Gerald Topsnik is now 0 for 2 in the Tax Court (there are other cases outside the Tax Court as well) in his battle with the IRS regarding whether he owes various taxes, though both cases resulted in published opinion—so arguably he’s an important loser. After an earlier loss in his 2014 case (Topsnik v. Commissioner, 143 TC No. 12, referred to as Topsnik IV in the current opinion) that dealt with failure to properly give up his permanent resident status for federal tax purposes, he was subject to U.S. tax as a resident until 2010.

In the current case (Topsnik v. Commissioner, 146 TC No. 1) the question arose regarding whether he owed tax in 2010 on an installment sale of stock in a U.S. corporation. He entered into the agreement in 2004 and was to receive payments through 2013.

Mr. Topsnik asserted that he was a German resident during 2010 and that his income was therefore exempt under the Germany-U.S. tax treaty. The IRS argues that this is not the case.

The taxpayer argues that his contacts with Germany in 2010 made him a German resident. As the Court notes “[p]etitioner’s German contacts include a German driver’s license and a German passport. He also contends that he owned the inn.”

But the Tax Notes that these contacts aren’t relevant to the matter unless they subjected him to tax by Germany on his worldwide income:

Petitioner’s recitation of his contacts with Germany during 2010 is not relevant to his status as a German resident during that year except insofar as they served to subject him to German taxation of his worldwide income. Petitioner does not allege that he is subject to German taxation on his worldwide income, and the evidence in the record is uniformly to the contrary.

In fact, the Court notes, Mr. Topsnik had actually claimed to be a nonresident for purposes of German taxation and did not file a return with Germany:

The information obtained by the German competent authority from the German tax authority reveals that (1) for tax year 2010 petitioner was registered in Germany as a person subject to taxation as a nonresident; (2) petitioner did not file a German tax return for 2010; (3) petitioner was not registered in the German township of Oerlenbach, Freiburg City, or Bruchsal in 2010, nor did he have a registered residence or habitual abode in Germany in 2010; and (4) since 2000 petitioner has, on occasion, resided in a room at Hans and Ingenborg Topsnik's house in Freiburg free of charge. There is no evidence in the record to refute the information obtained by the German competent authority. We find that petitioner was not a "resident" of Germany in 2010 as defined by article 4, paragraph 1, of the U.S.-Germany Tax Treaty. Accordingly, petitioner's monthly installment payments were taxable by the United States.

As was noted earlier (and in the earlier case), Mr. Topsnik did formally end his permanent resident alien status with the United States in 2010. Unforunately, during the time period between when Mr. Topsnik actually thought he had ended his tax U.S. permanent resident alien status and when he actually did, Congress passed the Heroes Earnings Assistance and Relief Act of 2008 which added the tax on those seeking to expatriate at IRC §877A.

So now the question expands beyond simply whether Mr. Topsnik was going to pay tax on the gain allocable to the 11 payments he received in 2010 but also to whether, due to his change in status, he would be subject to the tax on expatriates when he left the country. To begin to make this determination, the Court first must determine if he qualified as a “long-term resident.”

As the Court notes, IRC §877A(g)(5) provides a cross reference to IRC §877(e)(2) that defines a “long-term resident” as:

[A]ny 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]. For purposes of the preceding sentence, an individual shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country.

The Court finds Mr. Topsnik clearly meets that test:

Petitioner was an LPR of the United States beginning on February 3, 1977, the date he received his green card. If petitioner expatriated in 2010, as we find and discuss below, then to be a long-term resident he would have to be an LPR for 8 of the 15 tax years beginning with tax year 1996. In Topsnik IV we held that petitioner was an LPR of the United States during tax years 2004-09. We further held that petitioner was not a resident of Germany during tax years 2004-09. Id. at 261. We held above that petitioner was not a German resident in 2010. Those years constitute 7 of the 8 years necessary for petitioner to fit under the definition of long-term resident of the United States. Petitioner argues that he has been a resident of Germany since 1999. Even if we accept that he is correct for the tax years 1999-2003, he does not argue, and has presented no evidence to suggest, that he was not an LPR of the United States for the three years from 1996-98. Taken together with our holding in Topsnik IV, this means that petitioner was an LPR for at least 10 out of the 15 years before formally abandoning his LPR status. Therefore, petitioner is treated as a “long-term resident of the United States” for the purposes of section 877A.

Next the Court looked to determine if he is a “covered expatriate” under these rules—and it finds he is. Among other ways one can become a “covered expatriate” is if an expatriate fails to certify, in accordance with IRS regulations, that he/she was in compliance with the Internal Revenue Code for five years preceding his/her expatriation. While the IRS has not issued such regulations, it has issued Notice 2009-85 to guide taxpayers in complying with this rule, requiring such individuals to file Form 8854 in order to make this certification, under penalties of perjury.

Mr. Topsnik both failed to file Form 8854 and, in fact, was not in compliance with the law since (as was noted in the first Tax Court case) he had not filed returns for all of those years and had not paid all taxes due.

Now the problem arises—as a covered expatriate he is treated as having sold all of his property on the day before his expatriation date. Thus he is deemed to have sold the installment obligation, triggering the recognition and taxation of all remaining gain. As the Court has previously held that he remained subject to the U.S. tax until he formally abandoned the status in 2010, his expatriation date was in 2010.

The Court rejected his claim that no tax could be imposed on the installment obligation because it was entered into before §877A became part of the law. The Court notes that the tax is on property held as of the date of his expatriation, measured using similar rules that apply for estate tax purposes. The fact that his basis happens to be less than the face value of the note simply means he would have a gain if sold—and, thus, the Court decided there was no impermissible retroactive application of the law.

The Court also found that the IRS had properly computed his gain for the installment obligation under the mark-to-market rules, noting:

In computing a tax liability under the mark-to-market regime, a covered expatriate must use the fair market value of each interest in property as of the day before the expatriation date in accordance with the valuation principles applicable for purposes of Federal estate tax, without regard to sections 2032 and 2032A (relating to alternate valuation dates or the valuation of certain farm or real property). Notice 2009-85, supra. Section 20.2031-4, Estate Tax Regs., provides guidance for valuing installment notes for purposes of including the value in the value of a decedent's gross estate. It states: "The fair market value of notes, secured or unsecured, is presumed to be the amount of unpaid principal, plus interest accrued to the date of death, unless the executor establishes that the value is lower or that the notes are worthless." See Estate of Robinson v. Commissioner, 69 T.C. 222 (1977). On November 19, 2010, the day before petitioner expatriated, petitioner's right to receive monthly installment payments is presumed to have had a fair market value of $1,373,374 on the basis of the amount of unpaid principal and accrued interest.

Section 453B(b) provides that a taxpayer's basis in an installment obligation is the excess of the face value of the obligation (the remaining principal amount) over an amount equal to the income which would be returnable were the obligation satisfied in full (the portion of the payments which would be included in the taxpayer's income). Petitioner's basis in his right to receive monthly installment payments is $189,388, the excess of the face amount of the right, $1,373,374, over an amount equal to the income which would be returnable were the right satisfied in full, $1,183,986.