Posts Categorized: Tax Update

Case Summary: Ajemian v. Yahoo!, Inc.

Author: Bradford N. VezinaMcLane Middleton

The Massachusetts Supreme Judicial Court, in the case of Ajemian v. Yahoo!, Inc., held that the Stored Communications Act (SCA), a 1986 federal law that regulates the disclosure of electronic communications, does not prohibit Yahoo!, Inc., from voluntarily disclosing the contents of a decedent’s email account to the administrators of a decedent’s estate.

The decision represents the continuation of an eight year legal dispute, initially commenced in 2009, that arose after the administrators of John Ajemian’s estate filed a complaint with the probate court requesting “unfettered” access to John’s Yahoo email account.  Yahoo refused to provide access to this account.

The Supreme Judicial Court agreed to hear the case on its own motion after the estate appealed the probate court’s award for summary judgment in favor of Yahoo.  The probate court awarded summary judgment to Yahoo on the basis that the SCA prohibited Yahoo from disclosing the contents of the account to the estate administrators.  The Supreme Judicial Court ultimately disagreed and vacated the probate court’s judgment.

The Supreme Judicial Court’s decision turned on whether the estate’s request for access to the email account fell within the “lawful consent exception” of the SCA thereby permitting Yahoo to voluntarily disclose the contents of the emails.  Rejecting the industry consensus that this lawful consent exception requires actual or express consent of a decedent, the Court held that the administrators could consent to such a disclosure on behalf of the decedent.  To interpret the SCA otherwise, the Court reasoned, would prevent personal representatives from accessing a decedent’s digital assets and thereby preempt state probate and common law.

This decision, however, has its limits.  First, the Court did not mandate Yahoo to divulge the contents of the email account; it merely permitted Yahoo to do so.  As the Court explained, the SCA “does not stand in the way” of such a disclosure.  Second, it remains to be seen whether this case will be challenged in federal court, as it is a state court’s interpretation of federal law.  Third, the case raises the question of whether online providers such as Yahoo can rely on their terms of service agreements as a basis in refusing access to (and perhaps deleting altogether) a decedent’s digital assets.  The Supreme Judicial Court did not take up this issue instead electing to remand the case to the probate court for further hearing on this issue.  Stay tuned.

TIGTA Report Recommends Improvements for Estate and Gift Tax Return Examination Process

TIGTA Report Recommends Improvements for Estate and Gift Tax Return Examination Process

Author: Patti Weisgerber, M. Robinson Tax Law


While much focus this fall has been on tax reform proposals and debates, it’s possible some may have missed the September 26, 2017 TIGTA[1] report proposing recommendations to tighten the estate and gift tax return examination process. The report described a very manual process for the classification, prioritization and assignment of estate and gift tax returns with a variety of problems, such as, but not limited to:

  • Minimal guidance from the Internal Revenue Manual (IRM) on the process, which translates into a lack of formal written procedures,
  • A subjective prioritization of returns by a “national gatekeeper,”
  • Illegible and incomplete classification sheets,
  • Missing documents from case files, and
  • Timeframes not followed in the examination process.

These issues raised the question of whether or not the most productive cases were being assigned for examination. Some of the issues also bring into question whether a taxpayer’s rights are at risk of being violated. For the most part, the IRS agreed with all recommendations for improvement, including an update to the IRM for more guidance on how returns are classified, prioritized and assigned for examination.

In addition to the recommendations made, the report shared some insightful statistical information about estate and gift tax examinations.

Estate and Gift Tax Examination Information: By the Numbers[2]

  • 254: The number of field examination employees assigned to the IRS Estate and Gift Tax Program (per the 2016 payroll).
  • 36,130: The number of estate tax returns, including IRS Forms 1041 and 1041-N, that were filed for calendar year 2015.
  • 238,324: The number of gift tax returns filed in that same year.
  • 3,187: For FY 2016, the number of examined estate tax returns that were closed.
    • $248,000: The average recommended additional tax per return.
    • $790,000,000: The total additional recommended estate tax for FY 2016.
  • 1,843: Also for FY 2016, the number of examined gift tax returns that were closed.
    • $164,000: The average recommended additional tax per return.
    • $303,000,000: The total additional recommended gift tax in FY 2016.
  • 289: The average number of days to complete an estate tax examination.
  • 81%: Approximately, the percent of estate and gift tax cases resulting in the IRS position being either fully or partially sustained.
  • 4.4%: Approximately, the percent of estate and gift tax cases which go to Appeals.

