IRS Issues Final Regs Regarding Tax on Gifts and Bequests from Covered Expatriates

(Parker Tax Publishing February 2025)

The IRS issued final regulations that provide guidance on the application of the tax under Code Sec. 2801 on United States citizens and residents, as well as certain trusts, that receive, directly or indirectly, gifts or bequests from certain individuals who relinquished United States citizenship or ceased to be lawful permanent residents of the United States. The final regulations also provide guidance on the method of reporting and paying this tax. T.D. 10027.

Background

Code Sec. 2801 was enacted in 2008. It imposes a tax (the Section 2801 tax) on certain transfers of property by gift (covered gifts) and on certain transfers of property by bequest (covered bequests) from certain individuals who expatriate on or after June 17, 2008.

The Section 2801 tax is imposed on each United States (U.S.) citizen or resident receiving a covered gift or covered bequest (U.S. recipient). For this purpose, domestic trusts and foreign trusts that elect to be treated as domestic trusts solely for purposes of Code Sec. 2801 (electing foreign trusts) are included in the definition of a U.S. citizen. Foreign trusts that do not elect to be treated as domestic trusts for purposes of Code Sec. 2801 (non-electing foreign trusts) are not U.S. citizens or residents and, therefore, do not become subject to the Section 2801 tax upon receipt of covered gifts and covered bequests. Instead, the beneficiaries of non-electing foreign trusts who are U.S. citizens or residents (U.S. citizen or resident beneficiaries) become subject to the Section 2801 tax upon their receipt of a distribution from a non-electing foreign trust that is attributable to covered gifts and covered bequests made to that non-electing foreign trust.

The Section 2801 tax will be computed on Form 708, United States Return of Tax for Gifts and Bequests Received from Covered Expatriates, on which a U.S. recipient will report covered gifts and covered bequests received during the calendar year. If the aggregate value of the covered gifts and covered bequests received by the U.S. recipient during the calendar year exceeds the amount of the inflation-adjusted annual exclusion under Code Sec. 2503(b) ($18,000 for 2024), the Section 2801 tax is computed by multiplying the excess by the highest estate tax rate specified in Code Sec. 2001(c) in effect on the date of receipt, and then reducing the product by any gift or estate taxes paid to a foreign country with respect to the covered gifts and covered bequests. The value of each covered gift and covered bequest is its fair market value as of the date of its receipt.

In 2015, the IRS issued proposed regulations (REG-112997-10) related to the Section 2801 tax. The proposed regulations (1) set forth the general rules of liability for the Section 2801 tax; (2) defined relevant terms; (3) provided exceptions to the definitions of covered gift and covered bequest; (4) provided guidance on calculating the Section 2801 tax; (5) provided guidance on the treatment of foreign trusts; (6) addressed the interaction of Code Sec. 2801 with other Code sections; and (7) provided guidance on the responsibility of a U.S. recipient to determine if tax under Code Sec. 2801 is due.

T.D. 10027

On January 14, the IRS published final regulations in T.D. 10027 that adopt the 2015 proposed regulations with revisions made in response to practitioners' comments.

Indirect Transfers

A covered gift or covered bequest is defined in Code Sec. 2801(e) as any property acquired directly or indirectly by gift from or by reason of the death of a covered expatriate. Using transfer tax principles, Prop. Reg. Sec. 28.2801-2(i) of the proposed regulations identified the transfers that constitute indirect acquisitions of property, to include property (1) acquired through ownership of an interest in a corporation or other entity, (2) acquired through one or more foreign trusts, entities, or persons not subject to the Section 2801 tax, (3) paid in satisfaction of a debt or liability, (4) acquired through a power of appointment over property not in trust granted by a covered expatriate to a non-covered expatriate, and (5) acquired as a result of any other indirect transfer by a covered expatriate.

In comments, practitioners stated that the illustrations of indirect gifts in Prop. Reg. Sec. 28.2801-2(i)(2), (3), and (5) of the proposed regulations were overbroad because they could capture transfers that, in some cases, are not truly indirect transfers and should not be subject to tax under Code Sec. 2801. The IRS agreed, and therefore the final regulations modify, in part, the definition of indirect acquisition of property to address these concerns. Specifically, the final regulations replace the rules in Prop. Reg. Sec. 28.2801-2(i)(2) and (5) with a single illustration that is, in substance, a covered gift or covered bequest from a covered expatriate. In addition, the final regulations add a more general description of property that is gratuitously passed from or conferred by the covered expatriate through another person or entity, and the rules in Prop. Reg. Sec. 28.2801-2(i)(1) through (5) are converted in the final regulations to a nonexclusive list of illustrations describing the application of the definition for purposes of Code Sec. 2801.

