New Expatriation Tax Rules Enacted

Just before Memorial Day, the House and Senate passed by unanimous consent the Heroes Earnings Assistance and Relief Tax Act , P.L. 110-245, which provides benefits to military personnel and is partially funded by a provision that adopts new rules for taxing individuals who expatriate. The act also alters the tax treatment of foreign subsidiaries of U.S. companies for employment tax purposes and increases penalties for failure to file returns. The president signed the act into law on June 17, 2008.

The legislation imposes a mark-to-market regime for taxing gains of U.S. citizens and long-term U.S. permanent residents who expatriate (Sec. 877A(a)). All property of a covered expatriate will be treated as sold on the day before the expatriation at fair market value. Gains in excess of $600,000, adjusted for inflation after 2008, are includible in income and are taxed.

A gift tax is imposed on U.S. citizens or residents who receive on or after the date of enactment qualifying gifts or bequests from an expatriated individual (or an individual who immediately before death was a covered expatriate) (Sec. 2801). There is also a 30% withholding tax on qualifying deferred compensation paid to a covered expatriate (Sec. 877A(d)). The expatriation provision would raise an estimated $411 million over 10 years.

The act applies to individuals who expatriate on or after the date of enactment. As the AICPA suggested to congressional staff, the legislation includes a withholding approach, the new gift tax is effective prospectively for gifts and bequests received on or after the date of enactment from expatriates whose expatriation date is on or after the date of enactment, and a charitable and marital deduction is included in the legislation (Sec. 2801(e)(3)). The AICPA comments are available at http://tinyurl.com/66t7ry and http://tinyurl.com/5wy98l.

The expat provision is similar to (but has been improved and is more administrable than) the expat provision in a prior bill, H.R. 3997, which was passed by both the House and Senate in December 2007 but did not get enacted due to other differences between the House and Senate bills. The AICPA Tax Division’s Expat Task Force was instrumental in working with the tax-writing committees’ staff in improving and simplifying the provision. Some changes that have been made since December include:

• Only the new Sec. 877A (and not also Sec. 877, regarding expatriation to avoid tax) applies to people who expatriate on or after the date of enactment. Old Sec. 877 remains applicable only to people who expatriated prior to the enactment date (Sec. 877(h)).
• Deferred compensation attributable to services performed outside the United States while not a U.S. citizen or a U.S. resident is excepted from the provisions’ application even though part of a plan that is otherwise subject to the provisions (Sec. 877A(c)).
• The new inheritance tax under Sec. 2801 is prospective from the date of enactment (P.L. 110-245, Section 301(g)). Unlike earlier versions of this legislation, the transfer tax provision is not retroactive. There are two elements to this: The rule applies only to transfers received on or after the date of enactment and only to transfers received from individuals who expatriated on or after the date of enactment.