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The Expatriation Tax, Deferrals, Mark to Market, the Macomber Conundrum and Doubtful Constitutionality Henry M Saint Louis University School of Law Scholarship Commons All Faculty Scholarship 2017 The Expatriation Tax, Deferrals, Mark to Market, the Macomber Conundrum and Doubtful Constitutionality Henry M. Ordower Saint Louis University School of Law, [email protected] Follow this and additional works at: https://scholarship.law.slu.edu/faculty Part of the Constitutional Law Commons, Immigration Law Commons, Taxation-Federal Commons, and the Tax Law Commons Recommended Citation Ordower, Henry, The Expatriation Tax, Deferrals, Mark to Market, the Macomber Conundrum and Doubtful Constitutionality (2017). Pittsburgh Tax Review, Vol. 15, No. 1, 2017. This Article is brought to you for free and open access by Scholarship Commons. It has been accepted for inclusion in All Faculty Scholarship by an authorized administrator of Scholarship Commons. For more information, please contact [email protected], [email protected]. Volume 15 (2017) | ISSN 1932-1821 (print) 1932-1996 (online) DOI 10.5195/taxreview.2017.67 | http://taxreview.law.pitt.edu ARTICLES THE EXPATRIATION TAX, DEFERRALS, MARK TO MARKET, THE MACOMBER CONUNDRUM AND DOUBTFUL CONSTITUTIONALITY Henry Ordower This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 United States License. This journal is published by the University Library System of the University of Pittsburgh as part of its D-Scribe Digital Publishing Program, and is cosponsored by the University of Pittsburgh Press. Electronic copy available at: https://ssrn.com/abstract=3201117 ARTICLES THE EXPATRIATION TAX, DEFERRALS, MARK TO MARKET, THE MACOMBER CONUNDRUM AND DOUBTFUL CONSTITUTIONALITY Henry Ordower* I. INTRODUCTION Congress added § 877A—captioned “[t]ax responsibilities of expatriation”1—to the Internal Revenue Code in 20082 to prevent taxpayers who, because they expatriate,3 will cease to be subject to the U.S. federal income tax on their worldwide income4 from avoiding U.S. taxation on income, including asset appreciation, arising before expatriation. The expatriation tax terminates the deferral of some income5 and forces the * Professor of Law, Saint Louis University School of Law. Professor Ordower has an A.B. from Washington University, and an M.A. and J.D. from The University of Chicago. An earlier draft of this article was distributed and presented at the University of Michigan/McGill University Tax and Citizenship Conference, Ann Arbor, Michigan, October 9, 2015. Thanks to Xia Wang for research assistance and to Kelly Mulholland and Ilene Ordower for helpful comments. 1 This article refers to § 877A as the expatriation or exit tax. 2 Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008, Pub. L. No. 110-245, § 301(a), 122 Stat. 1624, 1638. 3 I.R.C. § 877A(g)(2) (defining expatriate as one who relinquishes citizenship or ceases to be a permanent resident). 4 Treas. Reg. § 1.1-1 (as amended in 2008) (worldwide income taxation of citizens and residents). 5 I.R.C. § 1001 For purposes of this article, “deferred income” refers to income the inclusion of which in gross income is deferred to a date later than the earliest date on which the Code could have required the taxpayer to include it in income consistent with the Sixteenth Amendment to the U.S. Constitution. In most instances, deferral results from an express statutory provision, but nonstatutory deferrals exist as well—nonstatutory deferred compensation, for example. The article will also use the term “deferral” in a broader sense to refer to quasideferrals; that is, income that the United States may not tax because the earner of the income is a foreign corporation (albeit owned by U.S. persons) not subject Pitt Tax Review | ISSN 1932-1821 (print) 1932-1996 (online) DOI 10.5195/taxreview.2017.67 | http://taxreview.law.pitt.edu 1 Electronic copy available at: https://ssrn.com/abstract=3201117 2 | Pittsburgh Tax Review | Vol. 15 2017 recognition of unrealized gains and losses6 when the taxpayers who were citizens or residents of the United States cease to be citizens or residents. The statute imputes a sale or exchange of the expatriating taxpayers’ property at fair market value7 on the day before the taxpayers’ expatriation dates.8 Absent § 877A, some deferred income9 and some gain realized and recognized following expatriation would not be taxable in the United States at all, despite the income having been earned and the property having appreciated in value while the taxpayers were U.S. citizens or permanent 10 residents. to U.S. taxation; instances in which payment of tax, but not the inclusion in income, is deferred like installment sale gain; and income that would be part of a comprehensive tax base like unrealized gain. See infra note 7 and accompanying text on realization and recognition of gain and loss from the sale or exchange of property. See also infra Part V.A. for discussion of various deferrals in greater detail. 