Challenging issue
Here is an issue that may be challenging but I’ll try it anyway.
Since the HEART act of 2008 certain resident aliens who have lived here a while and have done well during that time, will have to pay a “repatriation tax” when returning home (by giving up resident alien status and becoming a covered expatriate), for example when they retire. How does this repatriation tax apply to an IRA?
1. A regular IRA (fully tax-deferred). I understand that the value of the IRA is added to the income in the last year of US residency and you pay tax over the full amount, as if it is a withdrawal, though no penalty is due. But what happens to the IRA itself? Does it continue to exist? How do you deal with taxes on future withdrawals? Or does the IRA simply terminate? How is the IRA administrator informed about this? I can see that they take another big withholding tax when you take the money out; why would they believe you when you say that you already paid the tax. Expecting the IRS to inform them is probably too much to ask.
2. A Roth IRA. Nowhere is it made clear what happens to such an IRA. Is a Roth IRA considered a “Specified Tax Deferred Account”? Worst case would be, I guess, that the gain in the Roth IRA is considered taxable income. Does the Roth IRA also terminate?
Would there be any advantage of converting the IRA to a Roth IRA in the years before expatriation.
Note, please don’t confuse a resident alien going back home with the other kind of expatriate: a US citizen living abroad.
Any insights?
MR
Permalink Submitted by Mon Rob on Tue, 2012-02-21 07:07
Adding to my own post:
Reading Section 877A (Tax Responsibilities of Expatration) which covers the new exit tax, it describes “Specified tax deferred accounts” as including an IRA as defined in section 7701 (a)(37) with some exclusions, plus some other account types (Coverdell etc). Section 7701 (a)(37) defines an IRA as accounts described in sections 408(a) and 408(b). It does NOT mention section 408A, which describes Roth IRA. This seems to suggest that a Roth IRA is NOT a “Specified tax deferred account”. If that is the case, a Roth IRA would not be an exception to the Mark to Market rule, meaning that it is deemed “sold” on the day of expatriation. The “base” would then be your (after tax) contributions and any gain would be taxed as a capital gain (short or long term). Does my analysis make sense? If this is the case, what is the status of the Roth IRA after expatriation?
I also found that there is a new form W-8CE which the covered expatriate must give to the “payer”, which I assume is the IRA administrator. It informs the payer about your status “who is to be treated as receiving a distribution of your entire interest in the account”
Another question now comes to mind: is an IRA distribution after 12/31/2012 subject to the new Medicare tax Obama imposed?????
RM
Permalink Submitted by Bruce Steiner on Tue, 2012-02-21 16:52
Congress passes legislation. The President signs (or doesn’t sign) it.
IRA distributions will not be subject to the Medicare tax. This makes IRAs more attractive than they would otherwise be.