Matters of the HEART (Act) – Part Three

This is the third in a series of blogs discussing the rules for expatriates under the 2008 Heroes Earnings Assistance and Relief Tax (HEART) Act. As previously stated in our prior blogs regarding this topic, there are numerous traps under the HEART Act for expatriates who are “covered expatriates” as defined in the Act.


This blog concerns how the HEART Act imposes a tax on deferred compensation (such as retirement benefits under a 401k).


The tax applies to most all deferred compensation and retirement accounts. But the HEART Act makes a distinction between “eligible deferred compensation” and “ineligible compensation”. Eligible deferred compensation is any deferred compensation for which (i) the payor (usually your employer) is either a U.S. person or domestic company (or has elected to be treated as such) and (ii) the covered expatriate tells the payor that he/she is covered expatriate.  You do this by providing the payor with a form (Form W-8CE).  But by signing this form the covered expatriate also waives certain U.S. treaty rights having to do with withholding reductions on retirement benefit payments.


Ineligible deferred compensation is any deferred compensation that is not eligible deferred compensation.


In general, for eligible deferred compensation, the person or entity paying the deferred compensation must deduct and withhold a tax equal to 30 percent of any taxable payment. And since the covered expatriate must waive his or her right to claim treaty benefits with respect to an eligible deferred compensation item, the 30 percent withholding tax cannot be reduced or eliminated by treaty. Thus it could be taxed in the U.S. and then again in the foreign country where the expatriate plans to reside.


It gets worse for ineligible deferred compensation.  Ineligible deferred compensation is deemed to be distributed to the expatriate and is treated as having been received by the covered expatriate on the day before the expatriation date.  It’s considered a distribution under the plan (like an early withdrawal from a 401k) and must be included on the covered expatriate’s expatriation year Form 1040.  This could create an enormous tax liability for the covered expatriate.


Failure to properly consider the tax implications of the HEART Act as it pertains to deferred compensation can result in tax traps for an expatriate. If you are planning to relinquish your US Citizenship, or have been a long-term resident in the United States and plan to leave, and you seek to eliminate or, at least, minimize the tax liabilities that may result, then schedule your free consultation by calling (480) 888-7111 or submit a web request here.