Continuing the series …
Part 1 of this series introduced you to the idea that the United States taxes the non-US income of people who do NOT live in the United States and are tax residents of other countries. (Well this is the penalty for having been “Born In The USA”.)
Part 2 of this series explained that the rules used to impose taxation on those nonresidents were far more punitive than the rules imposed on Homeland Americans. It’s true. All other countries stop imposing taxation on their citizens who sever residence from and/or domicile from a country. But, the United States takes the opposite approach. The United States imposes worse taxation on those citizens (whether expats, emigrants or accidentals) who live outside the USA than on those who live in the USA. (Proving that the US taxation does not even pretend to be a “benefits based” tax system.)
Part 3 of this series explained how the way that Americans abroad are taxed by the United States depends – because of treaties – on the country where the individual lives. A US citizen living in France will be taxed differently (by the IRS) from a US citizen living in Canada. But, in both cases, the U.S. citizen is taxable on his income earned in France or Canada. That said, when it comes to the taxation of income earned in foreign countries, the US tax rules are clear! US citizens residing in foreign countries are required to treat the income earned in those countries as taxable by the United States. (Note that even income excluded under the 911 Foreign Earned Income Exclusion is first included on a US tax return and then excluded.)
Part 4 explained how US citizens living in certain US jurisdictions (including Puerto Rico) can escape US taxation on income earned in those US jurisdictions (although not in foreign countries).
Part 5 explained that although Americans abroad are taxable on their non-US source income, they are routinely excluded from benefits (including in some cases voting) that are available to citizens living in America.
Part 6 – The expatriation rules will NOT confiscate US based pensions but will confiscate non-US based pensions. Guess which Americans have non-US based pensions?
In Part 2 of this series, I have explained how the United States imposes a separate and more punitive taxation on the non-US assets and income of Americans abroad. Individuals who renounce US citizenship and are “covered expatriates” are subject to the 877A Exit Tax regime. The Exit Tax really is a collection of different kinds of taxes. (Pensions are treated differently from capital property which is subject to a deemed capital gain).
It’s interesting to see how the punitive taxation of Americans abroad continues with the S. 877A Exit Tax. The bottom line is:
US based pensions are NOT subject to punitive taxation at the of renunciation. The pension plan will (subject to meeting specific procedural requirements) remain intact. The distributions will be subject to taxation (subject to any treaty provisions) as they are made.
Non-US based pensions are subject to a confiscatory tax on the day before renunciation. Specifically, the non-US based pension is deemed to have been distributed in full on the day prior to renunciation. (This has the potential to result in a large income inclusion on income that was never actually received.) Let’s imagine a pension worth one million dollars. That million is treated as having been actually distributed on the day prior to renunciation (even though it has not been distributed) and a real tax is imposed based on that pretend distribution. As you can see this may result in a significant confiscation of part of the non-US pension.
This seems very strange given that the non-US pension has ZERO connection to the United States as was earned by the US citizen living and working outside the United States.
This is one more important reason why those considering renunciation should renounce before becoming a “covered expatriate”!
Think of it:
1. The US based pension escapes the confiscation.
2. The non-US based pension is subject to confiscatory taxation.
You will find the gruesome details in Internal Revenue Code S. 877A(d)*
Whether by accident or by design, the 877A Exit Tax rules, follow the rules of citizenship taxation and result in a particularly punitive application to Americans abroad.
John Richardson – Follow me on Twitter @Expatriationlaw
What follows is the actual text of the relevant part of 877A(d) of the Internal Revenue Code:
* (d)Treatment of deferred compensation items
(1)Withholding on eligible deferred compensation items
In the case of any eligible deferred compensation item, the payor shall deduct and withhold from any taxable payment to a covered expatriate with respect to such item a tax equal to 30 percent thereof.
For purposes of subparagraph (A), the term “taxable payment” means with respect to a covered expatriate any payment to the extent it would be includible in the gross income of the covered expatriate if such expatriate continued to be subject to tax as a citizen or resident of the United States. A deferred compensation item shall be taken into account as a payment under the preceding sentence when such item would be so includible.
(2)Other deferred compensation items
In the case of any deferred compensation item which is not an eligible deferred compensation item—
(i)with respect to any deferred compensation item to which clause (ii) does not apply, an amount equal to the present value of the covered expatriate’s accrued benefit shall be treated as having been received by such individual on the day before the expatriation date as a distribution under the plan, and
(ii)with respect to any deferred compensation item referred to in paragraph (4)(D), the rights of the covered expatriate to such item shall be treated as becoming transferable and not subject to a substantial risk of forfeiture on the day before the expatriation date,
(B)no early distribution tax shall apply by reason of such treatment, and
(C)appropriate adjustments shall be made to subsequent distributions from the plan to reflect such treatment.
(3)Eligible deferred compensation items
For purposes of this subsection, the term “eligible deferred compensation item” means any deferred compensation item with respect to which—
(A)the payor of such item is—
(i)a United States person, or
(ii)a person who is not a United States person but who elects to be treated as a United States person for purposes of paragraph (1) and meets such requirements as the Secretary may provide to ensure that the payor will meet the requirements of paragraph (1), and
(B)the covered expatriate—
(i)notifies the payor of his status as a covered expatriate, and
(ii)makes an irrevocable waiver of any right to claim any reduction under any treaty with the United States in withholding on such item.
(4)Deferred compensation item
For purposes of this subsection, the term “deferred compensation item” means—
(A)any interest in a plan or arrangement described in section 219(g)(5),
(B)any interest in a foreign pension plan or similar retirement arrangement or program,
(C)any item of deferred compensation, and
(D)any property, or right to property, which the individual is entitled to receive in connection with the performance of services to the extent not previously taken into account under section 83 or in accordance with section 83.
Paragraphs (1) and (2) shall not apply to any deferred compensation item to the extent attributable to services performed outside the United States while the covered expatriate was not a citizen or resident of the United States.