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Section 301 of the Heroes Earnings Assistance and Relief
Tax ("HEART") Act of 2008 added new sections 877A and 2801 to the Internal
Revenue Code ("IRC"). These sections
generally apply to any U.S. citizen who relinquishes his or her U.S.
citizenship and any long-term resident of the U.S. who ceases to be a lawful
permanent resident of the U.S. (referred to in the HEART Act as an "expatriate")
on or after June 17, 2008.
A "covered expatriate" is an expatriate who either (1) satisfies
(a) the "tax liability test" with respect to his or her average annual net
income tax liability for the five preceding taxable years ending before the
date of expatriation or (b) the "net worth test" as of the date of expatriation,
or (2) fails to certify, under penalty of perjury, that he or she is in
compliance with all U.S. tax obligations for the five taxable years preceding
the taxable year that includes the expatriation date (the "tax compliance
test") as of the date of expatriation.
Section 877A(a)(1) provides that in general, all property
of a covered expatriate "shall be treated as sold on the day before the
expatriation date for its fair market value."
The 23‑page Notice 2009-85 (Internal Revenue Bulletin: 2009-45) provides
helpful guidance for individuals who are subject to that section, pending the
issuance of regulations under it. IRC
Section 877 (Expatriation to Avoid Tax) continues to apply to individuals who
relinquished U.S. citizenship or ceased to be lawful permanent residents before
June 17, 2008.
ON RECIPIENT - AND AT TOP RATE
Section 2801 generally imposes a tax on the value of
property transferred by gift or bequest from a covered expatriate to a U.S.
citizen or resident (including a domestic trust) equal to the product of (1)
the highest estate or gift tax rate in effect at that time and (2) the value of
that "covered gift or bequest." Unlike
gift and estate taxes, the tax under Section 2801 is imposed on the person
receiving the gift or bequest rather than the donor or the decedent's estate. However, the amount of 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. The special
estate and gift tax rules under IRC Sections 2107 and 2501(a)(3) applicable to
expatriates under prior law do not apply to covered expatriates, but they
continue to apply to estates of, and gifts by, individuals who are subject to
tax under IRC Section 877(b).
The property subject to Section 2801 has no relationship
to the expatriate's property at the time of expatriation, and the tax generally
is imposed on every covered gift or bequest following the expatriation
date. However, Section 2801 only applies
to the extent that the value of all covered gifts and bequests received by any U.S.
citizen or resident during the calendar year exceeds the dollar amount in
effect under Code Section 2503(b) for that calendar year, relating to annual
exclusion gifts. There is no
present-interest requirement applicable to this exclusion, and it applies to
bequests as well as gifts. Surprisingly,
covered gifts or bequests in the form of payments on behalf of a U.S. citizen
or resident as tuition to a qualified educational organization or for qualified
medical care, described in IRC Section 2503(e), apparently do not qualify for
this exclusion. Not surprisingly, Section
2801 also does not apply to (1) any property shown on a timely filed gift or
estate tax return with respect to a gift by, or the estate of, a covered
expatriate subject to tax under the U.S. gift or estate tax laws, or (2) any
property which would qualify for a marital or charitable gift or estate tax deduction
if the expatriate were a U.S. person.
If a covered gift or bequest is made to a foreign trust,
Section 2801 applies to a later distribution of income or principal from that
trust to a U.S. beneficiary in the same manner as if the distribution were a
covered gift or bequest; and the tax imposed by that section would be allowed
as an income tax deduction to the extent such tax is imposed on the portion of
that distribution which is included in the beneficiary's gross income. Solely for purposes of Section 2801, a
foreign trust may avoid this result by electing to be treated as a domestic
Notice 2009-85, referred to above, does not provide
guidance with respect to Section 2801.
However, Section 9 of that notice provides that separate guidance will
be issued for U.S. persons who receive covered gifts or bequests on or after
June 17, 2008, and satisfaction of the reporting and tax obligations with
respect to such gifts or bequests will be deferred pending the issuance of that
guidance; and a reasonable period of time thereafter will be provided to comply
with those obligations.
It is noteworthy that unlike the gift and estate tax,
there is no unified credit against the Section 2801 tax nor a graduated rate
schedule. Thus, an individual planning
to expatriate should consider making substantial gifts before doing so to
persons to whom covered gifts or bequests would likely be made by him or her
after becoming a covered expatriate. For
individuals who have already expatriated, there might be planning opportunities
available this year for making sizeable covered gifts to U.S. beneficiaries,
because of this year's relatively low 35% top gift tax rate that would apply
under IRC Section 2801 - which will rise to 55% in 2011.
Section 2801 applies to a gift or bequest by a covered
expatriate to a U.S. citizen or resident, but the term "resident" is not
defined in that section. The definition
of a "resident" in Section 7701(b)(1) does not apply for purposes of Subtitle B
of the IRC, which is where the estate and gift tax law and Section 2801
reside. The definition of resident for
estate tax purposes in Regs. §20.0-1(b)(1) (which provides that a "resident"
decedent is a decedent who on the date of death was domiciled in the U.S.) indicates
that the Section 2801 tax only applies to gifts or bequests to U.S. citizens or
domiciliaries. (The gift tax regulations
do not contain a section comparable to Regs. §20.0-1(b)(1).) Presumably, clarification of this issue will
be provided in the forthcoming guidance with respect to Section 2801 referred
Morrison & Foerster's Trusts and Estates group
provides sophisticated planning and administration services to a broad variety
of clients. If you would like additional
information or assistance, please contact Patrick McCabe at (415) 268-6926 or
© Copyright 2010 Morrison & Foerster LLP. This article is published with permission of
Morrison & Foerster LLP. Further
duplication without the permission of Morrison & Foerster LLP is
prohibited. All rights reserved. The views expressed in this article are those
of the authors only, are intended to be general in nature, and are not
attributable to Morrison & Foerster LLP or any of its clients. The information provided herein may not be
applicable in all situations and should not be acted upon without specific
legal advice based on particular situations.
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