Installment Notes for the Covered Expatriate

Installment notes should receive special tax consideration when a person contemplates renouncing their U.S. citizenship. Under provisions of the Internal Revenue Code (“Code”), the expatriate is deemed to have sold the note for its fair market value. The Code presumes the fair market value of an installment note is equal to its face amount. The taxpayer has the burden of establishing that the fair market value is less than the face amount, which is done by obtaining professional valuation and appraisals that commonly apply discounts for marketability, liquidity, and minority interests when the asset is held by an entity. In Topsnik v. Commissioner, 146 T.C. 1 (2016), the taxpayer, apparently, made no attempt to discount the face amount of his installment obligation, and was subject to tax based on the entire principal balance. The primary dispute in Topsnik involved the determination of whether the taxpayer was a covered expatriate, and if so, the tax ramifications with respect to his installment note.[1] After concluding Topsnik was in fact a covered expatriate, the court affirmed the IRS’ determination that Topsnik realized $1,183,986 of gain from the installment note when he expatriated.[2]

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).[3]

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.[4]

For purposes of the mark-to-market regime, a right to receive installment payments is property whose value would be included in the value of the gross estate for Federal estate tax purposes.[5]

Code Section 453B(b) provides that a taxpayer’s basis in an installment obligation is the excess of the face value of the obligation (a.k.a. the remaining principal amount) over an amount equal to the income which would be returnable were the obligation satisfied in full (a.k.a. the portion of the payments which would be included in the taxpayer’s income).

In Topsnik, the taxpayer held an installment note with a principal balance of $1,373,374, entitling him to receive monthly payments of $42,500.[6]  Applying 453B(b), court determined Topsnik had a basis of $189,388, and realized gain of $1,183,986 upon expatriating in 2010. [7]

Assuming Topsnik had exemptions of $145,000, and was subject to a 15% capital tax rate, the installment note generated a tax liability of $155,848.  That is a sizeable bill considering no asset was actually sold. Interestingly, the court did not consider any discounts, apparently because Topsnik did not assert any.  Had a 20% discount been obtained, due to the time value of money or lack of liquidity, which is not far-fetched, Topsnik could have reduced his tax liability by $31,170, to say nothing of the penalties and interest.

The take away – a legitimate valuation can easily pay for itself. Before expatriation, obtain a professional valuation of all assets, including installment notes so that proper discounts can be taken. The service is inexpensive and straightforward, especially where a note provides for fixed, determined payments over a known term of years.  Failure to do so, as Topsnik found out, can be expensive.

- By Michael S. Cooper, Esq., Barnes Law


Michael is an associate attorney with Barnes Law, and is licensed to practice law in California.

The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Topsnik at 2

[2] Id. at 27

[3] Notice 2009-85

[4] Treas. Reg. 20.2031-4; “See also Estate of Robinson v. Commissioner, 69 T.C. 222 (1977)

[5] Notices 2009-85, 2009-45

[6] Topsnik at 5

[7] Id. at 27