If you receive a $50 check in the mail from your Nana in the UK a few days before your birthday, it is fairly easy to deal with the income tax consequences of this transaction, especially if the check comes in one of those generic puppy-dog cards from the supermarket. That being said, most accountants would advise you to cash that check at first opportunity, or else Nana might close the account, the check will bounce, she’ll go to the wrong address to straighten things out, and…well, it may be easier if you just watch the clip.
But let us assume that your more generous and well-heeled Nana from your dad’s side of the family, who is an American expat living in Italy, gives you title to a timeshare on the outskirts of Milan. Even if the document arrives in a puppy-dog card, the tax consequences of this transaction are considerably more abstruse. However, your friendly neighborhood revenue agent is here to help, and also claim Uncle Sam’s fair share.
Just a few weeks ago, the IRS finally got around to proposing rules mandated by the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008. That law added two new provisions to the tax code – the new Section 877A imposed an “exit tax” on those renouncing citizenship; Section 2801 concerned the tax due when expats give to non-expats. Rather unsurprisingly, the IRS was all over Section 877A and issued rules almost immediately. And, also unsurprisingly, the financial interests of expats and their families were placed squarely on the backburner for seven long years. But, I digress.
Before We Begin
The mere fact that you’ve already read this far into the post strongly suggests that you already know this stuff, so I’ll be very brief.
“Expatriates,” as the term is generally understood, means birth-citizens of one country that are living in another one while maintaining physical and emotional connections to the Motherland. A recent study suggests that most American expats originally moved abroad because of marriage or employment reasons. The HEART act adds the further qualification that an “expat” is a person who relinquished citizenship or a green card on or before June 17, 2008.
Politically, expats are something like the also-ran candidates in those pre-debate GOP Presidential candidate forums: almost everyone acknowledges their contributions, but almost no one would be terribly upset if they just went away.
What Gifts Qualify?
Gifts from expats have increased tenfold in the past seven years, so it’s high time the IRS told people how to fill out any tax returns that include these items.
First, the donor (person giving the gift) must have had an annual net income of at least $124,000 for the past five years, a total net worth of at least $2 million, or must qualify under certain other rule-related provisions. Second, the donee (gift recipient) must be a natural person or a trust. For HEART purposes, a foreign trust is considered to be a domestic trust in most situations. More on that in a minute. Finally, the taxable value of the property transfer is its fair market value at the time it was actually received.
Calculating the Tax Due
According to the proposed rules, the short answer is that any amount that exceeds the gift floor ($14,000 in 2015) is subject to “the highest estate or gift tax rate in effect during that calendar year.” It is important to note that the gift’s value is determined by Section 2512 et seq. and not what the donor or donee claims it to be. For now, the tax must be reported in Part IV of Form 3520; start watching your mailbox now for the new and improved Form 708. There is an awfully stiff penalty – 35 percent of the gift’s fair market value or $10,000, whichever is greater – for noncompliance.
Any gift or estate tax paid to any foreign jurisdiction is a credit against the 2801 tax. Gifts are entirely exempt if, a U.S. citizen or resident was the donor, the marital or charitable exemptions would have applied.
The Service admits that it is “difficult” for donees to determine the fair market value of a gift. But the very next sentence begins with “Nevertheless,” so the IRS is clearly not in the mood for excuses. Oh, and in case you didn’t already have enough work to do, it’s also the taxpayer’s burden to determine whether or not the donor was a covered expatriate under the HEART Act. So be sure your thank-you card includes a request for the last five years of tax returns. If the donor is dead or the information is otherwise unavailable, the IRS “may in certain circumstances” disclose the data. How helpful. When in doubt, there is a rebuttable presumption that the donor was a covered expat, so you can probably start from there.
As is often the case, the devil is in the details. While a new Porsche from Aunt Helga in Stuttgart is clearly a gift, what about life insurance proceeds from dearly departed Uncle Vladimir in St. Petersburg (no, not that Vladimir)?
If the money came while Uncle Vladimir was alive, be it from a term or whole life policy, the funds are probably not a “gift” for 2801 purposes. However, the proposed rules indicate that proceeds payable upon the covered expat’s death may indeed be taxable under the HEART Act.
Earlier, we touched on foreign and domestic trusts as donors and donees. While a foreign trust is considered a domestic trust for most purposes, there are situations when a foreign trust may elect to be treated as a domestic trust. To make this election, the trustee must:
- Timely file Form 708 and pay any tax due,
- Duly authorize and appoint a U.S. agent,
- Pinky-swear to file Form 708 like clockwork, and
- Promptly pay any back taxes without grumbling.
Any noncompliance with any of these elements effectively kills the election, and it is almost impossible to resuscitate it.
What about pensions and other deferred compensation plans? I’m so glad you asked. As an initial matter, everything is deemed vested for 2801 purposes. Then, there is good news and bad news. While most of these funds are exempt from the market-to-market tax, they may be subject to a 30 percent withholding. As a side note, these funds are typically subject to the exit tax in Section 877A.
The proposed Section 2801 rules are subject to public comment until December 9, 2015; they may become final within a few weeks afterwards. Ho, ho, ho.