This post is a collection of questions and answers from Debra Rudd’s January 15, 2021 International Tax Lunch webinar on the Net Worth Test.
The below questions were asked by viewers of the webinar, and answered by Debra during the webinar. Some questions have been slightly edited for clarity.
This post is not legal advice. Do not make big life decisions without consulting an expert.
Regarding the tax liability test, when testing a married filing jointly couple, both expatriating, do you divide their joint liability by two? Or does it need to be more precisely allocated to the source of income?
For the tax liability test for married couples who filed jointly, you do not get to divide by two. Each spouse uses the full tax liability in his or her tax liability test. One common strategy to avoid covered expatriate status when that’s an issue is to begin filing separately for a few years. Sometimes that will solve the problem.
Has the tax liability test been an issue for individuals who were subject to the IRC 965 mandatory repatriation tax back in 2017/18?
I haven’t personally encountered an issue with the tax liability test related to section 965, but I could certainly imagine that could create problems for some taxpayers.
What if a young person only had 2 years they may have had to file? Do you still need to do 3 returns with zero income?
It’s not required to do 3 years with zero income, but we generally like to use that approach for expatriates. Two benefits – it’s an explicit statement to the IRS that you had no taxable income for that year, and it triggers the statute of limitations to start running.
The $2M limit has never been inflation revised. Has this been tested in court, and if not, is there a case to be made here?
I am not aware of it having been tested in court. The statute where the rule is found specifically provides for inflation adjustment for the tax liability test, but not the net worth test. I’m not a lawyer and I’ve never studied whether there might be some legal avenue to dispute this, but I suspect probably not.
Do the taxes on a deferred compensation plan apply even if you are not a covered expatriate?
The exit tax on deferred comp applies only to covered expats. But if you have a US plan and you receive distributions from after expatriation, chances are you are taxed in the US unless a treaty applies to modify that.
Does a deferred compensation plan have to be included in the calculation of the $2 million threshold to determine whether or not you are a covered expat?
Deferred comp often (but not always) is included in the net worth test. It has a lot to do with whether the risk of forfeiture under the facts and circumstances available has lapsed or not.
What discount (interest) rate must you use in calculating the present value of a defined-benefit plan?
Discount rate is applied using actuarial principles found in IRS guidance for different types of assets under the gift tax rules for if you are giving away those assets.
Do tax deferred accounts include Canadian RRSP or RRIF accounts?
As I understand it, “specified tax deferred accounts” is a term that applies only to certain US accounts (IRAs and some others).
Is this a fair summary to state that 401k is included as an asset for the Net Worth calculation but that it is not included in the Exit Tax / Capital Gains Calculation?
A 401K is an asset for the net worth test calculation, and if you are a covered expat it is not included in the capital gains, but is instead subject to a separate “exit tax” where the account is deemed distributed and you have to pay tax as if it was actually distributed. Non-covered expats do not have that deemed distribution result.
Do we use “consideration put into the asset” when determining what your interest in the property is, particularly if the asset is titled joint?
That is one factor that can be part of the equation, yes. Particularly if you believe that title ownership does not reflect the true interest in the property.
These are US assets, correct? If they have a foreign property, is that included?
All worldwide assets are included in the net worth test, so both US and foreign property.
401k follow up: the deemed distribution takes place at the time of expatriation or when you redeem assets later on?
The deemed distribution takes place at the time of expatriation and you pay tax on it when you file the expatriation year tax return in the following calendar year. That’s what’s so insidious about it – you receive no money at all, but you have to pay tax as if you did.
I should mention for the 401k if you are covered you have the opportunity to claim a better tax result – no exit tax, and 30% withholding as distributions are made – if you file Form W-8CE within 30 days of expatriation.
Defined benefit foreign pension plan, is it acceptable to use a value that the pension administrator provides as the current value of the pension plan?
Yes, it is much easier if they will provide a present value, especially if their methodology includes an actuarial table for life expectancy and discount rates to present value.
The actuarial tables have many discount (interest) rates. How do you choose? We have an incentive to choose a higher discount rate. Are we required to use a particular discount rate?
There isn’t a single rate that we are required to use. The explicit guidance on this is quite thin, almost non-existent. We try to approach each situation separately and figure out the most reasonable approach there. When planning for the net worth test, we estimate conservatively and help create a buffer below the $2M of a couple hundred thousand or more, if possible, to eliminate any possible grey area with the IRS.
If the person who owns nothing but or less than 2million, got green card for a couple year and decided to give up the green card. they don’t need to worry about the exit tax right?
Correct, if they never meet the “in 8 of the last 15 years” test for long-term resident status, they can simply turn in the green card with Form I-407 and they do not have to worry about being an expatriate at all. No form 8854.
How would you value for beneficiary of a discretionary nongrantor trust with no history of distributions?
That’s a good question. This is a difficult area because it relies on a facts and circumstances test. If there’s nothing in the trust instrument or other documents, letter of wishes, and no history of distributions we can default to the Uniform Probate Code.
Creating liabilities to reduce Net Worth: as the GC candidate for expatriation, is it possible to borrow money from someone and then give this money to your US citizen spouse? Hence you are left with the liability and the asset belongs to your wife?
Yes, that’s possible, however the gift does have to be a real gift. In other words, the spouse could not turn around and give the money back so you can pay off the loan right after you expatriate.
You mean a real loan? How long do you need to keep the loan before you pay it back?
You can pay it back any time. The problem is giving a gift to your spouse, expatriating, and then your spouse giving the gift back. The problem is that the IRS would likely view this as the gift never really being a gift. If the spouse wants to make a gift to the expatriate later, I would suggest maybe waiting until the statute of limitations on the expatriation year tax return has expired.
Should we send the IRS a copy of form i-407 to the IRS so that they know they don’t expect a return from the taxpayer?
There is no requirement to send the I-407 to the IRS, you report the date on Form 8854 and I assume if they audit that, you might be asked to provide proof of the date you said you expatriated
For accounts titled to H & W individually, are community property laws not applicable?
Community property laws might still apply. In community property jurisdictions you run the risk that separately titled assets are not truly separate property.
Once a covered expat disposes of any US assets, would they have any further US tax obligations after paying the exit tax?
They may well still have US tax obligations. Take a piece of US real estate as an example. Purchased for $500K, worth 1M at expatriation, sold 10 years later for 2M. exit tax applies to 500K of gain, then there is a step up in basis, and they have a 1M gain on the ultimate sale.
If you are taking the position that in the year of expatriation they are non-domiciliaries, are you suggesting you can make gifts of intangibles (e.g., to fund a trust) without incurring gift tax while a US person?
Possibly – in the case of nongrantor trust interest, these can continue to be taxed after expatriation.
If there are no remaining US assets, would they have any tax obligations on overseas assets as they do with the exit tax?
Some deferred compensation items are sourced based on where the work to earn the compensation was performed. For those items, and for taxpayers with interests in foreign partnerships doing business in the US or foreign trusts with US source income, the asset generating the income might not be a US asset, but it could create US filing requirements.
Is a non-domiciled Green Card holder subject to Estate Tax on non-US assets?
If you meet the criteria for being a noncitizen nonresident under the gift and estate tax rules, then you would not be subject to US estate tax on non-US situs assets.
If someone has begun the expatriation process in 2020, but it is delayed due to covid, can it be undone?
If you have completed the process I do not know any way of un-doing it. If you have started the process but have not yet had an expatriation event (typically either filing I-407 or taking an oath of renunciation and signing Form DS-4079), then you are not an expatriate.