Taxpayers who receive gifts or bequests from certain individuals who gave up their U.S. citizenship or residency will be subject to tax under rules proposed by the IRS (REG-112997-10). The proposed regulations implement Sec. 2801, which was added to the Code in 2008 by the Heroes Earnings Assistance and Relief Tax Act of 2008, P.L. 110-245, to tax "covered gifts" and "covered bequests" a U.S. citizen or resident received from a "covered expatriate" on or after June 17, 2008.
Covered Expatriates, Gifts, and Bequests
Sec. 2801 imposes a tax, at the highest applicable gift or estate tax rates, on any U.S. person who receives a covered gift or bequest. A covered gift is defined as a direct or indirect gift from a covered expatriate within the meaning of Sec. 877A. The tax applies regardless of whether the property transferred was acquired by the donor or decedent covered expatriate before or after expatriation.
Covered gifts are defined as any property acquired by gift directly or indirectly from an individual who is a covered expatriate at the time the property is received by a U.S. citizen or resident, regardless of its situs and of whether such property was acquired by the covered expatriate before or after expatriation from the United States. A covered bequest is defined as any property acquired directly or indirectly because of the death of a covered expatriate, which is generally property that would have been includible in the covered expatriate's gross estate had he or she been a U.S. citizen or resident at death.
Under the proposed regulations, if an expatriate meets the covered expatriate definition in Sec. 877A, he or she is considered a covered expatriate for Sec. 2801 purposes at all times after the expatriation date, except during any period beginning after that date during which he or she is subject to U.S. estate or gift tax as a U.S. citizen or resident.
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 the expatriate's timely filed estate tax return are exempt from the Sec. 2801 tax if the gift or estate tax is timely paid. A covered expatriate's qualified disclaimers of property are excluded, as are charitable donations that qualify as estate or gift tax charitable deductions.
Prop. Regs. Sec. 28.2801-3(c)(4) excludes a gift or bequest to a covered expatriate's U.S. citizen spouse if the gift or bequest, had it been given by a U.S. citizen or resident, would qualify for the gift or estate tax marital deduction. For 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.
A gift or bequest of a partial or terminable interest in property made to a covered expatriate's spouse is excepted from the tax only to the extent it is qualified terminable interest property (QTIP) under Sec. 2523(f) or 2056(b)(7), and a valid QTIP election is made. If a covered gift or covered bequest is made to a nonelecting foreign trust (or to a separate share of the trust), a distribution from the trust (or from the separate share of the trust) to the U.S. citizen spouse of the covered expatriate who funded the trust (whether in whole or in part) will not qualify for the exception. A nonelecting foreign trust is a foreign trust that has not elected to be treated as a domestic trust.
Liability for Sec. 2801 Tax
A U.S. citizen or resident who receives a covered gift or bequest is liable for the tax as is a domestic trust or an electing foreign trust. A nonelecting foreign trust is not liable, but the U.S. citizen or resident who receives a distribution from the trust is liable for the tax on the receipt of that distribution to the extent the distribution is attributable to covered gifts or covered bequests to that trust. The U.S. citizen or resident paying the tax may qualify for a limited deduction of the tax under Sec. 164, which the proposed regulations explain how to calculate.
Calculating the Tax
The value of the covered gifts and bequests received during the year is reduced by the amount of the annual gift tax exclusion (i.e., $14,000 for 2015). The value is the property's fair market value on the date of receipt. This net amount is then multiplied by the highest gift or estate tax rate in effect for the calendar year.
A gift is considered received on the date it would be considered received for gift tax purposes. For bequests, the date of receipt is the date the bequest is distributed from the trust or estate, except when it passes by operation of law or a beneficiary designation, in which cases the date of receipt is the date of death.
The proposed regulations provide various special rules, including rules for the treatment of the tax paid by a trust for generation-skipping transfer tax purposes, for the payment of the tax by a charitable remainder trust, and for nonelecting foreign trusts to elect to become domestic trusts for purposes of the tax. There are also special rules for determining the tax when the electing foreign trust disagrees with the IRS about the amount of tax it owes.
The tax will be reported and paid on new Form 708, which the IRS has not yet issued and which it said it will issue when the proposed regulations are finalized. The IRS will provide the due date for filing Form 708 and for payment of the Sec. 2801 tax liability in the final regulations. After the IRS publishes the final regulations, taxpayers will be given a reasonable time to file the form for covered gifts or bequests received on or after June 17, 2008. Interest will not be imposed on the Sec. 2801 liability until the due date for payment specified in the final rules has passed.