IRS steps up enforcement of the individual expatriation tax

Editor: Mary Van Leuven, J.D., LL.M.

Each year, several thousand individuals renounce their U.S. citizenship or give up their green cards, which can trigger a substantial exit tax liability. Individuals who have expatriated or are considering expatriating should be aware that the IRS appears to be sharpening its enforcement efforts in these situations.

When the current individual expatriation tax regime was enacted in 2008, the Joint Committee on Taxation estimated that it would raise $411 million over the subsequent decade ( Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 110th Congress ( JCS-1-09) (March 2009), Appendix, p. 594). Although the number of individuals who expatriate has increased significantly since 2008, a 2020 report by the Treasury Inspector General for Tax Administration (TIGTA), More Enforcement and a Centralized Compliance Effort Are Required for Expatriation Provisions, Rep’t No. 2020-30-071 (Sept. 28, 2020), identified significant problems with enforcement and revenue collection under the expatriation regime (discussed more fully below). However, the IRS response to the TIGTA report, the inclusion of expatriation in the list of ongoing IRS compliance campaign initiatives, and the recent issuance of an IRS practice unit that focuses on the filing requirements applicable to covered expatriates all indicate that enforcement of the expatriation tax rules continues to be an area of focus for the IRS. This item provides a brief summary of the expatriation tax rules before analyzing each of these recent developments.

The expatriation tax regime

The current expatriation tax was introduced in June 2008 as part of the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act), P.L. 110-245. The HEART Act added Sec. 877A and certain other related provisions to the Internal Revenue Code.

The Sec. 877A expatriation tax generally applies to any U.S. citizen who relinquishes citizenship and any long-term resident (an individual who has held a U.S. green card in at least eight of the prior 15 years) who terminates green card status, if the individual meets any one or more of the following criteria:

• Average annual net income tax liability over the five years ending before the date of expatriation is greater than $201,000 (for expatriations occurring in 2024 — indexed annually for inflation);
• Net worth of $2 million or more on the date of expatriation; or
• Failure to certify their compliance with the U.S. tax laws for the five preceding tax years or failure to submit evidence of their compliance as required by the IRS.

If an individual is determined to be a covered expatriate, their worldwide property is considered to have been sold for its fair market value on the day before the individual’s expatriation. The resulting gain from this “mark to market” transaction is subject to tax to the extent it exceeds an exclusion amount of $866,000 (for expatriations occurring in 2024 — indexed annually for inflation).

Certain assets, including deferred compensation items, specified tax-deferred accounts, and interests in nongrantor trusts, are excluded from the mark-to-market rule and are subject instead to special tax rules.

Compliance campaign initiatives

Commencing in 2017, the IRS Large Business and International Division (LB&I) has published and regularly updates a list of compliance campaign initiatives. Expatriation tax was added to the list of active campaigns on July 19, 2019, with the following statement:

U.S. citizens and long-term residents (lawful permanent residents in eight out of the last 15 taxable years) who expatriated on or after June 17, 2008, may not have met their filing requirements or tax obligations. The Internal Revenue Service will address noncompliance through a variety of treatment streams, including outreach, soft letters, and examination.

Expatriation tax remains one of the 48 currently active campaigns. Other campaigns have been retired because they have either been fully implemented or discontinued for other reasons.

TIGTA report

The TIGTA report mentioned above was issued following an extensive review of the effectiveness of the IRS’s efforts in ensuring compliance with the expatriation tax provisions. The report identified a number of problems, including: (1) the IRS lacked sufficient controls to ensure that taxpayers subject to expatriation tax are filing Forms 8854, Initial and Annual Expatriation Statement, and paying the requisite tax; (2) the IRS is failing to follow up with taxpayers who do not file Form 8854; (3) the data in the existing expatriate database is not being sufficiently tracked or leveraged to enforce the exit tax; (4) certain highnet- worth individuals appear not to be paying the expatriation tax that is due; and (5) there is a low examination rate of the tax returns of expatriating individuals.

The IRS responded to a draft version of the report by committing to take the following steps: (1) coordinating with the U.S. Department of State to add a Social Security number data field to the Certificate of Loss of Nationality so as to improve the tracking of individuals required to file Form 8854; (2) updating the standard form letters sent to individuals who have failed to file Form 8854; (3) updating Form 8854 so as to collect more detailed information on assets owned at the time of expatriation; (4) improving the procedures for transcribing data from Form 8854 and identifying when information is missing; and (5) establishing processes to compile information on all expatriating individuals and using this information to identify individuals with a high risk of noncompliance.

