U.S. Inheritance ‘Exit’ Tax for U.S. Expatriates
Many individuals are aware that there is a U.S. expatriate tax regime after renouncing U.S. citizenship or renouncing a long-held green card, but less known are the gift and estate tax implications posed by the exit tax regime.
Gift and Estate Implications for former U.S. Expatriates subject to Exit Tax
Former U.S. citizens who are in scope of the exit tax regime will also be subject to a special tax on gifts or bequests made to a U.S. citizen, regardless of whether the gift or bequest is U.S.-sourced or foreign.
Covered Expatriate Gift and Estate Tax Implications
A new regime on gifts by covered expatriates was enacted in the ‘Heart Act’ (Heroes Earnings Assistance and Relief Act of 2008). This is often referred to as ‘Section 2801 tax’. In 2015, the IRS issued proposed guidance on the implementation of this regulation which has not yet been finalized (but it is expected to be effective once final).
Section 2801 imposes a tax on US citizens or residents that receive gifts or bequests from a covered expatriate (known as “covered gifts” and “covered bequests”), whether the transfers are made directly or indirectly. The purpose behind the act was to create a disincentive for US persons wanting to expatriate to avoid US tax on their estate and gifts.
There are certain exceptions to what property is not considered a covered gift or bequest in a transfer:
- Transfers to US charities;
- Transfers to a covered expatriate’s spouse or trust to the extent a marital deduction would have been allowed when the expatriate was a US citizen.
- Transfers subject to US gift tax on a timely filed gift tax return.
- Transfers subject to US estate tax on a timely filed estate tax return.
Because the U.S. beneficiaries are subject to the estate tax under this provision, it is known as an inheritance tax. The tax that would result on receiving gifts or bequests from a covered expatriate could be up to 40% of the value of the gift or bequest they receive.
The proposed regulations place the compliance burden on the recipient to report and pay the resulting tax. As they are not yet final, the regulations are still subject to change and could later be challenged in court. Technically, the application of Section 2801 is suspended until release of the final regulations; however, planning on the basis that it currently does not apply would be aggressive. Careful planning is recommended when preparing an estate or any bequests made by a former expatriate to U.S. beneficiaries such as any U.S. citizen children or spouse.