Expatriating long-term residents need clarification.

• Author: Packard, Pamela

Before the Health Insurance Portability and Accountability Act of 1996 (HIPAA), Sec. 877 would have applied only to U.S. citizens who had renounced or otherwise lost their citizenship (expatriated), if one of their principal purposes for doing so was to avoid paying tax. An expatriating taxpayer subject to Sec. 877 is taxed under Sec. 1 (regular tax) or Sec. 55 (alternative minimum tax), rather than under Sec. 871, for 10 years following his departure. Special sourcing rules apply under Sec. 877(d)(1). A nonresident alien is in most instances not liable for tax on portfolio interest under Sec. 871(h) or can sell stock issued by a U.S. company free of U.S. tax under the general sourcing rules of Sec. 865(a)(2) (if there were no Sec. 871 (a) (2) issue). However, an expatriating U.S. citizen (by definition, now a nonresident alien) subject to Sec. 877 has to report those income items and pay tax for 10 years after the expatriation date. Net-worth and tax-liability tests cause Sec. 877 to apply only to the "wealthy." Sec. 877(c) provides a ruling process under which a taxpayer can seek to establish that tax avoidance was not a principal purpose for the expatriation. Although Sec. 877 does not operate perfectly in this respect, it adheres to the general principle that wealth should be taxed where created.

The HIPAA extended the reach of Sec. 877 to include long-term residents who relinquish their "green cards" or otherwise cease to be taxed as residents. A long-term resident for this purpose is defined as a lawful permanent U.S. resident for eight out of the last 15 years, ending with the tax year in which the expatriation occurs. The changes to Sec. 877 may have been necessary to establish equal treatment between departing citizens and long-term residents. However, Congress left many issues to be resolved by regulations (which have yet to be published), and in some situations, it may have tipped the scales more heavily against departing long-term residents.

One such situation can arise when a departing taxpayer owns a controlled foreign corporation (CFC). As expected, Sec. 877 attempts to treat wealth accumulated in foreign corporations no differently from other holdings. Thus, Sec. 877(d)(1)(C) provides that any income or gain derived from CFC stock within 10 years of the date of the shareholder's expatriation is subject to Sec. 877's special tax rules.

Example: A, who is not a citizen, is the sole owner of a corporation that he formed in 1980...