What is a Federal Inheritance Tax for Expatriates, The Basics

What is a Federal Inheritance Tax for Expatriates, The Basics

Federal Inheritance Tax for Expatriates

While there is no “New” Federal Inheritance Tax for covered transfers, there is IRC Section 2801 — along with proposed regulations — which expatriates should be aware of. By way of brief background, Expatriation is the formal process of either renouncing US citizenship or relinquishing a green card for a permanent resident that is considered a long-term lawful permanent resident. The tax laws involving expatriation are very complicated — and unfortunately, inexperienced attorneys or “self-purported tax experts” who dabble in this area tend to get the information incorrect and then pass it on to other unsuspecting taxpayers like an adult version of the telephone game. One common misconception is the way inheritance tax works after expatriation. Before expatriating, Taxpayers should consult with a Board-Certified Tax Law Specialist. Let’s go through a simple analysis of how and when these types of taxes may kick-in for expatriates.

Is there a Federal Inheritance Tax?

Let’s start out with the basic premise that in general, there is no federal inheritance tax. The United States has a gift and estate tax – but not inheritance tax (although some states do have an inheritance tax). When a person passes away, the estate may become subject to tax depending on the value of the estate — but it is not technically an inheritance tax. The difference with expatriation is that if a US citizen or resident receives a gift or bequest from a covered expatriate — that does not qualify for an exception — then the recipient of the gift or bequest must pay a tax on the value of the gift or bequest AND foreign tax credits can apply to reduce the tax amount due.

Covered vs Non-Covered Expatriates

Another important aspect of expatriation is that not all expatriates are covered, expatriates. Therefore, just because a person expatriates, does not mean they are a “covered expatriate” and/or that these rules would apply to them. The main code section is 26 USC 2801.

Let’s take an introductory look:

Section 2801 Imposition of Tax

(a) In general

      • If, during any calendar year, any United States citizen or resident receives any covered gift or bequest, there is hereby imposed a tax equal to the product of—

      • (1) the highest rate of tax specified in the table contained in section 2001(c) as in effect on the date of such receipt, and

      • (2) the value of such covered gift or bequest.

What does this Mean

It means that if a person is considered a US citizen or resident and receives a gift from a covered person, then they may have to pay tax on that gift or request at the highest tax rate available on the value of the gift or bequest.

(b) Tax to be paid by recipient

      • The tax imposed by subsection (a) on any covered gift or bequest shall be paid by the person receiving such gift or bequest.

(c) Exception for certain gifts

      • Subsection (a) shall apply only to the extent that the value of covered gifts and bequests received by any person during the calendar year exceeds the dollar amount in effect under section 2503(b) for such calendar year.

What does this Mean

While the recipient of the gift or request must make payment, the same exceptions that would apply under 2503 are still in effect even after a person is considered a covered expatriate, so the rules involving transfers to spouses would still be applicable.

New Inheritance (Proposed) Tax Regulations

There are currently proposed regulations in place, which would create a specific form — IRS form 708 — used to report these types of gift transfer payments to the IRS. To date, the regulations are still proposed regulations — and form 708 has not been created yet.

Key Provisions from the Proposed Regulations:

      • Section 28.2801–7 provides guidance on the responsibility of a U.S. recipient, as defined in § 28.2801–2(e), to determine if tax under section 2801 is due. The Treasury Department and the IRS realize that, because the tax imposed by this section is imposed on the U.S. citizen or resident receiving a covered gift or covered bequest, rather than on the donor or decedent covered expatriate making the gift or bequest, U.S. taxpayers may have difficulty determining whether they are liable for any tax under section 2801.

      • Nevertheless, the same standard of due diligence that applies to any other taxpayer to determine whether the taxpayer has a tax liability or a filing requirement also applies to U.S. citizens and residents under this section. Accordingly, it is the responsibility of each U.S. citizen or resident receiving a gift or bequest, whether directly or indirectly, from an expatriate (as defined in section 877A(g)(2)) to determine its tax obligations under section 2801.

      • Thus, the burden is on that U.S. citizen or resident to determine whether the expatriate was a covered expatriate (as defined in section 877A(g)(1)) and, if so, whether the gift or bequest was a covered gift or covered bequest.

      • The Treasury Department and the IRS understand that a U.S. citizen or resident receiving a gift or bequest from an expatriate may be unable to obtain directly from the expatriate, the expatriate’s attorney, the expatriate’s executor, or other reliable sources the information necessary to make the above determinations.

      • If the IRS receives a request from a U.S. citizen or resident who received a gift from an expatriate who has consented to the disclosure of certain return information to that donee, a gift from an expatriate who is deceased at the time of the request, or a bequest from an expatriate, the IRS may in certain circumstances disclose to such U.S. citizen or resident the return or return information of the donor or decedent expatriate that may assist the U.S. citizen or resident in determining whether the donor or decedent was a covered expatriate and whether the transfer was a covered gift or covered bequest. See section 6103.

      • The types of information and requirements and procedures for requesting such information will be set forth in guidance published in the Internal Revenue Bulletin.

      • Although the IRS, if authorized, may disclose returns and return information upon request, the IRS will not make the determinations as to whether an expatriate from whom a gift or bequest was received was a covered expatriate or whether the gift or bequest was a covered gift or covered bequest.

      • Furthermore, the U.S. citizen or resident receiving a gift or bequest from an expatriate may not rely on any information provided by the IRS that the U.S. citizen or resident knows or has reason to know is incorrect. These determinations are the responsibility of the U.S. citizen or resident.

      • The proposed regulations provide that, if a living expatriate donor does not authorize the IRS to release to a U.S. citizen or resident the donor’s relevant return or return information, there is a rebuttable presumption that the expatriate donor is a covered expatriate and that each gift from that expatriate to a U.S. citizen or resident is a covered gift.

      • A taxpayer who reasonably concludes that a gift or bequest is not subject to section 2801 and intends to rebut the presumption may choose to file a protective return to start the period for assessment of any section 2801 tax. See §§ 28.2801–7(b)(2), 28.6011–1(b).

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