Wherein I pimp the CalCPA International Tax Conference and tell covered expatriates something depressing
Hey it's Phil and this is the biweekly Friday Edition. You signed up to get it, but if your inbox is suffering, just click the "unsubscribe" link at the bottom of this email and it will stop coming.
On the other hand we have other fabulous email newsletters that you can subscribe to, at hodgen.com/lists. This includes our fabulous new "CalCPA International Tax Conference and Other Events" list, which I will pimp heavily in about two seconds.
This email is coming to you from Houston, where I am going to give a talk on expatriation to the 18th Annual Texas International Tax Symposium. I'm headed home tonight. Kinda the reverse of Willie Nelson's "Bloody Mary Morning". (Warning: YouTube) 🙂
Well, it's a Bloody Mary morning
Baby left me without warning
Sometime in the night
So I'm flyin' down to Houston
With forgetting her the nature of my flight.
New mailing list – CalCPA International Tax Events
Hey, that was fast! Here we are in the Dept. of Shameless Promotion!
At this year's CalCPA International Tax Conference we had a signup sheet for people in attendance to get on a mailing list. You can sign up, too. You will get information about CalCPA international tax activities:
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The CalCPA International Tax Conference (the next one is in November, 2016 in San Francisco);
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CalCPA Webcasts and live courses related to international tax topics;
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Local CalCPA discussion group events when they are on international tax topics.
Note that you do not need to be in California, and you do not need to be a member of CalCPA. For those of you out there (wherever "there" is) who are looking for educational resources and continuing education credits on international tax topics, this list is for you.
Sign up on hodgen.com/lists.
The 2016 CalCPA International Tax Conference
We are already working on next year's International Tax Conference.
First speaker lined up
The first speaker we have lined up is someone from the IRS who will walk us through the procedural aspects of international appeals. When you can't resolve your audit with the Revenue Agent, this is where you go next.
We can't officially announce his name yet, because his speech has to be formally approved by management inside the IRS. But I think it will be approved, because he has given this talk before to other groups.
I am really looking forward to this presentation. It is insanely valuable to know how the system works. Our speaker will not — and cannot — give away the secret sauce about how he and others make judgment calls at the Appeals level. But just knowing what hoops you need to jump through to resolve your problem? Priceless.
Get on the mailing list. You will get regular updates as we organize the 2016 International Tax Conference, and learn more about the programs as we schedule them.
Why we want you to attend in person
We want you to participate next year, whether on the web or in person. Yes, you can watch the program on the web, and for all of you living in Burkina Faso (heh) I know it is a bit difficult to get to San Francisco. However, it is hugely valuable to you to attend in person.
- You can ask speakers (and other people attending) hard questions and get actual answers. "I have this friend — totes not me, reallllly — who has a problem. I'm just wondering what my friend should do."
(Disclosure: one of the members of our team at HodgenLaw PC did exactly this to John Appuzzo and got a solution to a Form 5471/timing/accounting period problem that had been bedevilling us).
- You meet the players and they meet you. International tax is a small community. Get to know people–they can help you, and they will.
(Example: one of the speakers popped me an email about help on an international tax divorce question, and I was able to immediately connect her with someone who could help). You need people around you who can help you like this. It makes you stronger.
- Free adult beverages. On Thursday night (the Conference is on Friday) I sat in the hotel bar with an open credit card to buy drinks for anyone who wanted to swing by. I will be doing it again next year.
"I have this friend" question opportunities PLUS free booze. What's not to like?
- Free adult beverages. Friday after the Conference, CalCPA again hosted a mixer with the opportunity for you to have a couple of free adult drinks on their nickel. I stood around and chatted with people for quite a while. It's a great chance to socialize with people just like you.
(Nota bene: every good thing that has happened to me in life has happened because I met someone new).
- You're in San Francisco. On a Friday. With a weekend ahead of you!
Double taxation and the covered expatriate
I will leave you with a little snippet from my speech in Texas — an expatriation topic. This can be a real problem for covered expatriates.
Double taxation of real estate capital gain
Let's say you are a dual U.K./U.S. citizen living in the U.K. who renounces his U.S. citizenship. One of your assets is a piece of rental real estate in the U.K. You are rich enough (more than $2 million net worth), so you are a covered expatriate. IRC §§877A(g)(1), 877(a)(2)(B).
You are treated as if you sold that U.K. rental real estate on the day before renouncing your U.S. citizenship. You face U.S. capital gain on the "pretend" capital gain on the "pretend" sale. IRC §877A(a). (Yes, there is an exclusion amount to soften the exit tax blow; let's ignore it for now, in order to put the problem in sharp relief).
So you pay tax to the United States in return for the privilege of renouncing your U.S. nationality. Helpfully, the Internal Revenue Code gives you a step-up in basis in your U.K. rental real estate, because after all you paid capital gain tax on the built-in gain. IRC §877A(a).
Except that U.S. basis in your U.K. rental real estate is not your problem. The U.K. basis in your U.K. rental real estate is your problem.
Ten years after renouncing your U.S. citizenship, you — a U.K. citizen living in the U.K., with U.K. assets only — sell your rental real estate.
No U.K. basis step-up
Let's calculate your U.K. capital gain tax, shall we? Oh wait. We have a problem. You did not get a step-up in basis for U.K. tax purposes, so you have to pay U.K. capital gain tax on the entire gain, not just the capital gain that has accrued since you renounced your U.S. citizenship.
