On June 17, 2008 President Bush signed into law the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008. The primary purpose of this bill is to provide $1.2 billion dollars of tax relief to veterans and military families. The bill, H.R. 6081 was introduced on May 16, 2008 by Rep. Charles Rangel, Democrat, New York, and passed, with a near unanimous vote, by the House of Representatives on May 20, 2008 and by the Senate on May 22, 2008.
While few will quibble with the primary purpose of this bill, the method of funding the bill has drawn criticism in that it will impose an immediate income tax on U.S. citizens who relinquish their citizenship and certain long term residents who relinquish their green card.
Who Will Be Subject to the Exit Tax?
The law will apply to U.S. citizens who meet the definition of a “covered expatriate.” A “covered expatriate” is defined as a U.S. citizen who relinquishes their U.S. citizenship or a long term resident who resided in the United States during 8 of 15 years ending in the year of relinquishment of their permanent resident status (green card); if the individual has a) a net worth of over $2,000,000, or b) has paid an annual average income tax of more than $139,000 in the 5 years immediately preceding relinquishment, or c) has failed to file a U.S. income tax return in the 5 years immediately preceding relinquishment.
Exceptions to this rule encompass an individual who became at birth a citizen of both the United States and another country, and who as of the expatriation date continues to be a citizen of, and is taxed as a resident of such other country, and who has been a resident of the United States for not more than 10 taxable years during the 15 taxable year period ending with the taxable year of expatriation. Or, an individual whose relinquishment of U.S. citizenship occurs prior to when the individual attains an age of 18 ½ and who has not been a resident of the United States for not more than 10 taxable years before the date of relinquishment.
What Is the Effective Date of This Law?
The law will apply to any individual who meets the definition of a “covered expatriate” on or after June 17, 2008.
What Is the Date of Relinquishment?
A U.S. citizen will be treated as relinquishing their U.S. citizenship on the earliest of the following dates:
The date the individual renounces his United States nationality before a diplomatic or consular officer of the United States
The date the individual furnishes to the United States Department of State a signed statement of voluntary relinquishment of United States Nationality confirming the performance of an act of expatriation
The date the United States Department of State issues to an individual a certificate of loss of nationality
The date a court of the United States cancels a naturalized citizen’s certificate of naturalization
How Will Income Tax Be Imposed?
All global assets of a “covered expatriate” will be treated as sold on the day before the expatriation date for its fair market value. This is referred to as “mark to market” tax.
The law allows for an exclusion of $600,000 from the amount includible in gross income as a result of this law.
There are three major exceptions to this rule:
An interest in most US tax qualified pension plans, an interest in a foreign pension plan, deferred compensation and a unvested right to property to be received in connection with the performance of services. Items in this category will be subject to a 30% withholding tax when paid.
Individual retirement accounts and individual annuity accounts
An interest in a non grantor trust. Distributions from a non grantor trust will be subject to a 30% withholding tax.
With respect to these exceptions, further guidance will be needed from the Treasury in the form of Regulations.
When Is the Tax Due?
The tax imposed by this law is due with the filing of the tax return for the year citizenship or residency is relinquished.
Can the Payment of the Tax Be Deferred?
Yes. An election can be made to defer payment of tax until the property is actually sold provided that a bond or other security is posted with the Treasury Secretary to insure both payment of tax and interest.
Gifts and Bequests from “Covered Expatriates”
Under current tax law a gift or request received by a US citizen or resident alien is not subject to either income tax or gift tax.
Under the HEART bill, if a US citizen or resident alien receives a gift or bequest from a “covered expatriate” the recipient is subject to tax assessed at the highest marginal gift or estate tax rate (currently 45%) on the fair market value of the gift in excess of $12,000.
If the gift or bequest is made to a United States Trust the Trust is treated as a U.S. citizen and the trust must pay the tax.
If the gift or bequest is made to a foreign trust and in subsequent years the foreign trust makes a distribution of principal or income to a US citizen or resident alien the recipient is subject to tax assessed at the highest marginal gift or estate tax rate (currently 45%) on the fair market value of the gift in excess of $12,000.
Gifts or bequests made to a U.S. spouse or to a U.S charity are not subject to this tax.
Repeal of 10 Year Period
Under prior law, a U.S. citizen or long term resident who relinquished their citizenship or residency for tax avoidance purposes were subject to U.S. income tax as if they were still a U.S. tax resident for 10 years after the date of their relinquishment on all U.S. source income. Also, if such person were physically present in the United States for more than 30 days during one of those 10 years, they were deemed to be residents of the United States for all of that year and subject to U.S. income tax on their global income. The HEART bill repeals this requirement for “covered expatriates.”
Commentary
U.S. citizens who are considering relinquishing their citizenship and certain long term residents who are considering relinquishing their green card now must carefully consider the immediate tax cost of doing so. And those who do so must also reconsider the gifts and bequests that they may have been thinking of making to a U.S. citizen or long term resident in the future.
U.S. citizens who relinquish their citizenship and who are deemed to be “covered expatriates” will still need to be mindful of U.S. tax law for the rest of their lives. Distributions from a trust usually happen over many years and bequests will only come upon death.
Foreign nationals who become residents of the United States (green card holders) will now need to make a decision regarding their future, after they have been in the United States 7 years. If the intent is to return home at a point in the future, they will need to decide whether to do so before they have been in the United States for 8 years, or to continue to live in the United States knowing that when they do leave they may be considered a “covered expatriate’ and subject to immediate U.S. income tax on appreciated assets.
The “innocent” person who will suffer under this new law is the foreign executive who has been in the United States on a long term assignment (more than 8 years) and who is now returning home.
One conclusion is clear; if a person is going to relinquish their U.S citizenship or long term residency and will be considered a “covered expatriate” they will need careful planning and professional assistance before doing so.
Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.
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