Tax-Expatriation

Finally – Proposed Regulations for “Covered Gifts” and “Covered Bequests” Issued by Treasury Last Week (Be Careful What You Ask For!)

Posted on September 16, 2015 Updated on September 16, 2015

The U.S. Treasury department has issued proposed regulations implementing the tax on “covered gifts” and “covered bequests.”  There have been numerous posts about this tax that was first created in 2008 by new IRC Section 2801 (which has it’s own chapter in Title 26 – aka the Internal Revenue Code or “IRC”:  Chapter 15, Gifts and Bequests from Expatriates).  The regulations can be reviewed here – Guidance under Section 2801 Regarding the Imposition of Tax on Certain Gifts and Bequests from Covered Expatriates

See prior posts, When does “Covered Expatriate” Status -NOT- matter?, (May 2015); See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.” (April 2014) and  Proposal to U.S. Treasury and IRS: awaits Final Regulations on “Covered Gifts” and “Covered Bequests” (December 2014).

The tax is levied currently at 40% and can be a big surprise to U.S. beneficiaries who receive so-called “covered gifts” and “covered bequests.”  The actual implementation of the tax and its enforcement was suspended until Treasury issued regulations.  That day has now come and final regulations will follow shortly.

The proposed regulations create an ingenious mechanism by which assets that are received from foreign trusts (which make an election to be taxed as domestic trusts) cannot escape the 40% taxation.  Specifically, there was concern expressed to me by Treasury officials drafting the regulations, when I had submitted a proposal to the U.S. Treasury on the subject in May of 2014.  See, COVERED GIFTS & BEQUESTS:  THE NEED FOR GUIDANCE (5+ YEARS OUT)

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There was concern by the U.S. Treasury that U.S. persons could escape the tax when assets are received by foreign trusts which elect to be taxed as domestic trusts.  In those cases, the statute imposes the tax liability on the trust and not the U.S. beneficiary.  Hence, the concern expressed by some of the key drafters at U.S. Treasury of the regulations, was that a foreign trust would make the election and purposefully NOT pay the tax imposed by the statute, since the trustee would be outside the U.S. and largely outside the jurisdiction of the IRS.

The proposed regulations create a mechanism by which the trustee cannot slip away so easily, as they will NOT be treated as a domestic trust (versus a foreign trust) in such circumstances where the tax is not actually paid.  In those cases, the U.S. beneficiary will be liable for the tax.

It also has some unique concepts that are not necessarily intuitive under the law.  For instance, those individuals who are not U.S. citizens, yet live in the U.S. on a nearly full time basis, might still be able to avoid the application of the tax (at least in certain circumstances) if they are not “domiciled” in the U.S.  The term “domicile” is a key estate and gift tax term of tax residency, that is not tied to the number of days an individual spend in the U.S.  Rather, it is tied to the subjective intention of whether they expect to spend the rest of their lives in the U.S.  See, Section 28.2801-2(b) of the  proposed regulations which defines residents as those under “Chapter 11” and “Chapter 12”; which are the rules of “domicile” for transfer tax purposes.  These are different from the rules of income tax residency found in IRC Section 7701.

The operative definition is found in (b)(1) of the Regulations:  26 CFR 20.0-1 – Introduction.:

“A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal.”

Notice, there is no reference to the number of days physically spent in the U.S.

More to be discussed on the proposed regulations in later posts.