Retirement Plan U.S. Exit Tax Treatment (with Examples)

Retirement Plan Treatment for U.S. Exit Tax (with Examples)

Retirement Plan Treatment for U.S. Exit Tax 

Retirement Plans in General

U.S. Retirement Plans (401K and Equivalent)

• • • “Eligible deferred compensation item” means any deferred compensation item with respect to which:

      • • The payor is either a U.S. person or a non-U.S. person who elects to be treated as a U.S. person for purposes of section 877A(d)(1),

        • The covered expatriate notifies the payor of their status as a covered expatriate on Form W-8CE, and

        • The covered expatriate irrevocably waives any right to claim any withholding reduction on such item under any treaty with the United States on Form 8854.

    • The Secretary may provide separate guidance providing a procedure for a payor who is a non-U.S. person and wishes to elect to be treated as a U.S. person for purposes of section 877A(d)(1).”

U.S. Retirement Plan Examples

• • • • Example:  Brian is a U.S. citizen who is ready to expatriate. He is not considered a covered expatriate and therefore does not have any exit tax implications. However, if Brian maintains his 401K after he expatriates, he may have to file an annual 8854 form.

      • Example: Brad is a U.S. citizen who is also ready to expatriate. He is a covered expatriate and does not want to close his 401K at the time he terminates his U.S. citizenship. Thus, Brad will not have to pay any exit tax on his 401K, but he may have a continuing form 8854 requirement and a U.S. tax liability at a future date.

      • Example:  Brenda is a long-term permanent resident who wants to terminate her permanent resident status. She will be relocating home to a treaty country and will not be withdrawing her 401K at the time she expatriates. Since Brenda is a covered expatriate, once she begins receiving 401K distributions, she may be taxed — and unfortunatenly is not able to claim treaty benefits at that time to reduce her 401K U.S. tax witholding. That is because at the time she expatriated as they covered expatriate, she must waive any treaty benefits as to the distribution of the 401K.

        • As provided by the IRS (in pertinent part)

          • “The mark-to-market tax does not apply to the following.

          • Eligible deferred compensation items.

          • Instead, item (1) is subject to withholding, provided that you (i) properly make an irrevocable waiver on your initial filing of this form of any right to claim any reduction in withholding under an applicable treaty between the United States and your country of residence (see Line 1a under Part II, Section C, later); and (ii) timely notify the payor on Form W-8CE. To timely notify the payor on Form W-8CE, you must file the Form W-8CE with the payor on the earlier of: The day before the first distribution on or after your expatriation date, or 30 days after your expatriation date.”

U.S. Retirement Supplement (IRA)

• • • “Line 1c. A specified tax deferred account includes:

      • • An individual retirement plan (except those described in section 408(k) or 408(p)),

        • A qualified tuition program,

        • A qualified ABLE program,

        • A Coverdell education savings account,

        • A health savings account, and

        • An Archer medical savings account. The amount of your entire interest in your specified tax deferred account on the day before your expatriation date must be included on your Form 1040 or 1040-SR, or other schedule, for the portion of your tax year that includes your expatriation date.

        • If you have one or more specified tax deferred accounts, you must attach a statement to the form that separately identifies each specified tax deferred account and provides the entire account balance of each specified tax deferred account on the day before your expatriation date.”

U.S. Retirement Supplement (IRA) Examples

• • • • Example: Charlie is a U.S. citizen who is ready to expatriate and is a covered expatriate. He has a Traditional IRA that he was intending on using to supplement for his retirement. Unfortunately, a Traditional IRA does not receive tax-deferred treatment as a 401K and then instead considered a specified tax-deferred account and deemed distributed at the time he expatriates.

      • Example: Christopher is a U.S. citizen who is also ready to expatriate and is a covered expatriate as well. He is 70 years old and has a Roth IRA that he has maintained for many years. Typically, Christopher will not be taxed on his Roth at the time of exit.

      • Example: Christine is a lawful permanent resident covered expatriate who wants to terminate her long term lawful permanent residency. Prior to expatriation, she left her employment and was required to rollover her 401K into an IRA (she made no contributions post-employment to the IRA). This is a gray area as to whether Christine would be taxed on the 401K as eligible deferred compensation or whether it would be considered a specified tax-deferred account and deemed distributed at the timeshare expatriates.

Foreign Retirement Plans and Step-up Basis

• • • • “Line 1b. “Ineligible deferred compensation item” means any deferred compensation item that is not an eligible deferred compensation item. The amount of this deferred compensation item (the present value of the accrued benefit) must be included on your Form 1040 or 1040-SR, or other schedule, for the portion of your tax year that includes your expatriation date.

