision introduced by the HEART Act, other than to say that guidance will be forthcoming and that satisfaction of the reporting and tax obligations for individuals receiving covered gifts or bequests is deferred until such guidance is provided.63
The 2009 Notice also does not address several other important issues, including: (i) whether, and on what terms, the deferred tax election can apply to property disposed of in nonrecognition transactions; and (ii) how the new rules are to be coordinated with U.S. tax treaties. In the case of the new tax mark-to-market tax, which is imposed on gains deemed to arise on the day before expatriation, the statute's inherent bias is that the income generally will be residence (i.e., U.S.) based and should not result in any double taxation. However, as a practical matter, gains arising from the subsequent actual disposition of a covered expatriate's assets, as well as deferred compensation and nongrantor trust distributions received subsequent to expatriation, are likely not to be U.S. source income and generally will also be taxed by the expatriate's country of residence at realization or receipt.64 Thus, there are likely to be bona fide treaty issues where a covered expatriate resides in a U.S. treaty partner following expatriation. Clearly, there will also have to be guidance on foreign tax credit issues that are bound to arise.65
In particular, there likely will be issues with the 30 percent withholding tax imposed on payments of eligible deferred compensation and distributions from nongrantor trusts that is considered imposed under section 871. Section 906(b)(4), pertaining to the allowance of foreign tax credits to nonresident aliens (which a covered expatriate becomes), expressly provides that a foreign tax credit is not allowed against any tax imposed by section 871(a). This generally is reasonable, because section 871 generally imposes tax on certain U.S. source income of nonresident aliens. However, as indicated above, amounts subject to tax under sections 877A(d)(1) and (f)(1) frequently will not be from U.S. sources and so should be entitled to foreign tax credits.
Two further points should be made about the need for additional guidance under the new expatriation tax rules. First, although the fundamental precept of the mark-to-market tax is that a covered expatriate is taxed on his wealth at the date of expatriation, there appears to be no income cap on taxable amounts received from nongrantor trusts. The new election to be treated as receiving the value of an individual's interest in such a trust, if ascertainable, is certainly an attempt to resolve or ameliorate this issue, but in many cases it may not be possible to fairly ascertain the value of a beneficiary's contingent, discretionary interest in such a trust with sufficient precision for either the expatriate or the IRS to be comfortable. Nor is there a wealth cap on taxable amounts received from a covered expatriate that are subject to the succession tax. If it is even administrable, this tax might be imposed on individuals and wealth that are generations removed from the covered expatriate's expatriation date.
Finally, as with the 2004 AJCA that preceded it, the HEART Act does not address the socalled "Reed amendment" provision of immigration reform enacted in 1996.66 That provision bars re-entry to the U.S. of former citizens who expatriated for a principal tax avoidance purpose in the opinion of the Attorney General.67 Because of certain statutory defects, it has never been implemented or enforced.68 The 2003 JCT Report recommended changing the provision to bar U.S. re-entry only to former citizens who have not fully complied with their expatriation tax obligations, but this unfortunately was not included with the AJCA's expatriation changes, notwithstanding that its provisions generally followed the 2003 JCT Report recommendations and tax avoidance purpose is no longer relevant to tax expatriation. Several prior mark-to-market proposals, including some under consideration in 2007, also included provisions based on the 2003 JCT Report, but these provisions unfortunately were not part of the HEART Act. As the Reed amendment continues to have a chilling effect on U.S. citizens considering expatriation (notwithstanding that, in its present formulation, it likely is unenforceable), it is to be hoped that Congress will address this problem.
Conclusion
Controlling the tax consequences of expatriation has attracted considerable attention, and given rise to much spirited debate in Congress and elsewhere, since the Clinton administration first proposed an exit tax in its fiscal 1996 budget.69 The proposed solution contained in 1996's HIPAA, although no doubt affecting the actions of many wealthy individuals considering the potential tax benefits arising from expatriation, was not, in the opinion of the 2003 JCT Report, ultimately successful in deterring tax-motivated expatriation. Nor, certainly, was it successful in raising the revenues envisioned by the 1996 scoring for the HIPAA provisions. The 2003 JCT Report concludes that this was attributable, in no small part, to the failure of the IRS to fully and properly administer and enforce the 1996 changes, although the report also acknowledges that the alternative tax regime has some inherent weaknesses.
The changes contained in 2004's AJCA were intended to facilitate easier administration and improved enforcement of the amended expatriation tax rules by removing the difficult, frequently uncertain and expensive (for both taxpayers and the Government) ruling program and requiring enhanced information reporting by expatriating taxpayers. In addition, the new short residence rule contained in section 877(g) was introduced to deter expatriation by many U.S. taxpayers. Whether this was sound fiscal or social policy is questionable, especially in the case of former long-term residents, who may have left the U.S. in retirement to return to the countries from which they originally arrived. Many such persons have children and grandchildren who have remained in the U.S., as well as continued U.S. vacation residences and other investments. Limiting their presence so drastically with the threat of renewed worldwide taxation seems short-sighted. However, in the final analysis, the alternative tax regime after the AJCA likely wasn't in place long enough to determine whether it achieved its intended goals.
