U.S. Tax Court: German Who Gave Up U.S. Residency Liable for Exit Tax

U.S. Tax Court: German Who Gave Up U.S. Residency Liable for Exit Tax

The case involved a German national, Mr. Topsnik. Mr. Topsnik was born in Germany and moved to the U.S. obtaining a green card and residency status in 1977.  Mr. Topsnik started a business with its principal place of business in California and purchased a home in Hawaii during the 1980’s. In 2003, Mr. Topsnik sold his primary residence in the U.S. and moved back to Germany. In 2004, Mr. Topsnik’s U.S. legal residency status renewed until 2014. On July 30, 2004, Mr. Topsnik sold his business in an installment sale with net proceeds worth $4,678,582 which were to be paid over a number of years. In 2010, Mr. Topsnik officially abandoned his legal residency status pursuant to U.S. Internal Revenue Code (“IRC”) Section 7701.

The primary issues before the Court were whether Mr. Topsnik was a legal resident at the time of the sale and therefore subject to U.S. taxation and/or whether he was a covered expatriate in 2010 and thus required to report the sale prior to expatriation. The Court held that despite his German contacts, which included owning real property, maintaining a German driver’s license and passport, that he was a U.S. resident and subject to taxation on the sale. While such a decision appears to contradict the provisions of the U.S.-Germany tax treaty, the factual circumstances present in the case are supportive of such a decision. Specifically, Mr. Topsnik’s statements and filings with the German tax authorities were contradictory in that he claimed that he was not subject to taxation by Germany on his worldwide income and was registered as a nonresident of Germany. Accordingly, the Court held that Mr. Topsnik was a resident during 2004-2010.

Since Mr. Topsnik formally abandoned his legal residency status in 2010, the Court also considered whether he was a covered expatriate. The determination that an individual is a covered expatriate results in the IRS deeming that the individual sold all of his worldwide assets at the fair market value on the day before expatriation. Any and all capital gains associated with the artificial sale are taxed as income as of the year of expatriation. An individual is deemed to be a covered expatriate if he/she meets any of the requirements described in IRC Sections 877(a)(2)(A-C). The Court held that Mr. Topsnik satisfied the third requirement as he failed to certify that he complied with his federal tax obligations and failed to file all necessary tax forms during the five years he considered himself to be a non-resident.

Despite the fact that Mr. Topsnik moved back to Germany and maintained limited ties to the U.S., the IRS was able to tax the sale of his business on two grounds. First, he failed to formally abandon his residency and second he failed to comply with U.S. tax law. The decision demonstrates the complexity associated with abandoning U.S. residency and the need for proper planning. With respect to abandoning residency, IRC Section 7701 must be complied with which includes filing INS Form I-407 and sending in the Alien Registration Receipt Card.  However, such compliance may not be sufficient as a myriad of tax laws must also be satisfied.

Topsnik, 146 T.C. No. 1 (2016)

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