Final Section 2801 Regs: Covered Gifts and Bequests From Covered Expatriates

Description

On January 14, 2025, the IRS published final regulations under Section 2801 regarding covered gifts and bequests made directly or indirectly to U.S. citizens and residents from covered expatriates. These long-awaited regulations, effective January 1, 2025, modify the proposed regulations issued on September 10, 2015. A covered expatriate under Section 2801 is a taxpayer subject to the exit tax, defined in Section 877A(g)(2) as a U.S. citizen or resident relinquishing citizenship on or after June 17, 2008, if the individual (1) has an average annual income tax greater than $124,000 ($206,000 for 2025 after inflation adjustments) for five years preceding the loss of citizenship or (2) has a net worth of $2 million or greater, or (3) fails to certify that all U.S. tax obligations have been satisfied.

In response to comments on the proposed regulations, the IRS acknowledged that: (i) the definitions of “covered bequest” and “indirect acquisition of property” were too broad, (ii) the deemed distribution rules of 643(i) were not to be adopted as part of the definition of “distribution” and that (iii) the presumptions in the absence of adequate records was unduly harsh.

However, the IRS rejected many of the proposed comments. In particular, the IRS firmly rejected the argument that the decision to expatriate is supposed to be “tax neutral.” This argument was based on legislative history. In fact, the rules are not tax neutral and the estate and gift tax consequences may be far worse than they would be absent expatriation.

The tax on covered gifts and bequests is paid by the recipient (and is tax inclusive because the base for the tax computation includes the amount of section 2801 tax payable by the recipient), which is a significant departure from the conventional estate and gift tax regime. Perhaps most problematic for recipients of gifts and practitioners is that the burden of determining covered expatriate status, reporting the transfer, and remitting the tax lies with the U.S. recipient. New Form 708, United States Return of Tax for Gifts and Bequests Received from Covered Expatriates, which has not been released yet, will be used to report covered gifts and bequests.

Listen as our panel of cross-border tax advisers explains the recently released regulations under 2801 for tax advisers working with international clientele.