Exactly what the goals of an expatriation tax should be is perhaps the core of the problem. Congress has several times indicated that tax neutrality is the correct policy – the law should neither serve as an inducement to leave U.S. tax solution nor as a bar to doing so. Unfortunately, the actions of Congress have not always followed this course.
The mark-to-market and succession tax regimes contained in the HEART Act are likely less a further philosophical or emotional onslaught against individuals who choose, for whatever reason, to leave full U.S. tax solution than a short-sighted and misguided effort to close the everpresent "tax gap." The several new taxing provisions, especially those pertaining to eligible deferred compensation, interests in nongrantor trusts, and the succession tax are not even wholly consistent with the implicit objective to tax an individual's wealth as he leaves the U.S. tax system. Further, additional IRS resources likely will be required to efficiently administer and try to enforce the tax. However, even in an increasingly transparent financial world with greater cross-border cooperation amongst national tax administrations, it will be difficult to impose and collect tax on foreign income and assets from individuals who are no longer generally within the U.S. jurisdiction.
Whether this is the final expatriation tax solution remains to be seen. The expatriation provisions found in the HEART Act are not sound tax policy, but they are scored to raise not insignificant revenue.70
Footnotes
62 The instructions to Form W-8CE indicate that the necessary information includes (but is not limited to): (i) a copy of the trust deed; (ii) a list of the assets (and their values) held on the day before the expatriation date; (iii) information regarding other potential trust beneficiaries; (iv) birth dates for all measuring lives for the trust's perpetuity period; (v) policies followed by the trustees when making discretionary distributions that might constitute an "ascertainable standard;" and (vi) any other relevant information.
63 The IRS is developing a new form, Form 708 ("U.S. Return of Tax for Gifts and Bequests Received From Expatriates"), for the purpose of making a return under the provisions of section 2801. The form is referred to in the latest version of Form 3520, Part IV, issued in early 2010. The instructions to Form 3520, item 57, state that a taxpayer's tax payment obligations with respect to any § 2801 tax liability will not be due until the date indicated on Form 708, once issued. See Announcement 2009-57, 2009-29 I.R.B. 158 for additional information.
64 That an expatriate may have made what amounts to a coerced waiver of treaty benefits in order to try to comply with U.S. reporting obligations so that, inter alia, his expatriation might be considered complete under §§ 877(a)(2)(C) and 877A(g)(1)(A), should not be found to preclude him from claiming treaty benefits under otherwise applicable residence-based tax treaties.
65 Note that, in the case of the § 2801 succession tax, the statute expressly provides that credit will be given for foreign gift and estate/inheritance taxes.
66 The Reed amendment was contained in the Illegal Immigration Reform and Immigrant Responsibility Act of 1996 (Pub. L. No. 104-208), enacted September 30, 1996.
67 Responsibility for administering and enforcing the provisions of the Reed amendment was formerly within the province of INS, an agency within the Department of Justice ("DOJ"). Because the role of the INS has now been transferred to USCIS, an agency of DHS , overall responsibility presumably has shifted from the Attorney General to the Director of DHS.
68 There are several apparent statutory flaws with the Reed amendment. First, it is unclear from the language of the statute whether it encompasses all acts of expatriation or only those expatriations accomplished by formal oath of renunciation. Second, it is unclear what the applicable tax avoidance standard is or should be; this is especially troublesome since tax avoidance has ceased to be relevant to enforcement of the expatriation tax provisions. Since the objective of the provision is to bar certain former citizens from re-entering the U.S. and, therefore, effectively to penalize them, it is questionable whether due process would permit the necessary tax avoidance to be presumed based upon certain economic factors, as was the case under HIPAA's § 877 changes. More likely, USCIS, which now administers the provision, would be required to make a factual determination on a case-by-case basis. However, its ability to do this would be severely limited, since, under § 6103, the IRS is precluded from disclosing specific taxpayer information even to other federal agencies, except in limited circumstances that would not extend to enforcement of the Reed amendment. Notwithstanding these problems, it is known that USCIS (and, before it, INS) was working to develop regulations to implement the Reed amendment, and the project was on the DHS's regulatory agenda as recently as 2006. See 71 Fed. Reg. 22643 (Apr. 24, 2006). The current status of the regulation project is unknown, but the inability of the IRS to provide tax information pertaining to specific taxpayers may require tax legislation to amend § 6103, if the project is to move forward. Several of the former mark-to-market proposals would have done that.
69 Indeed, the actions of the U.S. even spurred the enactment of limited expatriation tax provisions in a number of other countries, including France, Germany and the Netherlands.
70 See note 12, supra.
This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.
