The Covered Expatriate

Every person renouncing their US citizenship must file Form 8854. If a taxpayer meets certain income and asset thresholds detailed below, they are deemed a “covered expatriate.” The covered expatriate is treated as having sold all of their property in a hypothetical liquidation occurring the day before they expatriate.[1] It goes without saying this hypothetical liquidation can create substantial tax consequences and problems, particularly when tax is due and no cash is available for payment since no property was actually sold.

For expatriation occurring on or after June 17, 2008, IRC 877A applies. Subject to limited exceptions, a taxpayer is deemed a covered expatriate if any of the following apply:[2]

  1. Annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount ($147,000 for 2011, $151,000 for 2012, $155,000 for 2013, $157,000 for 2014, and $160,000 for 2015);
  1. Taxpayer had a net worth of $2 million or more on the expatriation date or termination of residency;
  1. Taxpayer failed to certify on Form 8854 that he or she complied with all U.S. federal tax obligations for the 5 year period preceding the date of expatriation or termination of residency; or
  1. Taxpayer expatriated before 2015 and:
  1. Deferred the payment of tax;
  2. Has an item of eligible deferred compensation; or
  3. Has an interest in a nongrantor trust

If any of these scenarios apply, taxpayer is a “covered expatriate.”

As one can see, the covered expatriate definition is expansive, and can snare “non-wealthy” taxpayers who hold interests in “tainted” assets including deferred compensation and nongrantor trusts.

Many individuals who are beneficiaries of a trust may not realize they hold an interest in a nongrantor trust. Notably, even if the nongrantor trust pays virtually no income or meaningful benefit, the beneficiary will still be subject to the constructive sale rules of I.R.C. 877(A). This light is either on or off – no dimmer here.

For those few persons with a menial interest in a nongrantor trust who choose to expatriate, a real tax headache might be on the horizon from the hypothetical liquidation imposed on virtually all covered expatriates.

 

by Michael Cooper, attorney with Barnes Law

 

Michael is associated with Barnes Law, and is licensed to practice law in California.

The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] I.R.C. 877A(a)(1)

[2] I.R.C. 877A(g)(1)(A)

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