You will pay tax on capital gain once in the United States (when you expatriate) and once again in the U.K. (when you sell the property).
No foreign tax credit
What about the foreign tax credit? Surely you can use the U.S. tax you paid when you expatriated as a foreign tax credit against your U.K. tax liability when you sell the property?
Not likely:
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There is a timing problem. The tax liability to the U.S. happened 10 years ago, and the tax liability to the U.K. happened now.
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There is a "creditable tax" problem. Is the U.S. tax imposed when you expatriated the right kind of tax for which Her Majesty's Revenue & Customs will grant you a tax credit? Maybe not: the exit tax is a real tax you pay on a mythical event, and that mythical event has no meaning in the U.K. because it is not a recognized event under U.K. tax principles.
Pensions, too
The same problem happens with pensions. You face the possibility of paying a massive U.S. lump sum tax on your U.K. pension when you expatriate, and again paying U.K. income tax on the pension distributions when you eventually retire. How about that?
Total tax on your pension approaching 100% of its value? Fabulous.
The template for solving this problem
The IRS solved this problem with Canada in 2010. Canada has a departure tax: when you convert from resident to nonresident status from the Canadian tax point of view, you have some tax potentially payable, using a system more or less like our exit tax system.
Consider a Canadian who declares nonresident status and moves to the United States. He pays tax in Canada, but does not get a step-up in basis or a foreign tax credit in the United States. This was a real problem that happened to real people.
In Revenue Procedure 2010-19, the IRS said that the Canadian departure would be a creditable tax for U.S. income tax purposes, and created a procedure for a Canadian in this position to make an election to have a deemed disposition of the Canadian assets for U.S. income tax purposes.
This gave the Canadian-moving-to-the-United States a step-up in basis for assets under both tax systems. It also allowed the taxpayer to use the Canadian departure tax to mitigate the double-tax hit on the U.S. income tax return.
Needed: Rev. Proc. 2010-19 in reverse, 200 times
In order to solve the double taxation problem for our mythical U.K./U.S. taxpayer, the IRS has to get the U.K. tax authorities to issue the U.K. equivalent of Rev. Proc. 2010-19.
And then the IRS has to do that for every other country on the planet.
Goodluckwiththat.
On that cheery note
On that cheery note, I bid you a fond farewell from Houston. See you in a couple of weeks.
Remember the disclaimer. This stuff is complicated, and you shouldn't make complex and expensive tax decisions based on something you read in an email newsletter from some dude. Do your homework, hire someone with a brain, and figure out rhe right answer for you.
All the best,
Phil.
Besides property and UK pensions, it’s worth noting that the pension double-tax jeopardy you describe above also applies to US retirement plans such as 401k and IRA. Art 17 para 1(a), not excepted by the saving clause, says that pension plans are only taxable by the country of residence (in this case the UK, and making the exit tax arguably a treaty override).
Some mitigation against double-tax may however be possible for all three. The final tax bill and financial loss for doing these may end up higher than before the exit tax, but will likely not be anything like as bad as the execrable exit tax itself.
For the property, selling to a third party to realize the gain for UK purposes will re-set the UK basis. This generates a concurrent tax liability in both countries but one can then be used as a credit for the other with no timing issues.
For a 401k or IRA, convert to a Roth. The UK fully recognizes Roths via the treaty, so out of the wood in future there. If Roth is impractical for some reason, collapse it and take early withdrawals. Probably a higher tax bill than the Roth route but still much better than the exit tax.
For UK pensions, extremely tricky because there are no early withdrawals permitted. The best (only?) solution may be to defer (unfortunately interest payable to IRS for deferring) the exit tax payments until the pension can be withdrawn. At that point again both country’s taxes become payable at the same time and under the treaty the US is bound to give credit for UK tax, Art 24 para 6. In this case the ability to rely on the treaty may be limited because the UK’s recognition of tax on former citizens extends only for ten years after renouncing.
Still, very unsatisfactory all round. It seems like it should be only a matter of time before somebody challenges the exit tax in the US courts as a breach of treaty.
Besides property and UK pensions, it’s worth noting that the pension double-tax jeopardy you describe above also applies to US retirement plans such as 401k and IRA. Art 17 para 1(a), not excepted by the saving clause, says that pension plans are only taxable by the country of residence (in this case the UK, and making the exit tax arguably a treaty override).
Some mitigation against double-tax may however be possible for all three. The final tax bill and financial loss for doing these may end up higher than before the exit tax, but will likely not be anything like as bad as the execrable exit tax itself.
For the property, selling to a third party to realize the gain for UK purposes will re-set the UK basis. This generates a concurrent tax liability in both countries but one can then be used as a credit for the other with no timing issues.
For a 401k or IRA, convert to a Roth. The UK fully recognizes Roths via the treaty, so out of the wood in future there. If Roth is impractical for some reason, collapse it and take early withdrawals. Probably a higher tax bill than the Roth route but still much better than the exit tax.
For UK pensions, extremely tricky because there are no early withdrawals permitted. The best (only?) solution may be to defer (unfortunately interest payable to IRS for deferring) the exit tax payments until the pension can be withdrawn. At that point again both country’s taxes become payable at the same time and under the treaty the US is bound to give credit for UK tax, Art 24 para 6. In this case the ability to rely on the treaty may be limited because the UK’s recognition of tax on former citizens extends only for ten years after renouncing.
Still, very unsatisfactory all round. It seems like it should be only a matter of time before somebody challenges the exit tax in the US courts as a breach of treaty.