Billionaires Income Tax On the Way & Covered Expats are Hit Hardest of All

If you or your clients are really (really) wealthy (more than $100 million in annual income or more than $1 billion in assets) and thinking about expatriation (relinquishing US citizenship or a green card as a long-term resident), the time is now.  Even if not super wealthy, the newly proposed Billionaires Income Tax should serve as writing on the wall.  I do not think it is a question of “if” the proposal is enacted, but merely a matter of “when”.

With 40 years of US international tax experience under my belt, I saw this happen many times.  A most notable example involves the current “exit tax” imposed on “covered expatriates”, which was enacted in 2008 with the Heroes Earnings Assistance and Relief Tax (HEART) Act.   The exit tax had its genesis well before then.

It harkened way back to 1995 with the Clinton administration proposing an exit tax in February of that year.  The debate launched by the Clinton administration was not forgotten (oh, they never forget ways to get more tax and what better way than from expatriates who no longer have any vote)! Exit tax proposals continued to be introduced in one form or another over the years before final enactment.  The exit tax as we now know it was successfully resurrected and enacted into law in 2008 when President Bush signed the HEART Act.

When the Billionaire’s Tax is eventually enacted (trust me, it will be), it will simply become a matter of time until the thresholds drop and more and more taxpayers are caught in the “Billionaire” dragnet.  Already, the proposal calls it a “Billionaire’s Tax”, but the annual income threshold is nowhere near that, at $100 million (not indexed for inflation).  So, the proposers of this legislation are already re-defining things to suit the upcoming agenda!

The Billionaires Income Tax

The Billionaires Income Tax was proposed by Senator Ron Wyden on November 30, 2023.  This post will first set out how it will generally work and will follow with a discussion of how the proposal will treat so-called “covered expatriates”.

Only taxpayers with more than $100 million in annual income or more than $1 billion in assets for three consecutive years would be covered by the proposal.  Neither number is indexed for inflation.

How it will Work

The Billionaires Income Tax will take mega tax dollars in the following ways:

1) Mark to Market Regime

Taxation of gains and losses from easily valued “tradable” assets such as stocks will be “marked to market” each year. This means that “billionaires” will pay tax on gains or take deductions for losses, regardless of whether they sell the asset.  So,  affected taxpayers will be paying tax on “pretend” income.

2) Deferral Charges

A deferral charge will be imposed on gains from assets that are not readily tradable – for example, real estate or an interest in a closely held business.  Since these assets are not subject to the mark to market approach, the proposal gets the tax dollars in an alternate way.  When a “billionaire” sells a non-tradable asset they would pay tax on the gain at the highest rate of tax in effect (currently 37%) in the year of the applicable transfer.  In other words, no beneficial capital gain rate. In addition, a “deferral recapture amount” must be paid. This is similar to interest on the tax that had been “deferred” during the time the individual held the asset.  The United States Senate Committee on Finance one-pager explains: “The amount owed is calculated by allocating an equal amount of gain to each year the billionaire held that specific asset, determining how much tax would have been owed on the gain in each year, and assessing interest on unpaid tax for the time the tax was deferred. The interest rate used is the short-term federal rate plus one percentage point ….”

Essentially, this proposal rehashes the taxation regime already imposed for years on (mostly overseas) Americans who have smaller ownership interests in foreign corporations or those investing in foreign mutual funds.  The so-called “Passive Foreign Investment Company” (PFIC) rules work the same way as the proposal, and it’s a nightmare.  You can read all about the PFIC regime here and here.

The proposal also contains transition and anti-abuse rules.

“Covered Expatriates” are Given Special Treatment

Covered expatriates will be required to mark all of their assets to market upon expatriation (this is not new) but they will not be allowed the deferral election permitted to other taxpayers under Code section 877A. (My blog post here discusses the deferral election.).

In addition, Code section 877 will apply to these taxpayers for the 10-year period after expatriation. What does this mean?

Code Section 877 contains what is called the “alternative tax regime” of the old expatriation rules – but these old rules are being resurrected in this proposal.  Generally, under the alternative tax regime of Section 877 certain categories of income and gains that would otherwise not be taxed to a nonresident alien, will continue to be treated as US-source income and taxed to the covered expatriate for 10 years after termination of US status. For example, income on gain from sales of US stocks and securities are recharacterized as having a US-source and taxed to the covered expatriate.

In addition, under Section 877, if the covered expatriate spends more than 30 days in the US in any year during the 10-year period following expatriation, he will be treated as a US citizen subject to US tax on worldwide income for that year.   Finally, to add insult to injury, the proposal mandates that all of the covered expatriate’s worldwide assets will be marked to market again at the end of the 10-year period.  So the exit tax hits them twice (once at expatriation, and again, 10 years later).  Ouch!

The Accidental “Billionaire”

Remember, one can become a covered expatriate even without meeting the income tax liability or net worth thresholds discussed in my earlier posts, referenced above. I have seen many people become “accidental” covered expatriates over the years. Usually this happens because they did not obtain proper tax advice before expatriating.  Expatriations can happen unknowingly.  Many laymen (sadly, tax professionals too) do not know that under certain circumstances, using a treaty tie breaker clause in a tax treaty is a deemed expatriation.  Similarly,  giving up one’s green card when confronted at the border by CBP officials is an expatriation if the card has been held for 8 tax years.

Even the average Joe Pauper can be a “covered expatriate” if he expatriates without having certified tax compliance for the 5-year period prior to relinquishing US status (currently required by filing Form 8854).  See my blog posts here and here. On account of these rules, the “accidental” covered expatriate will  hit the lottery and also become an “accidental” billionaire. Ka’Ching!

Think Fast, Act Faster

Thinking about keeping that US citizenship or green card?  Think fast! Take action before this proposal becomes law and just hope it is not enacted with retroactive effect, because absolutely nothing stands in the way of retroactive tax laws.  The single best investment that a billionaire can make might be to expatriate now and pay the current 23.8% exit tax.

Most importantly, choose a top notch tax professional with the right experience. Not all tax pro’s are the same and the area of expatriation is full of landmines.

Podcast

I’ve done a podcast with attorney John Richardson on the topic of  this proposed legislation.  Have a listen.

 

Posted December 4, 2023

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