Section 2801 imposes a tax on covered gifts and covered bequests received by U.S. citizens or residents from a covered expatriate. Section 2801 also applies to domestic trusts and foreign trusts electing to be treated as domestic trusts.
To provide some background, individuals who expatriate and meet the definition of a “covered expatriate” are subject to onerous expatriation tax rules. A covered expatriate includes any US citizen who relinquishes her US citizenship if she (i) meets a net worth test ($2,000,000 or more), (ii) meets a net tax liability test (more than $161,000), or (iii) fails to certify that she has been fully tax compliant for the five preceding tax years.
In contrast to existing transfer tax rules, the Section 2801 tax is imposed on the recipient, not on the covered expatriate transferor. Thus, when receiving a gift, bequest or distribution from a trust, a recipient must determine whether or not Section 2801 applies and if so, how she can ensure compliance. Since Section 2801 was enacted in 2008, recipients of covered gifts and covered bequests have had little instruction from the IRS on how to comply. The proposed regulations are the most extensive guidance so far.
To ascertain whether or not the 2801 tax applies, the recipient must know the source of the gift or bequest. This is simple in the case of a direct transfer, for instance with a cash gift or the inheritance of a share of property. It can, however, become more difficult to determine in the case of indirect transfers. The proposed regulations define key terms and thereby cast a wide net over what will be deemed a 2801 transfer. The proposed regulations provide a list of “indirect acquisitions of property” that are included within the definition of covered gifts or bequests such as covered gifts indirectly received through the use of multiple foreign trusts or other entities; and covered gifts or bequests to a corporation in which the transferee has an ownership interest. The proposed regulations seek to close any further loophole by adding the following general (and arguably vague) definition: “property acquired … in other transfers not made directly by the covered expatriate to the U.S. citizen or resident.”
The 2801 tax appears as an inheritance tax imposed on covered expatriates, but imposes a burden on the recipients of covered gifts or bequests who will be charged with figuring out whether something is, in fact, a 2801 transfer. The general takeaway is that the Section 2801 tax operates as a strong disincentive to expatriating for those who would qualify as covered expatriates, as the IRS merely shifts the payment of U.S. transfer taxes to those U.S. citizen or resident family members who have not chosen to expatriate.
Authored by Catja Carrell