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The Inheritance Tax under IRC §2801

Jun 08 2023

Article Written for:  TaxStringer, the NYSSCPA's (New York Society of Certified Public Accountants) 

The Heart Act added a new federal Inheritance Tax on certain lifetime and testamentary dispositions to U.S. recipients, made by a “covered expatriate.” This is the second article in our two-part series on the expatriation tax.

The Inheritance Tax is separate from and in addition to the Exit Tax [covered here]. The Inheritance Tax is payable by the recipient of the gift or bequest, not the expatriate. The application of §2801 does not expire;  a transfer made by a covered expatriate long after expatriating could potentially trigger the tax. The tax rate imposed by §2801 is 40% of the value of the gift or bequest.

The U.S. estate tax covers worldwide assets of U.S. citizens and residents (“U.S. Persons”). Non-resident aliens are not subject to U.S. estate tax on foreign situs assets. Section 2801 taxes U.S. persons on the value of gifts and bequests from expatriates, to the extent of avoiding U.S. transfer tax (due to the donor’s expatriation). The Inheritance Tax is similar to the Gift tax (imposed under Subtitle B of the Code), but is due from the U.S. donee of an expatriate.

Nonresident noncitizens may make tax-free gifts of foreign situs and intangible U.S. situs property to U.S. residents. Section 2801 prohibits “covered expatriates” from tax arbitrage (avoiding U.S. transfer taxes) when transferring foreign or intangible property to U.S. donees. The rationale seems based on the intended prohibition of having assets returned to the United States with an increased basis (post-expatriation) to U.S. citizens or residents.

Definitions under §2801              

“Covered gift or bequest” – §2801(e)(1) provides that a “covered gift” includes any gift acquired from a “covered expatriate” (even if mark-to-market tax is paid under §877A), when received by a U.S. citizen or resident. The definition applies (regardless of the situs of the asset given or whether the property was acquired by the covered expatriate before or after expatriation from the United States).[1] A “covered bequest” includes any property acquired directly or indirectly by reason of the death[2] of an individual who, immediately before such death (even if mark-to-market tax is paid under §877A), was a covered expatriate. The covered status applies regardless of asset situs and of whether such property was acquired by the covered expatriate before or after expatriation.[3]  Note that gifts or bequests made to a charity or to the spouse of a covered expatriate— to the extent such gifts or bequests would be deductible for Estate or Gift Tax purposes, if the decedent or donor were a U.S. person  are not taxed as covered gifts or bequests. Charitable giving may therefore be a potentially viable strategy for avoiding tax under §2801.

“Expatriate and covered expatriate” – The term expatriate is defined in §877A(g)(2) as “any U.S. citizen who relinquishes citizenship and any long-term resident of the United States who ceases to be a lawful permanent resident of the United States.” The term covered expatriate [§877A(g)(1)] limits coverage to certain minimum income, wealth and the tax compliance standards (covered in our last article).           

“U.S. Recipient” – a U.S. recipient includes a U.S. citizen, a U.S. domiciliary, a domestic trust, an electing foreign trust, and “the U.S. citizen resident shareholders, partners, members, or other interest-holders, as the case may be (if any) if a domestic entity that receives a covered gift or covered bequest”.[4]  For purposes of §2801, an individual donee of a covered gift or bequest is a “resident,” if domiciled in the United States.[5] As noted in our prior article, domicile (for transfer tax purposes) is determined under the U.S. Treasury Regulations, based on two elements: (i) physical presence and (ii) intent to remain in the United States. [6]

Exceptions to §2801 Tax

Certain transfers are exempt from the application of the §2801 Inheritance Tax. The U.S. Treasury issued proposed regulations on §2801 in 2015.[7] The proposed regulations apply to taxpayers who receive covered gifts or covered bequests on or after the final regulations are published in the Federal Register. The proposed regulations generally provide insight into the IRS’s intended application of the §2801 Inheritance Tax.

Reportable taxable gifts.  A transfer of property that is a taxable gift under §2503(a) reported on the donor’s timely filed Form 709 is not a covered gift under §2801 (provided the donor also timely pays any gift tax owing).

