The title of this post could also be “What a Difference a Day Makes”.
Most of my readers are quite familiar with the expatriation regime, as I have written many blog posts on this topic. Before delving into the question of the date to use when working through Form 8854, let’s have a quick review of the expatriation rules that apply to expatriations on or after June 17, 2008.
The US Expatriation Tax Regime
The current US “expatriation” tax rules are found in IRC Section 877A and apply only to certain US citizens or long-term residents (LTR) who have properly given up their US status. A LTR is an individual who has held a green card in at least 8 of the past 15 tax years. The tax regime applies only to so-called “covered expatriates” (CE). IRC Section 877A(g)(1) references IRC Section 877(a)(2) for the definition of a CE.
An individual will be treated as a CE if any one of the following tests applies (quoting the statutory text):
- (A) the average annual net income tax (as defined in section 38(c)(1)) of such individual for the period of 5 taxable years ending before the date of the loss of United States citizenship is greater than $124,000 [This amount is indexed annually for inflation and is US$190,000 for 2023]. This means income tax paid by the individual, not his or her income],
- (B) the net worth of the individual as of such date is $2,000,000 or more [This amount is not indexed for inflation], or
- (C) such individual fails to certify under penalty of perjury that he has met the requirements of this title for the 5 preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.
Exit Tax / Mark-to-Market Taxation
A CE is subject to the “exit tax” or “mark-to-market” (MTM) regime which generally means that all property owned by the CE worldwide is treated as sold for its fair market value on the day before the expatriation date. This “pretend” gain is then taken into account for the tax year of the deemed sale and subject to tax, usually at capital gains rates. Various nuances apply that are not addressed in this post. For example, the MTM regime does not apply to certain assets such as the CE’s interest in trusts, pensions or deferred compensation. Further, an exception for a certain amount of gain (which is adjusted annually for inflation) is provided in the tax law. On account of this exception, some individuals may not be impacted by the “exit tax”, but the exception is calculated a very specific way and it does not apply to ownership in certain kinds of property. As such, professional guidance should be taken.
Which Date to Use in Valuing Assets?
Different dates are used in working through the Form 8854.
Part II Section B of the Form 8854 provides a balance sheet to determine the individual’s net worth. All expatriating taxpayers must complete this section regardless of whether they are CEs. In calculating the individual’s net worth for purposes of the Net Worth Test, the fair market value of worldwide assets is determined on the date of the taxpayer’s expatriation (or termination of residency).
Part II Section C of the Form 8854 is the section where one determines the gain or loss for the MTM tax. This section is completed only by those individuals who are treated as a CE. In this Section, the taxpayer is to use the fair market value of assets on the day before the expatriation date.
The MTM rule in Section C looks to the day before the expatriation date for a very simple reason. Essentially it is to ensure that the taxpayer will be treated as a US person on the date of the deemed sale. As a US person, the taxpayer is not able to escape paying the MTM capital gains tax by arguing he or she is a nonresident alien individual (NRA); or perhaps by claiming treaty benefits. NRAs do not pay capital gain tax on sales of assets, including US assets (except for certain kinds of property such as US real estate). Treaty benefits are usually not available for US citizens due to the so-called “saving clause” found in most treaties. Generally, a saving clause preserves the right of each country to tax its own citizens and treaty residents as if no tax treaty were in effect. In essence, it preserves or “saves” the right of each country to tax such persons as if no tax treaty existed.
Due to these different rules, in the case of a CE, tax professionals will need two different fair market values to properly complete the two sections on Form 8854. It could be that there is no difference between the two dates, but in the case of stocks, it could certainly make a difference and could result in an individual having or avoiding CE status, or having higher or lower exit tax liability.
Shares in GameStop (GME) provide a great example. On January 28th 2021, GME had a share value of $4.40; on January 29th, the price per share rose to a whopping $81.25 per share (see chart here). Due to the steep increase in share value within that short 24-hour time frame, a taxpayer expatriating on January 28th, 2021 owning GME shares might escape CE status, but one expatriating on January 29th might not.
For the taxpayer who already qualified as a CE, calculating the MTM tax using the January 29 GME share value would result in significantly higher taxable gains than if the taxpayer could use the January 28th values. Which date he could use would depend on the date he or she expatriated, since the relevant date for the exit tax calculation would be the GME share value on the day before the expatriation date. In my example, with an expatriation date of January 29, the GME share value on that date of expatriation ($81.25) , might cause the taxpayer to qualify as a CE. However, expatriation on January 29th when GME shares were trading at $81.25, would result in far less exit tax for the GME shares since the gain would be computed using the stock value on the day before expatriation (i.e., $4.40 per share).
In summary – What a difference a day makes!
Posted April 6, 2023
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