Deferred compensation items (think “pensions”) will either be taxed as a lump-sum distribution or tax will be withheld as distributions are made to you. This applies, however, only to Covered Expatriates.
This stuff is strange and you really should hire an expert to figure this out for you.
The mark-to-market taxation rules explicitly do not apply to any “deferred compensation item.” Instead, the tax treatment depends on whether the item is an “eligible deferred compensation item” or an “ineligible deferred compensation item.”
An “eligible deferred compensation item” is taxed at a flat 30% rate. When the payor makes a payment to the Covered Expatriate, 30% of the payment is withheld as tax.
An “ineligible deferred compensation item” is generally treated as if the Covered Expatriate received a lump sum distribution on the day before the expatriation day. A present value calculation is made and tax is imposed.
The following items are defined by the IRS as “deferred compensation items.”
First, there are things that look like normal types of plans. These are defined as “any interest in a plan or arrangement described in section 219 (g)(5).” This means:
An interest in a foreign pension plan or similar retirement arrangement or program is a “deferred compensation item” for exit tax purposes. Yes, we will have to wrangle with that pension you built up for decades before becoming a U.S. resident.
Deferred compensation items also include things that are defined in Section 5.B(4) of Notice 2009-85. This is a “catch-all” provision. If you have the right to get some compensation, the IRS wants to deal with it for the exit tax.
Sometimes employees are given property (like stock in the employer company) as compensation. They can make an election to treat themselves as having received the full value of that property in the year of receipt. The provision of the Code is Section 83. Alternatively, they might not make the election, in which case they wait until some future date to take the item into income.
The exit tax rules say that if you made the Section 83 election, the item is not a deferred compensation item. (Makes sense. It is now an asset that is taxed under the mark-to-market rules.) But if you did not make the Section 83 election, then it is a deferred compensation item and must be dealt with accordingly for exit tax purposes.
Once you have decided that you have a deferred compensation item, the next thing you have to do is figure out whether it is an “eligible” deferred compensation item or an “ineligible” one.
An eligible deferred compensation item means any deferred compensation item where:
Payments from an eligible deferred compensation item are taxed at 30% as distributions are made. The withholding applies to the portion that would be gross income to you. The payor is required to withhold the tax and send the balance to you, the Covered Expatriate.
An ineligible deferred compensation item is anything that is not an eligible deferred compensation item.
Ineligible deferred compensation plans are taxed immediately upon expatriation. Calculate the present value of the Covered Expatriate’s interest in the deferred compensation item and include it in taxable income for the year of expatriation.
For someone who accrued deferred compensation benefits outside the United States before becoming a resident or citizen, there is a bit of a break. Those deferred compensation items are not subjected to the exit tax rules.
If you were a U.S. citizen or green card holder working abroad when you accrued the benefits, however, they are not excluded from the exit tax calculations.