      • If you have one or more ineligible deferred compensation items, you must attach a statement to the form that separately identifies each ineligible deferred compensation item and provides the present value of such ineligible deferred compensation item as of the day before your expatriation date.

      • Example 19.H relinquishes his citizenship on November 13, 2009, and becomes a covered expatriate. On November 12, 2009, the day before H’s relinquishment of citizenship, H is a participant in a foreign pension plan that provides benefits pursuant to a trust described in section 402(b)(4) and that does not provide for a deferral of compensation under Treas. Reg. § 1.409A-1(b)(6). The trustee of the trust under the foreign pension plan does not comply with the procedures for electing to be treated as a U.S. person for purposes of section 877A(d)(1). Therefore, H’s interest in the plan is an ineligible deferred compensation item even if H complies with the prescribed procedures for notifying the payor of his status as a covered expatriate and makes an irrevocable waiver of any right to claim treaty benefits with respect to withholding on the payment.

      • Under section 877A(d)(2), on November 12, 2009, H is treated as having received an amount equal to the present value of his accrued benefit in the plan determined in accordance with section 5.D of this notice and is required to report such amount (other than his investment in the contract) on his federal income tax return for the taxable year that includes November 12, 2009.”

Foreign Retirement Plans Step-up Basis Examples

• • • • Example:  David is a U.S. citizen who previously worked in a foreign country and accumulated a significant amount of pension income. David has been a dual citizen his entire life and therefore he was a U.S. citizen when he was accumulating the foreign pension. Under most circumstances, the foreign pension would be deemed ineligible deferred compensation and grossed up as part of his exit tax if he is considered a covered expatriate.

      • Example: Danielle is a U.S. citizen who also previously worked in a foreign country, but she accumulated a majority of her foreign pension before she became a U.S. person. Danielle is a covered expatriate and so the value of her foreign pension plan would be grossed up and deemed distributed at the time she expatriates. However, since the majority of the income was earned prior to her becoming a U.S. person she may be able to claim step up benefits so that she is only taxed at exit on the value of the pension that represents her time as a U.S. person and not the amount of pension accumulated before she was a U.S. person.

Restricted Stock (Non-Vested)

• • • “(7) Restricted stock unit means a right to receive compensation in cash, shares of stock, or other property, as defined in section 5.B(5) of this notice, following the satisfaction of a specified vesting condition. A restricted stock unit is a stock-settled restricted stock unit to the extent that the compensation payable under such restricted stock unit is in the form of a transfer following the satisfaction of such vesting condition of shares of stock or other property or a right to receive property in the future. A restricted stock unit is a cash-settled restricted stock unit to the extent that it is not a stock-settled restricted stock unit.

    • With respect to any ineligible deferred compensation item described in section 5.B(1)d of this notice, the rights of the covered expatriate to such item will be treated as becoming transferable (within the meaning of Treas. Reg. § 1.83-3(d)) and not subject to a substantial risk of forfeiture (within the meaning of Treas. Reg. § 1.83-3(c)) on the day before the expatriation date.

    • Thus, for example, in the case of property transferred to or on behalf of the covered expatriate in connection with the performance of services that has not become substantially vested as of the expatriation date, such as restricted stock, to the extent that the covered expatriate has not previously taken into account under section 83 or in accordance with section 83 with respect to such transfer, generally such property will be treated as having become substantially vested for purposes of section 83 on the day before the expatriation date. Consequently, the fair market value of such property (determined without regard to any lapse restriction as defined in Treas. Reg. § 1.83-3(i)), reduced by the amount (if any) the covered expatriate paid for the property, generally will be includible in the covered expatriate’s income for Federal income tax purposes as of such date.”

Restricted Stock (Non-Vested) Example

• • • Example: Matthew is a U.S. citizen who is getting ready to expatriate. Most of his assets are in pre-vested restricted stock. Even though all of Matthew’s deferred compensation has not yet vested, that does not mean it has a zero value. Instead, the taxpayer must determine what the substantially vested value would be.

Should You Withdraw U.S. Pension or Not?

• • • “You must file your annual Form 8854 (Parts I and III) if you expatriated before 2024 and you:

      • Deferred the payment of tax,

      • Have an item of eligible deferred compensation, or

      • Are a beneficiary of a nongrantor trust.”

Late-Filing Disclosure Options

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

IRS Voluntary Disclosure Procedures (VDP, Willful)

Quiet Disclosure

Late Filing Penalties May be Reduced or Avoided

Current Year vs. Prior Year Non-Compliance

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

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