Earlier in 2008, U.S. President Bush signed the Heroes Earnings Assistance and Relief Tax (HEART) Act.
The HEART Act provides tax and savings assistance for mi l itar y personnel and their families. In order to pay for the cost of these benefits, the HEART Act imposes a new markto- market exit tax under Section 877A on certain U.S. citizens and long-term U.S. residents who expatriate or surrender their green card after 16 June 2008. In addition to covering high net worth individuals who consider expatriation in order to avoid or minimise U.S. gift and estate tax obligations, Section 877A may also apply to green card holders on long-term international assignments in the United States who expatriate without proper up-front planning. The HEART Act requires covered expatriates to pay tax on unrealised gains with respect to all of their worldwide property in excess of U.S. $600,000 (subject to a cost of living adjustment). All worldwide property of a covered expatriate is deemed to be sold for its fair market value on the day before expatriation. Alternatively, a covered expatriate may be able to elect to defer this tax, subject to paying interest at the Internal Revenue Service (IRS) underpayment rate, if adequate security is provided. A “covered expatriate” generally is a person who relinquishes permanent U.S. resident status after holding it in eight of the last 15 years and who: has an average annual net income tax liability for the five preceding years of more than U.S. $139,000 (for 2008), has a net worth of U.S. $2,000,000 or more, or failed to certify compliance with U.S. tax obligations for the prior five years.
Deferred Compensation Exempt from Mark-to-Market Exit Tax
Certain items of deferred compensation can qualify for an exemption from the mark-tomarket exit tax. Deferred compensation includes tax-favoured retirement plans, foreign pension plans and property earned through services to the extent not previously taxed because of vesting restrictions. To qualify an item of pay as an eligible deferred compensation plan, the payor must be a U.S. person (or must elect to be so treated), and the covered expatriate must notify the payor of his or her status and waive any rights to claim reduced withholding rates pursuant to any treaty. Eligible deferred compensation is subject to a 30 per cent withholding tax at the time payments are made to the extent otherwise includible in U.S. taxable income.
Deferred Compensation Subject to Mark-to-Market Exit Tax
In contrast, items of ineligible deferred compensation will be subject to the markto- market exit tax. This means that all of the deferred compensation will be treated as paid immediately before the expatriation date, even though the covered expatriate has not received any cash compensation. This tax applies to the present value of the deferred compensation benefit. A covered expatriate is also treated as receiving a payment of the entire interest in any “tax deferred account” immediately before expatriation. Tax deferred accounts include Individual Retirement Accounts, Health Savings Accounts, Section 529 accounts and qualif ied tuition plans. Careful planning is required for employees on long-term assignments in the United States. Long-term green card holders who are not committed to staying in the United States indefinitely will want to consider surrendering their green card before becoming a covered expatriate. Employers should consider tracking deferred compensation subject to Section 877A and assisting covered expatriates in qualifying pay under the “eligible deferred compensation” exemption. When this issue went to press, the IRS was working on guidance defining key terms (such as the scope of a deferred compensation plan) that were not defined in Section 877A.
For more details regarding Section 877A, see McDermott On the Subject “HEART Act Applicable to Expatriates and Long-Term Residents,” available at http://www.mwe.com/info/news/ots0608e.htm.