The Deferral of Payment of Exit Tax for Mark-to-Market Assets
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Deferral of Payment of Tax (Mark-to-Market)
When it comes time to exit the United States, some taxpayers (covered expatriates) may have an exit tax liability at the time of expatriation. Depending on how much net unrealized gain the taxpayer has, there may be a significant amount of taxes due. While the taxpayer is not required to actually sell their domestic or foreign assets, they are required to make payment of the exit tax. In order to avoid making payment — at least regarding the mark-to-market net unrealized gain –– the taxpayer may seek a deferral of payment of tax. For other types of income such as tax-specified deferred accounts and ineligible deferred compensation, this rule does not apply. Deferring the payment of tax is not as simple as it sounds, since it can require the posting of a bond/security interest, which carries interest and may be very expensive for some taxpayers depending on the amount of bond they have to secure. Let’s take a brief look at the deferral of payment of tax under the mark-to-market regime.
877 (A) Election to defer tax
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In general
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If the taxpayer elects the application of this subsection with respect to any property treated as sold by reason of subsection (a), the time for payment of the additional tax attributable to such property shall be extended until the due date of the return for the taxable year in which such property is disposed of (or, in the case of property disposed of in a transaction in which gain is not recognized in whole or in part, until such other date as the Secretary may prescribe).
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Determination of tax with respect to property
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For purposes of paragraph (1), the additional tax attributable to any property is an amount which bears the same ratio to the additional tax imposed by this chapter for the taxable year solely by reason of subsection (a) as the gain taken into account under subsection (a) with respect to such property bears to the total gain taken into account under subsection (a) with respect to all property to which subsection (a) applies.
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Termination of extension
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The due date for payment of tax may not be extended under this subsection later than the due date for the return of tax imposed by this chapter for the taxable year which includes the date of death of the expatriate (or, if earlier, the time that the security provided with respect to the property fails to meet the requirements of paragraph (4), unless the taxpayer corrects such failure within the time specified by the Secretary).
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(4) Security
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(A) In general
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No election may be made under paragraph (1) with respect to any property unless adequate security is provided with respect to such property.
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(B) Adequate security
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For purposes of subparagraph (A), security with respect to any property shall be treated as adequate security if—
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(i)it is a bond which is furnished to, and accepted by, the Secretary, which is conditioned on the payment of tax (and interest thereon), and which meets the requirements of section 6325, or
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(ii)it is another form of security for such payment (including letters of credit) that meets such requirements as the Secretary may prescribe.
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Notice 2009-85 and the Deferral Election
We have broken this portion of the notice down into bite-size pieces for explanatory purposes.
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“Section 877A(b) provides that a covered expatriate may make an irrevocable election (“deferral election”) with respect to any property deemed sold by reason of section 877A(a) to defer the payment of the additional tax attributable to any such property (“deferral assets”). The deferral election is made on an asset-by-asset basis.”
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What Does This Mean?
If a person is considered a covered expatriate, then they may be able to make an irrevocable election to defer the payment of additional tax subject to that property. This election is made on asset-by-asset allocation and not for all assets of which there is a market-to-market gain.
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“In order to make the election with respect to any asset, the covered expatriate must provide adequate security (defined below) and must irrevocably waive any right under any U.S. treaty that would preclude assessment or collection of any tax imposed by reason of section 877A. If the IRS subsequently determines that the security provided for the deferred tax no longer qualifies as adequate security, the deferred tax and interest will become due immediately, unless the covered expatriate corrects such failure within 30 days after the IRS mails notification of such failure to the last known addresses of the covered expatriate and the covered expatriate’s U.S. agent.”
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What Does This Mean?
Essentially, the US government wants to protect its interest in the amount of tax that is due. Therefore, to provide security, the taxpayer must provide adequate security sufficient to meet the IRS requirements. If for any reason the security is no longer accurate, and the taxpayer does not fix the failure to have accurate security within 30 days, the tax and interest will become due.
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“Subject to the preceding sentence, the time for payment of the tax attributable to a particular deferral asset under the mark-to-market regime is extended until the earlier of the due date (without extensions) of the covered expatriate’s income tax return for (a) the taxable year in which the asset is disposed of by sale, non-recognition transaction, gift, or other means, or (b) the taxable year that includes the date of death of the covered expatriate. However, a covered expatriate may pay any tax deferred under section 877A(b), together with accrued interest, at any time.”
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What Does This Mean?
This paragraph provides that the payment of the tax must be made either when the due date comes for the tax return that includes the asset being disposed of by sale, non-recognition transaction, gift, or otherwise, and/or the covered expatriate passes away. In addition, there is no additional prepayment penalty so the covered expatriate can pay deferred tax with the accrued interest at any time.
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“Interest accrual: Section 877A(b)(7) provides that for purposes of section 6601, the last date for the payment of tax will be determined without regard to the deferral election. Interest will be computed at the underpayment rate established under section 6621 from the due date of the return (without extensions) for the taxable year that includes the day before the expatriation date and will compound daily under section 6622 until the date the tax is paid.”
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What Does This Mean?
This is one of the biggest headaches for covert expatriates who are seeking a deferral of the tax. That is, interest accrues on the amount of the tax liability. The interest is computed at the underpayment rate which can be found under internal revenue code section 6621 and will be compounded daily under section 6622. Depending on the amount of the tax liability and length of deferral, this may result in a significant amount of interest in addition to the taxes already due.
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