SCOTUS Reports

Tag: Expatriation Tax

  • Topsnik v. Commissioner, 146 T.C. 1 (2016): Expatriation Tax and Mark-to-Market Regime under I.R.C. § 877A

    Topsnik v. Commissioner, 146 T. C. 1 (2016)

    In Topsnik v. Commissioner, the U. S. Tax Court ruled that Gerd Topsnik, a German citizen and former U. S. lawful permanent resident (LPR), was liable for U. S. taxes on gains from an installment sale of stock and on the deemed sale of his installment obligation under I. R. C. § 877A upon expatriation. The court determined that Topsnik expatriated on November 20, 2010, when he formally abandoned his LPR status, and was a “covered expatriate” due to non-compliance with U. S. tax obligations, thus subjecting him to the mark-to-market tax regime.

    Parties

    Petitioner: Gerd Topsnik, a German citizen who was a lawful permanent resident of the United States from February 3, 1977, until his expatriation on November 20, 2010. Respondent: Commissioner of Internal Revenue.

    Facts

    Gerd Topsnik, a German citizen, became a lawful permanent resident of the United States on February 3, 1977. In 2004, he sold his stock in Gourmet Foods, Inc. , a U. S. corporation, for $5,427,000 in an installment sale. The sale terms included an initial down payment and subsequent monthly payments of $42,500 until the full amount was paid. In 2010, Topsnik received $510,000 in monthly installment payments. On November 20, 2010, he formally abandoned his LPR status by filing a Form I-407 with the U. S. Citizenship and Immigration Services. Topsnik did not file a Form 8854 to certify compliance with U. S. tax obligations for the five preceding years nor did he file a U. S. income tax return for 2010 until August 2, 2011, when he filed a delinquent Form 1040NR claiming the installment payments were exempt under the U. S. -Germany Tax Treaty.

    Procedural History

    The Commissioner issued a notice of deficiency for the 2010 tax year, asserting a deficiency of $138,903, an accuracy-related penalty of $27,781, and an addition to tax for failure to timely file of $13,890. The deficiency included tax on the first 11 monthly installment payments received in 2010 and on the deemed sale of the installment obligation under I. R. C. § 877A. Topsnik moved for summary judgment, contending that he was a German resident in 2010 and that § 877A did not apply. The Commissioner cross-moved for partial summary judgment, asserting that Topsnik was not a German resident and was a “covered expatriate” subject to § 877A. The Tax Court granted the Commissioner’s motion for partial summary judgment and denied Topsnik’s motion.

    Issue(s)

    Whether Gerd Topsnik was a resident of Germany during 2010 under the U. S. -Germany Tax Treaty?
    Whether Gerd Topsnik was a “covered expatriate” under I. R. C. § 877A and thus subject to the mark-to-market regime upon his expatriation on November 20, 2010?
    Whether I. R. C. § 877A applies to the right to receive installment payments from the 2004 sale of stock and whether the Commissioner correctly applied § 877A to Topsnik’s transaction?

    Rule(s) of Law

    Article 4 of the U. S. -Germany Tax Treaty defines a “resident of a Contracting State” as any person liable to tax therein by reason of domicile, residence, place of management, place of incorporation, or any other similar criterion, excluding persons liable to tax only on income from sources within that state. I. R. C. § 877A imposes a mark-to-market regime on “covered expatriates,” treating all property as sold on the day before expatriation. A “covered expatriate” includes any long-term resident who ceases to be a lawful permanent resident of the United States and fails to certify compliance with U. S. tax obligations for the five preceding years. An installment obligation is treated as property for purposes of the Code and is subject to valuation.

    Holding

    The Tax Court held that Gerd Topsnik was not a resident of Germany during 2010 under the U. S. -Germany Tax Treaty. Topsnik expatriated on November 20, 2010, when he formally abandoned his LPR status. He was a “covered expatriate” under I. R. C. § 877A due to his failure to certify compliance with U. S. tax obligations for the five preceding years. Consequently, Topsnik was liable for tax on the gains from the first 11 monthly installment payments received in 2010 before his expatriation and on the deemed sale of his right to receive future installment payments under § 877A.

    Reasoning

    The court determined that Topsnik was not a German resident in 2010 because he was not subject to German taxation on his worldwide income, as required by Article 4 of the U. S. -Germany Tax Treaty. Topsnik’s German contacts, such as a driver’s license and passport, were insufficient to establish residency under the treaty’s definition. The court found that Topsnik’s expatriation date was November 20, 2010, when he filed a Form I-407 and surrendered his green card. As a long-term resident who failed to certify tax compliance for the five preceding years, Topsnik was a “covered expatriate” subject to the mark-to-market regime under § 877A. The court rejected Topsnik’s argument that § 877A could not be applied retroactively to his 2004 transaction, finding that the installment obligation was property subject to valuation on the day before expatriation. The court also upheld the Commissioner’s application of § 877A, finding that the fair market value of the installment obligation was correctly determined based on the unpaid principal and accrued interest as of November 19, 2010.

