September 29, 2015 - Phil Hodgen

Expatriation Chronicles update; deferred compensation pain factory

Hey, it’s Phil, writing this time from the Maple Leaf Lounge at LAX — before dawn.

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The Expatriation Chronicles

In case you have not been following the blog posts, we have an ongoing saga involving a 17-year old Accidental American living in the U.K. Born in the United States, she faces profound financial difficulties when she goes ot university next year — if she keeps her U.S. passport.

She is in the process of renouncing her citizenship, and has her renunciation appointment set for October, 2015 at the London Embassy.​

If you’re interested in reading her reports from the trenches, go our website and you will find a feature box in the right hand menu that lists all nine episodes — so far — in her quest to relinquish U.S. citizenship.

​This is about as clean an expatriation as you can get.

  • She has a Social Security Number (we hope — but we shall see if the Social Security Administration coughs up a confirmation of this), so she does not need to apply for an identification number for tax purposes.
  • She has never earned income so her tax filings required for the previous five years are almost certainly “none”.
  • She can’t possibly be a covered expatriate, and even if she is, the tax cost of that status is zero.

The only unusual feature of her situation is that she is a minor. Technically, the State Department could refuse to allow her to renounce citizenship until she turns 18. However, her appointment at the Embassy apparently puts her in the clear on this point. See Episode 8 for the details.

Use this to understand how your children can expatriate.

Deferred compensation

The latest expatriation projects for us have involved a lot of deferred compensation questions.

Deferred compensation (for exit tax purposes) means:​

  • the typical “carrot dangled in front of your nose to make you work harder” — bonus plan, stock options, restricted stock units; and
  • normal pension plans.

a + b = pain factory

The big risk here is the unholy conflagration caused by being a covered expatriate and having an “ineligible” deferred compensation plan. It creates a massive tax.​

  • You are a covered expatriate if you are too rich ($2,000,000 or more in net worth, or had high average Federal tax liability over the previous five years, where “high” is around $160,000 and indexed for inflation) or a bad dog (your tax returns are not exquisitely correct for the previous five years and/or you owe money to the IRS).
  • You have “ineligible” deferred compensation if you have a foreign-administered pension or other type of plan, or you blow the EXCEEDINGLY “haha gotcha, sucker!” 30-day time deadline for filing Form W-8CE.

If you get this wrong, you are taxed (by the IRS) as if you received a giant lump sum distribution of that deferred compensation on the day before expatriation.

To put it in concrete terms, pretend that you have a bone-dog ordinary foreign pension from your foreign country employer that will pay you $4,000 per month for life after you retire. You think you will pay income tax on that $4,000 per month as you receive the actual, y’know, cash.​

Two hits?

The IRS thinks differently. Through the magic of actuarial science, they compute the value of that $4,000 per month income stream for life as a giant lump sum. Life expectancy, $4,000 per month, some present value calculations, and you’re done.

Let’s say (make up a number, Phil) that the lump sum present value of $4,000 per month to you until you die is $600,000. You get to pay income tax on $600,000 of income in the year you expatriate, even though you might not start receiving your pension payments for another 20 years.

  • That’s quite a hit to your cash reserves. Would you like to pay a couple of hundred thousand dollars of tax now — years before you get the money?
  • Then maybe pay tax AGAIN on those pension distributions when you actually receive them — years from now, while retired — in your home country?

Spawn of Satan.

Until next time

It’s time to board AC790 — the 7:00 a.m. flight to Toronto. When you read this I will be in Toronto, possibly getting rained on. 🙂

See you in two weeks,