Covered Gifts or Bequests for Expatriates & US Tax Requirements

Covered Gifts & Bequests for Expatriates & US Tax Requirements

Covered Gifts or Bequests for Expatriates & US Tax  

When a US person wants to formally renounces their US citizenship or relinquish their green card and is considered a lawful long-term permanent resident, the formal process is referred to as, expatriation. In prior years, expatriation was limited to US citizens but about 20 years ago the rule was modified to include lawful permanent residents who maintained that status for at least eight out of the past 15 years — and do not qualify for any exceptions, exclusions, or imitations. Once a person cuts ties with the United States, they are no longer taxed as a US person on their worldwide income. Rather, they are taxed as nonresident aliens on their US-sourced income. One important and oftentimes overlooked consideration for individuals who want to expatriate is whether or not the person is a covered expatriate — and if so whether they have any US persons they plan on giving gifts or bequests to beyond charitable donations and spouses. This is because covered gifts may result in taxes for the US person recipient.

What is a Covered Gift or Bequest?

A covered gift or bequest is when a US person receives a gift or bequest from a covered expatriate. When this occurs, the US recipient is required to pay the tax upon receipt of the gift (subject to the annual exclusions and other exceptions). The US person pays it at the highest rate — 

26 USC 2801(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.

What does this Mean?

It means for purposes of covered gifts and bequests when a US person receives a gift or bequest from a covered expatriate — it will qualify as a covered gift and be subject to the tax implications of  IRC 2801.

Example of a Covered Gift or Bequest

Here is an example: Peter is a covered expatriate who wants to give a gift to a US person. He transfers a US person $400,000. In accordance with the covered expatriate IRC section 2801 covered gift and bequest rules — the tax consequences will be 40% of $385,000.

Gift Tax Exception & Exclusion Amount

Internal Revenue Code section 2801 (c) provides the following exception:

• • (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?

It means that under subsection c, there is an exception for the dollar amount included in 2503 (b) — which is otherwise known as the annual gift exclusion, in which the first certain portion of a gift to another person is exempt from gift tax (or reporting)

Who Pays the US Tax?

The US recipient is required to pay the tax — not the covered expatriate. The transaction is required to be reported on form 70,8 but at the current time form 708 does not actually exist yet.

Gift or Estate Tax Exceptions

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. 

What does this Mean?

There are some exceptions for a US Person to have to pay this tax

• • • Chapter 12 refers to Gift Tax

    • Chapter 11 refers to Estate Tax

Exceptions to Spouse or Charity

 (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.

• • • • IRC 2055: Transfers for public, charitable, and religious uses

      • IRC 2056: Bequests, etc., to surviving spouse

      • IRC 2522: Charitable and Similar Gifts

      • IRC 2523: Gift to Spouse 

What does this Mean?

Generally, the same exceptions and rules for non-covered gifts and bequests to spouses and charities applies to covered gifts and bequests.

Covered Gifts to Domestic and Foreign Trust Rules

As with nearly any tax issue involving a trust, when it comes to gifts and bequests involving covered expatriates — the trust reporting is more complicated as well.

Domestic Trusts

(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.

What does this Mean?

It means if a covered expatriate gives a gift to a domestic trust, the trust will be treated the same as if it was a US individual.

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.

What does this Mean?

The foreign trust rules are a bit more complicated:

• • • (i) Refers to the fact that once that gift or bequest is distributed to a US person, the covered rules will apply.

    • (ii) If the distribution is made to the US citizen or resident and taxes are paid or accrued — it can apply as a credit toward US taxes that are due.

    • (iii) The foreign trust may left to be treated as a US trust.

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