Certain property is excepted from application of the mark-to-market tax.
1) Deferred compensation.
2) Specific tax-deferred accounts.
3) Interests in non-grantor trusts.
Eligible Deferred Compensation
IRC Section 877A(c)(1) provides that the tax under the mark-to-market regime, provided in Section 877(a) does not apply to any deferred compensation item. In the case of an “eligible deferred compensation item” IRC Section 877A(d)(1)(A) provides generally that the payor must deduct and withhold a tax equal to 30% of any taxable payment to a covered expatriate with respect to such an item.
IRS Section 877A(d)(1)(B) provides that a taxable payment is any payment to the extent it would be includable in gross income of the covered expatriate if such person continued to be subject to tax as a citizen or resident of the U.S.
Since the covered expatriate must waive his right to claim treaty benefits with respect to an eligible deferred compensation item, the 30% withholding tax cannot be reduced or eliminated by treaty.
Deferred compensation is classified as “eligible deferred compensation” if either:
1) the payor is a U.S. person, or
2) the payor is a foreign person who elects to be treated as a U.S. person.
Deferred compensation specifically does not include deferred compensation attributable to services performed outside the U.S. while a covered expatriate was not a U.S. citizen or resident.
Tax on the payment of an “eligible deferred compensation item” is deferred until a covered expatriate received a taxable payment at which time tax is collected by a 30% withholding tax at the source.
For purposes of IRC Section 877A deferred compensation item means:
1) Any interest in a plan, described in IRC Section 219(g)(5) which means a plan described in IRC Section 401(a) that includes a trust exempt from tax under IRC Section 501(a), an annuity plan described in IRC Section 403(a).
2) An annuity contract described in the IRC Section 403(b).
3) A simplified employee pension (IRC Section 408(k)).
4) A simplified retirement account (IRC Section 408(p)
5) A trust described in IRC Section 501(c)(18).
6) Any interest in a foreign pension plan.
7) An item of deferred compensation as defined in IRS Notice 2009-85 (Section 5(B)(4).
8) Any property that the individual is entitled to receive in connection with the performance of services, to the extent not previously taken into account under IRC Section 83.
Examples of items of deferred compensation include:
1) A cash-settled stock appreciation right.
2) A phantom stock arrangement.
3) A cash-settled restricted stock unit.
4) An unfunded and unsecured promise to pay money or other compensation in the future.
Ineligible Deferred Compensation
Ineligible deferred compensation means any deferred compensation item that is not an eligible deferred compensation item. With respect to ineligible deferred compensation, an amount equal to the present value of an individual’s account is treated as received and taxable on the day before expatriation, and must be included in the covered expatriate’s Form 1040 (or other schedule as provided in Treas. Reg. Section 1.6012-1(b)(2)(ii)(b) for the portion of the taxable year that includes the day before the expatriation date.
Within 60 days of the receipt of a properly completed Form W-8CE, the payor of the ineligible deferred compensation item must advise the covered expatriate of the present value of the covered expatriate’s accrued benefit in the deferred compensation item on the day before the expatriation date.