On May 15, 2012, the press reported Facebook co-founder Eduardo Saverin, who is set to earn billions when the social networking giant goes public on the U.S. stock market, has drawn criticism for renouncing his U.S. citizenship in a move that could save him millions in taxes. The Singapore resident still will end up paying fees, but experts say the benefits of expatriation for Saverin, and many others, may outweigh the costs. It is reported that Mr. Saverin’s position in Facebook has been estimated to be $4 billion. Assuming that the income would be capital gains, which may not be the case, i.e., the portion attributable to the exercise of compensatory (non-qualified) stock options, it was reported that the capital gains tax will be 15% or $600 million.
Expatriating Individuals, Including Long-Term Residents Relinquishing U.S. Residency
Congress significantly changed the tax rules associated with the exiting individual citizen or long term resident in the Heroes Earnings Assistance and Relief Tax Act of 2008, P.L. 110-245 (6/17/08). Under revised §877, now §877A, U.S. citizens renouncing their citizenship as well as certain “long-term residents” desirous of returning their green card, or collectively referred to as “expatriates” are no longer subject to U.S. tax under an alternate U.S. income tax model for a ten year period commending after the date that the act of expatriation occurs. The Heroes legislation added two new sections, 877A, which imposes certain expatriates to an exit or toll charge tax and §2801, a transfer tax provision, whereby U.S. recipients of gifts and bequests from certain expatriates are subject to gift or estate tax.
The Service, in Notice 2009-85, 2009-45 IRB 598, issued much guidance on the operation of both provisions. Taxpayers are permitted to rely on the positions taken in the Notice until final regulations are issued.
Individuals Subject to Section 877
Section 877A applies to “covered expatriates, i.e., U.S. citizens who renounce their citizenship as well as green card holders who relinquish their permanent residency visas or “green cards” after having been a permanent U.S. resident for at least 8 of the 15 years prior to the year in which expatriating occurred, including the year of expatriate. §877A(g)(5). As an aside, where a subject individual with a green card is present in the U.S. for one day in a calendar year, such still constitutes a “year” of U.S. residency. §7701(b)(1)(A)(i).
The toll charge or exit tax applies to "covered expatriates," with the term “expatriate” described in the preceding paragraph. To be a “covered” expatriate, per §877A(g)(1)(A), the expatriate must either: (i) have a net worth of at least $2M on the date of expatriation, i.e., the so-called “net worth test”; or (ii) an average annual net income tax for the five years prior to the year of expatriation greater than $145,000 (for 2009), which is adjusted for inflation, i.e., the so-called “income tax test”. Mr. Saverin would easily fall within the threshold.
There is yet a third category of a “covered expatriate”. This is an individual who fails the so-called “certification test”. This is where the expatriate (post 6/17/08 acts) fails to properly certify, under penalties of perjury, that he or she has been compliant with the U.S. tax laws for the 5 year period prior to expatriation. The certification test requires the filing of Form 8854. Failure to satisfy the certification test and file Form 8854 will result in the expat’s being classified as a covered expatriate and subject to the exit tax, regardless of whether such individual meets the “net worth test” or the “income tax test”.
In addition, there are two exemptions from the expatriation rules. The first pertains to individuals who became dual citizens at birth and meet certain requirements: (i) the individual must have obtained both U.S. citizenship and citizenship of another country solely by reason of birth; (ii) at time of the expatriation the individual must remain both a citizen and income tax resident of the other country; and (iii) such individual must not have qualified as a U.S. resident under the substantial presence test for more than 10 years of the preceding 15-year period ending with the year of expatriation. §877A(g)(1)(B)(i). The second exemption from §§877A and 2801 applies to persons who expatriate before reaching 18 ½ years of age and who did not qualify as a U.S. resident under the substantial presence test for more than 10 tax years prior to the year of expatriation. §877A(g)(1)(B)(ii) .
The Toll Charge Tax on Exiters
Section 877A subjects a covered expatriate to a toll charge tax on the net unrealized gain on his or her worldwide In general, Section 877A subjects a covered expatriate to an exit tax on the net unrealized gain with respect to all worldwide property when that covered expatriate terminates U.S. citizenship or permanent U.S. residency. The property owned by the covered expatriate will be deemed sold on the day before the expatriation date, and if and to the extent that the gain on the deemed sale exceeds a $627,000 exclusion, the covered expatriate will be liable for tax. Other special rules apply with respect to grantor and non-granto trusts.
Exit Tax Base
While the statute generally subjects a covered expatriate to the exit tax on the FMV of all property, wherever located, on the day before the expatriation date, it does not define what property is considered to be included in the covered expatriate’s tax base. Notice 2009-85 , however, explains in section 3.A. that for purposes of determining the tax base, a covered expatriate is deemed to "own any interest in property that would be taxable as part of his or her gross estate for Federal estate tax purposes under Chapter 11 of Subtitle B of the Code as if he or she had died on the day before the expatriation date as a citizen or resident of the United States." The credits provided by Sections 2010 through 2016 are excluded from the determination as to whether property constitutes part of the covered expatriate’s gross estate. Once the tax base is determined, the Notice instructs that for valuation purposes the principles applicable to estate tax valuations (i.e., Section 2031 and the accompanying Regulations) are to be used for determining the FMV of the tax base on the day before the expatriation date.