The full report, “Improvements Are Needed in the Estate and Gift Tax Return Examination Process,” can be found here.

[1] Treasury Inspector General for Tax Administration.

[2] All statistics are from the TIGTA analysis and/or the IRS.

Republican House Tax Bill

Author: Heather N. Harris, Day Pitney LLP

Yesterday, Republicans in the House of Representatives unveiled the “Tax Cuts and Jobs Act.” Notably, the tax reform bill:

  • Increases the basic exclusion amount for estate tax and generation-skipping transfer tax from $5,000,000 to $10,000,000 for decedent’s dying and generation-skipping transfers made after December 31, 2017 (adjusted for inflation after 2010).
  • Repeals the estate tax and generation-skipping transfer tax for decedent’s dying and generation-skipping transfers made after December 31, 2023.
  • Increases the basic exclusion amount for gift tax from $5,000,000 to $10,000,000 for gifts made after December 31, 2017 (adjusted for inflation after 2010).
  • Does not repeal the gift tax, but reduces the top rate for the gift tax to 35 percent from 40 percent for gifts made after December 31, 2023.
  • No change to the step-up in basis of an asset at death.
  • No change to treatment of retirement accounts.
  • Repeals the Alternative Minimum Tax.
  • Pass-through businesses pay a 25% tax rate, excluding some professional service partnerships such as lawyers and accountants.
  • Reduces the corporate tax rate to 20 percent from 35 percent

IRS Announces Inflation-Adjusted Amounts for 2017

Author: Susan A. Robb, First Republic Trust Company

On October 25, 2017, the IRS released Revenue Procedure 2016-55, which outlined various inflation-adjusted amounts for 2017.  These amounts apply to returns for tax year 2017 that will be filed in 2018.  Some of the key provisions are as follows:

Estate and Gift Tax

  • Estates of decedents who die during 2017 will have a basic exclusion amount of $5,490,000, up from $5,450,000 for estates of decedents who died in 2016.
  • Accordingly, the generation-skipping transfer tax exemption will also rise to $5,490,000 for 2017.
  • The annual exclusion from gift tax will remain at $14,000 for 2017.
  • The exclusion from tax on a gift to a spouse who is not a U.S. citizen will be $149,000 for 2017, up from $148,000 for 2016.

Income Tax

  • Highest tax bracket
    • The 39.6% tax rate will affect single taxpayers whose income exceeds $418,400 ($470,700 for married taxpayers filing jointly) for 2017, up from $415,050 ($466,950 for married taxpayers filing jointly) for 2016.
    • The 39.6% rate will apply to estates and trusts with income of more than $12,500 for 2017, up from $12,400 for 2016.
  • Standard deduction
    • The standard deduction for married filing jointly will rise to $12,700 for 2017, an increase of $100 from 2016.
    • For single taxpayers and married individuals filing separately, the standard deduction will rise to $6,350 for 2017, up from $6,300 for 2016.
    • For heads of households, the standard deduction will rise to $9,350 for 2017, up from $9,300 for 2016.
  • Itemized deductions
    • For individuals, the limitation for itemized deductions for 2017 will begin with incomes of $287,650 or more ($313,800 for married couples filing jointly).
  • Personal exemption
    • The personal exemption for 2017 will remain unchanged at $4,050.
    • The personal exemption is subject to a phase-out that will begin with adjusted gross incomes of $261,500 ($313,800 for married couples filing jointly) and phase out completely at $384,000 ($436,300 for married couples filing jointly).
  • “Kiddie tax”
    • The kiddie tax threshold amounts will remain unchanged for 2017. The kiddie tax applies to dependents under nineteen and dependent full-time students under twenty‑four who have unearned income of more than $1,050 but less than $10,500.
    • As was the case for 2016, for 2017, the first $1,050 of unearned income a child earns will be offset by the $1,050 standard deduction (assuming the child has no earned income), and the next $1,050 of such unearned income will be taxed at the child’s tax rate.
    • All of the child’s unearned income in excess of $2,100 will be taxed at the parent’s tax rate.
  • AMT
    • The Alternative Minimum Tax exemption amount for 2017 will be $54,300 and begin to phase out at $120,700 ($84,500, for married couples filing jointly, for whom the phase out begins at $160,900). The 2016 exemption amount was $53,900 ($83,800 for married couples filing jointly).
    • The AMT exemption amount for estates and trusts will be $24,100 for 2017, up from $23,900 for 2016.
    • For 2017, the 28 percent tax rate will apply to taxpayers, including estates and trusts, with taxable incomes above $187,800 ($93,900 for married individuals filing separately).
  • Foreign earned income exclusion
    • For 2017, the foreign earned income exclusion will be $102,100, up from $101,300 for 2016.
  • Parking and transportation
    • For 2017, the monthly limitation for the qualified transportation fringe benefit will remain at $255.
    • The monthly limitation for qualified parking will also remain at $255.

