New Rules for Expatriates and Trustees, the Mark-to-Market Exit Tax

Date : June 10, 2008

Dear Valued Reader,

We know an expatriate as one who relinquishes their US citizenship. You may not intend to renounce your citizenship and you may think that the subject of this newsletter has no relationship to you or your affairs, but hold on. The new rules for expatriation are surely a sign that tax increases are around the corner.

There has never been an “exit” tax, until now (President Bush has not signed H.R. 6081, yet.) As I have been researching this bill, and speaking to sources in the community, many questions have surfaced. This bill, entitled Heroes Earning Assistance and Relief Tax (HEART) Act, introduced by Charlie Rangel, NY Democrat, has passed both the House and the Senate. Many sites report it is brand new, but it has been in the works. Charlie Rangel is Chairmen of the Ways and Means Committee.

The report from Congress on May 22, 2008 states the following.

H.R. 6081 would primarily amend tax law as it relates to veterans of the military and active servicemen and servicewomen. Among its provisions, the act would modify the rules applicable to veterans eligible for qualified mortgage bonds, expand the rebate program enacted in the Economic Stimulus Act of 2008 (P.L. 110-185) and impose payroll taxes on wages paid under certain government contracts. The Joint Committee on Taxation (JCT) and the Congressional Budget Office estimate that enacting H.R. 6081 would increase revenues by $18 million in 2008 and by $124 million over the 2008 – 2018 period. It would add an estimated $734 million to off-budget surpluses over the 10-year period. The remaining budgetary effects would increase on-budget deficits by $102 million over the 2008-2013 period and by $728 over the 2008-2018 period.

It is simple to understand that this bill increases tax revenue; but it seems that there is a crossfire going on; that is the crossfire involving expatriates as the revenue source for the bill. Somehow, (midway through the bill) there are three provisions in the bill pertaining to all citizens, regardless of their relationship to the armed services or government contracts.

1. The act consists of a mark-to-market tax on all of the expatriate’s worldwide income.

2. A tax on certain gifts and bequests made by the covered expatriate to any US person; and

3. A repeal of the current so-called 10-year shadow period for covered expatriates.

If it is a little confusing, it means that all persons renouncing their US citizenship and some long-term Green Card holders will now pay an exit tax.

This means that under this act, for tax purposes, that such persons’ (expatriates) property would be treated as sold for its market value on the day before the relinquishment of citizenship or residency. Gains of greater than $600,000 would be subject to income taxation. Second, H.R. 6081 would extend the definition of a US employer to include foreign subsidiaries of US parent companies that employ a US citizen working in connection with a US government contract. The controlling entity and the employee are liable for employment taxes.

In addition, trustees of non-grantor trusts must withhold and pay the IRS 30 percent of the portion of any distribution (whether direct or indirect) that would have been taxable to the expatriate had he not expatriated. Failure to withhold the tax could subject the trustee to direct liability for the unpaid U.S. tax. Generally, the mark-to-market tax does not apply to non-grantor trusts when one is not an expatriate.

The Act makes a distinction between grantor trusts and non-grantor trusts. A grantor trust is ignored as a taxable entity for U.S. federal income tax purposes. The ‘owner' of a grantor trust must include in computing his personal tax liability the items of income, deduction and credit that are attributable to the trust. Therefore, in the case of the portion of any trust for which the covered expatriate is treated as the owner under the grantor trust provisions, the assets held by that portion of the trust are subject to the mark-to-market tax.

Some of the motivation behind the bill may be an attack on the oil business as Iraq’s oil business and government contracts with private entities. Partisan politics may be playing to keep money and people with assets from bleeding into other countries who offer opportunities not available in the US and using them as a source for funding veteran benefits. The jury is still out on the reaction to this, but Bush is expected to sign the bill imminently.

Individuals Covered

The Act applies to any expatriate if that individual,

- has a net worth of US $2 million or more;

- has an average net US income tax liability of greater than US $139,000 for the five year period prior to expatriation; or

- fails to certify that he has complied with all US federal tax obligations for the preceding five years (the ‘covered expatriate').

The Act contains two exceptions, which are broader than those contained in current law.

- An individual is not a ‘covered expatriate' if he certifies compliance with US federal tax obligations as specified above, and

- He was at birth a citizen of the US and another country, provided that (a) as of the expatriation he continues to be a citizen of, and a tax resident of, such other country, and (b) he has been a resident of the US for no more than 10 of the 15 taxable years ending with the taxable year of expatriation, or

- He relinquished US citizenship before reaching the age of 18 ½, provided that he was a resident of the US for not more than 10 taxable years before relinquishment.

There is much more to this bill and once again, only an expert planner, attorney or accountant and probably all three in a team, should advise you. I think that the government will have an easier time keeping track of the government workers and their assets, but since this applies to Green Card holders and the private sector, I ask if it is going to be enforceable and practical.

How will other countries handle the US when all of this claimed “tax” money has been transferred to their country or are they going to extradite the expatriate back to the US for not paying their taxes? The HEART Act has the potential for misplaced power tipping the scales toward the IRS and a Democratic legislation. My final quandary concerns foreign investment in the United States. Will this deter foreign investors from long-term interest and investing? We will be waiting to see how this unfolds.

Until next time,

John

ABOUT THIS EDITOR:

John Dietz is a strategic advisor at Trustmakers.com with a passion for client solutions that can encompass your business, your real estate, and your personal assets. Mr. Dietz serves to educate you on the latest in asset protection planning.

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