Allocation of Exclusion
While Section 877A(a)(3) provides each covered expatriate with an exclusion, it does not discuss how to allocate the exclusion among the covered expatriate’s gain assets. Notice 2009-85 , however, clarifies in section 3.B. that the exclusion is to be prorated among all gain assets based on the amount of relative built-in gain on each such asset. It also confirms that the exclusion applies to all assets that are subject to the deemed sale rule, including U.S. real property interests (USRPI). What is perhaps the strangest result of this provision, at least from a policy standpoint, is that it can permanently exempt from U.S. federal income tax some gain on USRPIs that otherwise would be subject to tax in the hands of anyone other than a covered expatriate.
Section 877A provides that "proper adjustment" is to be made to any gain or loss subsequently realized, to account for any gain or loss realized on property marked-to-market under Section 877A ("determined without regard to" the exclusion provided under Section 877A(a)(3) ). 9 Notice 2009-85 confirms that the adjustment is to be made by way of an increase or decrease, as the case may be, to the taxpayer’s basis in each asset. The Notice sets forth examples of downward as well as upward adjustments. Of course, from an income tax standpoint, assuming the expatriate never again resumes U.S. income tax residency, these adjustments are relevant only with respect to assets that remain subject to U.S. taxing jurisdiction, such as U.S. trade or business assets and USRPI.
Deferral and Adequate Security
A covered expatriate may defer payment of the exit tax in exchange for providing security to the IRS that satisfies Section 877A(b)(4) . As discussed further below, however, it remains to be seen how many taxpayers will actually find it possible to take advantage of this provision. Section 877A(b) provides that if "adequate security" is posted, a covered expatriate (who irrevocably waives any relevant treaty benefits 10 that otherwise might preclude assessment or collection of the tax) may elect to defer payment of the tax due under Section 877A , on an asset-by-asset basis, until the earlier of an actual sale of the asset in question or the expatriate’s death. Where deferral is successfully elected, Notice 2009-85 provides that interest accrues on the deferred tax at the usual underpayment rate under Section 6621 , compounded daily pursuant to Section 6622 . The Notice says that although the election to defer tax must be "irrevocable," the covered expatriate may pay the tax and interest due at any time.
Notice 2009-85 provides that monitoring of the deferral program is assigned to "Advisory" in the Service’s Plantation, Florida, office, and that the agreement is governed by the laws of the U.S. (although no particular state law is mentioned in the Notice). The request to enter into a deferral agreement itself, however, is filed in Bensalem, Pennsylvania, and this request is made by submitting two copies of the deferral agreement on the due date of the tax return for the year that includes the day before the expatriation date. The deferral request must show the calculation of the gain on assets for which deferral is proposed and documentation of the proposed collateral, a copy of the agreement to appoint an agent, and a copy of the covered expatriate’s income tax return. The deferral request also must be attached to that income tax return and may be filed simultaneously therewith.
Coordination With Other Code Sections
Section 877A(h)(1)(A) causes the termination, on the day before the expatriation date, of any period for acquiring property that otherwise would result in a reduction in the amount of gain recognized by the covered expatriate with respect to the disposal of property. Notice 2009-85 , section 4, clarifies that this provision is intended to apply to like-kind exchanges and involuntary conversions.
Similarly, Section 877A(h)(1)(B) provides that any extension of time to pay tax terminates on the day preceding the expatriation date. The Notice explains that as a result of this rule, tax is due and payable on the earlier of (1) the date the tax would have been due in the absence of the application of Section 877A or (2) the due date of the covered expatriate’s return for the tax year that includes the date preceding the expatriation date.
Section 877A also implicates a number of other specific Code sections, and Notice 2009-85 provides some guidance on coordinating these provisions.
Section 367. Section 367(a) applies to outbound stock (or other property) transfers to a foreign corporation. The Notice provides a timing rule with respect to gain recognition agreements under that section. Temp. Reg. 1.367(a)-8T(d)(6) states that if a U.S. transferor loses citizenship or permanent residency (i.e., a green card), the individual is treated as having disposed of the stock of the transferee corporation at that time. Notice 2009-85 clarifies that this deemed disposition is considered to occur before the application of Section 877A
Application of prior expatriation rules continues. Notice 2009-85 reiterates that an individual whose expatriation date occurred prior to 6/17/08 continues to be subject to the ten-year alternative tax regime set forth in Section 877 , as well as the accompanying reporting requirements under Section 6039G , as in effect on the individual’s expatriation date.
Deferred Compensation; Presumably a Large Portion of Mr. Saverin’s Assets in Facebook Pre IPO
Under Section 877A(d) , deferred compensation items, including unexercised stock options for services rendered, are generally subject to the exit tax under Section 877A(a) , and thus an amount equal to the present value of the covered expatriate’s account is treated as having been received on the day before expatriation and is taxed to the expatriate accordingly, unless the deferred compensation item at issue qualifies as an "eligible deferred compensation item."