    Disposition

    The Tax Court granted the Commissioner’s motion for partial summary judgment and denied Topsnik’s motion for summary judgment. An appropriate order was issued.

    Significance/Impact

    The Topsnik decision clarifies the application of I. R. C. § 877A to long-term residents who expatriate and fail to certify compliance with U. S. tax obligations. It reinforces the importance of the mark-to-market regime in ensuring that expatriates are taxed on unrealized gains upon expatriation. The decision also underscores the stringent requirements for establishing residency under tax treaties, requiring liability for worldwide income taxation. Subsequent cases have cited Topsnik in interpreting the scope of § 877A and the definition of “covered expatriate. ” The ruling has practical implications for tax practitioners advising clients on expatriation and the potential tax consequences of failing to comply with certification requirements.

  • Kronenberg v. Commissioner, 64 T.C. 428 (1975): Taxation of Liquidating Distributions After Expatriation

    Kronenberg v. Commissioner, 64 T. C. 428 (1975)

    Liquidating distributions received by a former U. S. citizen are taxable if one of the principal purposes of expatriation was to avoid U. S. taxes.

    Summary

    Max Kronenberg, a dual Swiss-U. S. citizen, renounced his U. S. citizenship one day before receiving liquidating distributions from his company, Polymica & Insulation Co. , Inc. (PIC). The IRS sought to tax these distributions under Section 877 of the Internal Revenue Code, which targets expatriation to avoid taxes. The Tax Court ruled that one of Kronenberg’s principal purposes for expatriation was tax avoidance, thus the distributions were taxable. The court also determined the fair market value of a note received in the distribution and denied a deduction for moving expenses to Switzerland, as they were not connected to taxable U. S. income.

    Facts

    Max Kronenberg, a Swiss-born naturalized U. S. citizen, owned a controlling interest in Polymica & Insulation Co. , Inc. (PIC), a mica importing business he founded. In 1966, he sold PIC’s assets to James W. Marshall and agreed to work for Marshall’s new company, P & I Co. , Inc. , initially in the U. S. and later in Europe. PIC was liquidated in early 1967. In December 1966, Kronenberg learned that renouncing his U. S. citizenship before receiving PIC’s liquidating distributions could exempt them from U. S. taxation. He and his family moved to Switzerland on February 21, 1967, renounced their U. S. citizenship on February 23, 1967, and received the distributions the following day. The distributions included cash, securities, and a note from P & I.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Kronenberg’s 1967 federal income tax, asserting that the liquidating distributions were taxable under Section 877. Kronenberg petitioned the U. S. Tax Court, challenging the taxability of the distributions, the valuation of the P & I note, and claiming a deduction for moving expenses to Switzerland.

    Issue(s)

    1. Whether the liquidating distributions received by Kronenberg after he became a nonresident alien are taxable under Section 877 of the Internal Revenue Code.
    2. What is the fair market value of the note distributed in the liquidation?
    3. Whether expenses incurred in moving to Switzerland are deductible under Section 877(b)(2).

    Holding

    1. Yes, because one of Kronenberg’s principal purposes for expatriation was to avoid U. S. income taxes on the distributions.
    2. The fair market value of the note was $20,679. 36 at the time of distribution, reflecting its speculative nature and the terms of payment.
    3. No, because the moving expenses were not connected with the gross income included under Section 877.

    Court’s Reasoning

    The court focused on the timing and circumstances of Kronenberg’s expatriation, concluding that his decision to renounce his U. S. citizenship was influenced by tax considerations. The court noted that Kronenberg accelerated his plans to move to Switzerland and renounce his citizenship after learning of the potential tax advantage, just one day before receiving the distributions. This timing suggested that tax avoidance was a principal purpose of his expatriation. The court applied Section 877, which was enacted to prevent tax-motivated expatriation, and found that it applied broadly to all types of income, including capital gains from liquidating distributions. The court valued the P & I note at $20,679. 36, considering its nonnegotiable and unsecured nature, the lack of interest, and the uncertainty of payment. The moving expenses were denied because they were connected to Kronenberg’s subsequent income in Switzerland, not the taxable U. S. income from the distributions.

    Practical Implications

    This decision clarifies that Section 877 applies to expatriates seeking to avoid taxes on any type of income, including capital gains from liquidating distributions. It underscores the importance of the timing and circumstances surrounding expatriation in determining tax liability. Practitioners should advise clients that last-minute expatriation before receiving significant income may trigger Section 877. The valuation of speculative assets like the P & I note highlights the need for careful valuation in tax planning. The denial of moving expense deductions under Section 877(b)(2) indicates that such expenses must be directly connected to taxable U. S. income to be deductible. Subsequent cases, such as Markus v. Commissioner and Hartung v. Commissioner, have further clarified the scope of deductions for expatriates, though they dealt with different sections of the tax code.