Proposed Regs. Under § 2704

Author: Allison A. Kazarian, Paster & Harpootian, Ltd.

On August 2, 2016, the IRS released proposed regulations under Internal Revenue Code section 2704. If the proposed regulations are finalized as written, they will have a significant impact on the valuation of interests in family-controlled entities for estate, gift, and GST tax purposes due to new limitations on discounts for lack of control.

The proposed regulations, if finalized, will make the following changes to § 2704:

Three-Year Recapture Rule.  The proposed regulations narrow the current exception to § 2704(a), which provides that a transfer of an interest resulting in the lapse of a voting or liquidation right is not subject to 2704(a) if the rights associated with the transferred interest are not restricted or eliminated. The proposed regulations adopt a three-year recapture rule.  The exception for rights with respect to transferred interests that are not restricted or eliminated continues to apply unless the transfer occurs within three years of the transferor’s death.  If a transfer results in the lapse of the transferor’s right to force liquidation and such transfer occurs within three years of the transferor’s death, it will result in a deemed transfer of the value of the lapsed right at the transferor’s death.

Transferee with Assignee Status. The proposed regulations clarify that § 2704(a) applies to lapses of rights resulting from transfers made to assignees that do not participate in management.  For example, when a partner in a general partnership dies and under state law the deceased partner’s estate receives an assignee interest entitled to participate in profits but not management, such transfers may still be treated as taxable lapses.

Disregarded Restrictions.  Section 2704(b) currently provides that restrictions on liquidation rights shall be disregarded for valuation purposes when an interest of a family-owned business is transferred among family members and the restriction can be removed by the family.  The proposed regulations adopt additional “disregarded restrictions,” which include any restriction that (1) limits the interest holder to liquidate or redeem his interest; (2) limits liquidation proceeds to less than a “minimum value” (defined as a pro rata share of the net value of property held by the entity less outstanding obligations of the entity); (3) defers payment of liquidation proceeds for more than six months; or (4) permits payment of liquidation proceeds by a note from the entity or family members unless the note meets certain specifications.

A transfer of an interest that is subject to a disregarded restriction will be valued as if there is no such restriction. However, the “disregarded restriction” will not be ignored for valuation purposes if the entity has nonfamily members that meet the following tests: (1) the nonfamily members have held interest for at least three years; (2) the nonfamily member’s interest is equal to at least 10% of the entity’s equity interests or capital and profits interest (and 20% in the aggregate with other nonfamily members); and (3) the nonfamily member has the right to redeem the interest with six months’ notice for “minimum value” payment.

Marital and Charitable Deductions. The proposed regulations clarify that if restrictions are disregarded for purposes of valuing an interest in an estate, it will also be disregarded when valuing the interest for purposes of the marital deduction.  Interests transferred to charity are not subject to § 2704 because § 2704 only applies to family member transfers.

Covered Entities. The proposed regulations clarify that § 2704 applies to corporations, partnerships, limited liability companies, and other entities and business arrangements.

Effective Dates. Comments have been requested, and a hearing is scheduled for December 1, 2016.  It is anticipated that final regulations will be issued and take effect sometime in 2017.

The “disregarded restrictions” rules will become effective 30 days after the proposed regulations are finalized.

The provisions related to voting and liquidation rights apply to rights and restrictions created after October 8, 1990, but only to transfers that are completed after the regulations are finalized. However, it is unclear whether the three-year recapture rule will apply to a transfer of interest completed prior to the date the regulations are finalized.  Therefore, there is a potential that transfers may be recaptured even if such transfers are made before the regulations are finalized.

