If you are thinking about expatriating, beware of taxation under Section 877 and 877A of the Internal Revenue Code – Expatriation to avoid tax, and tax responsibilities of expatriation.
Covered expatriates are subject to specific taxing mechanisms under these sections.
Broadly speaking, expatriates are taxable as non-resident aliens from the date of expatriation subject to certain restrictions. For example, specific sourcing rules exist to reclassify income and gains from stock held in a controlled foreign corporation as United States-sourced rather than foreign sourced. This applies where the covered expatriate owns directly, indirectly or constructively, more than 50% of the total combined voting power during the 2-year period ending on the date of the loss of United States’ citizenship.
As a non-resident alien individual after expatriation, a covered expatriate must file a non-resident income tax return annually and treat income from a controlled foreign corporation as United States-sourced. Credits for foreign tax paid are available.
Covered expatriates are subject to specific rules as regards deductions that can be claimed from United States-sourced income, and restrictions on the ability to claim capital losses. In addition, they must file Form 8854 Initial and Annual Expatriation Statement on an annual basis and are subject to a market-to-market tax upon expatriation.
Specific rules also exist with respect to non-grantor trusts. Distributions from non-grantor trusts to expatriates must be withheld at 30% on the taxable portion of the distribution. The taxable portion is calculated as if the expatriate were still subject to tax as a citizen or resident of the United States. The covered expatriate cannot reduce the amount of withholding under an income tax treaty to which the United States is a party.