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Section 877 – The Exit Tax

October 26, 2011— Section 877 and 877 A

The expatriation tax provisions under Section 877 and Section 877A of the Internal Revenue Code (IRC) apply to U.S. citizens who have renounced their citizenship and long-term residents (as defined in IRC 877(e)) that have ended their US resident status for federal tax purposes. Different rules apply according to the date of your expatriation.

Code Section 877 still applies to those that expatriated prior to June 17, 2008. The Pre-Heroes Act instituted an alternative tax regime to Covered Expatriates. Under Pre-Heroes Act Law, a Covered Expatriate included:

 
  • U.S. citizens that relinquished their citizenship
  • Certain Long-Term Residents (LTR) who would be considered a Covered Expatriate if he/she was a:
   
  • Lawful permanent resident of the U.S. (Green Card Holder) for 8 out of the last 15 taxable years prior to:
     
  • Ceasing to being a Green Card Holder, or
  • Commencing to be treated as a resident of a foreign country under the provisions of a tax treaty between the U.S. and a foreign country who does not waive the benefits of such treaty applicable to residents

In addition, in order for a Covered Expatriate to be subject to the alternative income tax regime he/she must have been an individual who met the following:

  • Income Tax Test: Had an average net taxable income tax liability for the period of five taxable years prior to expatriation of greater than US$139,000
  • Net Worth Test: Had a net worth of US$2 million or more on the date of expatriation.
  • Compliance Test: Failed to certify under the penalties of perjury that he complied with all U.S. Federal tax obligations for the preceding five years or failed to submit such evidence of compliance as the IRS may require.

Heroes Act - Section 877A

During the May 2008 Session, the House of Representatives and the Senate unanimously approved H.R. 6081, the "Heroes Earnings Assistance and Relief Tax Act of 2008" (the "Heroes Act"). Specifically, new Section 877A was added to the Internal Revenue Code and changes the taxation rules for certain U.S. citizens that relinquish their citizenship and certain long-term U.S. residents who terminate their residency after June 17, 2008.  Section 877A provides a new "mark-to-market" sale regime for all assets owned by Covered Expatriates upon Expatriation.

The significance of Section 877A is that if a Covered Expatriate expatriates, all of the person's property, including worldwide assets, are treated as sold the day before the expatriation for their fair market value ("Mark to Market Sale"). Any gain or loss realized will be taken into account for the taxable year of the expatriation. Losses, however, are only allowed to the extent that they are otherwise allowed under the general principles of tax law. The mark-to-market regime does not apply to specified tax-deferred accounts, interests in certain non-grantor trusts, or deferred compensation items. For more detailed information on the mark-to-market regime, please see Notice 2009-85.

Exceptions

Dual Citizen Exception
You are not a Covered Expatriate if you are a citizen at birth of the United States and another country or you are not a tax resident of the United States for more than 10 of the last 15 years.  However, you still must file Form 8854 and final tax returns.
Minor Exception
You are not a Covered Expatriate if you relinquish your citizenship before 18 ½ and you are not a U.S. resident for more than 10 years. 

Failing to File Form 8854 or Income Tax Return

Among the various new requirements contained in IRC 877A, individuals that renounced their U.S. citizenship or terminated their long-term resident status for tax purposes after June 3, 2004 are required to certify to the IRS that they have satisfied all federal tax requirements for the 5 years prior to expatriation.  If all federal tax requirements have not been satisfied for the 5 years prior to expatriation, even if the individual does not meet the monetary thresholds in IRC 877 or 877A, the individual will be subject to the IRC 877 and 877A expatriation tax provisions.

Anyone who has expatriated or terminated their U.S. residency must file Form 8854. A US$10,000 penalty will be imposed for failing to file Form 8854 when required. 

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