Please join the Estate Planning Committee on Friday, October 28, 2016, for a brown bag lunch on Estate Planning for Closely Held Business OwnersJeffrey W. Roberts and Johanna L. Wise Sullivan of Nutter McClennen & Fish LLP will provide an overview of key issues and planning points that attorneys should keep in mind when engaging in estate planning for a business owner.  The program will include an overview of different tax structures (C corporations, S corporations and LLCs), other structural issues (women-owned businesses and business succession planning), and drafting considerations.  It also will include a discussion of planning options, including the use of discounted valuations, freezing techniques and liquidity issues.  Section 2704 will be discussed.


Rev. Proc. 2016-42: Language To Be Included In A CRAT To Qualify Under IRC Section 664(f)

Author: Kerry Reilly, Esq., K. Reilly Law LLC

Rev. Proc. 2016-42 – Language To Be Included In A CRAT To Qualify Under IRC Section 664(f)

The IRS has released sample language to be included in Charitable Remainder Annuity Trusts (CRATs) to satisfy the qualified contingency requirements under Internal Revenue Code (Code) Section 664(f). The sample language applies to all CRATs created after the effective date of the Rev Proc.

By using the language provided in the Rev. Proc., the CRAT will not “fail to qualify as a CRAT under Code §664,” nor be subject to the “probability of exhaustion test” pursuant to Rev. Proc. 70-452 (see also Rev. Proc. 77-374). The language is designed to ensure that (1) the beneficiary does not benefit at the expense of the charity, (2) that the charity ultimately receives an amount in keeping with the donor’s charitable deduction at the creation of the CRAT, and (3) that the charity be protected from some of the investment risk of the assets in the CRAT.

The use of similar but not identical language to the sample provision will not guarantee treatment as a “qualified beneficiary” pursuant to §664(f).

The sample language is as follows: (emphasis unchanged)

“The first day of the annuity period shall be the date the property is transferred to the trust and the last day of the annuity period shall be the date of the Recipient’s death or, if earlier, the date of the contingent termination. The date of the contingent termination is the date immediately preceding the payment date of any annuity payment if, after making that payment, the value of the trust corpus, when multiplied by the specified discount factor, would be less than 10 percent of the value of the initial trust corpus. The specified discount factor is equal to [1/(1+i)]t, where t is the time from inception of the trust to the date of the annuity payment, expressed in years and fractions of a year, and i is the interest rate determined by the Internal Revenue Service for purposes of section 7520 of the Internal Revenue Code of 1986, as amended (section 7250 rate), that was used to determine the value of the charitable remainder at the inception of the trust. The section 7520 rate used to determine the value of the charitable remainder at the inception of the trust is the section 7520 rate in effect for [insert the month and year], which is [insert the applicable section 7520 rate].”

Bank of America v. Commissioner of Revenue

Author: Kerry Reilly, Esq., K. Reilly Law LLC

Bank of America v. Commissioner of Revenue

SJC – 11995 (July 11, 2016)

On July 11, 2016, the Massachusetts Supreme Judicial Court (“SJC”) upheld the decision of the Appellate Tax Board (the “board”) that Bank of America N.A. (“B of A”), in its capacity as corporate trustee, qualified as an inhabitant of the Commonwealth of Massachusetts (“MA”) and was subject to the state’s fiduciary income tax for the trusts in question.

G.L. c.62 §10 (a) provides that income received by trustees is subject to MA taxes if “the persons to whom the same is payable, or for whose benefit it is accumulated, are inhabitants of the commonwealth…”  Under G.L. 62 §1(f), inhabitant” means – “(1) any natural person domiciled in the commonwealth, or (2) any natural person who…maintains a permanent place of abode in the commonwealth and spends in the aggregate more than 183 days of the taxable year in the commonwealth.” Section 14 subjects corporate trustees to the same tax regime as “natural” trustees.

The SJC affirmed that B of A was an inhabitant of the Commonwealth based on its extensive branch structure, its conducting of business related specifically to the trusts at issue – “maintaining relationships with the beneficiaries, making decisions about distributions to those beneficiaries, administering trust assets, and retaining certain records” – as well as conducting similar business for other trusts, and was thus subject to taxes pursuant to G.L. c.62 §10.

