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Proposed Regulations Address Tax on Gifts and Bequests from Expatriates.

(Parker Tax Publishing September 11, 2015)

The IRS has issued proposed regulations relating to the Code Sec. 2801 tax on U.S. citizens and residents who receive gifts or bequests from certain individuals who relinquished U.S. citizenship or ceased to be lawful permanent residents of the U.S. on or after June 17, 2008. REG-112997-10 (9/10/15).


Prior to the enactment of the Heroes Earnings Assistance and Relief Tax Act of 2008,(the HEART Act), citizens and long-term residents of the U.S. who expatriated to avoid U.S. taxes were subject to an alternative regime of U.S. income, estate, and gift taxes under Code Secs. 877, 2107, and 2501, respectively, for a period of 10 years following expatriation.

Because citizens and residents of the United States generally are subject to estate tax on their world-wide assets at the time of death, Congress determined that it was appropriate, in the interests of tax equity, to impose a tax on U.S. citizens or residents who receive, from an expatriate, a transfer that would otherwise have escaped U.S. estate and/or gift taxes as a consequence of expatriation. Thus, the HEART Act added new Code Sec. 2801 and new chapter 15 to the Code, effective for transfers occurring on or after June 17, 2008. The Code Sec. 2801 tax applies to covered gifts and bequests regardless of whether the property transferred was acquired by the donor or decedent before or after expatriation.

The regulations are proposed to be effective when finalized.

General Rules and Definitions for Code Section 2801

Prop. Reg. Sec. 28.2801-1 sets forth the general rules of liability under Code Sec. 2801 for the tax on certain gifts and bequest from covered expatriates. This tax is imposed on U.S. citizens or residents who receive, directly or indirectly, covered gifts or covered bequests (including distributions from foreign trusts attributable to covered gifts and covered bequests) from a covered expatriate.

Prop. Reg. Sec. 28.2801-2 defines the term "citizen or resident of the United States" as an individual who is a citizen or resident of the U.S. under the general estate and gift tax rules. Accordingly, whether an individual is a "resident" is based on domicile in the U.S. The proposed regulations generally define the term "covered gift" by reference to the general definition of gift for gift tax purposes, and defines the term "covered bequest" as any property acquired directly or indirectly because of the death of a covered expatriate. Such property generally is property that would have been includible in the gross estate of the covered expatriate had he or she been a U.S. citizen at time of death. Prop. Reg. Sec. 28.2801-2 also provides definitions for "domestic trust," "foreign trust," "electing foreign trust," "U.S. recipient," "power of appointment," and "indirect acquisition of property."

The proposed regulations provide that, if an expatriate meets the definition of a covered expatriate, the expatriate is considered a covered expatriate for purposes of Code Sec. 2801 at all times after the expatriation date, except during any period beginning after the expatriation date during which such individual is subject to U.S. estate or gift tax as a U.S. citizen or resident. Code Sec. 2801 defines "covered expatriate" as an individual who expatriates on or after June 17, 2008, if, on the expatriation date:

(1) the individual's average annual net income tax liability is greater than $124,000 (indexed for inflation) for the previous five taxable years,

(2) the individual's net worth is at least $2,000,000 (not indexed), or

(3) the individual fails to certify under penalty of perjury that he or she has complied with all U.S. tax obligations for the five preceding taxable years.

Exceptions Applicable to Covered Gifts and Covered Bequests

Prop. Reg. Sec. 28.2801-3 addresses rules and several exceptions to the definitions of "covered gift" and "covered bequest." These exceptions include taxable gifts reported on a covered expatriate's timely filed gift tax return, and property included in the covered expatriate's gross estate and reported on such expatriate's timely filed estate tax return, provided that the gift or estate tax due is timely paid.

Qualified disclaimers of property made by a covered expatriate are also excepted from the definition of a covered gift and a covered bequest, as are charitable donations that would qualify for the estate or gift tax charitable deduction. In addition, the proposed regulations provide exceptions for a gift or bequest to a covered expatriate's U.S. citizen spouse if the gift or bequest, if given by a U.S. citizen or resident, would qualify for the gift or estate tax marital deduction.

