You've Got to Have HEART -- Except for Green Card Holders
By James J. Tobin, Esq.
Ernst & Young LLP, New York, NY
When Eddie Fisher had a million-seller in 1958 singing
“You’ve gotta have heart,” the film version
of the hit play Damn Yankees (from which the song was lifted)
was in theatres and the Senators were still playing baseball in
Washington. Fifty years later, the Nationals are playing baseball in
Washington and the Senators, along with their colleagues in the House,
were crafting the Heroes Earnings Assistance and Relief Tax Act of
2008, also known as the HEART
Act.1
The purpose of the HEART Act is to provide tax relief to members of
the military and their families, as well as veterans, and you won't
hear me criticizing that in the slightest. Rather, my beef is with one
of the revenue-raisers that Congress chose to use to pay for the
well-deserved benefits provided by the Act.
Specifically, I'm referring to the rules subjecting those
relinquishing their U.S. citizenship -- and particularly those
relinquishing long-term residency, green cards -- to income tax on the
net unrealized gain in their worldwide property as if it had been sold
for its fair market value on the day before the expatriation or
residency termination occurred -- a mark-to-market tax. (Arguably,
there is some “poetic justice” in using an
anti-expatriation provision, especially as it applies to those who
give up their citizenship, to pay for benefits to members of the U.S.
military!)
While I'm not particularly a fan of wealthy Americans who renounce
their citizenship to save on taxes, despite my usual focus on
corporate taxes I've recently had occasion to see how the
mark-to-market provisions of the HEART Act can apply in practice, to
the unjustified detriment of former green card
holders.
Background
New §877A, as added by the HEART Act, applies to U.S. citizens
who relinquish citizenship and to long-term residents who terminate
U.S. residency on or after June 17, 2008 -- the date of enactment of
the HEART Act -- if the individual has an average annual net income
tax liability for the five preceding years ending before the date of
the loss of U.S. citizenship or residency termination that exceeds
$124,000 (as adjusted for inflation after 2004 -- $139,000 in 2008);
has a net worth of $2 million or more on that date; or fails to
certify under penalties of perjury that he or she has complied with
all U.S. federal tax obligations for the preceding five years or fails
to submit such evidence of compliance as the Secretary may
require.
For this purpose, a “long-term resident” is a
noncitizen who is a lawful permanent resident of the United States for
at least eight taxable years during the period of 15 taxable years
ending with the year during which the individual either ceases to be a
lawful permanent resident of the United States or commences to be
treated as a resident of a foreign country under a tax treaty between
such foreign country and the United States (and does not waive such
benefits). A “lawful permanent resident” is an alien who
is a green card holder.2
As noted, under new §877A, U.S. citizens who relinquish their
U.S. citizenship and certain long-term U.S. residents who terminate
their U.S. residency are subject to income tax on the net unrealized
gain in their worldwide property as if the property had been sold for
its fair market value on the day before the expatriation or residency
termination. Gain from the deemed sale is taken into account at that
time without regard to other Code provisions. Any loss from the deemed
sale generally is taken into account to the extent otherwise provided
in the Code, except that the wash sale rules of §1091 do not
apply. Any net gain on the deemed sale is recognized to the extent it
exceeds $600,000 (indexed for inflation).
The new rules also trigger immediate tax on the value of certain
deferred compensation plans, even if not yet vested! They also tax
distributions from non-grantor trusts and certain tax deferred
accounts, as well as (under new §2801) gift tax in certain
situations. At the election of the taxpayer, payment of the exit tax
may be deferred until property is sold, but only if adequate security
is provided; plus, this does not apply in the case of deferred comp
and certain other items. Such deferral is irrevocable, carries an
interest charge, and requires the taxpayer to waive any treaty rights
relative to the taxation of the property.
Note that these new rules supersede the existing rules of
§877, under which an expatriating citizen or long-term resident
may be subject to U.S. income tax for the 10 taxable years after
giving up U.S. citizenship or long-term residency at the rates
applicable to U.S. citizens. However, the §877 tax only applied
to U.S.-source income. Thus, some people will be better off paying the
new one-time exit tax while others clearly will not
be.
Potential Impact of §877A on Green Card Holders
Imagine a British subject and green card holder who accepted an
opportunity offered by his employer, a U.K. investment bank, to
relocate to the United States in 1998 to take a position in the
investment bank's New York City office. Not being certain of the
duration of the U.S. assignment, he did not sell his flat in London,
but rented it to a friend. After getting an important promotion and
offer to stay in New York in 2000, he bought a condominium in a
restored building in the meat packing district for $200,000. He also
continued putting money into stocks in the United States, the United
Kingdom, and several emerging markets. In 2003, his grandfather died,
leaving the banker a small condominium on the Croissette in Cannes
overlooking the Mediterranean that he bought in 1985, which was used
for the grandparents' frequent vacations in the south of France.
On June 10, 2008, the banker's boss calls him into her office and
offers him an irresistible opportunity to run a division of the bank
back home in London.
His response is, “When do I leave?”
His boss answers, “As soon as possible.”
