Covered Gifts and Bequests: the Need for Guidance (5+ Years Out)

• Jurisdiction: United States,Federal
• Author: By Patrick W. Martin
• Citation: Vol. 23 No. 2
• Publication year: 2014

Covered Gifts and Bequests: The Need for Guidance (5+ Years Out)

By Patrick W. Martin¹

EXECUTIVE SUMMARY

This paper makes some suggestions for guidance under section 2801 of the Internal Revenue Code,² which has yet to be issued by the Internal Revenue Service ("IRS") and United States Department of the Treasury ("Treasury").

Section 2801³ was passed into law in 2008 as part of the "HEART" Act.⁴ In short, the statutory provision provides that "any United States citizen or resident" who receives "any covered gift or bequest"⁵ is subject to a tax (currently 40%⁶) on the value of such gift or bequest.

The IRS announced in 2009 that it would issue guidance, specifically including a new IRS Form 708 to report such gifts and bequests.⁷ No such form exists to date. The need for guidance is particularly acute for several reasons.

First, the collection of the tax has been suspended until after guidance is issued along with IRS Form 708.⁸ Second, this is the first U.S. federal tax of its kind as a true "inheritance" tax, in the case of bequests. It is also apparently the first tax of its kind on the recipient of gifts, which are otherwise exempt from income tax.⁹ Third, the IRS has no way to help effectively track the tax, its application, collection and general enforcement. Fourth, there is no basic guidance beyond the statute for "any United States citizen or resident" who receives such a gift or a bequest to make a host of decisions to properly determine or calculate the tax. Fifth, presumably no "United States citizen or resident" has ever even paid such a tax, due to its suspension; although the law is now almost six years old.

Sixth, the statute imposes no time requirement for when the tax must be paid. Seventh, since many of the assets likely to be gifted or bequeathed will be located outside the U.S. in different countries with different currencies and economic variables and legal systems compared to the U.S., there is a particular need to know the allowable methods of valuing the property gifted or bequeathed. Eighth, Chapter four of Subtitle A of the Internal Revenue Code ("FATCA") will bring greater awareness of U.S. tax law requirements for United States citizens and residents living outside the U.S., specifically including Section 2801.

Ninth and finally, there have been a record number of United States citizens who have renounced or relinquished their citizenship during the year 2013, which increases the number of affected taxpayers who might receive covered gifts or bequests.¹⁰

I. DISCUSSION

A. Background: Heart Act and Covered Bequests and Covered Gifts

United States citizens and residents are taxed on their worldwide income, regardless of where they might physically live.¹¹ A non-citizen meeting certain residency or lawful permanent residency ("LPR") status is treated similarly to a citizen and is defined as a "resident"¹² and hence a "U.S. person"¹³ under the Internal Revenue Code.

The estate tax also applies to the worldwide assets of United States citizens, regardless of where they might physically reside.¹⁴ Similarly, the U.S. gift tax applies to the worldwide assets of United States citizens, regardless of where they might physically reside.¹⁵ Gifts received by citizens and residents generally are exempt from U.S. federal income taxation.¹⁶

This system of worldwide taxation of estate and gift tax transfers¹⁷ based only upon citizenship, seems odd to many individuals and tax advisors in other countries; since the U.S. is apparently alone in its imposition of worldwide estate and gift taxation on United States citizens or "residents" if the individual is physically resident in a particular country (e.g., for a sufficient number of days).¹⁸

There also are a series of complications for the U.S. government in enforcing the U.S. tax regime against persons and assets located outside the U.S. In the case of covered bequests or gifts, it is possible the majority of them will be received by U.S. persons who reside exclusively outside the U.S. The 1998 Treasury study still has much relevance to this topic where (even though its focus was on Subtitle A and not Subtitle B of the Internal Revenue Code) it stated as follows:

Other factors also operate to limit both compliance measurement and improvement. Because the United States asserts taxing jurisdiction over those with little or no connection to the United States other than citizenship or status as a lawful permanent resident, in many cases overseas U.S. taxpayers are difficult to trace or contact. Moreover, even when valid tax assessments can be made against overseas taxpayers, IRS has limited enforcement recourse if the taxpayer's assets are physically located outside of the United States. In addition, persons may be unaware of their status as U.S. taxpayers with an obligation to file a U.S. tax return. . . . For example, an individual who was born outside the United States and has never even visited the country may, nevertheless, be a U.S. citizen by reason of his parents' U.S. citizenship. Such a person may not even know that he is a U.S. citizen and thus likely will not know of his obligation to file a U.S. tax return [or his or her estate's obligation to file an estate tax return].¹⁹

[Page 7]

The purpose of this proposal is to recommend various steps the Treasury and IRS can adopt to help make the law enforceable, and minimize confusion that currently exists for U.S. persons who receive these types of gifts or bequests. Concurrently, there is much confusion, including to what extent these U.S. persons may have exposure to tax penalties regarding such covered gifts and covered bequests.

1. "Covered" Bequests and Gifts Expands the U.S. Global Tax Reach

Section 2801 furthers the reach of the U.S. tax regime by imposing the 40 percent tax on U.S. citizens and "residents" residing outside the U.S., along with those living in the U.S.

Any covered gift or bequest²⁰ means property that is received by a U.S. citizen or "resident" from a "covered expatriate;"²¹ i.e., a former U.S. citizen or a former long-term resident.²² The tax is levied and paid by the U.S. citizen or resident who receives it, and not the donor or the estate.²³ The only amounts exempted from the tax are the annual exclusion amount of US$10,000, indexed for inflation (currently US$14,000),²⁴ and certain qualifying transfers to a spouse or charity.²⁵ Importantly, the tax is reduced by the amount of any gift or estate tax paid to a foreign country with respect to the covered gift or bequest.²⁶

2. No Guidance Hinders and Delays the Collection of the Tax

The IRS has expressly stated it has suspended the collection of the tax until after guidance is issued along with an expected, but yet to be issued, IRS Form 708.²⁷ The longer the collection of the tax is suspended, the less likely it will be collected, particularly for U.S. citizens living outside the U.S.²⁸

B. Proposals for Guidance

1. Identify a Specific Date for When the Tax Is Due (IRS Form 708)

The statute does not identify when the tax is due and hence payable by the U.S. citizen or resident. There are a number of different methods that could be used, with specific dates. Probably the least burdensome for taxpayers is the due date of when U.S. individual income tax returns are due by the recipient of the covered gift or covered bequest. The tax return generally is due by April 15th;²⁹ or June 15th³⁰ for those U.S. citizens or residents residing outside the U.S.

These individuals must generally report large...