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?
@Ruby, thanks!
Phil, thank you very much for the clarifications. I enjoyed reading your topics and posts because it’s practically well-explained in a street-smart way which makes it fun to read. 🙂
@Ruby,
If your answer to question 3 is no, then leave question 4 blank.
For question 5 you need to satisfy both conditions in order to answer yes. You have lived outside the USA for a long time so that half of the question is satisfied, but you were not under age 18.5 when you expatriated. You will answer “no”.
In Part IV number 3 of form 8854, if I answer NO on it, do I have to answer number 4 or can I just leave it with blank answer?
In Part IV number 5 of form 8854, it is a very tricky question for me because I’m way over 18 but I live in the US of not more than 10 years. What is the correct answer for me to mark on this number 5, yes or no?
Please help
@teenage,
I think filling in the balance sheet is unavoidable, even if one of the two exceptions (such as the “age 18” exception) applies to make you not a covered expatriate. The reason I think it is required is because of Internal Revenue Code Section 6039G(b)(5), where Congress tells expatriates (of all flavors) to give income, asset, and liability details.
Thus, while it is impossible for you to be a covered expatriate, the “we collect gratuitous information on you . . . because we can” Standard Operating Procedure (so beloved by the U.S. government) will stand.
If you do not provide this information, then you have not fully complied with all of your obligations under Title 26 of the United States Code — the Internal Revenue Code. Section 6039G is in Title 26. As a result, you would fail the certification test (question 6 in Part IV, Section A of Form 8854).
The exceptions to being a covered expatriate because of wealth do not exempt you from the certification test. You can be a dual citizen, fail the certification test, and thus become a covered expatriate. You can properly renounce citizenship at age 18 and fit yourself within the requirements of that exception. But if you fail the certification test, you will be a covered expatriate.
Yes, it’s stupid. Yes, it achieves nothing of value for the U.S. government. Yes, it will cost you a lot of extra money to do the stupid stuff that the U.S. government requires from you. Just remember, though. You have one more Gate of Stupidity to pass through, then you’re done. The rest of us who remain U.S. taxpayers must marinate in this system forever. Lucky you. 🙂
Highly volatile assets might not be the only consideration. What about volatile exchange rates? If Scottish people vote to leave the UK tomorrow, a person with UK assets who is expatriating in London on Thursday might wish she had waited until next week.
You mention that “6039G is the infamous rule that triggers the quarterly publication of names of people who renounce U.S. citizenship”.
Aha! So the numbers that are oft-mentioned, such as 1,001 in 2014 Q1, are really only the ***covered expatriates**? Then surely, there must be an even greater number who expatriate by renouncing, but are not covered (such as the dual-citizen foreign-residing teenager entrepreneur), or who are relinquishing.
Is there any report or estimate of the number of people filing Form 8854 each year? Might the true number of people giving up US citizenship be hugely greater than is reported in the quarterly publication, perhaps more than 100,000 per year?
Anecdotally, tax accountants and lawyers must be able to say what proportions of their clients are filing Form 8854 as covered rather than not covered expatriates.
Must a non-covered expatriate teenager compute “net worth on the date of your expatriation for tax purposes”?
Form 8854 Part IV has six lines. The instructions say “This section must be completed by all individuals who expatriated in 2013.” Line 2 is “net worth on the date of your expatriation for tax purposes”.
But if I check “Yes” on lines 5 and 6 then I am not covered, by reason that I was under age 18 1/2 when I expatriated and I have I complied with all tax obligations for the past 5 years. Given these facts (or that I have checked “Yes” on lines 3, 4 and 6), the information requested in lines 1 and 2 is not needed by the IRS in order to apply the law to my case. So can I leave them blank and yet be in adequate compliance with instruction “This section must be completed by all individuals who expatriated in 2013″?
Line 1 is easy to complete by copying from my past five tax returns, but line 2 will be expensive to complete. It will be very time-consuming to find all the necessary records and my tax accountant will charge $1000s to compute my net worth. Also, since my net worth is in excess of $2,000,000, I worry that I will be waving a red flag to a bull. The Form 8854 instructions for line 2 say “You can use the balance sheet in Part V (Schedule A) to arrive at your net worth.” But I will not be completing Part V since this is only required for covered expatriates.
It looks to me as if Form 8854 Part IV lines 1 and 2 are asking me for information that the law does not require me to provide.
This begs a more general question: do instructions and questions in IRS Forms have the force of law, or are they only the IRS’s attempt to implement law, and so can be safely ignored if they are not supported by law?