'Topsnik:' Retroactive Expatriation Under §877A(?)

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By Edward Tanenbaum

Alston & Bird LLP, New York, NY

Poor Gerd Topsnik. He's batting 0 for 2 in the Tax Court.1

Mr. Topsnik, a German citizen, applied for and received a Green Card, becoming a "lawful permanent resident," back in 1977. Although believing that he had "abandoned" his U.S. residency prior to 2010, it was not until November 20, 2010, that he completed Form 1-407, Abandonment of Lawful Permanent Residence Status, officially abandoning his lawful permanent residence status for tax purposes in accordance with U.S. tax regulations.

In the meantime, in 2004, Topsnik sold stock in a California corporation on the installment basis with a down payment that year and with installment payments to be made in each of the years 2005 through 2013. The taxpayer filed (albeit untimely) tax returns for the years 2004 and 2005, reflecting the installment payments received in each of those years, but he did not file U.S. tax returns for 2006-2009. The IRS filed substitute returns on his behalf for each of those years. The taxpayer subsequently filed for a refund of his 2005 taxes and filed nonresident tax returns for the 2006-2009 period showing no taxes due in each year.

In the first Tax Court case, Topsnik claimed that he had "informally" abandoned his lawful permanent residence status as early as 2003 (when he moved back to Germany) and that he was a German resident in all years in issue. Thus, his position was that he was not subject to U.S. tax under Articles 4 and 13 of the U.S.-Germany Income Tax Treaty. The IRS argued that he had not formally abandoned his lawful permanent residence status for U.S. tax purposes until 2010 and that, based on all of the facts, he was not a German resident in any of the years in question.

The court sided with the IRS, confirming the fact that Topsnik had not abandoned his lawful permanent residence until 2010 when he finally did so officially in accordance with U.S. tax regulations. Moreover, the court also concluded on the facts that he was not a German resident and, therefore, could not invoke the treaty's tie-breaker rule to claim German residency for tax purposes.  Thus, his installment sales payments could be taxed by the United States for the 2004-2009 period.

Well, things got progressively worse for Mr. Topsnik. The taxpayer also did not file a U.S. resident tax return for the 2010 year but filed a late Form 1040 NR. The IRS issued a Notice of Deficiency for that year based on the fact that the taxpayer had already received 11 monthly installments in 2010 prior to the formal abandonment of his Green Card in November of 2010. Moreover, the IRS claimed that, under §877A, the taxpayer was subject to a mark-to-market deemed sale of his right to future installment payments.

In the second Tax Court case, the court again found that the taxpayer was not a German resident in 2010 based on information made available to it by the German Competent Authority, i.e., he never filed a German tax return for that year, he had registered as a nonresident for tax purposes in Germany, and he did not have a registered residence or habitual abode in Germany in 2010. Thus, the taxpayer should have filed a regular U.S. resident tax return reporting those installment proceeds.

But the court also found that the taxpayer was a "covered expatriate" under §877A and was, therefore, subject to the mark-to-market rules of that section with respect to his right to receive the balance of his installment payments through 2013.

Section 877A was enacted in 2008 and provides for a mark-to-market tax (an exit tax) on "covered expatriates," i.e., all property of a covered expatriate is deemed to have been sold on the day before the expatriation date. An "expatriate" is a U.S. person who renounces U.S. citizenship or a "long-term resident" of the United States who ceases to be a long-term resident. A long-term resident is one who is a lawful permanent resident in at least eight taxable years during the preceding 15-year period.  A "covered expatriate" is an expatriate who meets a tax liability test, meets a net worth test, or fails to certify under penalties of perjury that he has met his U.S. tax obligation for the five preceding taxable years.

First, the court determined that the relevant 15-year period for the purposes of §877A was 1996-2010. The court then determined that the taxpayer was a lawful permanent resident in the years 2004-2009 (as it found in the first Topsnik Tax Court case) and that he was also a lawful permanent resident in 2010.  Those seven years, together with the 1996-1998 years (not even counting, according to the court, the 1999-2003 years during which the taxpayer maintained he was a German resident), met the required eight-year period per the definition of "long-term resident."

The Tax Court then found that, since filing his Form 1-47 (officially abandoning his lawful permanent residence status for tax purposes), he had not filed the required Form 8854, Initial and Annual Expatriation Statement, and failed to certify, under penalties of perjury, that he had complied with all of his U.S. tax obligations for the five taxable years preceding the taxable year that includes the expatriation date. In fact, the taxpayer had not filed all of his prior income tax returns and had not met all of his prior payment obligations. Thus, he was a "covered expatriate."

Finally, the court analyzed whether the taxpayer's right to installment obligations was "property" in his hands such that he would be deemed to have sold that property on the day before his expatriation date. The court took notice of Notice 2009-85, which provides that, for purposes of §877A, "property" is defined as property of a type whose value would be includable in the value of the decedent's gross estate for federal estate tax purposes if the covered expatriate died on the day before his expatriation date.

The court then observed that an installment obligation is generally treated as property for purposes of the tax law, citing Reg. §15A.453-1(d)(2)(i). Further, the court observed that an installment obligation held at death is included in the value of a decedent's gross estate for federal estate tax purposes, citing Reg. §20.2033-1(b) and Gump v. Commissioner, 124 F.2d 540, 543 (9th Cir. 1942). Thus, the court found that the value of the right to the installment obligation was property that was required to be marked to market under §877A.

The taxpayer's final argument was that §877A, enacted in 2008 and before the taxpayer's expatriation date in 2010, could not be applied to his installment sale which took place in 2004.  The court dismissed that argument stating that the taxpayer's right to his installment obligations in 2010 when he expatriated was a property right that existed at the time of his expatriation which took place in 2010.

The taxpayer's argument that §877A cannot be retroactively applied to his 2004 sale is perhaps the most interesting and the most inviting. Nonetheless, a plain reading of the statute and regulations led the court to dismiss the taxpayer's argument without further discussion.

This commentary also appears in the March 2016 issue of the  Tax Management International Journal. For more information, in the Tax Management Portfolios, see Bissell, 907 T.M., U.S. Income Taxation of Nonresident Alien Individuals, Klasing and Francis, 6080 T.M., Section 911 and Other International Tax Rules Relating to U.S. Citizens and Residents and in Tax Practice Series, see ¶7150, U.S. Persons – Worldwide Taxation.

  1 Topsnik v. Commissioner, 143 T.C. 240 (2014); Topsnik v. Commissioner, 146 T.C. No. 1 (Jan. 20, 2016).

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