Eligible Deferred Compensation Items & U.S. Expatriation Tax Laws
This is a common question we receive from clients re: Expatriation, so we wanted to try to explain it in plain (relatively plain) “English.”
When it comes time to expatriation from the U.S. and the relinquishing/renouncement of your U.S. Citizenship or Green Card Status – you may still have a tax liability to uncle Sam.
Oftentimes, clients will come to us to prepare a hybrid expatriation/offshore disclosure submission, since it is impossible for covered expatriates to safely exit the U.S. Tax system if they are not in full compliance with IRS tax laws.
When it comes to the deemed sale rules and U.S. Expatriation, the IRS uses a mark-to-market model to determine your phantom or shadow income tax bill (deemed as if you sold everything on the day before you expatriated) — but there are some exceptions.
One main exception is “Eligible Deferred Compensation Item(s)”
*This is not the same as Specified Tax Deferred Accounts (which is also taxed differently). Noting, that while a simple IRA may be deferred compensation, most other IRAs are generally tax deferred.
**The difference is important, because Eligible Deferred Compensation Items are not taxed the same as Tax Deferred Accounts (which are deemed distributed).
When a person expatriates from the U.S., most of the focus and concern is about any potential tax liability to the U.S.. when the person is deemed a “covered expatriate.”
For example, Jim a Legal Permanent Resident and (LTR) amassed a fortune when he came to the U.S.
Assuming there are no step-up issues for property acquired overseas, foreign pensions, etc. — when it is time to expatriate, Jim would calculate the value of each asset, determine the gain, apply the exclusion amount proportionate to the asset — and then net out the assets to arrive at the gain (or loss)
Deferred Compensation Items
“Deferred compensation” works differently. It is also important to distinguish between Eligible and Ineligible.
Eligible deferred compensation receives deferred treatment (explained below). Ineligible Deferred Compensation (such as most foreign pensions) are deemed distributed the day before expatriation.
With eligible deferred compensation, there is no immediate tax liability.
Sounds great, right….wrong.
The IRS is Still Going to Tax You…
…in the future.
At the time the now non-U.S. Person receives distributions from the fund, 30% will be withheld by the Payor AND, the person (who is now a non-U.S. Person) is no longer entitled (irrevocable election) to treaty benefits.
What is Eligible Deferred Compensation?
Eligible deferred compensation item means any deferred compensation item with respect to which:
– The payor is either a U.S. person or a non-U.S. person who elects to be treated as a U.S. person for purposes of section 877A(d)(1), and
– The covered expatriate notifies the payor of his or her status as a covered expatriate on Form W-8CE, and irrevocably waives any right to claim any withholding reduction on such item under any treaty with the United States on Form 8854.
– The Secretary may provide separate guidance providing a procedure for a payor who is a non-U.S. person and wishes to elect to be treated as a U.S. person for purposes of section
For purposes of this subsection, the term “deferred compensation item” means—
(A) any interest in a plan or arrangement described in section 219(g)(5)
(B) any interest in a foreign pension plan or similar retirement arrangement or program
(C) any item of deferred compensation, and
(D) any property, or right to property, which the individual is entitled to receive in connection with the performance of services to the extent not previously taken into account under section 83 or in accordance with section 83.
Ineligible Deferred Compensation
Ineligible Deferred Compensation is usually foreign pensions, and results in an immediate tax liability (deemed distributed)
Safely Get Into IRS Offshore Compliance
Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance.