IRS Proposes Rules for Tax on Gifts From Expatriates

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Sept. 9 — The IRS proposed rules for a tax on high-net-worth U.S. citizens and residents who receive gifts from expatriates—a tax some have called an exit tax on the person receiving the gift when someone else is expatriating.

In the proposal (REG-112997-10, RIN 1545-BJ43) released Sept. 9, the Internal Revenue Service enumerates the details of tax code Section 2801, enacted in the Heroes Earnings Assistance and Relief Tax Act of 2008. The regulations address issues tax practitioners have sought answers for, including the question of how to determine whether a distribution from a foreign trust is “attributable to a covered gift or bequest,” where the trust includes other property.

“The statute is seriously flawed and the regs perpetuate those flaws,” Ellen Harrison, a partner at McDermott Will & Emery LLP in Washington told Bloomberg BNA Sept. 9. “They operate as a serious disincentive to expatriating unless the whole family is leaving.”

It imposes a tax on each U.S. citizen or resident who receives a “covered gift or bequest” on or after June 17, 2008, from a “covered expatriate” whose expatriation date was on or after that date (25 DTR G-6, 2/6/13)

Calculating the Tax

The amount attributable is determined by multiplying the total distribution by a ratio, the IRS said, explaining how to compute the ratio.

“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 per-donee 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 regulations said.

The IRS said in Notice 2009-85 that the reporting obligation for the tax is deferred until the final regulations are issued, but the proposed rules provide no further relief from the tax during the more than seven years taxpayers have waited for the regulations, Harrison said (198 DTR G-3, 10/16/09).

Foreign Trusts

The regulations include a pro-rata rule for foreign trusts when the trust includes donations from a covered expatriate. For example, if half of the foreign trust is donated by a covered expatriate, half of each distribution is subject to the tax. Harrison said there should be an exception for identifiable property, for example, shares in a family business.

“The proposed regulations define the term ‘distribution' broadly to include any direct, indirect, or constructive transfer from a foreign trust, including each disbursement from such a trust pursuant to the exercise, release, or lapse of a power of appointment,” the proposed rules said.

The rules also say that cash basis taxpayers entitled to income tax deductions tied to distributions from foreign trusts must take the deduction in the year the tax is paid, not when the distribution is made. Harrison said that the deduction should work like foreign tax credits where the deduction or credit is matched to the year that generated the tax.

The rules also do not allow for a basis step up in a covered gift to reflect the tax paid under Section 2801.

IRS to Issue Form 708

The IRS intends to issue Form 708, on which to report the receipt of gifts and bequests subject to that Section 2801, once the regulations are published as final. The final regulations will also include the due dates for the form and the tax.

Clients looking to expatriate largely “work around the issue” by avoiding gifts or structuring the gifts prior to expatriation, James McCann, a partner at Kleinberg, Kaplan, Wolff & Cohen P.C. said.

“People who are advised go in with their eyes open and by and large have avoided this so far,” McCann said. “There are situations where people aren't aware of it or become aware of it after the fact. The real issue has been enforcement. There hasn't even been a mechanism to pay the thing.”

But those who aren't advised can end up structuring their gifts in the “worst possible ways,” Harrison said.

“The Committee believed that the code should not be used to discourage individuals from relinquishing citizenship or terminating residency,” the proposal said. Also, “the code should not reward individuals who leave the United States.”

“The idea that this is tax neutral is laughable,” Harrison said. “That's the biggest farce.”

Comments on the proposal are due by Dec. 9, as are requests to speak at a public hearing scheduled for Jan. 6, 2016.

To contact the reporter on this story: Laura Davison in Washington at
To contact the editor responsible for this story: Brett Ferguson at

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