While individuals expatriating from the U.S. often consider the income tax impacts of expatriation, few have a clear understanding of the U.S. gift and estate tax implications that their families may face should they, as a covered expatriate:
- Make gifts or bequests to U.S. persons, including U.S. family members, after expatriating, or
- Pass away while retaining U.S. real estate or other U.S. situs assets after expatriating.
The tax implications in these scenarios can be severe, and advisors may offer great value to mobile families in devising planning solutions to mitigate the global tax impact.
Internal Revenue Code (IRC) Section 2801, the Code section that governs gifts and bequests from expatriators, was enacted effective June 17, 2008, by the Heroes Earnings Assistance and Relief Tax Act of 2008 (the “HEART Act”).
Section 2801 generally taxes U.S. persons who receive, directly or indirectly, an otherwise nontaxable gift or bequest in excess of the annual gift tax exclusion amount ($15,000 in 2018) from a covered expatriate. The §2801 tax is equal to the product of the highest gift or estate tax rate on the date of receipt (currently 40%) multiplied by the fair market value of the covered gift or bequest. There is a credit available for any foreign gift or estate taxes paid on the transfer.
Because the imposition of the §2801 tax depends on a number of factors, including whether a gift or bequest is reported on a timely filed U.S. gift or estate tax return and whether the gift or bequest is subject to foreign gift or estate taxes, it is extremely important for a taxpayer who may be subject to §2801 to obtain appropriate tax advice in the U.S. and his home country.
Potential planning strategies will create tradeoffs between the two countries, so advisors must take into consideration both countries to ensure the most beneficial global result for the taxpayer. The complexities involved can be briefly illustrated with an example.
Taxpayer A and Taxpayer B are citizens of Country X. They moved to the United States and lived here for many years as lawful permanent residents (green card holders). They have two U.S. citizen children.
After their many years in the U.S., in Year 1, they relinquish their green cards and move back to Country X. They are both covered expatriates. In Year 2, Taxpayer A passes away. At the time of his death, in addition to his assets in Country X, he still owned a U.S. stock account holding $500,000 of securities.
Country X charges an estate tax of 30%, and it does not have an estate tax treaty with the U.S.
As a nonresident not a citizen of the United States, Taxpayer A is subject to U.S. estate tax on his U.S. situs assets, which in this case include his $500,000 U.S. stock account. He is entitled to an exemption of only $60,000. He must file a Form 706-NA nonresident estate tax return, and he will owe approximately $140,000 in U.S. estate tax.
His assets in Country X are not subject to U.S. estate tax, but he will pay a 30% estate tax in Country X. The assets that are properly reported on his U.S. estate tax return can be passed to his U.S. citizen children without incurring §2801 tax; any other assets that the children receive will be subject to §2801 tax.
The majority of Taxpayer A’s assets were in Country X. Assets that pass to Taxpayer B, his surviving spouse who is also a covered expatriate, incur estate tax at 30% in Country X but no §2801 tax because she is not a U.S. resident.
However, upon Taxpayer B’s death, according to the law of Country X, all of her assets will be subject to estate tax in Country X at another 30% (including the assets she inherited from Taxpayer A). This leads to two rounds of Country X estate tax at 30% on Taxpayer A’s assets that pass to Taxpayer B. In addition, the §2801 tax will apply to all assets passing to her U.S. citizen children at her death (but under §2801, a credit is given to reduce the §2801 tax for the Country X estate tax paid).
Assets that pass to Taxpayer A’s children directly upon his death will be subject to the §2801 tax, reduced by Country X estate taxes paid. Since both spouses were covered expatriates, and their U.S. citizen children will be the eventual beneficiaries of their estates, they are almost certain to run into §2801 issues.
There are a number of potential strategies to minimize their worldwide gift, estate, and inheritance tax liabilities, but those will all depend on the specific facts and circumstances of the family, prior estate planning and prior transfers, tax and legal considerations in relevant jurisdictions, etc.
QDOT. One possibility to consider is the qualified domestic trust (QDOT). Any of Taxpayer A’s assets that funded a QDOT (and for which a proper QDOT election is made) would escape current U.S. estate taxation. The related U.S. estate tax liability would be deferred until the assets are taken from the QDOT or until Taxpayer B’s death. Generally, a U.S. trust is also subject to §2801 tax on the receipt of a covered bequest, but the marital deduction is allowed for assets passing to a QDOT.
While the QDOT would allow for an estate tax deferral in the U.S., it would also create an annual U.S. income tax return filing requirement. Taxpayer B may wish to avoid future U.S. filings to the extent possible and therefore prefer to avoid this scenario.
Also, deferring the U.S. estate tax liability may create foreign tax credit issues due to the timing mismatch between estate taxation in the U.S. and Country X. Losing out on foreign tax credits would likely more than offset the benefit of U.S. estate tax deferral. Some other trust planning may also be rendered ineffective or inefficient, depending on how a U.S. trust would be viewed (or ignored) in the foreign jurisdiction.
Qualified Disclaimer. It may also be preferable to pass some assets directly to the children at Taxpayer A’s death rather than waiting until Taxpayer B’s death and incurring a second round of Country X estate tax. Taxpayer B may, therefore, wish to make a qualified disclaimer, if possible, of some assets that otherwise would pass to her upon Taxpayer A’s death.
This would accelerate the §2801 tax on those assets, but that tax would be partially offset by the Country X estate taxes, and those assets would also escape a second round of the 30% estate tax imposed by Country X.
Regular Gifting. Taxpayer B may also reduce the total §2801 tax due by taking advantage of the annual $15,000 gift tax exclusion amount to “drip” assets to her children over time without incurring §2801 tax.
U.S. Residency. Another option, if palatable to Taxpayer B, could be to move back to the U.S. at a future date and regain U.S. domicile before making future gifts or bequests. As a U.S. domiciliary, all transfers will be subject to U.S. gift or estate tax, and therefore should escape §2801 tax, benefitting from larger exemptions and graduated tax rates. However, this is an area where additional clarifying legislation or regulations would be helpful.
Additional Expatriation. In certain select cases, most likely if they were planning to expatriate anyway, the U.S. heirs may wish to renounce their U.S. citizenship, lose their U.S. domicile, and therefore avoid §2801 tax.
These are just a handful of potential planning opportunities that may be available to a family dealing with the §2801 tax. In every case, the taxpayers will need to obtain appropriate advice in all countries concerned, tailored to their specific situation, to ensure that they minimize their global income, gift, estate, and inheritance tax liabilities.
 IRC §877A(g)(1).
 IRC §2503(b) and Revenue Procedure 2017-58.
 IRC §877A(g)(1).
 IRC §2001(c).
 IRC §2801(a)
 IRC §2801(d).
 IRC §2801(e)(2).
 Treasury Regulations §20.0-1(b)(2).
 IRC §2104(a).
 By way of the $13,000 unified credit provided by IRC §2102(b)(1).
 IRC §2056(d)(2)(A).
 IRC §2056A(b)(1).
 IRC §2801(e)(4)(A).
 IRC §2801(e)(3).
 IRC §2518.