Estate of Sarah D. Holliday

By, Kevin M. Ellis, Esq. of Hemenway & Barnes LLP

Citation: TC Memo 2016-51

Overview:  The Tax Court held that the value of investment assets transferred to a family limited partnership (“FLP”) by decedent must be included in the decedent’s estate without discount.  The Tax Court determined that there were no legitimate and nontax reasons for transferring assets to the FLP, and that there was an implied agreement that the decedent retain the possession or enjoyment of, or the right to use the income from, the transferred property.

Summary of Facts:  Decedent (through her son, who held her power of attorney), created a limited partnership in which she was the 99.9% limited partner, and her wholly-owned LLC was the 0.1% general partner. Approximately a week after creating the entities, decedent contributed nearly $6 million of marketable securities to the partnership.  On that same day, she sold her entire membership interest in the LLC to her two sons, and gave 10% of her interests in the limited partnership to an irrevocable trust that she created.

Following all of the transfers, decedent owned 89.9% of the limited partnership, and also retained significant assets outside of the partnership.

The limited partnership agreement stated that one of its purposes was to provide “a means for members of the Holliday family to acquire interests in the Partnership business and property, and to ensure that the Partnership’s business and property was continued by and closely-held by members of the Holliday family.” Limited partners did not have a right to participate in the partnership’s business or operations, but the agreement did provide for distributions to limited partners to “the extent that the General Partner determine[d] that the Partnership ha[d] sufficient funds in excess of its current operating needs to make distributions.”

The partnership made one small ($35,000) pro rata distribution.

Decedent died two years after the creation of the FLP, and her estate claimed a 40% discount for her remaining 89.9% limited partnership interests.

Tax Court Analysis: The IRS argued that the transfer of assets to the partnership triggered §2036(a)(1), requiring that the partnership assets be included in decedent’s estate without a discount.

Inclusion under §2036(a)(1) requires that (i) the decedent made an inter vivos transfer of property, (ii) the decedent retained (either explicitly or by implied agreement) the possession or enjoyment of, or the right the income from the property, and (iii) the transfer was not a bona fide sale for adequate and full consideration.

Focusing on the second requirement of §2036(a)(1), the Tax Court found that decedent retained, by implied agreement, the enjoyment of the property. The Tax Court focused on language in the partnership agreement requiring the distribution of “distributable cash” (cash in excess of operating needs) on a periodic basis. The Tax Court also determined that that the decedent was entitled to distributions in certain circumstances, and that operationally, according to testimony of decedent’s son, if decedent needed a distribution, one would have been made to her.

Further, focusing on the third requirement of for inclusion under §2036(a)(1) – that the transfer was not a bona fide sale for adequate and full consideration – the Tax Court rejected the nontax arguments for the creation of the limited partnership. Specifically, the Tax Court rejected the following as legitimate and significant reasons for creating the partnership:

  1. Protection from litigators’ claims: The Tax Court noted that decedent had never been sued before, was not at high risk from “trial attorney extortion,” and in fact held other substantial assets that could be reached by any attempted extortion.
  2. Protection of assets from “undue influence of caregivers”: The Tax Court focused on the fact that decedent’s property was managed by her sons as evidence of her reduced susceptibility to this concern, and also cited a lack of evidence of any concern about this issue in forming the partnership.
  3. Preservation of assets for the decedent’s heirs: The Tax Court noted that the decedent was not involved in creating the entities, but that her sons did so as her power of attorney, and that other family assets were managed well without need for this structure.

The Tax Court made other determinations that undermined evidence of a bona fide transaction. The Tax Court found that this was not an arms-length transaction because no real negotiation or bargaining occurred. Further, the limited partnership did not maintain adequate books and records or follow other formalities that supported its operating as a meaningful stand-alone entity. Finally, the Tax Court noted that there was no active management of the assets, but rather only passive trading, which supported an argument that the transfers occurred only to obtain a valuation discount.

Estate of Purdue v. Commissioner

By, Caleb S. Sainsbury, Esq. of Morgan, Lewis & Bockius LLP

Citation: 145 T.C. Memo. 2015-249 (December 28, 2015)

Overview: This case addresses (1) whether the decedent retained an interest under §2036 of assets transferred to an FLP; (2) whether gifts of FLP interests qualify for the annual exclusion; and (3) whether interest on a loan to the estate to pay estate taxes may be deducted.

