By Laurie Marson, CPA, CISA
Hidden at the end of the Defenders of Freedom Tax Relief Act of 2007 (Senate bill 1593), which was forwarded to the Senate finance committee in mid-June for further review, is a proposal to implement what is effectively an exit tax on expatriating individuals. Congress has previously considered such a tax without successfully implementing it. However, their persistency could result in some modification to existing law before too much longer. Currently U.S. citizens and long-term permanent residents (Green-Card Holders) who give up their U.S. citizenship or permanent residency rights are considered to have "expatriated" and are subject to an expatriation tax regime that extends their tax filing obligations for 10 years past the termination of their U.S. citizenship or permanent residency. With proper planning, the tax cost of expatriating under the current rules can be minimized, although there is a 10-year administrative requirement (preparation and filing of potentially complex U.S. tax returns for 10 years). U.S. nonresident returns may be due in subsequent years, depending upon whether the individual receives income that is properly subject to U.S. taxes in those years. Such taxes would be applicable to other nonresidents as well.
Currently, Section 12 of the Defenders of Freedom Tax Relief Act of 2007 contains a provision that individuals â€˜expatriating' will be required to value all their asset holdings at fair market value on the day before they relinquish their citizenship/permanent residency and pay tax as if those assets were sold on that date. The provision also contains a proposed reduction amount of $600,000 (to be indexed for inflation) to offset such gains before the calculation of tax due, which supposedly targets this tax to those individuals that have accumulated significant wealth through a U.S. connection. Tax under this provision would be due no later than 90 days after expatriation. As an alternative to paying tax on the gains calculated above within the 90 day window, individuals can irrevocably elect to be taxed as a U.S. citizen on all the calculated gains at expatriation, but pay such tax when it would be due a U.S. citizen (i.e. when the investment is actually disposed). This election also requires that the taxpayer waive any right under any treaty that would preclude assessment or collection of tax imposed related to such taxes and provide security as deemed appropriate by the IRS. Additional provisions within the section address retirement plans, deferred compensation plans, interests in certain trusts, gifts and inheritances by setting forth the amounts that will be subject to the tax. Should the bill pass in its current form, this provision will be effective when the bill is enacted.
UPDATE: More Action on the Implementation of an "Exit Tax"
On July 19, 2007, the House Ways and Means Committee approved HR3056 â€˜Amendment in the Nature of a Substiture to Tax Collection Responsibility Act of 2007. Section 5 of this Act is entitled "Revision of tax rule on expatriation". In comparing the language in this section with the language in Section 12 of the Defenders of Freedom Tax Relief Act of 2007, we find very similar language as well as some other thoughts on what should be subject to an â€˜exit tax' and how to implement such tax. While noting that the provisions in the House and Senate versions of the proposed â€˜Exit Tax' vary somewhat, it does seem that there is support in both of our legislative bodies to obtain additional revenues from those individuals who are or have been treated as citizens of this country. As an additional point related to the House bill, it also includes language specifically targeting gifts and bequests from expatriates. Under these provisions the recipient of the gift would be subject to tax on gifts or bequests received in excess of $10,000 (and this amount would not be indexed for inflation). Any such tax on a gift or bequest could be reduced by any foreign gift or estate taxes paid on such item(s). As with the Senate version, the provision would be effective immediately upon enactment.
If you are considering "expatriating" or know someone that is considering such action, or may have inadvertently expatriated, contact your accountant for professional tax assistance.
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