Expatriate Gifts and Inheritance May Be Subject to US Tax Laws

Expatriate Gifts and Inheritance May Be Subject to US Tax Laws

What is Inheritance Tax for Expatriates

What is Inheritance Tax for Expatriates: One of the main reasons why a U.S. Citizen or Long-Term Lawful Permanent Resident (aka ‘Expatriate’) does not want to be considered a covered expatriate is because it may result in subsequent IRS gift and inheritance tax in the future — if they are going to gift or bequest money or assets to a US Person. While there are some exceptions, limitations and exclusions when gifts are being made to spouses or charity — these exceptions are limited — and gifting wealth is a common occurrence for a high-net worth covered expatriate. The situation can become very complex, when the Covered Expatriate has children for example, that either relocated to the United States temporarily/permanently — and are currently considered US persons. This may subject the US Person to an inheritance tax when they receive the gift/bequest from the Covered Expatriate. Let’s review the basics of inheritance tax for covered expatriates:

Estate Tax vs Inheritance Tax

In general, the United States follows an estate tax model. Therefore, technically when a person passes away then their state may be subject to an estate tax based on the value of the worldwide estate. It is important to note, that within estate tax, the tax is on the estate and not the inheritance per se (although some states do have an inheritance tax). When a person is a covered expatriate then the rules are different and it can turn into an inheritance tax on the recipient at the time of receiving the gift/bequest.

Example of a Covered Expatriate Inheritance Situation

Scott is a former U.S. Citizen who relinquished his US Citizenship but was a Covered Expatriate at that time. He didn’t think much about it initially, since his children were non-US Residents as well. But, due to Educational Pursuits and Lifestyle Choices — his children decided to relocate to the United States, and are now considered US Persons. Scott’s eldest son just got married and he would like to gift him and his spouse $800,000. This may result in an inheritance tax scenario.

IRC 2801 – What does it Provide?

Section 2801 is the key Internal Revenue Code that refers to covered expatriate gifts and inheritance tax and gift 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.”

Result

In accordance with Section 2801, when a covered expatriate gives a gift to a US person, the gifts will be taxable by the higher tax rate available under IRC 2001 (c). If the gift was $800,000 and the tax rate was 40% — the tax would be $320,000.

(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.”

Result

The person who receives the gift is the person responsible for making sure the payment is made.

“(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.”

Result

Each year, Taxpayers can make certain gift (currently $15,000) which is excluded from reporting. Therefore, even when a covered expatriate is the person making the gift, they can also exclude the first $15,000 of annual exclusion amount.

“(d) Tax reduced by foreign gift or estate tax

      • The tax imposed by subsection (a) on any covered gift or bequest shall be reduced by the amount of any gift or estate tax paid to a foreign country with respect to such covered gift or bequest.”

Result

When a foreign tax has already been paid on the gift, the covered expatriate gift tax due is reduced by foreign taxes already paid overseas on the gift.

“(e) Covered gift or bequest

(1) In general

      • For purposes of this chapter, the term “covered gift or bequest” means—

        • (A) any property acquired by gift directly or indirectly from an individual who, at the time of such acquisition, is a covered expatriate, and

        • (B) any property acquired directly or indirectly by reason of the death of an individual who, immediately before such death, was a covered expatriate.

(2) Exceptions for transfers otherwise subject to estate or gift tax

      • Such term shall not include—

        • (A) any property shown on a timely filed return of tax imposed by chapter 12 which is a taxable gift by the covered expatriate, and

        • (B) any property included in the gross estate of the covered expatriate for purposes of chapter 11 and shown on a timely filed return of tax imposed by chapter 11 of the estate of the covered expatriate.”

Result

      • The IRS allows for some exceptions for the recipient to have to pay the gift tax under 2801:

          • Chapter 12: Gift Tax

          • Chapter 11: Estate Tax

“(3) Exceptions for transfers to spouse or charity

      • Such term shall not include any property with respect to which a deduction would be allowed under section 2055, 2056, 2522, or 2523, whichever is appropriate, if the decedent or donor were a United States person.”

Result

The IRS also allows for a deduction to be claimed for property that would otherwise be subject to covered expatriate gift tax, include:

      • IRC 2055: Public, Charity or Religious Use

      • IRC 2056: Bequest to Surviving Spouse

      • IRC 2522: Charitable or Similar Gifts

      • IRC 2523: Gifts to Spouse

“(4) Transfers in trust

      • (A) Domestic trusts

        • In the case of a covered gift or bequest made to a domestic trust— (i)subsection (a) shall apply in the same manner as if such trust were a United States citizen, and (ii) the tax imposed by subsection (a) on such gift or bequest shall be paid by such trust.

      • (B) Foreign trusts

        • (i) In general In the case of a covered gift or bequest made to a foreign trust, subsection (a) shall apply to any distribution attributable to such gift or bequest from such trust (whether from income or corpus) to a United States citizen or resident in the same manner as if such distribution were a covered gift or bequest.

        • (ii) Deduction for tax paid by recipient

          • There shall be allowed as a deduction under section 164 the amount of tax imposed by this section which is paid or accrued by a United States citizen or resident by reason of a distribution from a foreign trust, but only to the extent such tax is imposed on the portion of such distribution which is included in the gross income of such citizen or resident.

        • (iii) Election to be treated as domestic trust

        • Solely for purposes of this section, a foreign trust may elect to be treated as a domestic trust. Such an election may be revoked with the consent of the Secretary.”

Result

The IRC 2801 trust rules can be more complicated. Essentially, it allows the trust to be swapped out for the individual (depending on whether it is a foreign or domestic trust) and allows for certain elections.

“(f) Covered expatriate

      • For purposes of this section, the term “covered expatriate” has the meaning given to such term by section 877A(g)(1).”

In conclusion, when a person expatriates from the USA, they should aim to avoid covered expatriate status. If they are covered expatriates, then even if they can avoid the exit tax, they may still be on the hook for gift and estate tax at a future date, which many not be on their current radar at the present time.

Golding & Golding: International Tax & Compliance

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and Covered Expatriate Inheritance Tax rules.

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