Trusts and Estates

Ca. Trs. & Estates Quarterly Volume 15, Issue 2, Summer 2009


By Erin L. Prouty, Esq.*


Federal tax laws that apply to expatriating citizens and long-term permanent residents of the United States have been drastically changed. On June 17, 2008, President Bush signed into law the Heroes Earnings Assistance and Relief Tax Act of 20081 (the "Heroes Act"). The Heroes Act adds two new sections to the Internal Revenue Code affecting U.S. citizens who relinquish their U.S. citizenship and certain long-term lawful permanent residents ("green card" holders)2 who relinquish their right to permanent residency in the United States on or after June 17, 2008. These new sections impose (1) an "exit tax" on the appreciation of an expatriate’s worldwide assets,3 (2) continuing U.S. income tax on certain deferred compensation and distributions from nongrantor trusts,4 and (3) estate and gift taxes on gifts and bequests from an expatriate to any U.S. person.5 On October 15, 2009, the Internal Revenue Service ("IRS" or "Service") issued Notice 2009-85,6 which provides guidance on the exit tax and the continuing U.S. taxation of certain deferred compensation and of distributions from nongrantor trusts. Further guidance will be issued for the estate and gift taxes on gifts and bequests from an expatriate to a U.S. person.

The goal of this new regime is to capture the tax revenue that would have been generated in the United States if the expatriating individual had retained citizenship or green card status. It apparently is based on the presumptions that the individual would have sold all of his or her assets at some point before death, that lifetime gifts by that individual would all have been subject to U.S. gift tax, and that the individual’s entire estate remaining at the time of death would have been subject to U.S. estate tax. These presumptions naturally produce the best tax result for the U.S. government. For example, not all U.S. citizens sell all of their appreciated assets before death, in which case the heirs receive the assets with a stepped-up basis, and capital gains tax on the appreciation prior to death is never paid.

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