Valuation date for expatriate's balance sheet

The Internal Revenue Code contains unnecessary complexity, which — if you are not careful — can trip you up. Here is one such item, triggered by an email from reader G.  My “off the cuff” answer to him was wrong.  Here is the right answer.

The moral of this story is: always look at the law before answering a question. :-)

The problem

When someone renounces U.S. citizenship, the law requires them to (among other things) give the U.S. government a balance sheet showing assets and liabilities. You’re taking a snapshot of your financial situation.  The question is at what moment in time you take that snapshot?

The exit tax rules have two different “moments in time” built into the law. Remembering which moment matters is the problem.

Section 6039G: Useless

The Instructions to Form 8854 tell you that the balance sheet information is required under Internal Revenue Code Section 6039G.  Let’s start there.

Section 6039G is the infamous rule that triggers the quarterly publication of names of people who renounce U.S. citizenship. In addition to requiring the publication of this list, it also specifies information that must be provided by people terminating their U.S. citizenship.

One of those items required? A balance sheet.  Specifically, the taxpayer is required to provide:

information detailing the income, assets, and liabilities of such individual[.]

See Section 6039G(b)(5).

Section 6039G does not specify the effective date for when you should take a snapshot of your income, assets, and liabilities. Let us now go in search of something specific, elsewhere in the Internal Revenue Code.

Balance Sheet: The Day You Renounce

For purposes of filling in the balance sheet on Form 8854, the values of your assets and liabilities must be computed as of the day you renounce your citizenship.

Section 877A(g)(1)(A) says you are a “covered expatriate” if you satisfy one of the tests in Section 877(a)(2).

Section 877(a)(2)(B) is one of the three tests found at Section 877(a)(2).  It is the net worth test.  After you parse through the clumsy cross-referencing from Section 877A to Section 877, it says that someone is a covered expatriate if:

the net worth of the individual as of such date is $2,000,000 or more[.]

In order to figure out what they mean by “such date”, we have to look at the paragraph immediately above Section 877(a)(2)(B).  This is where the Internal Revenue Code defines the net income tax test for expatriation purposes, and the paragraph refers to a time period that ends before a specific date:

the date of loss of United States citizenship[.]

Since Section 877(a)(2) is written as one giant, clumsy, convoluted sentence broken up into bits and pieces, my 6th Grade grammar says that the reference to “such date” should logically refer to the immediately preceding definition of a date in the long, convoluted sentence.

Therefore I conclude that the the Internal Revenue Code asks you to determine your net worth as of the date that you lose your U.S. citizenship.

This is consistent with the Instructions to Form 8854.  You are told to use values as of your expatriation date:

List in U.S. dollars the fair market value (column (a)) and the U.S. adjusted basis (column (b)) of your assets and liabilities as of . . . [y]our expatriation date if you expatriated on or after June 17, 2008.

Confusion:  Mark to Market Date

The confusion comes in when you look at the “mark-to-market” rules.  These are the rules that apply to covered expatriates. The mark-to-market rules pretend that you sold everything you own on the day before your expatriation date:

All property of a covered expatriate shall be treated as sold on the day before the expatriation date for its fair market value.

There are similar rules for deferred compensation, specified tax deferred accounts, and interests in trusts.  For computing your exit tax, Section 877A pretends that certain events occur on the day before your expatriation date.  This, after all, is the very last day on which you are a full-blown U.S. taxpayer, subject to all of the tax rules.

Not Much Difference

There’s not much difference, really.  The only people who might conceivably care about the difference (“Do I use values on the expatriation date or the day before?”) are those who are really, really close to the $2,000,000 net worth threshold for becoming a covered expatriate, and who own highly volatile assets.

I personally wouldn’t cut things that close.  If your status as a covered expatriate depends on the markets — you’re heavily invested in futures or commodities, for instance — then I think the prudent thing to do is to cash out, expatriate, then re-enter the market.  Why allow outside forces to dictate whether you become a covered expatriate?