How Loans and Liabilities Impact the US Exit Tax
When it comes to expatriating from the United States, some Taxpayers who are either US citizens or long-term lawful permanent residents and considered covered expatriates may become subject to an exit tax. There are three (3) main ways that a person may be considered a covered expatriate: they meet either the net worth test, the net income tax liability test, or the ‘five years of tax compliance’ test. Once a person is considered a covered expatriate and therefore must prepare the exit tax calculation, oftentimes a large part of that calculation involves the mark-to-market computation of gain assets that are owned by the Taxpayer. There are other exit tax implications as well such as specified tax-deferred accounts and ineligible deferred compensation — but mark-to-market is usually (but not always) the most common. One question then becomes if a Taxpayer has losses, how does it impact whether a person becomes a covered expatriate and whether they have exit tax? Let’s look at the difference between having losses in determining covered expatriate status under the net worth test as opposed to having losses as part of the exit tax calculation for mark-to-market.
Balance Sheet $2M Net Worth Form 8854
To determine what a person’s net worth is for purposes of the exit tax, the taxpayer must complete a balance sheet to include all different types of assets, investments, and other holdings. A common question is whether liabilities are considered when completing Form 8854? Luckily, the Taxpayer can offset assets with liabilities. Therefore, if a Taxpayer has $3M in Assets and $2M in liabilities (such as a Mortgage), then the Taxpayer would fall below the $2M net worth.
Mark-to-Market Gain of Individual Assets
It works differently once a person is considered ‘covered’ and has to calculate the exit tax. Once a person is deemed a covered expatriate, they then must conduct the exit tax calculation – which usually includes mark-to-market gain. For the exit tax calculation each asset is looked at individually and the Taxpayer cannot offset loss properties with gain properties for this part of the calculation.
How Does the Exclusion Work?
There is an exclusion amount of about $767,000 of gain that is excluded for the Taxpayer – and is applied to each asset based on its percentage relative to the total gain. First, the Taxpayer does not get to pick which assets to the apply the exclusion to; rather, it is applied to each asset to correspond with the value of the asset compared to the value of all of the gain assets. Moreover, the character of the gain remains the same for exit tax calculations, so that Long Term Capital Gain (LTCG) remains Long Term Capital Gain, and Short Term Capital Gain (STCG) remains as Short Term Capital Gain. This is important because LTCG receives certain tax rate benefits whereas STCG is taxed at the ordinary income tax rates. When it comes time for the calculation, the Taxpayer has to look at the value of each gain asset in conjunction with the total value of the gain assets and apply the exclusion amount to each specific asset based on its percentage as compared to the total value of gain assets.
We reproduced the instructions in part from form 8854 to provide some guidance on how the process works:
As provided by the IRS:
Column (e). Before you complete column (e), you must allocate the exclusion amount to the gain properties on a separate schedule. Attach a copy of the separate schedule to this form.
To allocate the exclusion amount, determine the gain of each gain property listed in column (a) and enter that gain in column (d). If the total gain of all the gain properties exceeds the exclusion amount ($767,000 for 2022), then allocate the entire exclusion amount to the gain properties by multiplying the exclusion amount by the ratio of the gain determined for each gain property in column (d) over the total gain of all gain properties listed in column (d).
After you have allocated the exclusion amount to the gain properties, subtract the exclusion amount allocated to each gain property from the gain reported for that property in column (d), and enter the resulting amount of gain in column (e). If the total gain of the gain properties in column (d) is less than the exclusion amount (but greater than -0-), then you must use the total gain amount as the exclusion amount, and you must allocate the exclusion amount, as adjusted, to the gain properties under the method described above.
The exclusion amount allocated to each gain property cannot exceed the amount of that gain property’s built-in gain. See Notice 2009-85, section 3B, for more information. Example. X, a covered expatriate, renounced his citizenship on Date 2. On Date 1, the day before X’s renunciation of his citizenship, X owned three assets, which he had owned for more than 1 year. Asset A is business property and assets B and C are personal property. As of Date 1, Asset A had an FMV of $2,000,000 and a basis of $200,000; Asset B had an FMV of $1,000,000 and a basis of $800,000; and Asset C had an FMV of $500,000 and a basis of $800,000. X must allocate the exclusion amount as follows: Step 1: Determine the built-in gain or loss of each asset by subtracting the basis from the FMV of the Date 1:
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