Timely Paid Requirement

For property reported on the covered expatriate's gift or estate tax return to be excluded from the definition of a covered gift or covered bequest, Prop. Reg. Sec. 28.2801-3(c)(1) and (2) of the proposed regulations required not only the timely filing of that return, but also the timely payment of the tax shown on that return (timely paid requirement). Practitioners suggested eliminating the timely paid requirement, stating that the requirement exceeded the IRS's statutory authority and that the requirement would cause a double tax to be imposed on a single transfer if the gift or estate tax is not timely paid.

The IRS disagreed with the reasoning of those comments. However, the IRS stated that it considered other existing enforcement mechanisms which also could address compliance concerns, such as the establishment of special gift and estate tax liens under Code Sec. 6324 and the transferee gift tax or estate tax liability under Code Sec. 6901. In addition, the IRS determined that a timely paid requirement could present administrability and finality challenges - for example, when the amount paid with the return differs from the amount that is ultimately owed due to a valuation change or other adjustment after examination. Therefore, the final regulations eliminate the timely paid requirement as it relates to this exception from the definitions of covered gift and bequest.

Date of Receipt of a Covered Gift or a Covered Bequest

Under Prop. Reg. Sec. 28.2801-4(d)(2) of the proposed regulations, the date of receipt of a covered gift, which is the date the Section 2801 tax is imposed, generally was determined by reference to the date of the gift, as if the covered expatriate had been a U.S. citizen at the time of the transfer. In the event of a transfer of assets by a covered expatriate to a domestic revocable trust, Prop. Reg. Sec. 28.2801-4(d)(2) provided that the date of receipt of the transfer is the date the covered expatriate relinquishes the right to revoke the trust. Prop. Reg. Sec. 28.2801-4(d)(3) provided that the date of receipt of a covered bequest generally is the date the property is distributed from the covered expatriate's estate or revocable trust, unless the interest passes by operation of law or beneficiary designation, in which case the date of receipt is the date of the decedent's death.

In comments, practitioners recommended changing the rules regarding the date of receipt for both covered gifts and covered bequests. Practitioners pointed out that the date on which a covered expatriate makes a gift often is not the same date on which the property is received by the U.S. citizen or resident donee. A discrepancy between those dates can impact a recipient's ability to pay the Section 2801 tax liability because the recipient may not yet have received the economic benefit of the gifted property. Practitioners also suggested that the rule determining the date of receipt for purposes of the Section 2801 tax should distinguish between receipt of a present interest in property and receipt of a future interest in property. The IRS responded that in most instances, the lengthy amount of time between the date of receipt and the due date of the return and payment of the Section 2801 tax (generally, 17.5 months after the close of the year in which the covered gift or covered bequest is received) should be sufficient to allow a U.S. recipient to make necessary arrangements to timely report and pay any Section 2801 tax liability. Moreover, the IRS stated that the rules for transfers in trust satisfactorily resolve the potential problems for many situations of deferred possession.

However, for future interests in property that are not held in a trust (for example, a remainder interest in real property), the IRS agreed with practitioners' administrative and valuation concerns with the proposed definitions of the date of receipt. In view of these concerns, Reg. Sec. 28.2801-4(d)(8)(i) of the final regulations includes a special rule providing that the date of receipt of a covered gift or covered bequest of a future interest in property that is not held in trust is the earlier of (1) the date the future interest is disposed of by the U.S. recipient or (2) the date that is the later of (i) the date that the interest vests in the U.S. recipient or (ii) the date that the last term interest in the property held by an intervening recipient terminates. Further, to assist recipients both in achieving finality regarding the Section 2801 tax liability and in avoiding the potential for administrative hurdles caused by a long delay in receipt, Reg. Sec. 28.2801-4(d)(8)(ii) of the final regulations provides that the U.S. recipient of a covered gift or covered bequest of a future interest in property not held in trust may elect to treat the covered gift or covered bequest as having been received on the date of receipt of the gift or on the covered expatriate's date of death, respectively. To the extent a domestic or electing foreign trust receives or may eventually receive a covered gift or covered bequest that is a future interest in property that is not in trust, such domestic or electing foreign trust may take advantage of this election.

In addition, to provide further clarification on the date of receipt of a transfer to a domestic trust or an electing foreign trust that is an incomplete gift, a new paragraph is added in Reg. Sec. 28.2801-4(d)(4) of the final regulations. In the event of a transfer by a covered expatriate to a revocable domestic trust or electing foreign trust, the date of receipt by the trust is the later of (1) the date the right to revoke the trust is relinquished or extinguished and (2) the date of extinguishment of all powers over or interests in the trust that would prevent the transfer from being a competed transfer for gift tax purposes. In the event of a transfer by a covered expatriate to an irrevocable domestic trust or electing foreign trust over or in which the covered expatriate retains powers or interests that prevents the transfer from being complete, the trust receives the transfer on the date all of such powers or interests are extinguished.

For a discussion of the tax on gifts and bequests from covered expatriates, see Parker Tax ¶223,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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