Properties subject to the U.S. Estate Tax. Property included in the gross estate of the covered expatriate and reported on a timely filed Form 706 or Form 706-NA (provided estate tax is paid) is not a covered bequest,  taxed by §2801. Under §2801, distributions from or on the remainder of a qualified domestic trust (QDOT) are not covered if reported on a timely filed Form 706, if the tax due is timely paid.[8]

Transfers to charities. A gift to a donee described in §2522(b) or a bequest to a beneficiary described in §2055(a) is not a covered gift or covered bequest (under §2801), to the extent a charitable deduction under §2522 or §2055 would have been allowed if the covered expatriate had been a U.S. citizen or resident at the time of transfer.[9]

Transfers to spouse.  A transfer from a covered expatriate to the covered expatriate’s spouse is not a covered gift or covered bequest, provided a marital deduction under §2523 or §2056 would have been allowed if the covered expatriate had been a U.S. citizen or resident at the time of the transfer.[10]

Qualified disclaimers.  A transfer pursuant to a qualified disclaimer by a covered expatriate  [as defined in §2518(b)], is not a covered gift or covered bequest.[11]

Application of §2801

A “covered beneficiary” means a U.S. citizen, a U.S. domiciliary, a domestic trust, an electing foreign trust, and “the U.S. citizen resident shareholders, partners, members, or other interest-holders, as the case may be (if any) of a domestic entity that receives a covered gift or covered bequest”.  §2801 taxes U.S. trust beneficiaries domiciled in the U.S. on gifts or bequests (to the applicable trust) by “covered expatriates”.

Liability for §2801 Inheritance Tax          

A covered beneficiary who receives a covered gift or covered bequest must pay the §2801 tax. A foreign trust (absent an election to be treated as a domestic trust) that receives a covered gift or covered bequest is not liable for the payment of the §2801 tax. Each U.S. beneficiary is liable for payment of Inheritance Tax upon receipt, either directly or indirectly, of a distribution from the foreign trust, to the extent the distribution is attributable[12] to a covered gift or covered bequest made to the foreign trust.[13]

Computation of §2801 Inheritance Tax

Calculation of taxThe §2801 tax is calculated by multiplying the value of the “net covered gifts and covered bequests” received by a U.S. recipient during the calendar year by (as applicable) (i) the highest rate of estate tax under §2001(c) or (ii) the highest rate of gift tax under §2502(a).[14]  Net covered gifts and covered bequests means the total value of all covered gifts and covered bequests received by the U.S. recipient during the calendar year, less the §2801(c) per-donee annual exclusion (currently $17,000).[15]

Tax Basis for Payment of §2801 Tax

The U.S. recipient’s tax basis in property received as a covered gift or covered bequest is determined under §1015 and §1014.[16] As covered bequests are not taxable as part of the decedent’s gross estate (under title 11 of Subtitle B), the property acquired (by the U.S. recipient) will not receive a “step-up” in basis to fair market value (regardless of the any §2801 tax paid).[17] Likewise, any covered gift will be governed by the tax basis rules of §1015, thus maintaining a carryover basis from the donor.[18] Although §1015(d) generally permits a basis step-up for the gift tax paid (under chapter 12 of Subtitle B), it does not credit to basis any Inheritance Tax paid under §2801 for covered gifts.[19] 

§2801 applies to existing and all non-U.S. situs assets acquired by the covered expatriate (after the expatriation event). The U.S. recipient (liable for the tax) will not obtain a basis increase for the §2801 tax paid. Covered expatriates receive no exemption for foreign or U.S. intangible covered gifts (even if acquired after expatriation).

Part VI – Potential Planning Strategies

Avoiding covered expatriate status:. Please see the author’s  analysis in The Exit Tax,  which explains how to avoid covered expatriate status by keeping net worth under $2 million [https://forsterboughman.com/index.php/seminar-videos/item/231-expatriation-from-the-united-states-the-exit-tax ].

Avoiding covered beneficiary.  The §2801 Inheritance Tax is triggered upon the expat making a covered gift or bequest to a covered beneficiary. A covered beneficiary is a U.S. citizen, a U.S. domiciliary, a domestic trust, an electing foreign trust, and “the U.S. citizen resident shareholders, partners, members, or other interest-holders, as the case may be (if any) of a domestic entity that receives a covered gift or covered bequest.”  The expatriate should coordinate U.S. situs gifts to non-U.S. recipients (i.e., non-U.S. citizens and non-U.S. domiciliaries).

