IRS Proposes Rules on Gifts and Inheritances from Expats

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The Internal Revenue Service has issued proposed regulations that provide guidance to U.S. taxpayers who receive gifts or inheritances from certain individuals who have expatriated.

The proposed rules stem from the Heroes Earnings Assistance and Relief Tax Act of 2008, or “HEART Act,” which applied to certain individuals who terminate their U.S. citizenship or permanent residents who surrender their green cards on or after June 17, 2008.

The HEART Act introduced two new sections to the Tax Code, 877A and 2801. Section 877A imposed an exit tax on such individuals, and the Treasury and the IRS released guidance in 2009 for Section 877A. However, the Treasury and the IRS have not issued guidance for Section 2801 until now.

The key component of Section 2801 is that U.S. taxpayers who receive gifts and inheritances from people who previously expatriated are subject to gift and/or estate taxes on the receipt of such gift or bequest.

Kevin Packman, a partner in Holland & Knight’s Miami office, a member of the law firm’s International Estate Planning Group and chair of its Offshore Compliance Team said the bottom line on these new rules is that there will be “more taxes, taxes, taxes” facing expatriates and their families. The proposed regulations fill in an important piece of the puzzle that’s been missing since the law passed 2008.

“When the law came out, it introduced two new Code provisions, 877A, which is what everybody focuses on because it’s got the big, bad exit tax, and 2801,” said Packman. “Maybe it’s the nature of my practice. I started as an estate and gift guy. That certainly had more of an interest for me. Then the IRS came out with guidance for 877A, and nothing on 2801. We’ve had this law since 2008, basically saying if somebody leaves the country and they qualify as a covered expatriate, and then they make a gift, or if they die and send a bequest back to you as a U.S. person, there’s a tax. That’s the law. That’s 2801. But we’ve had no regulations. We’ve had no forms. We’ve had no means to comply or even report the tax consequences of any of those transactions if one did arise.”

Taxpayers were left on their own to decide what to do. “The IRS basically said, ‘This is the law, but you don’t have to do anything more until you hear from us,’ basically. So we’ve had seven years of a law with zero ability to comply with really no enforcement, because of course you can’t have enforcement if there’s no way to comply,” Packman added. “What’s newsworthy is we now know what’s required to comply with the law.”

The number of people giving up their U.S. citizenship has accelerated in recent years, in part due to later legislation such as the Foreign Account Tax Compliance Act, or FATCA, which was passed in 2010 as part of the Hiring Incentives to Restore Employment Act, also known as the “HIRE Act.” Last year, 3,415 Americans renounced their citizenship (see Americans Living Abroad Set Record for Giving Up Citizenship). There have been calls in Congress from Sen. Rand Paul, R-Ken., and others to repeal FATCA. But Packman pointed out that taxes aren’t the only reason why Americans move abroad.

“At the end of the day people give up their status for many different reasons,” he said. “Certainly for a number of people who never thought twice about holding onto a green card, as U.S. enforcement has gone up, they realize that it’s expensive, burdensome or difficult if they live in, say, Timbuktu to find a CPA who is qualified to prepare a U.S. tax return. It’s impossible to comply or expensive, so those people are giving up their status. Those people aren’t running away from the U.S. They’re probably already living in a foreign country.”

Under the estate and gift tax rules, a foreign person can make a gift to somebody in the U.S., and there is no gift tax as long as it’s not a U.S.-sited asset. “There’s no tax consequence to the recipient,” said Packman. “If the value of the gift is over $100,000, they need to file a 3520, but there’s no tax consequence. It’s the same as it relates to death. If you inherit property from a foreign person, and the value is over $100,000, you file a 3520, but there’s no tax consequence. You may have an 8938 filing obligation because an interest in a foreign estate is a reportable asset, but don’t you don’t have to do anything more.”

The existing law has been fairly straightforward. “Now we’re saying you gave up your status, you’re a covered expat, you paid the exit tax, and when you want to make a gift to your U.S. kids or your grandkids or a former business partner, unless you pay the gift tax, the recipient is now required to pay gift tax,” said Packman. “And on the estate side, it’s the same issue. Assets coming back into the U.S. are subject to estate tax by the recipient. There’s an exception if the funds would have qualified for a charitable deduction had you been U.S., then you can get an exemption and there’s an exemption for bequests to a U.S. spouse or a gift to a U.S. spouse.”

The new proposed regulations delve into the existing law in greater detail and nuance.

One area that could provide a potential loophole involves life insurance. “Certain practitioners who focus on life insurance as a practice area have proposed and premised that somebody who is a covered expat could buy a life insurance policy or do something with life insurance and that probably would not be included in many of these rules because life insurance always has such a wonderful tax classification and characterization in the Code,” said Packman. “I don’t see anything in the law that would prohibit that.”

However, the proposed regulations do mention, in a section about covered bequests, “life insurance proceeds payable upon the covered expatriate’s death that would have been includible in the covered expatriate’s gross estate under section 2042 if the covered expatriate had been a U.S. citizen at the time of death.”

The proposed regulations also note, “For every policy of life insurance listed on the return, the U.S. recipient must procure a statement from the insurance company on Form 712 and file it with the IRS office where the return is filed. If specifically requested by the Commissioner, the insurance company must file this statement directly with the Commissioner.”

Packman pointed out that a new Form 708 is also required under the proposed regulations to report by the recipient of a gift or bequest by an expatriate. The form has not been issued yet. According to the proposed regulations, the deadline to file the form is the 15th day of the 18th calendar month following the close of the calendar year in which the gift or bequest was received. For anybody who received a gift or bequest that would be covered by these rules prior to the period of the regs having come out, the deadline for filing is “a reasonable period of time after the date of the publication of the final regulations.”

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