On Jan. 14, 2025, the Internal Revenue Service recently issued final regulations (final regs) imposing a tax on U.S. citizens, residents and certain trusts that receive gifts or bequests from certain individuals who have expatriated from the United States. The final regs only apply to covered gifts or bequests received on or after Jan. 1, 2025. It was previously anticipated that the final regs would apply to all transfers made when the proposed regulations (proposed regs) were initially disseminated in 2015.
The final regs were issued to implement the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act), which enacted a new market-to-market tax (Internal Revenue Code Section 877A) for expatriating individuals and a new transfer tax (IRC Section 2801) for certain transfers from individuals who had expatriated to the IRC. The tax was to subject transferred assets to tax in a similar manner to the transfer tax due if the covered expatriate were still a U.S. citizen or permanent resident (U.S. person) at the time of the transfer. However, in the preamble to the final regs, which were issued 10 years after the proposed regs, the Treasury concedes that the tax imposed by Section 2801 “does not equal, and in some cases is not similar to, the tax that would have been imposed on the transfer of such gifts or bequests by a U.S. transferor” In the Treasury Decision that contains the final regs.
Covered Expatriates
The Section 2801 tax is imposed on certain transfers made by “covered expatriates” who expatriated on or after June 17, 2008. Under Treasury Regulations Section 28.2801-2(h), a covered expatriate is a person who was a U.S. person and gave up such citizenship or residency and (1) has an average annual net income tax liability for the five years preceding expatriation above $206,000 (2025 value indexed for inflation), or (2) has a net worth of $2 million or more at the time of expatriation, or (3) fails to certify under penalties of perjury that all U.S. federal tax obligations for the five years preceding expatriation have been complied with. The tax is imposed on the receipt of property received directly or indirectly from a covered expatriate by virtue of the death of the covered expatriate (covered bequest) or as a gift from the covered expatriate, regardless of the situs of the gifted asset (covered gift). (I’ll refer to covered bequests and covered gifts as “covered transfers.”) If the recipient of a covered transfer is a trust and the trust is either a domestic trust or a foreign trust that elects to be treated as a domestic trust for the purposes of Section 2801, the trust pays the Section 2801 tax. If the trust is a foreign trust that doesn’t elect to be treated as a domestic trust (non-electing trust), the beneficiary who receives the covered transfer from the trust pays the Section 2801 tax when the covered transfer is distributed from the trust to the beneficiary.
Who Pays the Tax?
The Section 2801 tax is imposed on the recipient of a covered transfer that exceeds the per-donee annual gift tax exclusion amount (in 2025, meaning a gift that exceeds $19,000), and the tax on the covered transfer is equal to such excess multiplied by the highest estate tax rate (currently 40%), reduced by estate or gift tax paid to a foreign country on said transfer. The Section 2801 tax should be reported and computed on Form 708, which the IRS hasn’t yet issued.
Six Crucial Clarifications
While the majority of the final regs related to Section 2801 don’t differ significantly from the proposed regs, the final regs contain crucial clarifications that will impact when advising recipients of such covered transfers:
- The definition of a U.S. resident in the proposed regs was an income tax definition, whereas in the final regs, the term U.S. resident uses the transfer tax definition.
- The proposed regs defined a covered bequest as any property acquired due to a covered expatriate’s death, whether such property was acquired directly or indirectly. The final regs limit this definition to include only three categories of covered bequests: (1) property acquired or received by a recipient on or after June 17, 2008 that would have been included in the covered expatriate’s taxable estate had they been a U.S. person immediate prior to their death; (2) property that would have been included in the covered expatriate’s taxable estate even if not acquired due to the death of the covered expatriate (for example, Section 2035 property); and (3) distributions made because of the death of a covered expatriate from non-electing foreign trusts to the extent that the distributions are attributable to covered transfers. Critically, bequests reported on a timely filed U.S. estate tax return are excluded from the definition of a covered bequest (similarly, gifts reported on a timely filed U.S. gift tax return are excluded from the definition of a covered gift).
- The proposed regs required that the Section 2801 tax be “timely paid.” The final regs eliminate this requirement as it “could present administrability and finality challenges.” This is positive news given that Form 708 hasn’t been issued yet.
- Under the proposed regs, it was possible for the same covered transfer to be subject to Section 2801 tax multiple times (for example, if a covered expatriate gifts a remainder interest in property during their lifetime and the income interest is transferred at their death). The final regs include a new rule that limits subsequent Section 2801 taxation to the excess value of the covered bequest that had not already been taxed as a covered gift.
- The proposed regs stated that a gift or bequest that qualifies for the marital deduction isn’t a covered gift or bequest, and, therefore, qualified domestic trusts (QDOTs) and qualified terminable interest property trusts (QTIPs) could be excluded from the definition of a covered transfer. The final regs clarify that QDOT and QTIP elections may only be made with respect to U.S. situs property and, therefore, covered expatriates will need to be careful about placing non-U.S. situs property in these structures.
- The proposed regs stated that the date of receipt of a covered gift is determined as if the covered expatriate had been a U.S. person when the gift was made. The final regs provide a broader definition of the date of the gift to ease potential difficulties in determining the value of the covered transfer and payment of the associated Section 2801 tax.
Disproving Presumption
An important takeaway is that it’s the responsibility of the recipient of a covered transfer to determine whether the person making the transfer is a covered expatriate and whether the transfer qualifies as a covered transfer. The final regs state that there’s a presumption that any gift or bequest to a U.S. person from an expatriate is a covered transfer. It’s, therefore, the recipient’s burden to disprove such presumption. This burden can be particularly onerous when the transfer at issue is a distribution from a non-electing foreign trust, and the trust beneficiary who receives the property doesn’t know who funded the trust or when such funding occurred.