For purposes of the mark-to-market rules, under Section 877A(d)(4) a "deferred compensation item" generally includes the following:
• Any interest in a qualified plan or other arrangement described in Section 219(g)(5) .
• Any interest in a foreign pension, retirement, or similar plan or arrangement.
• Any "item of deferred compensation."
• Any interest in property to be received in connection with the performance of services to the extent not previously taken into account in accordance with Section 83 .
Notice 2009-85 expands on several of the foregoing classes of items, in particular providing guidance on what items are includable by reference to Section 83 , and what specific items are considered to be within the class that the statute unhelpfully refers to only as "item[s] of deferred compensation."
With respect to Section 83 items, section 5.B(1)d of the Notice states that until further guidance is provided (presumably until Regulations are issued), Section 83 items are those items of property that have been transferred (as defined in Reg. 1.83-3(a) ) to the covered expatriate, or a right to property to which the covered expatriate has a legally binding right as of the date preceding the expatriation date, in connection with the performance of services. Notice 2009-85 clarifies that it is not relevant whether such items are substantially vested. Therefore, nonvested amounts are deemed to vest for purposes of this rule. Nevertheless, such items are includable only to the extent they have not been previously included by the covered expatriate.
Examples of includable items are:
•Statutory and nonstatutory stock options.
•Stock and other property.
•Stock-settled stock appreciation rights.
•Stock-settled restricted stock units.
Notice 2009-85 , section 5.B(4), similarly defines an "item of deferred compensation" to mean any amount of compensation if the terms of the compensation arrangement give the covered expatriate a legally binding right to the compensation as of the day before expatriation, the compensation has not been actually or constructively received by that date, and pursuant to the compensation arrangement the amount is payable to or on behalf of the expatriate. This catch-all provision, however, does not encompass items that are includable within one of the other classes of "deferred compensation items" under Section 877A(d)(4) (not to be confused with "items of deferred compensation" under Section 877A(d)(4)(C) ), namely, as either an interest in a qualified plan or other arrangement described in Section 219(g)(5) , an interest in a foreign pension, retirement, or similar plan or arrangement, or a Section 83 item.
Pursuant to Section 877A(d)(3) , a deferred compensation item is "eligible" only if the payor is either (1) a U.S. person or (2) a foreign person who elects to be treated as a U.S. person for this purpose, and provided that the covered expatriate notifies the payor of his or her status and makes an irrevocable waiver of any right to claim a reduction in withholding under an applicable U.S. tax treaty. In contrast to ineligible deferred compensation, eligible deferred compensation items are not subject to U.S. income tax until a covered expatriate receives a "taxable payment.
Now Back to Mr. Saverin.
Mr. Eduardo Saverin, and every other income earner who renounces their U.S. citizenship, as previously discussed, is subject to the tax imposed under Section 877A on his worldwide assets (net FMV) as of the day prior to the expatriation (date renunciation of US citizenship is effective). One well known legal professor suggested that Eduardo, who renounced his citizenship in Fall, 2011, will claim his Facebook stock was significantly less than the value of the stock on the open because he had such a large block of stock that he couldn’t have sold it privately. Presumably the Service will disagree.
Singapore seems to fit Eduardo’s criteria of where to live, i.e., in a country where you can make great sums of money without paying much tax. Singapore is a source country and is therefore not tax on foreign sourced income. The same is true for his native Brazil, which also does not impose worldwide tax.
Critics Slam Saverin’s Renunciation Departure.
The fall out from the Saverin exit-strategy to avoid hundreds of millions of dollars in US tax has prompted two senators, Chuck Schumer (D-N.Y.) and Bob Casey (D-Pa.), to introduce legislation referred to as the “Ex-PATRIOT Act”, which stands for "Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy". The proposal would force anyone who "expatriates for a substantial tax purpose — as judged by the Internal Revenue Service" to pay a mandatory 30 percent tax on future capital gains. The ex-citizens would also be turned back at the border if they ever tried to come back."This is a great American success story gone horribly wrong," Schumer told reporters Thursday. "Eduardo Saverin wants to defriend the United States of America just to avoid paying taxes. We aren’t going to let him get away with it."
Schumer called Saverin’s behavior "outrageous," arguing that "Saverin has turned his back on the country that welcomed him and kept him safe, educated him and helped him become a billionaire."Schumer also predicted the GOP would go along with the measure.
"Why wouldn’t they?" he said. Casey added, "I’d like to hear the reason why not."
The big advantage for Saverin is that, assuming the price of Facebook stock continues to rise, any future gains will not be subject to tax at all, because Singapore doesn’t tax capital gains.Saverin’s Facebook stock, thought to be about 4 percent of the total, is likely to be worth $3 billion to $4 billion. If the price doubles over time, not having to pay capital gains tax would save him $600 million at the current 15 percent U.S. rate, which could go up in the future. There would also be adverse estate tax impact were Saverin to die a U.S. citizen.