The IRS recently issued long-awaited guidance on the Heroes Earnings Assistance and Relief Tax Act of 2008 (the HEART Act). This legislation governs the rules for gifts given to United States citizens by former U.S. citizens and long-term residents who expatriate on or after June 17, 2008 and are classified as “covered expatriates.” A “covered expatriate” is someone who has an average annual net income tax liability greater than $124,000 adjusted for inflation (i.e. $160,000 for 2015) for the previous five tax years, has a net worth of $2 million or more, or has failed to certify that he or she has complied with all U.S. tax obligations for the five preceding taxable years.
Prior to the enactment of the HEART Act, citizens and long-term residents of the U.S. who expatriated to avoid U.S. taxes were subject to an alternative regime of U.S. income, estate, and gift taxes for 10 years following expatriation.
Typically, a gift tax only applies to the person giving away the gift, not the person receiving it. However, because U.S. citizens and residents are generally subject to estate tax on their assets at the time of death, Congress decided that, to maintain fairness, a tax should be imposed on U.S. citizens or residents who receive a transfer from an expatriate that otherwise would have escaped U.S. estate and/or gift taxes as a consequence of expatriation.
New Proposed Regulations
The new proposed regulations issued by IRS clarify the rules governing taxation of these items and provide certain critical definitions.
A special tax law provision, Section 2801 of the Internal Revenue Code, was added to the HEART Act and enforces a tax at the highest applicable gift or estate tax rates on any U.S. person who receives a “covered” gift or bequest from a covered expatriate who left the United States on or after June 17, 2008. The tax applies regardless of whether the property was acquired before or after the taxpayer moved abroad.
A “covered gift” is defined the same way as other gifts subject to gift tax under the tax code: a direct or indirect gift from a covered expatriate. A “covered bequest” is defined as any property acquired directly or indirectly because of the death of a covered expatriate that would have generally been included in the expatriate’s estate if he or she was a U.S. citizen or resident at the time of their death.
The new regulations also provide definitions for several other terms, such as “domestic trust,” “foreign trust,” “electing foreign trust,” “U.S. recipient,” “power of appointment,” and “indirect acquisition of property.”
The new regulations include several key exceptions to these definitions. Most notably, there is an exception for taxable gifts and property reported on a covered expatriate’s gift tax or estate tax return as long as the tax is filed and paid in a timely fashion. Other exceptions include:
- Qualified disclaimers of property made by a covered expatriate
- Charitable donations that qualify for the estate or gift tax charitable deduction
- Gifts or bequests to a covered expatriate’s U.S. citizen spouse if the gift or bequest, had it been given by a U.S. citizen or resident, would qualify for the gift or estate tax marital deduction
This last exception will be forfeited if the distribution to the citizen spouse is made through a covered gift or covered bequest to a non-electing foreign trust – one that hasn’t elected to be treated as a domestic trust for U.S. tax purposes.
Calculations and Enforcement
To calculate the tax owed, the property’s value is determined on the date it is received and then reduced by the available annual gift tax exclusion ($14,000 for 2015) if the recipient qualifies. That amount is then multiplied by the highest gift or estate tax rate for that calendar year.
If you have received covered gifts or bequests from an expatriate’s estate on or after June 17, 2008, understanding the new rules governing the taxation of this property is essential. If you’d like to learn more about covered expatriate estate gifts and the associated regulations, call us at 818-334-8624 or click here to contact us. We look forward to speaking with you soon!