Dale Mason, CPA Robert Len, CPA, PFS The Wolf Group 1818 Society The Exit Tax Dale Mason, CPA Robert Len, CPA, PFS The Wolf Group

Pursuant to Circular 230, promulgated by the Internal Revenue Service, any U.S. tax advice contained in the body of this presentation was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. © 2011 The Wolf Group

The Exit Tax Agenda History Overview Applicable Provisions /Compliance Issues Planning © 2011 The Wolf Group

History New “exit tax provisions” applicable to persons who relinquish their U.S. citizenship or terminate their long-term residence status after June 16, 2008 Prior law: Generally a 10 year alternative tax regime First enacted 1966 Strengthened in 1996 to include “long-term residents” Presumptive tax avoidance if assets/income thresholds reached 2004 law eliminated subjectivity & increased asset/income thresholds 1966 Act – Only applicable to US citizens on US source income for the principal purpose of tax avoidance 1996 Act – Covered expats now included “long-term” residents (green card holders) - Presumptive tax avoidance was presumed if net worth > $500K or $100K income tax liab - 10 year filing period required 2004 Act - Changed the income tax and net worth thresholds to $124K and $2M Changed to completely objective standard. Eliminated “presumtive tax avoidance” Expatriator was resident again if spent more than 30 days in US © 2011 The Wolf Group

Exit Tax Overview Section 877A: “Mark-to-Market” tax on gains exceeding $636,000 (2011) and distribution of certain deferred compensation Deemed sale of worldwide assets on the day prior to expatriation Applies to “covered expatriates” Renounce or relinquish U.S. citizenship Termination of “long-term residency” status (GCH 8 out of 15yrs) Net worth exceeds $2 million Average 5 year tax liability exceeds $147,000 (2011) Exceptions for dual-nationals (at birth) and expatriation before 18 ½ years old. Dual citizens (at birth in other country) Taxed as a resident of the other country Resident of the US for not more than 10 years out of the last 15 Also, exception also for people less than 18.5 and who were a US resident 10 years or less © 2011 The Wolf Group

Exit Tax Overview Imposition of a tax at the highest gift or estate tax rates on receipt by a U.S. person of a “covered gift” or bequest from a “covered expatriate” Recipient pays the tax Special rules apply to assets held in trust by a “covered expatriate” Compliance requirements: Form 8854 and W-8CE © 2011 The Wolf Group

Provisions IRC Section 877A IRS Notice 2009-85 IRS Notice 97-19 Form 8854 and Instructions Form W-8CE and Instructions Note that regulations have not been issued but should be and eventually will be issued. So we just have the following materials to understand the “exit tax” law so far. Details can be found in the above internal revenue code provisions and IRS releases Even though the Exit Tax was passed in 2008, IRS Notices from 1997 still apply because they are referenced in the 2009 Notice © 2011 The Wolf Group

Covered Expatriate Failure to file Form 8854 U.S. citizens who relinquish U.S. citizenship Termination of “Long-term residency” Green Card Holders cease to be lawful permanent residents 8 out of 15 years Counting of years important Revoked or abandoned (not simply expired) Treaty tie-breaker provision Failure to file Form 8854 Safe to say that the relinquishment of US citizenship is straightforward and not too many people do this so I will focus on Termination of LT Residency 8 out of 15 years Any one day in the US within a calendar year with a Green Card is considered a year. Therefore, 6 years and 2 days is the shortest period of time Termination of LT Residency Tax Law: “Ceases to be a lawful permanent resident by revocation or Administratively or judicially determined to be abandoned (Immigration law: GC may have expired) There is a difference between immigration law and Tax law Treaty Tie-Breaker provision Filing a tax return as a nonresident may immediately terminate long-term residency and therefore trigger the exit tax. Must file Form 8854 otherwise: Even if the person has not met the threshold, they may be seen as having expatriated Must certify under penalties of perjury that “you have complied with all of your tax obligations for the 5 preceding tax years”. Have you complied? Fully paid tax on all your worldwide income? Filed form 5471 / 8865 / New Specified Foreign Financial Form? © 2011 The Wolf Group

