Covered Gifts & IRC 2801
Covered Gifts & IRC 2801: When a person is a covered expatriate, the US tax rules can follow them for many years after they renounced or relinquished their U.S. Citizenship or Permanent Resident Status. The IRS post-expatriation tax consequences of being a covered expatriate become most apparent when a covered expatriate wants to provide gifts to a US person. Unlike US persons, the gift and estate tax exemption does not apply (although the annual exclusion rules do apply). This could mean serious tax consequences for a covered expatriate who issues gifts to a US person.
Let’s walk through an example of the gift tax for covered expatriates:
Gift Tax Covered Expatriate Example
Scott is a covered expatriate who resides outside of the United States. He is domiciled in a foreign country, but still has US-person children who were born as US Citizens and have not renounced their US Citizenship.
Scott’s eldest son just got married and he would like to gift him and his spouse $800,000.
IRC 2801 – What does it provide?
Section 2801 is the key Internal Revenue Code that refers to covered expatriate gifts.
“(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.”
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.”
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.”
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.”
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.”
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.”
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.”
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 Gift Tax rules.
Contact our firm today for assistance.