Which Properties to Include for MTM Exit Taxes: How to Calculate

Which Properties are Subject to U.S. Taxes at Exit

Which Properties to Include for MTM Exit Taxes 

Expatriation is the process of formally renouncing U.S. Citizenship or relinquishing Permanent Residency Status for Long-Term Lawful Permanent Residents. And, for some expatriates who are categorized as Covered Expatriates, they may also have to pay an exit tax at the time of expatriation. While there are many different buckets of income that may qualify for exit treatment, the MTM or (Mark-to-Market) tends to cause the biggest tax headache for covered expatriates. And, while common types of Mark-to-Market assets include securities, real estate, and mutual funds/ETFs – there are actually many different types of MTM assets that may become subject to the exit tax. Let’s walk through the basics of the MTM Tax Regime.

First, What is an Expatriate?

An expatriate is either a U.S. Citizen or Long-Term Lawful Permanent Resident. The latter refers to permanent residents who have been Permanent Residents for eight of the last 15 years and did not elect to be treated as a foreign person for tax purposes.

As provided by the IRS:

      • Long-term resident (LTR) defined.

        • You are an LTR if you were a lawful permanent resident of the United States in at least 8 of the last 15 tax years ending with the year you are no longer treated as a lawful permanent resident. In determining if you meet the 8-year requirement, don’t count any year that you were treated as a resident of a foreign country under a tax treaty and didn’t waive treaty benefits applicable to residents of the country”

What is Exit Tax?

Exit tax refers to the tax a Covered Expatriate may have to pay at the time they expatriate and file their final year tax return and Form 8854. While Exit Tax is a vast area of law, for purposes of this article, let’s stay focused on MTM — noting that only ‘covered expatriates’ may be subject to an exit tax (although there is a tax pitfall that may also affect non-covered expatriates who have certain PFIC investments)

Which Properties are Included in the MTM Tax Regime? 

When it comes time for the Covered Expatriate to calculate the MTM portion of their exit tax, it is important that they first determine which properties are included in the MTM calculation:

As provided by the IRS:

      • “A CE is treated as owning at FMV any interest in property that would be taxable as part of their gross estate as if they had died on the day before the expatriation date as a U.S. citizen or resident.

      • A CE must determine the FMV of each interest in property as of the day before the expatriation date in accordance with the valuation principles applicable for purposes of federal estate tax.

      • The FMV of the CE’s worldwide assets is determined under the principles of IRC 2031 (Definition of gross estate), without regard to IRC 2032 (Alternate valuation) and IRC 2032A (Discounted valuation for certain farm and real property), as if the covered expatriate had died as a citizen or resident of the United States on the day before the expatriation date.

      • For purposes of the MTM tax regime, gross estate includes all property that a decedent has an interest in, real or personal, tangible or intangible, wherever situated.

It is important to note that the assets are global assets and not just U.S. assets. Thus, a U.S. Citizen who lives abroad and only has foreign assets may still be subject to the U.S. exit taxes.

Examples of MTM properties

The IRS provides examples (not exclusive) of certain properties included in the MTM election.

      • “Examples include, but are not limited to:

        • Real estate

        • Stocks, including those issued by foreign corporations

        • Bonds, including tax exempt

        • Mutual funds

        • Accrued dividends

        • Accrued interest

        • Mortgages, notes and cash

          • If there is an expectation of repayment and an intention to enforce the debt.

          • Includes installment obligations.

          • IRC 7872 addresses interest free loans and loans with below market interest rates.”

Four Common Types of MTM Properties

Here is a list of the more common types of MTM properties as provided by the IRS:

Life Insurance Policies

        • If payable on the expatriate’s life or if the CE has power to change the beneficiary or to cancel, surrender, assign or borrow against the policy.

        • If local community property law applies, include only the portion allocable to the CE.

Jointly Owned Property

        • If property held as joint tenant with a right of survivorship with someone other than spouse, include the entire value of the property unless you can establish otherwise.

        • If property held as joint tenant with right of survivorship between spouses, then inclusion is 50% of the value of the property.

Grantor Trust

        • Include FMV of the CE’s beneficial interest in trust to the extent it would not be part of the CE’s gross estate in accordance with IRC 2512 (Valuation of gifts) without regard to any prohibition or restriction on such interest.

Power of Appointment

        • Assets held with a general power of appointment that an expatriate can exercise or release before expatriation.

When it comes to jointly owned property, a key distinction is that unless a joint property is held jointly with the spouse, if it is JTWROS with a non-spouse, then the presumed ownership is 100% with the burden on the CE to prove otherwise.

Other Assets also Subject to MTM Inclusion

While there are many other assets that may also be subject to the MTM inclusion, here is a short list from the IRS:

      • Assets transferred for less than full and adequate consideration with retained interest for life or for a period not ascertainable without reference to date before expatriation or for a period that does not actually end before the transferor’s date before expatriation.

        • This includes:

          • The right to use/possess/enjoy

          • The right to income

          • A life estate

          • Transferee possessions conditional on surviving the expatriate

          • Revocable transfer (where transferor prior to expatriation retains the power to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3- year period ending on the date before expatriation

          • Life insurance policies transferred within 3 years of date before expatriation

          • Payment of gift tax within 3 years of date before expatriation

      • Assets transferred before expatriation in exchange for a note are includible if not a bona fide debt. In determining whether a debt is a bona fide debt, consider the following factors:

        • Expectation of repayment

        • Intention to enforce the debt

        • Promissory note or evidence of indebtedness

        • Interest charged

        • Security or collateral

        • Fixed maturity date

        • Demand for repayment

        • Actual repayment

        • Borrower’s ability to repay

        • Records documenting the transfer as a loan

        • Characterization of the transfer for federal tax purposes

Key Resources for MTM Taxes

        • Notice 2009-85 – Expatriation, Section 3A

        • IRC 2031 – Definition of Gross Estate

        • IRC 2032 – Alternate Valuation

        • IRC 2032A – Valuation of Certain Farm, Etc., Real Property

        • IRC 2033 – Property in Which the Decedent had an Interest

        • Form 706 – U.S. Estate Tax Return

        • Form 706 Instructions

        • Form 706 – U.S. Estate Tax Return

        • Form 706 Instructions

        • IRC 7872 – Treatment of Loans with Below-Market Interest Rates

        • Form 706 Instructions, Schedule D

        • Reg. 20.2042-1(b)(2)

        • IRC 2042 – Proceeds of Life Insurance

        • Form 706 Instructions, Schedule E

        • IRC 2040(b) – Joint Interests

        • Notice 2009-85 – Expatriation, Section 3

        • Form 706, Schedule F – U.S. Estate Tax Return: Other Miscellaneous Property

        • IRC 2512 – Valuation of Gifts

        • IRC 2041 – Powers of Appointment

        • Form 706, Schedule H – U.S. Estate Tax Return: Power of Appointment

        • Form 706 Instructions, Schedule H

        • Estate of Lockett v Comm – T.C. Memo 2012-123

        • Miller v Comm, 71 T.C. Memo 1674

        • IRC 2033 – Property in Which the Decedent had an Interest

        • IRC 2040(a) – Joint Interests

        • IRC 2040(b) – Joint Interests

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