Giving Up U.S. Citizenship – Estate and Gift Tax Traps
It may be a common misunderstanding that a U.S. citizen or permanent resident (Green Card holder) can give up their citizenship or surrender their Green Card and then as a non-U.S. taxpayer make gifts or pass their estate to U.S. taxpayers free of estate and gift tax. The IRS recognized this loophole and has proposed a new Regulation designed to tax the recipient of the gifts or inheritances from “covered expatriates” at maximum estate and gift tax rates.
“Under Code Sec. 877A , a U.S. citizen who gives up U.S. citizenship or a long-term U.S. resident who gives up his residency status and who is a covered expatriate is subject to a mark-to-market rule. Under this rule, his property is deemed to be sold on the day before the expatriation, and he is taxed on the gain above a $600,000 threshold amount (as adjusted for inflation; $690,000 in 2015). An election is available to defer the tax, at the cost of an interest charge. The tax on certain deferred tax items and interests in non-grantor trusts is deferred until the amounts are distributed to the covered expatriate.” Federal Tax Weekly Alert
The tax rate on the mark to market assets is the capital gains tax rate. So, if we assume that a “covered expatriate” is in the ordinary income tax bracket of 39.50 percent for federal purpose and can move to a “tax haven” jurisdiction for a one-time payment of tax on appreciation on his/her assets of 20 percent (long Term Capital Gains rate) and then “gift” a portion of their estate to a U.S. person, (presumably a family member), they have just reduced the maximum income tax rate to zero and their estate and gift tax rate from 45 percent to zero. A net savings of 25 percent on estate and gift tax. The proposed Regulation is intended to prevent that form of aggressive tax planning from occurring.
“The proposed regs would provide that, if an expatriate meets the definition of a covered expatriate, the expatriate would be considered a covered expatriate for purposes of Code Sec. 2801 at all times after the expatriation date, except during any period beginning after the expatriation date during which the individual is subject to U.S. estate or gift tax as a U.S. citizen or resident.” Federal Taxes Weekly Alert
What this means is that the recipient of the gift or inheritance is going to have to report the gift or inheritance and pay tax at the rate of 45 percent on the value of the gift or inheritance. Failure to report the gift or inheritance, particularly if the gift or inheritance includes foreign financial accounts can lead to serious penalties (such as the penalties for willful failure to file an FBAR which penalty is the greater of $100,000 or 50 percent of the highest account balance per year per account).
Expatriation planning requires careful analysis and should only be undertaken with the advice of skilled professionals. We have the skills and training to analyze expatriation issues and help plan accordingly.