That evening, he tells a friend all about the impending move. The
friend is an international tax lawyer and mentions that he understands
that the U.K. tax system has certain advantages that are likely to
result in the banker paying less income tax than he would have staying
in the United States, but only if he gives up his green card. He notes
that green card holders have to keep paying U.S. taxes on their
worldwide income, regardless of where they live.
“Won't I lose the green card anyway if I move back home
without an intent to live here again, though?” the banker
asks.
“I'm no immigration lawyer,” the friend answers,
“but now that you mention it, that sounds about
right.”
“Then I might as well surrender the darn thing right
now,” the banker says. He takes a sip of his drink and asks what
happens U.S.-tax-wise if he just gives up his green card now.
“It's not really my area of expertise,” the friend
answers, “but, as I recall, there are rules that could subject
you to U.S. tax for 10 years after you give up the green card, but
only on your U.S.-source income.”
The banker tells his friend that he's decided not to sell his New
York condo and he confirms that any rent he receives would be
U.S.-source income.
The friend also notes that as long as the banker doesn't sell the
condo or any other U.S. assets for 10 years after he leaves, he should
be okay. The conversation then turns to the friend's three-week
vacation to Vietnam. He's leaving the next day.
The banker is scheduled to leave for London, where temporary
housing has been arranged until a tenant moves out of his flat, on
June 30. Among the paperwork he rushes to deal with in the days
leading up to his move are items concerning his 401(k), as well as an
application, prepared by another lawyer friend, for abandonment of
residence status, to be filed the next day with the U.S. Immigration
and Naturalization Service.
The banker's move goes smoothly, but when he gets home from his
first day of work in London, there is a message on his answering
machine from his international tax lawyer friend, who just got back
from vacation. He says that President Bush signed something called the
HEART Act on June 17.
“You didn't give up your green card, did you?” he asks
ominously. “Call me.”
On the day before the banker surrendered his green card, his NY
condo was worth a million dollars. Even worse, his flat in London was
worth $2.0 million and so was the condo in Cannes, both figures
attributable in significant part to the strength of sterling and the
euro against the dollar. The Cannes condo was only worth $200,000 when
his grandfather bought it in 1985, a year when the dollar was very
strong against the French franc. He purchased the London flat for a
song with his first year's bonus from the bank. On top of that, he's
got $500,000 in a 401(k). The built-in loss on his stock portfolio is
about $50,000.
Trembling, the banker calls his friend, who tells him that the good
news is that his 401(k) account should not be currently taxable, as
long as he waives reduced treaty rates on the taxable income it
generates later on.
“The only other good news is that there's a $600,000
exemption. As best I can figure, you've got about $3.6 million dollars
of mark-to-market gain, so you're going to owe U.S. tax on roughly $3
million.”
“That's nearly half a million bucks!” the banker
screams into the phone. “And I'm bloody well not planning to
sell the real estate. I don't have that kind of money!”
“You're not going to like this, either,” the lawyer
friend adds. “They're going to tax the value of your deferred
comp package, although probably not until you get payouts.”
The banker utters an expletive.
Understandably.
For reasons I don't quite understand, in some ways new §877A
treats expatriating green card holders even worse than at least
certain U.S. citizens who renounce their citizenship. In this regard,
people who became dual citizens at birth can escape §877A if they
have been U.S. residents for less than 10 years during the 15 years
that preceded the renunciation. So, a 65-year-old dual citizen of,
say, Ireland and the United States who has lived here for up to nine
years since turning 50 can escape the wrath of §877A, but a green
card holder who leaves to return home after an equal number of years
here, or takes an overseas assignment, cannot.
Something seems wrong here. And it's arguably compounded by the
fact that if the former green card holder sells assets after
expatriating to pay his or her U.S. tax bill and incurs a foreign tax
in doing so, it appears (at this early stage of the new law's life, at
least) that no foreign tax credit would be available in the United
States for any non-U.S. tax incurred.
Is this the kind of message we want to be sending to well-educated,
highly-motivated foreign nationals who come to the United States and
build successful careers here -- and, consequently, benefit the U.S.
economy -- and then, later on, move back home (or get an opportunity
to take an overseas assignment as part of that career)? While I'm not
an immigration expert, I think that in the case of someone moving back
home -- or otherwise not planning to return to the United States --
the green card will be lost in any case, whether or not it's formally
abandoned. Thus, as a practical matter, the green card holder is
essentially held hostage in the United States unless he pays what may
be a huge tax bill.
The new law had been proposed in the past but never enacted, and
its enactment this year (as a revenue offset) was not exactly
universally expected, so what were our lawmakers thinking when they
decided on a date-of-enactment effective date, providing many green
card holders with no chance to escape the new law's draconian
measures?
Not a lot of heart there. Maybe we need to think again.
This commentary also will appear in the September 2008, issue of
the Tax Management International Journal. For more information,
in the Tax Management Portfolios, see Klasing and Francis, 918
T.M., Section 911 and Other International Tax Rules Relating to
U.S. Citizens and Residents, and in Tax Practice Series, see
¶7130, U.S. Persons--Foreign Activities.
1
P.L. 110-245, signed by President Bush on June 17, 2008.
2
Regs. §301.7701(b)-1(b)(1).
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