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Internal Revenue Code - Expatriate Provisions

Canada
Individuals considering renouncing their US citizenship, or terminating their long-term residency status, should familiarise themselves with the associated tax responsibilities mandated by the Internal Revenue Code ("IRC"). The current rules make it financially onerous for wealthy individuals to avoid tax by cutting their ties with the US. These provisions are also relevant to individuals seeking to obtain US citizenship or residency status.

Taxand Canada explores how the new regime under IRC 877A is applicable to wealthy individuals who expatriate.

Who does IRC 877A apply to?
Not all expatriates are subject to the tax regime under 877A. An expatriate is someone who renounces, relinquishes or loses their US citizenship. 877A only applies to "covered expatriates". Individuals who are captured by any part of the covered expatriate definition, and are not saved by one of the listed exceptions, may be subject to a so called exit tax.

Consequences for Covered Expatriates: The Mark-to-Market Tax
A covered expatriate is deemed to have sold their worldwide property for fair market value on the day before expatriation. The worldwide property captured by this mark-to-market regime includes all property that would be taxable as part of the covered expatriate's estate under US federal estate tax rules. Covered expatriates are then subject to income tax on the net unrealised gain on that property. This exit tax is due immediately.

Notwithstanding other IRC provisions, any gain recognised on the deemed sale will be taken into account for the tax year of that sale and taxed at the appropriate capital gains rate. A covered expatriate cannot benefit from other ameliorative IRC provisions that might have provided relief. Any loss recognised on the deemed sale will be taken into account for the tax year of that sale, to the extent otherwise provided by tax law.

Considerations
Many expatriates may not be able to avoid characterisation as a covered expatriate. For these individuals 877A has broad application with immediate tax consequences. If the covered expatriate's tax liability exceeds the $636,000 exclusion, he/she will have to determine whether it is in his/her best interest to elect to defer the exit tax on some or all of her worldwide assets. This may be necessary if there are liquidity issues. However, the long term costs of deferral may be prohibitive and the uncertainty of future tax rates should be considered.

Taxand's Take


If an individual is looking to expatriate, guidance should be sought from the IRS website, which provides the current forms and filing instructions. It is important to note that there are substantial penalties for covered expatriates who fail to file the required information returns. Advice from a tax expert is necessary to ensure compliance with the IRC's complex mark-to-market regime.

Your Taxand contact for further queries is:

Brieanne Brannagan
T. +1 416 862 7525
E. brieanne.brannagan@gowlings.com

Taxand's Take Author