global Tax What are the Tax Implications of Deferred Compensation for Expats? July 30, 2024 Deferred compensation is treated differently than most other types of assets or income at the time of expatriation. The tax implications are determined by whether the income is considered eligible or ineligible deferred compensation. Let’s explore the differences. Taxation Under Section 877A If you are a covered expatriate in the year you expatriate, you are subject to income tax on the net unrealized gain in your property as if the property had been sold for its fair market value on the day before your expatriation date (“mark-to-market tax”). This applies to most types of property interests held on date of expatriation but there are exceptions. Check out our blog to determine if you are considered a covered expatriate, Relinquishing U.S. Citizenship? What You Should Know about the Exit Tax and Covered Expat Status. Exceptions The mark-to-market tax does not apply to the following: Eligible deferred compensationIneligible deferred compensationSpecified tax deferred accountsInterests in non-grantor trusts Eligible Deferred Compensation Eligible types of deferred compensation, such as a 401(K) plan, IRA, employee pension or unvested stock option plan get better tax treatment than ineligible ones. When the individual exits the U.S., the income is not deemed distributed on the day before expatriation. Instead, once the individual begins receiving income in the future (so it will not be deferred at that time since it is being realized), the U.S. administrator withholds 30%. In special cases, individuals may be exempt from this tax under certain tax treaties. To be considered an eligible deferred compensation plan, the plan must meet two requirements: The payor is a U.S. person (or foreign person who elects to be treated as a U.S. person for this purpose)The covered expatriate notifies the payor of his or her status as a covered expatriate and waives the right to claim any reduction in withholding under an applicable treaty between the United States and the expatriating individuals’ country of residence Ineligible Deferred Compensation Ineligible deferred compensation is any deferred compensation item which is not eligible deferred compensation under 877A(c)(3). For example, if the payor is foreign or the expatriating individual failed to notify the payor of his or her covered expatriate status then the IRS will deem the full amount of the present value of the accrued benefit in the plan as distributed on the day before expatriation. Since this is not the result of a Mark-to-Market unrealized gain, the value of money in the account can be quite substantial! It is apparent that the tax implications can be very different if a deferred compensation is treated as eligible vs ineligible. Careful planning before expatriation is crucial.
