Installment sale marked to market before taxpayer’s expatriation

The Tax Court upholds a 2008 law's retroactive application and denies a treaty exemption.
By David R. Silversmith, CPA

The Tax Court held that Gerd Topsnik, an expatriate for purposes of U.S. tax law, was liable for tax on gains from installment sale payments that he received in 2010 before his expatriation. The Tax Court also held that he was a covered expatriate as defined in Sec. 877A and that he was liable for tax on the day before his expatriation on the deemed sale of his right to receive future installment sale payments.

Facts: Topsnik immigrated to the United States from Germany in 1977 and received permanent residence status. He subsequently started a gourmet food business in California. In 2004, after a dispute with his partners, Topsnik sold his interest in the business in an installment sale. In 2010, Topsnik formally abandoned his permanent resident status and his green card.

In 2011, Topsnik filed a delinquent Form 1040NR, U.S. Nonresident Alien Income Tax Return, for tax year 2010, on which he reported that the gain on the installment sale payments was exempt under the United States—Germany tax treaty. The IRS disallowed the treaty exemption and, in July 2013, issued a jeopardy assessment for a tax deficiency of $138,903, an accuracy-related penalty of $27,781, and a failure to timely file addition to tax of $13,890 for the 2010 tax year. In September 2013, it issued a notice of deficiency with determinations of the same deficiency, penalty, and addition to tax.

Issues: The U.S.—Germany tax treaty exempts residents of the respective countries from U.S. tax on some items of their income. Topsnik argued that he was a German resident during 2010, and per the U.S.—Germany tax treaty, his income for that year was exempt from U.S. tax.

The next question was whether Topsnik, as the IRS had found, was a "covered expatriate" as defined in Sec. 877A. If so, then all of his property would be deemed sold or "marked to market" the day before his expatriation, and the gain from that sale would be taken into account in the year of the deemed sale. The IRS asserted that his official expatriation date was Nov. 20, 2010, the day he surrendered his green card, so the gain from the deemed sale was includible in Topsnik's 2010 income. Topsnik contended that because he was a German resident in 2010, his official expatriation date was Dec. 31, 2009, and thus he was not subject to tax on the deemed sale gain in 2010.

Alternatively, Topsnik argued that since Sec. 877A was enacted in 2008, his installment sale payments were not covered because the sale was made in 2004, and the law cannot be enforced retroactively.

Holding: On cross motions for summary judgment, the Tax Court rejected all of Topsnik's arguments and held for the IRS.

Based on the U.S.—Germany tax treaty and information from the German authorities, the court found that Topsnik was not a resident of Germany prior to his expatriation date, which, as discussed below, was Nov. 20, 2010. Topsnik was not entitled to the treaty exemption because, under the treaty, a resident was defined as "any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature" but not someone who simply has business interests in that country. Topsnik did not have a qualifying domicile or residence in Germany, so he was not a German resident. Thus, the gain from the installment payments he received before his expatriation date was includible in his U.S. income.

The court also held that Topsnik was a covered expatriate as defined in Sec. 877A. The court first had to determine whether Topsnik was a "long-term resident," defined by Sec. 877(e)(2) as "any individual (other than a citizen of the United States) who is a lawful permanent resident of the United States in at least 8 taxable years during the period of 15 taxable years ending with the taxable year" of expatriation. The court found that Topsnik was a lawful permanent resident for at least 10 out of the 15 years before formally abandoning his permanent resident status. Thus, he met the criteria of a long-term resident.

The next step was to consider whether Topsnik was a "covered expatriate," which is defined as someone who meets one of the requirements under Secs. 877(a)(2)(A) through (C). Subparagraph (C) required Topsnik to certify that he complied with all of his U.S. federal tax obligations for the five tax years preceding the tax year containing his expatriation date. There are no specific Treasury regulations on how to certify tax compliance, but IRS guidance from Notice 2009-85 states that a U.S. citizen or long-term resident is required to file Form 8854, Initial and Annual Expatriation Statement. In addition, the court noted that he had not filed all of his U.S. income tax returns and paid all of his income taxes for the five years before his expatriation. Thus, because Topsnik could not have certified that he was in tax compliance as required by Sec. 877(a)(2)(C), the court determined that he was a covered expatriate as defined under Sec. 877A.

The court held that Topsnik's official expatriation date was Nov. 20, 2010, not Dec. 31, 2009. It based this decision on Sec. 877A(g)(3), which defines the expatriation date as "the date an individual relinquishes U.S. citizenship or, in the case of a long-term resident of the United States, the date on which the individual ceases to be a long-term resident of the United States." Regs. Sec. 301.7701(b)-1(b)(3) states that the "resident status is considered to be abandoned when the individual's application for abandonment (INS Form I-407) is filed with the [(the former) Immigration and Naturalization Service]."

With regard to his alternative argument, the court found that Topsnik was incorrect in arguing that the IRS was applying Sec. 877A retroactively to the 2004 installment sale transaction, which gave rise to his right to receive the installment payments. Rather, the court said, it was being applied to the property he held the day before his expatriation, which was the right to receive the remaining payments due under his installment sale agreement, and therefore the IRS was not applying the statute retroactively. The court further explained that Notice 2009-85 stated that, for purposes of Sec. 877A, a covered expatriate is considered to own any interest in property that would be taxable as part of his or her gross estate for federal estate tax purposes as if he or she had died on the day before the expatriation date as a citizen or resident of the United States. Citing Gump, 124 F.2d 540 (9th Cir. 1942), the court found that the right to receive the installment payments is includible in a decedent's gross estate.

  • Topsnik, 146 T.C. No. 1 (2016)

—By David R. Silversmith, CPA, a practitioner in Woodbury, N.Y.

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