Common expatriation mistakes: The IRS rules involving expatriation and exit tax for covered expatriates are very complicated. When an expatriate is considered a covered expatriate, they may have to pay an exit tax. Whether or not they have to pay the exit tax, covered expatiates must perform a detailed analysis involving the unrealized capital gain for their U.S. and worldwide assets. In addition, they may have a deemed distribution for such assets as ineligible deferred compensation, tax deferred accounts, and certain trust ownership.
Here are some of the common mistakes we find with expatriation and exit tax preparation.
Long-Term Resident vs. Long-Term Visa Holder
Just a because a person has lived many years in the United States, does not mean they can be subject to the covered expatriate rules.
A person must be either a U.S. Citizen or Long-Term Legal Resident before they can even be considered a covered expatriate.
Still, if a person is a long-term visa holder or other long-term resident (but not an LTR per se), they may have other tax issues, including:
- Substantial Presence Test
- Sailing Papers
- 183 Day Capital Gain Rule
Not Considering IRC 877(a)(2)(C)
Just because a U.S. Citizen or Long-Term Resident fails the Net Worth or Net Income Tax Liability tests (which is a good thing), does not mean they are out of the woodwork just yet.
The taxpayer also has to show tax compliance for the past 5-years.
If a person has not (correctly) filed their taxes or reported their foreign accounts and assets properly, they are unable to comply with this code section and would be considered a covered expatriate (Read: Take care of this BEFORE expatriating).
Not Taking Step-Up Basis Into Consideration
If a person had certain assets prior to becoming a U.S. person, they may qualify for a step-up of the value.
For example, if Marina had purchased a property for $300,000 before coming to the U.S., which was worth $600,000 on they day she became a U.S. person, the step-up value will not be less than the FMV on that day ($600,000).
Therefore, if the property is worth $800,000 on the date before expatriation, that can have a big impact (including if it was her primary residence).
401K Administrator Notice (30-days or 1st Post-Expatriation Distribution)
You have to give the 401K administrator proper notice, or you lose deferral rights and may have to pay an immediate tax liability in a deemed distribution scenario.