Income Tax & Net Worth Tests Income tax test Each taxpayer responsible for joint liability Net worth test Global assets minus global liabilities Value of assets determined under “gift tax principles” Tax liability determined under “estate tax principles” Present value of pension is included in net worth calculation Average tax liability $147,000 . © 2011 The Wolf Group

Net Worth Test Cont. Present value of World Bank pension included in net worth test We believe that the taxpayer should use a special discount rate applicable to defined benefit plans Actual calculation should be made by the Bank or an actuary 120% of the federal mid-term rate which stands at less than 2% now. However, another provision under Rev. Proc. 2004-37 suggests that we could use a 7% interest rate in certain situations. The Form W-8CE says that within 60 days of receiving the firm that the payor should provide the individual with the “present value of their accrued benefit” in the pension plan. This would be the gross amount. The taxable amount would also need to be determined which is about 50- 60% of the gross. © 2011 The Wolf Group

Q & A

Mark-to-Market Tax $636K exclusion amount allocated pro rata to all assets having built-in gain Green card holders are deemed to have basis in assets equal to FMV of assets on date first became a tax resident. Gains/income included in final U.S. resident tax return Defer tax? First become a tax resident when they became a tax resident under any test, not necessarily just becoming a lawful permanent resident. Example: If the individual is a “covered expatriate” they trigger the exit tax: 1. Deemed sale of their worldwide asset Use as the deemed sales price the FMV of the asset at the day before the expatriation date Use as the cost basis the greater of the cost basis when purchased or when the individual became a US tax resident. Net gain is then reduced by $636,000 Remainder of gain is included in the taxpayers final US tax return The taxpayer may defer tax by entering into an agreement with the IRS until the person sells the particular assets or dies. Interest is applied. I don’t know anyone who has done this. © 2011 The Wolf Group

Tax on Deferred Compensation Not part of “Mark-to-Market” tax calculation Deferred compensation U.S. and foreign retirement plans Eligible deferred compensation Applicable to payments of deferred compensation made by U.S. payors Payor must deduct and withhold 30% withholding tax Deferred compensation plans are subject to a special tax regime under the Exit Tax. The most important thing to remember is that the $636K exclusion only applies to the Mark-to-Market Tax and not the tax on deferred compensation or specified tax deferred accounts (IRSs). Eligible deferred compensation: Deferred compensation paid by “US payors” For example, if you had a deferred compensation plan with a U.S. domestic employer then a 30% withholding tax would apply on each distribution. © 2011 The Wolf Group

Tax on Deferred Compensation Ineligible deferred compensation Non-U.S. payor who fails to make the election to become U.S. payor Present value of the covered expatriate’s “accrued benefit” is treated as being received on the day before expatriation W-8CE presented to payor. Payor should provide the amount of the PV of accrued benefit within 60 days (Rev. Proc. 2004-37) Inelible Deferred Compensation: Deferred compensation paid by a non-US payor. Since the World Bank uses an offshore trust to hold its pension assets it is considered a non-US payor and therefore pension payments fall under the rules for ineligible deferred compensation. There is a possibility of electing US payor treatment but the IRS has not issued guidelines and I understand that the Bank will not be electing US payor status. Therefore, the present value of the covered expatriate’s “accrued benefit” is treated as being received on the day before expatriation. Again the payor should provide this info to you. The taxable portion of the benefit should be included in the covered expatriates final income tax return. “Until further guidance is issued, in the case of a defined contribution plan, the PV of is the account balance. In the case of a Defined Benefit Plan use the method set forth in Rev. Proc 2004-37. Under this method, it uses a 7% interest rate to calculate the PV of the accrued benefit….But let an actuary or the Bank perform this calculation. I have yet to have an expatriate trigger the tax, so I don’t know how this is done. © 2011 The Wolf Group