2023 IRS practice unit

The release of the IRS practice unit Expatriation On or After June 17, 2008 — Mark-to-Market (MTM) Tax Regime in July 2023 represents the latest manifestation of the IRS’s ongoing focus on expatriation tax and its related compliance issues. Practice units serve as professional aids for IRS examiners and as internal training materials on general tax concepts and specific transactions. Although they are not official pronouncements on law or practice and cannot be relied on or cited as authority, they provide valuable insights into how the IRS views certain substantive and procedural issues.

This practice unit is noteworthy in that it provides significantly more detail than was available in previous guidance on the range of assets that could give rise to gain subject to expatriation tax and how these assets should be valued and reported on Form 8854. In addition to the more commonly held kinds of property — such as real estate, stocks, bonds, and mutual funds — it lists a number of less commonly held assets — such as life insurance on the life of a third party; leaseholds or reversionary or remainder interests; judgments and claims in litigation; and assets transferred for less than full and adequate consideration with certain retained interests.

The fact that the IRS has compiled such an extensive list indicates the level of detail required when completing Form 8854 and the kinds of questions that could be raised if a covered expatriate’s income tax return is subjected to audit.

The practice unit provides detailed guidance on how to value properties subject to expatriation tax. In particular, it states that household and personal effects should be itemized room by room and named specifically, unless no articles in the same room have a value exceeding $100. Further, an expert appraisal is required for articles with artistic or intrinsic value exceeding $3,000, and that appraisal must be filed with the tax return. Beneficial interests in trusts and interests in life insurance policies are to be valued under gift tax valuation principles. Trusts generally require an examination of the terms of the trust and the pattern of prior distributions; life insurance policies require determination of the price at which the life insurance company would sell the contract or a similar contract.

The practice unit also includes guidance on jointly held property and property subject to community property rules. If jointly held property is held by a covered expatriate as a joint tenant with a right of survivorship with someone other than their spouse, the entire value of the property should be attributed to the covered expatriate, absent evidence supporting a different attribution. If it is held as a joint tenant with a right of survivorship between spouses, 50% of the value of the property should be attributed to the covered expatriate.

Property subject to community property law (which can apply under either U.S. state law or foreign-country law) is attributed to a covered expatriate under community property principles, which generally provide that both spouses have equal, undivided interests in any property acquired during a marriage. Thus, only the portion allocable to the covered expatriate should be included for purposes of the mark-tomarket tax calculation.

Finally, the practice unit provides some guidance on calculating gain from the deemed sale of assets under Sec. 877A. It clarifies that the Sec. 121 exclusion of gain from the sale of a principal residence does not apply for purposes of a Sec. 877A deemed sale. Sec. 121 allows qualified taxpayers to exclude up to $250,000 of gain ($500,000 for married taxpayers filing jointly) from the sale of a principal residence that they have owned and occupied for at least two of the prior five years. There had been some dispute among commentators as to whether this exclusion could be claimed by covered expatriates in addition to the separate exclusion amount (currently $866,000) allowed for purposes of the mark-to-market rule, on the grounds that the deemed sale of the principal residence should be treated in the same way as an actual sale. The practice unit addresses the issue and sets out the IRS’s position that only the Sec. 877A exclusion applies to offset the gain from the deemed sale.

The practice unit also clarifies that passive activity losses subject to the limitation of Sec. 469 are not triggered by the deemed sale of assets. The Sec. 469 passive activity rules generally require that any net losses from a passive activity in which a taxpayer holds an interest are suspended until the tax year in which the taxpayer disposes of their entire interest in the passive activity in a fully taxable transaction. It was previously open to question whether the deemed sale of assets under Sec. 877A triggered passive activity losses. However, the practice unit has clarified the IRS’s position that such losses are not triggered but remain suspended until an actual sale of the passive activity occurs.

More exits, greater scrutiny

The number of individuals who renounce their U.S. citizenship or terminate their green card status has increased significantly since the enactment of the current expatriation tax regime in 2008. Lists of these individuals published quarterly by the IRS in the Federal Register show that the number of individuals expatriating has increased from 312 in 2008 to 3,260 in 2023, with a peak of 6,705 in 2020.

Individuals on assignment to the United States who are considering whether to retain or terminate green card status and any individuals considering giving up U.S. citizenship should be aware of their potential exposure to expatriation tax, given the IRS’s ongoing focus on this issue.

Editor notes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C. Contributors are members of or associated with KPMG LLP. For additional information about these items, contact Van Leuven at mvanleuven@kpmg.com.