Eduardo Savarin, one of Facebook’s co-founders, recently announced that he renounced his U.S. citizenship in September of 2011, several months in advance of Facebook’s initial public offering (“IPO”).  The resulting tax consequences (not to mention the political fallout from Washington) offer an interesting case study into the Internal Revenue Code’s expatriation rules, which are covered in Section 877A.    

Per Section 877A, individuals who are “covered expatriates” are treated as selling all of their assets for their fair market value (e.g., mark-to-market) upon their expatriation (thereby triggering income tax on any built-in-gain), even if they don’t actually sell the underlying assets (the so-called “exit tax”).  As a result, covered expatriates are often subject to significant U.S. tax without any corresponding liquidity event.  The term “covered expatriates” includes individuals whose average net income over the previous 5 years exceeds approximately $150,000 per year, individuals with a net worth in excess of two million dollars, and individuals who fail to certify that their tax filings for the previous 5 years are complete and accurate.

An individual who qualifies as a covered expatriate must calculate his exit tax as of his “expatriation date”.  An individual’s expatriation date is the earliest occurrence of one of the following four events:  

  • The date the individual formally renounces his U.S. nationality in front of a diplomatic or consular officer of the U.S.;
  • The date the individual furnishes to the U.S. Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming an act of expatriation;
  • The date the U.S. Department of State issues a certificate of loss of nationality to the individual; or
  • The date a U.S. court cancels a naturalized citizen’s certificate of naturalization.

The calculation of the exit tax is at the center of Savarin’s tasty tax tale.  Because he must determine the fair market value of his assets as of the expatriation date, the value of his Facebook stock is certain to be controversial.  Of course, Savarin is apt to argue that his Facebook stock was worth significantly less in September 2011 than it was 5 months later upon the announcement of Facebook’s IPO.  Herein lies Savarin’s greatest tax arbitrage opportunity.  For the cost of a 15% haircut on the value of his Facebook stock as of September 2011, Savarin eliminated any future capital appreciation in his Facebook stock (including all run-up directly attributable to the IPO announcement) from U.S. taxation.

Further, Savarin ensured that he is taxed at the current long term capital gains rate of 15%, a rate that will quite possibly increase at the end of 2012.  Finally, Savarin can mitigate the impact of the mark-to-market exit tax by deferring the exit tax for the cost of an interest charge equal to the standard deficiency rate (which currently remains relatively low).  Savarin will only have to actually pay the tax upon the earlier of his sale of his Facebook stock or his death.

But, was this a tax efficient move?  If he would not have been subject to a tax recognition event upon Facebook’s IPO (which would be the case so long as he does not exercise stock options treated as deferred compensation), Savarin would have zero current tax, and all capital appreciation would similarly accrue income tax free (although any dividends would be subject to tax).  Rather than liquidate his stock during his lifetime, Savarin could have borrowed against his portfolio, thereby reaping the financial benefits for the cost of an interest charge.  Then, at his death (and assuming the estate tax laws do not drastically change and also assuming that he owns the Facebook stock or other stock in U.S corporations), the beneficiaries of Savarin’s estate would get a stepped up basis in his stock – eliminating any U.S. income taxes completely. Note that whether or not he expatriated, Savarin’s Facebook stock would be subject to U.S. estate taxes upon his death either by virtue of Savarin’s U.S. citizenship or because it is considered a U.S. sitused asset.

Ultimately, like everyone else, Savarin probably made his decision for a combination of personal and tax reasons.