"Taxing Goodbyes: The IRS's Take on Expatriate Gifts":  Final Regulations on Tax for Gifts and Bequests from Covered Expatriates

The IRS recently published final regulations under Section 2801 of the Internal Revenue Code. Section 2801 was enacted as part of the Heroes Earnings Assistance and Relief Tax Act (HEART Act) on June 17, 2008. The purpose of this law was to impose a tax on U.S. citizens and residents who receive gifts or bequests from individuals who have relinquished their U.S. citizenship or ceased to be lawful permanent residents. Proposed regulations were first issued in 2015, and it has taken years to finalize them due to the need for thorough review and consideration of feedback from various stakeholders.

Key definitions:

• Covered Expatriate: This term refers to people who meet the criteria under Section 877A(g)(1). These are people who have given up their U.S. citizenship or long-term residency.
• Covered Gift/Bequest: Property received from a covered expatriate, either directly or indirectly, falls under this category. It’s important for recipients to figure out if the property they get qualifies as a covered gift or bequest.
• U.S. Recipient: This includes U.S. citizens, residents, and certain trusts that get gifts or inheritances from covered expatriates. Knowing who qualifies as a U.S. recipient is crucial for tax reporting.

It is worth noting that many taxpayers who have given up their Citizenship or Greencard are not covered expatriates.  There are many exceptions and this is something that will have been determined in the year of expatriation but you can read more details here:  Giving up Green Card or Passport? – Ostberg Sinclair & Co

Examples of Who This Will Affect

• Example 1: Scott is a covered expatriate who lives outside the United States. He wants to gift $800,000 to his son, who is a U.S. citizen. Under Section 2801, Scott’s son will be subject to a tax on the gift, calculated at the highest estate tax rate, which could be up to 40%.
• Example 2: Jane, a U.S. resident, receives a bequest from her aunt, who recently relinquished her U.S. citizenship. Jane will need to determine if the bequest qualifies as a covered bequest and, if so, report and pay the tax on it.

Exceptions and Exclusions

The rules provide several exceptions and exclusions to the tax on covered gifts and inheritances. Notably, gifts and inheritances reported on timely filed gift or estate tax returns are excluded. “Covered expatriates” who are thinking of gifting US situs assets to a US person will need to file gift tax returns to ensure that they meet the timely filed criteria.

Also, transfers to spouses or charities and qualified disclaimers are not subject to this tax. These exceptions are designed to prevent double taxation and encourage charitable giving.

Tax Calculation and Payment

The tax on covered gifts and bequests is calculated based on the highest estate tax rate in effect for the calendar year, currently 40%. The value of the gift or inheritance is determined at the time of receipt. U.S. recipients need to file Form 708 to report and pay the tax. This form ensures that the IRS gets accurate information about the value and nature of the gifts or inheritances.  As of yet, whilst we know that the form has been drafted by the IRS it has not yet been published.

Foreign Trusts

Special rules apply to distributions from foreign trusts. These trusts can choose to be treated as domestic trusts for tax purposes, which can simplify the tax reporting process. Understanding these rules is essential for recipients of distributions from foreign trusts to ensure compliance with U.S. tax laws.

Recordkeeping and Reporting

U.S. recipients must keep accurate records and file the necessary forms to comply with the rules. Failure to do so can result in significant penalties. The IRS emphasizes the importance of proper recordkeeping to ensure that all gifts and bequests are accurately reported and taxed.

Penalties for Non-Compliance

Penalties for not following these rules can be severe. They include penalties for not filing Form 708, not paying the tax on time, accuracy-related penalties for underpayment of tax due to negligence or disregard of rules, and fraud penalties for underpayment due to fraud. It’s crucial for U.S. recipients to understand these penalties and take steps to comply with the rules to avoid them.

As usual with the IRS the devil is in the detail.  We hope that form 708 when published will give clear guidance to taxpayers who are caught by these rules and in particular what to do about historical gifts.  In the meantime, if you would like to discuss your own position, please do contact your usual advisor at Ostberg Sinclair.

The information in this publication provides a broad overview of the topics addressed. While we strive for accuracy, we cannot guarantee it will remain accurate in the future. It should not be considered exhaustive or relied upon for decision-making or as a substitute for professional advice. Ostberg Sinclair is not responsible for any consequences arising from actions taken or not taken based on this material. Please contact us if you would like to discuss your specific circumstances further.