Expatriation from the United States: The Inheritance Tax Under I.R.C. [section]2801.

• Author: Forster, Gary A.

In addition to the Exit Tax, the Heart Act added a new federal transfer tax, which imposes an "Inheritance Tax" on certain gifts or bequests (testamentary dispositions) made by a "covered expatriate" to U.S. recipients. This is the second article in our two-part series on the expatriation tax.

The Inheritance Tax is payable by the recipient of the gift or bequest, not the expatriate. There is no expiration of the potential applicability of [section]2801. Thus, a gift or bequest made by a covered expatriate several years (or longer) after expatriation could trigger the tax. The Inheritance Tax is imposed in addition to the mark-to-market tax paid by the covered expatriate upon exit. (1) Currently, the tax rate imposed by [section]2801 is 40% of the value of the gift or bequest. (2)

U.S. citizens and residents are generally subject to U.S. gift and estate tax on worldwide assets. Nonresident aliens are not subject to U.S. gift and estate tax on foreign-situs assets. Section 2801 taxes U.S. citizens or residents who receive gifts and bequests from covered expatriates, which would otherwise have escaped U.S. transfer taxes (as a consequence of the donor's expatriation). Transfers by covered expatriates are subject to a tax similar to the gift and estate tax (imposed under Subtitle B of the code) but saddle the donee with the Inheritance Tax.

The U.S. Treasury issued proposed regulations on [section]2801 on September 10, 2015. (3) 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 [section]2801 Inheritance Tax.

Definitions Under [section]2801

* "Citizen or Resident of the United States"--A citizen or resident of the United States is an individual citizen or a resident as defined in Ch. 11 (Estate Tax) and Ch. 12 (Gift Tax) of the code, at the time of receipt of the covered gift or covered bequest. (4) Under [section]2801, the definition of U.S. citizens also includes domestic trusts (as defined under [section]7701(a)(30)(E)), as well as foreign trusts (as defined under [section]7701(a)(31)) electing to be treated as a domestic trust under Prop. Treas. Reg. [section]28.2801-5(d). (5)

* "Covered gift or bequest"--[section]2801(e)(1) generally provides that a "covered gift" means any gift acquired from a "covered expatriate" (even if mark-to-market tax is paid under [section]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). (6)

A "covered bequest" includes any property acquired directly or indirectly by reason of the death (7) of an individual who, immediately before such death was a "covered expatriate" (regardless of the situs or whether such property was acquired by the covered expatriate before or after expatriation). (8) The taxation of the covered bequest applies (even if mark-to-market expatriation, deemed sale tax is paid under [section]877A). 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." (9) Charitable giving may, therefore, be a potentially viable strategy for mitigating tax under [section]2801.

* "Expatriate and Covered Expatriate"--The term "expatriate" is defined in [section]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" is defined in [section]877A(g)(1), as expatriates falling within the applicable minimum income, wealth, and the tax compliance standards outlined in our initial article, "The Tax Implications of Expatriation: The Exit Tax." The determination of whether an individual is a "covered expatriate" is made as of the "expatriation date" as defined in [section]877A(g)(3). If the expatriate meets the definition, the expatriate is considered a "covered expatriate" (for the purposes of [section]2801) at all times subsequent to the expatriation date.

An expatriate is not treated as a "covered expatriate" during any period beginning after the expatriation date during which such individual is again subject to U.S. transfer taxes (under Ch. 11 or Ch. 12 of Subtitle B), as a U.S. citizen or resident. An individual's status as a "covered expatriate" is determined as of the date of the most recent expatriation (if more than one). (10)

* "U.S. Recipient"--a U.S. recipient includes a...