Proposed Regulations Issued on Covered Gifts or Bequests
On September 9, 2015, the IRS issued notice of proposed rule-making (NPRM) 112997-10. It relates to 2008 legislation regarding Section 2801 – gifts to US persons (US citizens, US residents or domestic trusts) made by former US citizens and long-term residents who expatriate after June 16, 2008, and are classified as ‘covered expatriates.’
Below we provide a brief and straight forward synopsis of the proposed regulations.
These regulations affect former US citizens or long term green card holders who have given up their US citizenship (or green card) and to whom one of the following applies:
- their average annual net income tax liability for the preceding five taxable years (prior to expatriation) was greater than $160,000 (currently as indexed for inflation, amount is progressively smaller for expatriationsy6 in earlier years); or
- their net worth is at least $2 million on the day before expatriation; or
- they fail to certify under penalty of perjury that they have complied with all US tax obligations for the five preceding taxable years (this is accomplished by confirming on a timely-filed form 8854 for the year of expatriation).
If you have expatriated (in 2015), you should already be aware if you are a covered expatriate or not. If you are planning to expatriate and have not had a conversation about being a covered expatriate, you should contact your tax advisor or US Tax & Financial Services immediately (both as related to this proposed rule and for the potential exit tax liability as a covered expatriate). There are planning opportunities prior to expatriation that could bring significant tax savings.
Please note these proposed regulations will be effective only after final regulations are published in the Federal Register. The tax imposed by Section 2801 will not be due until after the regulations are finalized and Treasury produces the Form 708 that will be used to report and pay the tax on covered gifts and bequests.
So, what is this tax and who pays it? Generally, a gift or estate tax is due by the person giving the gift or by the estate. However, the role is reversed with regard to the Section 2801 tax. The person receiving the gift (donee) or bequest (beneficiary) from the covered expatriate is the one who owes the tax. The tax is calculated by first reducing the total amount of covered gifts and covered bequests received during the calendar year by the dollar amount of the per-donee exclusion ($14,000 in 2015) and then multiplying by the highest estate or gift tax rate (currently 40%).
This tax affects both direct and indirect gifts. As a brief example of an indirect gift, if a covered expatriate makes a gift or bequest to a non-US trust and that trust subsequently makes a distribution to a US beneficiary, the distribution is taxable under Section 2801 to the extent that it is attributable to the gift or bequest from the covered expatriate.
This tax may also apply to domestic trusts (or foreign trusts that elect to be treated as domestic trusts). The rules and calculations can become quite complex and this blog does not cover those details.
Interestingly, it will likely be left up to the donee or beneficiary to prove that a gift or bequest is not from a covered expatriate. The best and simplest proof could be to provide a copy of the final tax return and Form 8854 showing that the former US person was not a covered expatriate. Where you have family members/friends who have given up US citizenship and you have reason to think you may receive a gift or bequest from them in the future, it makes sense to raise the issue with them now and ask that they keep copies of these documents in a safe place. It is possible that the IRS will disclose the donor or decedent’s tax return or return information, but as yet, it is not clear if and how this will work. Therefore, it is better to be safe than sorry.
There are additional rules, calculations and exceptions that can apply and which are not covered here. You should contact US Tax & Financial Services for further assistance.