The proposed regulations also provide that, if a covered expatriate makes a transfer in trust and such transfer is a covered gift or covered bequest, the transfer is treated as a covered gift or covered bequest to the trust, without regard to the beneficial interests in the trust or whether any person has a general power of appointment or a power of withdrawal over trust property.

Liability for Code Section 2801 Tax

Prop. Reg. Sec. 28.2801-4 provides rules regarding who is liable for the payment of the Code Sec. 2801 tax. Generally, the U.S. citizen or resident who receives the covered gift or covered bequest is liable. Similarly, the proposed regulations provide rules explaining that a domestic trust that receives a covered gift or covered bequest is treated as a U.S. citizen and thus is liable for payment of the Code Sec. 2801 tax.

Calculation of Tax

Prop Reg. Sec. 28.2801-4 also provides guidance on how to compute the Code Sec. 2801 tax. Generally, the tax is determined by reducing the total amount of covered gifts and covered bequests received during the calendar year by the dollar amount of the per-donee exclusion under Code Sec. 2503(b) in effect for that year ($14,000 in 2015), and then multiplying the net amount by the highest estate or gift tax rate in effect during that calendar year.

OBSERVATION: The IRS intends to issue Form 708, U.S. Return of Gifts or Bequests from Covered Expatriates once the proposed regulations are finalized and will provide the due date for filing Form 708 and for payment of the Code Sec. 2801 tax liability in the final regulations.

For purposes of calculating the tax, the value of a covered gift or covered bequest is the fair market value of the property on the date of its receipt by the U.S. citizen or resident.

Treatment of Foreign Trusts and Election to be Considered a Domestic Trust

Prop Reg. Sec. 28.2801-5 provides guidance on the treatment of foreign trusts under Code Sec. 2801. If a covered gift or covered bequest is made to a foreign trust, the Code Sec. 2801 tax applies to any distribution from that trust to a recipient that is a U.S. citizen or resident, unless the foreign trust elects to be treated as a domestic trust. The Code Sec. 2801 tax applies only to the portion of a distribution from a nonelecting foreign trust that is attributable to covered gifts and covered bequests contributed to the foreign trust. The proposed regulations define the term "distribution" broadly to include any direct, indirect, or constructive transfer from a foreign trust, including each disbursement from such a trust pursuant to the exercise, release, or lapse of a power of appointment.

Solely for purposes of Code Sec. 2801, a foreign trust may elect to be treated as a domestic trust. Consequently, the Code Sec. 2801 tax is imposed on the electing foreign trust when it receives covered gifts and covered bequests, rather than on the U.S. trust beneficiaries when distributions are made from the trust. Prop. Reg. Sec. 28.2801-5(d)(3) provides guidance on the time and manner of making the election. The trustee must make the election on a timely filed Form 708.

Interaction with Other Code Sections

Prop. Reg. Sec. 28.2801-6 provides guidance on the interaction of Code Sec. 2801 with various other sections of the Code including:

(1) how the basis rules under Code Secs. 1014, 1015(a), and 1022 impact the determination of the U.S. recipient's basis in the covered gift or covered bequest;

(2) clarifying the applicability of the GST tax to certain Code Sec. 2801 transfers;

(3) discussing the interaction of Code Sec. 2801 and the information reporting provisions of Code Secs. 6039F and 6048(c); and,

(4) addressing the Code Sec. 6662 accuracy-related penalties on underpayments of tax, the Code Sec. 6651 failure to file and pay penalties, and the Code Sec. 6695A penalty on substantial and gross valuation misstatements attributable to incorrect appraisals.

Recipient's Responsibility to Determine Applicability

Prop. Reg. Sec. 28.2801-7 provides guidance on the responsibility of a U.S. recipient to determine if tax under Code Sec. 2801 is due. Under the proposed regulations, the burden is on that U.S. citizen or resident to determine whether the expatriate was a covered expatriate and, if so, whether the gift or bequest was a covered gift or covered bequest.

The proposed regulations also include administrative regulations that address filing and payment due dates, returns, extension requests, and recordkeeping requirements with respect to the Code Sec. 2801 tax.

For a discussion of the tax on gifts and bequests received from covered expatriates, see Parker Tax ¶ 223,100. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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