If a person relocates from the United States to overseas and is either a Legal Permanent Resident who relinquished the “Green Card” or a U.S. Citizen who renounced their citizenship – what are the Gift Tax implications of making gifts to the United States?
The main concern of the Department of Treasury (DOT) and Internal Revenue Service (IRS) is making sure the United States collects all the tax it is rightfully due, and often times individuals will try to reduce their overall tax liability by making gifts and inheritances to family members and loved ones.
Here’s an example of what the IRS and Department of treasury are worried about:
Mary is originally from Spain. Mary’s family relocated to the United States when she was very young. Since Mary was born in Spain and at some point intended on returning to spin, she never obtained her US citizenship. Unfortunately, Mary’s parents died when she was relatively young and left her a sizeable estate.
As time has passed, Mary has turned that estate into a nest egg worth upwards of $15 million. The majority of her estate is comprised of foreign investments and foreign properties outside of the United States.
Mary decides that she going to go back to Spain and does so after a few more years. At the same time, she was not sold on the American dream and relinquished her legal permanent resident card. Mary had no idea about the expatriate tax so when she left the United States, she did not pay any expatriate tax as she might’ve been required to. Since the IRS is currently operating at around 15% capacity, she simply slipped through the cracks and the IRS is none the wiser.
Fast forward 5 years later and Mary passes away due to an unforeseen illness. Her estate is now worth $25 million and she has left the bulk of the state to individuals who reside in the United States. Since the individuals from the United States are receiving money from a non-US citizen, nonresident the United States does not have the right to tax that estate the same with that they would if Mary was a legal permanent resident (the IRS would be able to tax the estate at 40% of every dollar over $5.43 million).
In addition, there is no Federal inheritance tax so the individual recipients of the money in the United States will not be taxed at all.
The Internal Revenue Service does not like this outcome. Mainly, it is because “Mary” (for the most part) developed and grew her estate while she resided in the United States even if most of the investments are overseas.
Proposed Regulations – IRC 2801
Purpose of these Proposed Regulations
Prior to the enactment of the HEART Act, citizens and long-term residents of the
United States who expatriated to avoid U.S. taxes were subject to an alternative regime of U.S. income, estate, and gift taxes under sections 877, 2107, and 2501, respectively, for a period of 10 years following expatriation. Recognizing that 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.
- In other words, Congress wanted to ensure that individuals who expatriate and then leave large sums of money to individuals in the United States do not escape estate tax. Since the IRS would not necessarily have authority over individuals who are no longer US citizens or legal permanent residents, Congress determined that they should go after the recipients of the transfers from the U.S. expatriates.
IRC Section 2801 – What Does it Mean?
Section 2801 imposes a tax (section 2801 tax) on covered gifts and covered bequests received by a citizen or resident of the United States (U.S. citizen or resident) from a covered expatriate.
The section 2801 tax applies with regard to any property transferred to a U.S. citizen or resident which qualifies as a covered gift or covered bequest under section 2801, regardless of whether the property transferred was acquired by the donor or decedent covered expatriate before or after expatriation.
The value of a covered gift or covered bequest is its fair market value at the time the gift or bequest is received by the U.S. citizen or resident. A U.S. citizen or resident receiving a covered gift or covered bequest (U.S. recipient) is liable for payment of the section 2801 tax imposed under this chapter.
A domestic trust that receives a covered gift or covered bequest is treated as a U.S. citizen and therefore is liable for payment of the section 2801 tax. A foreign trust may elect to be treated as a domestic trust (an electing foreign trust) for this purpose; absent this election, the trust’s U.S. citizen or resident beneficiaries will be taxed as distributions are made from the trust (a nonelecting foreign trust).
Who is Subject to the Law?
U.S. Citizens and Residents
Section 28.2801-2 of the proposed regulations defines terms for purposes of new chapter 15. The proposed regulations define the term “citizen or resident of the United States” as an individual who is a citizen or resident of the United States under the estate and gift tax rules of chapter 11 and chapter 12, respectively, in subtitle B of the Code. A
Who is a Covered Expatriate?
Section 2801 defines “covered expatriate” by reference to the section 877A(g)(1) definition of that term. Section 877A(g)(1) generally provides that an individual who expatriates on or after June 17, 2008, is a covered expatriate if, on the expatriation date:
- 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. See section 877A(g)(1); Notice 2009-85, 2009-45 I.R.B. 598.
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 section 2801 at all times after the expatriation date, except during any period beginning after the expatriation date during which such individual is subject to United States estate or gift tax as a U.S. citizen or resident.
Exceptions to the Rule
- 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 excepted from the definitions of a covered gift and covered bequest. In addition, charitable donations that would qualify for the estate or gift tax charitable deduction are excepted from the terms “covered gift” and “covered bequest.”
- Section 28.2801-3(c)(4) provides that a gift or bequest to a covered expatriate’s U.S. citizen spouse is excepted from the terms “covered gift” and “covered bequest” if the gift or bequest, if given by a U.S. citizen or resident, would qualify for the gift or estate tax marital deduction. In the case of a gift or bequest in trust, this means that, to the extent the gift or bequest to the trust (or to a separate share of the trust) would qualify for the estate or gift tax marital deduction, the gift or bequest is not a covered gift or covered bequest.
* Note that gifts and bequests made by a covered expatriate to his or her noncitizen spouse are subject to an annual limit under section 2523(i).
- A gift or bequest of a partial or terminable interest in property that a covered expatriate makes to his or her spouse is excepted from the definitions of a covered gift and covered bequest only to the extent that such gift or bequest is qualified terminable interest property (QTIP), as defined in section 2523(f) or section 2056(b)(7), and a valid QTIP election is made.
Who is Liable for the Tax?
- Section 28.2801-4 provides specific rules regarding who is liable for the payment of the section 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 section 2801 tax imposed under this section.
- An electing foreign trust also is treated as a U.S. citizen. See §§28.2801-2(b) and 28.2801-5(d). However, a non-electing foreign trust is not liable for the section 2801 tax. Instead, a U.S. citizen or resident who receives a distribution from a non-electing foreign trust is liable for the section 2801 tax on the receipt of that distribution to the extent the distribution is attributable to covered gifts or covered bequests to that trust.
Computation of the Expatriate Gift/Estate Tax
- Section 28.2801-4 of the proposed regulations also provides guidance on how to compute the section 2801 tax. Generally, the section 2801 tax is determined by reducing the total amount of covered gifts and covered bequests received during the calendar year by the section 2801(c) amount, which is the dollar amount of the perdonee exclusion in effect under section 2503(b) for that calendar 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.
- The reference to section 2503(b) in section 2801 is included solely to provide a dollar amount by which to decrease the U.S. recipient’s aggregate covered gifts and covered bequests received during that calendar year to determine the 17 amount subject to the section 2801 tax; section 2801 does not incorporate the substantive rule of section 2503(b) that applies to donors of gifts under chapter 12. The resulting tax then is reduced by any estate or gift tax paid to a foreign country with regard to those transfers. See §28.2801-4(e)
This is a brief summary of the proposed regulation. Overall, chances of these regulations will be accepted and implemented as the code session does provide that this tax can be levied upon US citizens and residents already.
*If you are former ex-pat seeking to provide gifts or inheritance to US residents and citizens, we may consider speaking with an experienced international tax lawyer first to evaluate your situation.