I

INTRODUCTION

The curiously titled “Heroes Earnings Assistance and Relief Tax Act of 2008” became law June 17, 2008. . This Act provides laudable benefits to armed service veterans, but to allegedly pay for those benefits, it  changed the tax regime governing (1) expatriating U.S. citizens (those who renounce U.S. citizenship) and (2)  “long term permanent residents”, defined as those holding a Green Card for eight out the fifteen years prior to expatriation, including the year of expatriation. (Holding a green card for one day counts as a whole year of permanent residency).

This new tax regime is severe. There is no question that wealthy U.S. Citizens have, over the years, expatriated for purely tax reasons.  However, extending this punitive tax regime to non-citizen permanent residents (so-called Green Card Holders) is, in this writer’s opinion, difficult to justify and it will certainly discourage the wealthier or highly trained  foreigner from taking up permanent residency..

The Act defines a  “covered expatriate” , subject to the new tax regime,  as (1)  a U.S. citizen, and (2) a “long term permanent resident”,  who have a net worth of  $2 million, OR have an annual net income tax for the five previous years greater than $139,000, adjusted for inflation. As discussed below, an expatriate with less net worth will be subject to the Act absent some affirmative action.

Green Card Holders (covered expatriates) might choose to expatriate for any number on non-tax related reasons. There are those who  are U.S. Citizens only because their parents were or are Citizens or they just happened to have been born here, and they may just decide to go back “home”, but they will be subject to the new tax rules..

A green card holder may expatriate , just for example,  for family reasons, to marry, or as a result of  illness,  or for a foreign based business opportunity, or to run for office in his/her home country.

A foreigner might have to apply for a Green Card to qualify for and/or take advantage of a U.S. business opportunity. While there are various visas available, the Green Card may be the only way to qualify for a long term U.S. assignment.  The Act will no doubt make it more difficult for U.S. companies to attract foreign talent, at least for more than eight years.

In any case, Congress and the President apparently chose to disregard all this to attract new revenues from covered expatriates to pay for the Act’s veterans’ benefits.  This may be wishful thinking. Moreover, the Act’s tax regime is so punitive it will no doubt accomplish its  purpose to discourage wealthy U.S. Citizens from expatriating, and it will likely reduce the number of expatriating permanent residents. The Act may negate the sources of revenue it was created to attract.

 

II

COVERED EXPATIRATES: EXCEPTIONS

U.S. Citizens with the requisite net worth or tax history are subject to the new tax rules except for the following narrow exceptions, which apply only to Citizens:

• The expatriate holds U.S. Citizenship solely be reason of birth, and is also is a Citizen of another country where he/she pays taxes at the time of expatriation, AND

• Such expatriate has not been a U.S. resident under the “substantial presence “test (183 days in any one year or by formula over three years) for more than 10 years out the previous fifteen years.
  
  
• A U.S. Citizen who expatriates before the age of 18 ½.
  
  

III

THE NEW TAX REGIME

The expatriation rules have always been rather complex, but until 2004 it was possible to apply to the IRS for a private ruling that expatriation was not for tax avoidance purposes. In 2004, however, the law was changed to provide a “bright line” test to impose a ten year forward U.S. tax regime on expatriates with assets over $622,000 (indexed for inflation).

The new rules eliminate the ten year forward tax regime, and instead covered expatriates will now be taxed as if they sold their assets at fair market value the day before expatriation, with a $600,000 exemption. Expatriating Green Card holders do get one advantage, in that the tax basis of property is deemed the fair market value at the date U.S. residency started.  Citizens and Green Card holders are taxed on world wide income, and therefore the exit tax is assessed on world-wide assets.

After paying the exit tax, the expatriate is then  subject to a completely new estate and gift tax regime: future direct and indirect gifts or bequests by the expatriate to U.S. beneficiaries are subject to tax at the highest (45%)  applicable gift or estate tax rate, and this tax is imposed on the U.S. beneficiaries. Gift taxes are normally imposed on the donor, and estate taxes on the estate but now the tax obligation falls on the beneficiary, regardless of the situs of the gifted assets. Consider the possibility that a former Green Card holder cannot (without sophisticated pre-planning) either gift or bequest assets to his U.S. family without imposing an onerous tax burden.

An exception to the tax on gifts or bequests is that applicable charitable or marital deductions will apply. For example, if the beneficiary of the expatriate’s estate is a U.S. citizen spouse, the bequest should not be considered a “covered” gift or bequest. The U.S. beneficiary can in any case deduct from income tax any tax paid on the distribution. The annual gift exemption tax exemption applies but not gifts for medical and educational expenses under Section 2503(e)). (It is possible for a permanent resident to have a foreign domicile sufficient to avoid U.S. estate tax on non-U.S. assets, but exit tax on world wide assets would seem to substantially negate this planning opportunity).

The Act imposes additional tax burdens on covered expatriates:

 

IV

AFFIRMATIVE ACTION REQUIRED

The Act requires an affirmative action by any person expatriating, and not just by  “covered expatriates”. Each expatriate must sign a declaration under penalty of perjury they he/she has complied with all tax laws for 5 years prior to expatriation. Failure to do so, regardless of net worth, will cause such person to be subject to the new tax regime including the exit tax.  Form 8854 is also required, and additional required forms are likely.

V.

SUMMATION

Clearly, a foreigner with sufficient assets should carefully consider the consequences of applying for permanent U.S. residency. If a green card is issued, permanent residency is measured from the date of the application.  As is always the case when new tax rules  penalize free mobility, pre-planning is essential.. It may be possible, for example, that an offshore  U.S. compliant  life insurance policy or policies, funded either before or after expatriation , can benefit  U.S. beneficiaries without the tax on inheritance. Other pre-planning opportunities may be relevant depending on the expatriates circumstances and objectives..

Whatever else the Act accomplishes, it should certainly cause foreigners to consider the potential consequences of  applying for or holding a green card , and those who have held a green card for less than 8 years might want to consider their options..

Citations: IRC Sections 877;877A. 2107; 2801, 6039G; see Technical Explanation of HR 6081.

 

 

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