6 I.R.C. § 1001 (realization and recognition of gain and loss from the sale or exchange of property). Under § 1001(a) and (b), realization is the determination of the gains and losses from the sale or other disposition of property, and recognition is the inclusion of gain or loss from the sale or exchange of property in income under § 1001(c). Section 1001(a) and (c) are not parallel insofar as § 1001(a) measures the gain on sale or other disposition, rather than sale or exchange of property, and suggests that there may be dispositions of property that result in realization but that are not subject to the recognition rule even though those dispositions historically have not been treated as generating includable income—for example, gifts of appreciated property do not cause the donor to recognize gain from the disposition of the property (a nonstatutory deferral that in combination with the preservation of the donor’s adjusted tax basis under § 1015 shifts the tax responsibility for the donor’s historic appreciation in the property to a selling donee but no statute expressly prevents the donor from becoming subject to tax on the disposition). See generally Jeffrey L. Kwall, When Should Asset Appreciation Be Taxed?: The Case for a Disposition Standard of Realization, 86 IND. L.J. 77 (2011) (arguing for giving effect to the “other disposition” language). 7 I.R.C. § 877A(a)(1). The statute does not define “fair market value,” but it is a term used throughout the Code. In the case of market traded securities, it is the market trading price at any moment. For other property, “[t]he fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” Treas. Reg. § 20.2031-1(b) (as amended in 1965). 8 I.R.C. § 877A(a)(1) (fixing the time for the constructive sale at fair market value), (g)(3) (defining expatriation date). 9 For example, deferred payments for services rendered by a U.S. person outside the United States for a non-U.S. service recipient. 10 For example, gain from the sale of appreciated personal property sourced at residence under § 865. See infra note 30 and accompanying text. Pitt Tax Review | ISSN 1932-1821 (print) 1932-1996 (online) DOI 10.5195/taxreview.2017.67 | http://taxreview.law.pitt.edu Electronic copy available at: https://ssrn.com/abstract=3201117 Vol. 15 2017 | The Expatriation Tax | 3 In 1920, the U.S. Supreme Court decided Eisner v. Macomber,11 holding that unrealized gain is not income under the Sixteenth Amendment.12 Absent an actual sale or exchange of property, Macomber may remain a barrier to taxing unrealized gain as the expatriation tax does.13 The Court has never reversed its holding in Macomber. Despite Macomber, many commentators see no constitutional barrier to taxing unrealized gain. In 1984, Congress enacted the mark-to-market rules of § 1256 of the Code14 for commodities and certain other investments. Section 1256 requires taxpayers to treat those investment positions as sold, even though no sale or other disposition has taken place, at their fair market values on the last day of the taxable year and to include their gain or loss on those positions in their gross incomes. The Supreme Court has not ruled on the constitutionality of those mark-to-market inclusion rules.15 This article discusses the techniques and business structures U.S. persons use to avoid or evade U.S. income tax liability on their foreign activities, and reviews statutory provisions that limit U.S. taxpayers’ ability to defer or avoid the U.S. income tax on their incomes from foreign sources. Income from U.S. sources is always taxable for U.S. income tax purposes without regard to the citizenship or residence of the income earner.16 The 11 252 U.S. 189 (1920). 12 U.S. CONST. amend. XVI (the income tax amendment). The Court in Macomber stated inter alia: We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital, at the same time shows he has not realized or received any income in the transaction. Macomber, 252 U.S. at 212. 13 Henry Ordower, Revisiting Realization: Accretion Taxation, the Constitution, Macomber, and Mark to Market, 13 VA. TAX REV. 1, 9–10 (1993) (arguing that there is a continuing constitutional barrier to taxing unrealized gain). 14 I.R.C. § 1256 (added to the Code by the Economic Recovery Tax Act of 1981, Pub. L. No. 97- 34, § 503(a), 95 Stat.
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