Seventeen years after Congress enacted IRC Section 2801, the IRS (finally) released final regulations implementing the law on January 10, 2025. It’s been a long wait. The regulations clarify (to a certain extent) the tax implications for U.S. persons receiving certain gifts and bequests from former U.S. citizens and long-term resident green card holders.
At its core, IRC Section 2801 imposes a transfer tax (currently at the rate of 40%) on the value of “covered gifts” and “covered bequests” received by U.S. persons (citizens or residents) from “covered expatriates.” Covered expatriates are individuals who meet certain criteria and who renounce U.S. citizenship or abandon long-term resident status. For green card holders, a tax expatriation can happen inadvertently when challenged at the border about meeting requirements for continued U.S. permanent residence.
The regulations issued are highly complex, span 129 pages and still leave various issues open. For example, the tax responsibilities for U.S. taxpayers who received a gift or inheritance years ago post-enactment of Section 2801 but prior to issuance of the regulations, remain unclear.
The expatriation tax laws have changed numerous times to continually close perceived loopholes that were viewed as allowing tax avoidance through expatriation. One thing is clear, the IRS is looking more closely at expatriations.
IRC Section 2801 Transfer Tax On “Covered” Gifts And Bequests
A “covered expatriate” is an individual who renounced U.S. citizenship or gave up a green card that was held for at least 8 of the previous 15 tax years and who meets any one of the following tests:
- Had a net worth of $2 million or more as of the expatriation date.
- Had an average annual net income tax liability for the 5 years ending before the expatriation date exceeding a set amount, adjusted annually for inflation ($201,000 for 2024; $206,000 for 2025). This is the average of U.S. income tax paid, not average income.
- Failed to certify compliance with all U.S. tax obligations for the five years before expatriation. It comes as a surprise to many that excise taxes (such as those imposed when Americans have foreign life insurance or annuities) count in determining tax compliance.
Generally, this definition seeks to ensure that the expatriation tax regime applies to high-net-worth / high income individuals who are presumed, on the basis of objective criteria, to have a tax-motivated reason for expatriating.
U.S. Recipients Of “Covered” Gifts And Bequests Pay The Price
If a U.S. citizen or resident received a gift or bequest from a foreign person after June 17, 2008, they may be required to file Form 708 and pay the Section 2801 transfer tax to the IRS. The IRS has not yet made Form 708 available. Taxpayers and their advisors anxiously await this form.
The U.S. recipient must determine whether the transfer is subject to the transfer tax under Section 2801. The burden falls on the recipient to determine that the gift or bequest is not a “covered” gift or bequest by substantiating that the donor or decedent was not a covered expatriate at the time of the transfer.
Transfer Tax Broad Parameters of Covered Gifts And Bequests
Covered gifts generally encompass any property transferred as a gift from a covered expatriate to a U.S. recipient. Property is treated as a covered bequest when acquired by reason of a covered expatriate’s death including property rights passing under a right of survivorship, annuity payments, property subject to a general power of appointment, and life insurance proceeds.
Powers of appointment, often seen in trusts and wills, require special attention in the context of the transfer tax. The exercise or release of a general power of appointment held by a covered expatriate over property for the benefit of a U.S. citizen or resident can be a covered gift or covered bequest. Similarly, the grant to a U.S. person by a covered expatriate of a general power of appointment over property can be a covered gift or covered bequest to the powerholder.
Foreign Trusts And The Transfer Tax
If a covered gift or covered bequest is made to a foreign trust, the Section 2801 tax applies to any distribution to a U.S. recipient from that trust, whether of income or corpus. The portion of a foreign trust distribution that is attributable to covered gifts/ bequests includes the ratable portion of any appreciation and income that has accrued since the covered gift or bequest was initially contributed to the trust.
Recordkeeping is particularly critical in certain situations. Examples include when there are various donors to a foreign trust, or when it is necessary to account for contributions to the trust made both before and after the donor’s expatriation.
It is possible to shift the burden of taxation from the trust’s U.S. beneficiaries to the trust itself if the trust elects to be treated as a U.S. domestic trust solely for purposes of Section 2801. An “electing foreign trust”, will be subject to the transfer tax when it receives covered gifts/ bequests from a covered expatriate instead of the U.S. beneficiaries being subject to the tax when trust distributions are made.
Exceptions To The Section 2801 Transfer Tax
The regulations carve out several exceptions to the 40% tax, including:
- Gifts or bequests already subject to U.S. gift or estate taxes provided the U.S. gift or estate tax return was timely filed.
- Gifts that qualify for the annual gift tax exclusion (e.g., $19,000 per recipient in 2025).
- Gifts or bequests to a U.S. citizen spouse or to qualified charities.
- Property transferred to a U.S. recipient because the covered expatriate made a qualified disclaimer with respect to the asset.
Section 2801 Transfer Tax Calculation And Reporting
The recipient of a covered gift or bequest is responsible for paying the tax. The tax is computed based on the fair market value of the transferred property, applying the maximum gift or estate tax rate, which is currently 40%.
Recipients must file IRS Form 708 to report and pay the tax. When this form is made available by the IRS, it should further clarify various lingering procedural uncertainties.
Significantly, the burden falls on the U.S. recipient to determine that the gift or bequest is not “covered” by substantiating that the donor or decedent was not a covered expatriate at the time of the transfer. As will be detailed by the IRS in a future announcement, it will be possible to request tax information from the IRS about a former American so that one can determine their “covered expatriate” status.
With respect to living donors, the regulations create a rebuttable presumption that the transfer is a “covered gift”, subject to Section 2801 tax if the donor does not consent to release of IRS tax records. This entire topic is filled with issues, especially since the IRS has been known to lose records or destroy them.
I believe it will be extremely difficult, if not impossible. to get IRS records if the gift or bequest is received many years after the expatriation occurred. All expatriates should keep detailed U.S. tax records, obtain tax returns and transcripts directly from the IRS if possible and keep all documentation with important papers, such as wills. Family members and the family attorneys and advisors should be advised about the Section 2801 issues and where these important records are kept since they can serve as evidence of the former American’s status.
Filing “protective” returns on Form 708 is also possible. A protective return allows a taxpayer to take a position they believe is correct, including stating that a gift or bequest is not “covered.” Filing in this manner starts the statute of limitations period, limiting the IRS’ time to challenge the taxpayer’s position or assess additional tax.
Implications For U.S. Recipients And Expatriates
The final regulations bring long-awaited information and highlight the importance of careful estate and tax planning for expatriates and their U.S.-based heirs. U.S. persons receiving gifts or inheritances from foreign persons should consult with tax professionals to navigate these rules and build a file to demonstrate the status of the transfer and transferor. Failure to plan properly could result in unintended tax burdens.
I help with tax matters around the globe.
Reach me at vljeker@us-taxes.org
Visit my US tax blog www.us-tax.org It is an invaluable guide in all areas of U.S. international tax, including updates about the IRS Section 2801 transfer tax regulations and Form 708. My blog will help you stay on top of U.S. international tax and legislative developments, keeping you ahead of U.S. tax changes impacting your life, family or business.
Read the full article here