 


 

Gary Forster, JD, LLM, is managing partner and co-founder at the law firm of ForsterBoughman. Orlando, Fla.



[1] Prop. Treas. Reg. §28.2801-2(g)

[2] The same meaning under chapter 12 of Subtitle B, including, but not limited to, any transfer upon death by bequest, devise, trust provision, beneficiary designation or other contractual arrangement, or by operation of law. See Prop. Treas. Reg. §28.2801-3(b)

[3] Prop. Treas. Reg. §28.2801-2(f) 

[4] Prop. Treas. Reg. § 28.2801-2(e).

[5] Prop. Treas. Reg. § 28.2801-2(b).

[6] For the purposes of the Internal Revenue Code, “domicile” is defined as living within a country with no definite present intent of leaving. Determining domicile for estate and gift tax purposes (Subtitle B of the Code) is fact specific. Once a non-citizen establishes the United States as their domicile, they remain a United States domiciliary until a new domicile is established. If there is doubt as to the location of domicile, there is a rebuttable presumption that the decedent was domiciled within the country where he or she resided. See Treas. Reg. §20.0-1(b)(1).

[7] Reg-112997-10, 26 CFR Part 28 (December 10, 2015)

[8] Prop. Treas. Reg. §28.2801-3(c)(2)

[9] Prop. Treas. Reg. §28.2801-3(c)(3)

[10] Prop. Treas. Reg. §28.2801-3(c)(4)

[11] Prop. Treas. Reg. §28.2801-3(c)(5)

[12] As determined by Prop. Treas. Reg. §28.2801-5(b) and (c)

[13] Prop. Treas. Reg. §28.2801-4(a)(3)

[14] Prop. Treas. Reg. §28.2801-4(b)(1)

[15] Prop. Treas. Reg. §28.2801-4(b)(2)

[16] Prop. Treas. Reg. §28.2801-6(a)

[17] Treas. Reg. § 1.1014-2(b)(2) – the fair market value basis step-up under § 1014(a) does not apply for “property not includible in the decedent's gross estate such as property not situated in the United States acquired from a nonresident who is not a citizen of the United States.”

[18] Treas. Reg. § 1.1015-1(a)

[19] Treas. Reg. § 1.1015-5
 

Views expressed in articles published in Tax Stringer are the authors' only and are not to be attributed to the publication, its editors, the NYSSCPA or FAE, or their directors, officers, or employees, unless expressly so stated. Articles contain information believed by the authors to be accurate, but the publisher, editors and authors are not engaged in redering legal, accounting or other professional services. If specific professional advice or assistance is required, the services of a competent professional should be sought.



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Gary A. Forster

Gary Forster is the managing partner and co-founder of ForsterBoughman.  His practice includes domestic and international corporate law, asset protection, tax, and estate planning. Gary handles a wide variety of corporate and personal planning matters.  Gary is the author of two books.  In 2013, he wrote Asset Protection for Professionals, Entrepreneurs and Investors, a guide to asset protection strategies for clients and their financial advisors, now in its second edition.  In 2020, he finished the second edition of The U.S. Estate and Gift Tax and the Non-Citizen, which explains how resident and non-resident foreign nationals are impacted by the U.S. Estate and Gift Tax.  Gary writes and lectures nationally to state bar and CPA groups on the topics of asset protection, international tax and corporate law.  He has also instructed classes at the University of Florida (Levin College of Law) and Rollins College (Crummer Graduate School of Business).  Gary’s articles can be found in such publications as the Florida Bar Journal and the American Bar Association’s Probate and Property Magazine.  Gary earned a B.A. from Tufts University, graduating cum laude with majors in Economics and Spanish Literature.  He received his J.D. from the University of Florida College of Law, graduating with honors.  Gary continued his studies as a graduate fellow at the University of Florida College of Law, Masters of Taxation program, earning an LL.M.  His education also includes studies at the University of Madrid, Oxford University and Leiden University in the Netherlands.  Gary is rated AV-Preeminent by Martindale-Hubbell and speaks Spanish fluently.

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