IRS proposes new tax on gifts and bequests from expatriates

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The IRS has issued proposed regulations under Code Sec. 2801 to implement a new tax on transfers of property from individuals who abandon U.S. citizenship or residency (a “covered expatriate”) and who later make a gift or bequest to a U.S. taxpayer (individual or U.S. trust). The tax applies to transfers of property on or after June 17, 2008 from an individual who expatriated on or after that same date.

The tax equals the total amount of gifts and bequests received, reduced by the gift tax exclusion for the year, and multiplied by the highest estate or gift tax rate in effect. A transfer is not reduced by any gift or estate tax exemption, other than the annual gift tax exclusion.

Comment. Congress decided that since U.S. taxpayers are subject to estate tax on their worldwide income, it was appropriate to tax transfers from expatriates that would have escape estate or gift tax.

Although the tax took effect in 2008, the regulations indicate that a U.S. recipient who receives a taxable transfer does not have to report and pay the tax until the IRS issues Form 708 and final regulations that provide the due date for filing the form and paying the tax.

The tax applies to U.S. individuals who receive either a gift from a “covered expatriate” or a bequest because of the death of a covered expatriate. An expatriate is an individual who has left the United States and relinquished U.S. citizenship or residency. A covered expatriate is an individual who, on the expatriation date:

  • Had average annual net income tax liability over $124,000 for the previous five years (indexed for inflation);
  • Had net worth of at least $2 million (not indexed); or
  • Failed to certify under penalties of perjury that he or she had complied with all U.S. tax obligations for the prior five years.

Comment. Practitioners note that someone may have failed to file the certification, even if he or she was not liable for taxes. It remains to be seen whether a person can go back and certify for a prior year.

A transfer to a U.S. trust can also be subject to the tax. A transfer to a foreign trust is not taxable; however, a transfer from the foreign trust to a U.S. beneficiary (whether income or corpus) is taxable to the recipient. A foreign trust may elect to be treated as a U.S. trust. The proposed regulations describe the time and manner for making this election. The election will also be made on Form 708.