Tax on Deferred Compensation Present value of “accrued benefit” does not include ineligible deferred compensation attributable to services performed outside the U.S. before the person became a U.S. citizen or green card holder. Attributable to “services performed outside the US”. This is actually right in the statute and therefore only to “the extent that deferred compensation is attributable to services performed outside the United States.” For most of the WB client base a substantial amount of their services were performed in the US. The guidance as to how to make this calculation is set forth in Rev. Proc. 2004-37. But until further guidance is published any “reasonable method” will be allowed. © 2011 The Wolf Group

Specified Tax Deferred Accounts Not included in the “Mark-to-Market” tax Specified Tax Deferred Account: Individual Retirement Accounts Coverdale education accounts Health savings account Deemed distributed on the day before expatriation date No early withdrawal penalty Also includes 529 plans No 30% tax withholding Included entirely on the taxpayer’s last US tax return © 2011 The Wolf Group

Q & A

Compliance Issues Dual status tax return required for year of expatriation File Form 1040NR in subsequent years Form 8854 Must certify compliance with all U.S. tax obligations for past 5 years (otherwise will automatically be considered a “covered expatriate”) File the Form 8854 by the due date of tax return Make election for “step-up” of assets at date of becoming a lawful permanent resident Penalty for failure to timely file is $10,000 Form W-8CE REFER THE CROWD TO THE FORM AND INSTUCTIONS IN THE HANDOUT Dual status return is required in year of expatriation from the time the green card is given up the person files as a resident up until that time and then for the remainder of the year they must file as a nonresident and thus are considered “dual status”. Tricky tax return to file and really hard to do this using Turbotax. Form 8854 If expatriated in 2011, use PART I, PART IV AND PART V Must be filed to “certify” compliance with performing all your US tax obligations for the past 5 years. Step-up in basis of assets at date of becoming a US tax resident. Failure to file form 8854 results in being a “covered expatriate” and/or being subject to a penalty of $10,000 per year. FILE Form W-8CE File with the payor of deferred compensation ONLY IF YOU ARE A “COVERED EXPATRIATE” Again – If the payor is a US payor and therefore eligible deferred compensation payor the deferred compensation or specified tax deferred account (IRA) will withhold 30% taxable payment to a covered expatriate File with payor of ineligible deferred compensation so that the payor will calculate the present value of the covered expatriates accrued benefit in the deferred compensation item. The payor should do this within 60 days of receiving the W-8CE. This would be the gross amount: The taxable amount could be calculated using the Rev. Proc 2004-37 © 2011 The Wolf Group

U.S. Gift/Estate Tax Consequences U.S. citizen or resident receives property either by gift or bequest from a “covered expatriate” Transfer of the property is subject to tax $13,000 annual exclusion applies Equal to the value of the property multiplied by the highest rate of tax for federal estate tax or gift tax The tax is payable by the recipient US recipients of transfers by covered expatriates are subject to tax Basics of Gift & Estate Tax: Transfer of wealth in lifetime / Transfer at death US citizen and US green card holder domiciled in US and subject to gift/estate tax on transfer of worldwide assets Back to unified system $5 Million exemption (2012 law ends) Person transferring the money is subject to the gift/estate tax! A “covered person” is subject to these provisions except that the recipient is subject to this new tax. There is a $13,000 exemption $134,000 to noncitizen spouse per year. © 2011 The Wolf Group

Exit Tax Planning Become a U.S. citizen! File U.S. taxes forever Hold on to “long-term resident” status Surrender green card before becoming a long-term resident (less than 8 year threshold) and obtain non-immigrant visa Surrender green card before income tax/asset thresholds met and obtain non-immigrant visa Become a U.S. citizen! File U.S. taxes forever © 2011 The Wolf Group

Q & A