Summary of Facts: In 1995, the estate planning lawyer for Mr. and Mrs. Purdue advised them to establish an FLP and various trusts.  In 2000, the Purdues acted on this advice and contributed $22 million of marketable securities, an interest in a commercial building worth $900,000, a $375,000 promissory note from one of their children and an $865,523 certificate of deposit in exchange for all of the FLP membership interests.  The final agreement listed the following six reasons for establishing the FLP: to (1) consolidate the management and control of the property and improve efficiency in managing the property; (2) avoid fractured ownership; (3) keep ownership of the assets within the extended family; (4) protect assets from unknown creditors; (5) provide flexibility and management of assets not available through other business entities; and (6) promote the education and communication among extended family with respect to financial matters.

In addition, prior to the execution of the FLP, the estate planning attorney sent a memorandum to the Purdues summarizing five advantages of the structure. These advantages were (1) limited liability; (2) pass through income taxation; (3) minimum formalities; (4) appropriate entity for owning real estate; and (5) tax savings.

Prior to signing the documents, the Purdues had experienced some health issues. Mrs. Purdue had become semi-invalid due to a leg injury.  She had also experienced stroke-like symptoms in October 2000, but did not have residual neurological impairment.  Mr. Purdue was physically healthy at the time of the signing, but did experience symptoms of Alzheimer’s disease and was subsequently diagnosed with that disease.

Mr. Purdue died unexpectedly in August 2001 and his estate passed to a family trust and two QTIP trusts. From 2002 through 2007, Mrs. Purdue made gifts of the FLP membership interests to an irrevocable trust with beneficiary withdrawal rights.  The trust made approximately $1.95 million of distributions to the children from 2001 to 2007, with the majority of the cash coming from the FLP interests contributed to the trust.

Upon Mrs. Purdue’s death in 2007, a dispute arose among her children on whether the FLP should make a distribution to pay estate taxes. Because the FLP operating agreement required unanimous consent, this gridlock resulted in funds from the FLP not being available to pay the tax.  As such, some of the beneficiaries and the QTIP trusts loaned money to the estate to fund the estate tax payment.  The estate deducted the interest on the loan on the estate tax return.

Court Analysis:

  1. §2036 Issues

The IRS argued that Mrs. Purdue had a retained interest in all assets transferred to the FLP. However, the Court reasoned that §2036 did not apply with respect to the transfers to the FLP for the following reasons: (1) the record established legitimate and significant nontax reasons for creating the FLP, (2) the Purdues were not financially dependent on FLP distributions, (3) FLP funds and personal funds were not comingled, (4) the FLP maintained its own records and formalities were respected, (5) the assets were transferred to the FLP in a timely manner, and (6) the Purdues were in good enough health at the time of the transfers.

  1. Annual Exclusion

To qualify as a gift of a present interest in the context of FLP interests, the donees must have the use, possession or enjoyment of the FLP interests or the income from those interests. Although the donees could not transfer the FLP interests without the consent of all members, the Court reasoned that the donees did receive income from those interests and this satisfied the present interest requirement.  Therefore, the gifts did qualify for the annual exclusion.

  1. Deductibility of Interest

In order for the interest on a loan to the estate to be deductible on an estate tax return, the loan must be (i) bona fide, (ii) necessary and actually incurred in the estate administration and (iii) essential to the property settlement of the estate. See Treas. Reg. §20.2053-1(b)(2), §20.2053-3(a).  The Court reasoned that the loan was necessary because the FLP members could not agree on whether to make a distribution to pay the estate taxes.  Thus, the interest deduction was allowed.

Take Away Considerations:  This case provides a roadmap for highlighting factors resulting in a positive result for the client.  Particularly, advisors must take care to review the factors noted by the Court to avoid having the full value of assets transferred to an FLP included in the estate under §2036.

IRS Releases Proposed Regulations on Taxing Expatriates’ Gifts and Bequests to U.S. Citizens and Residents

By, Caitlin Glynn of Rackemann, Sawyer & Brewster

Recent guidance has been issued to implement Internal Revenue Code Section 2801 (“Section 2801”) which imposes a succession tax on U.S. citizens and residents who receive gifts or bequests from individuals who relinquished U.S. citizenship or ceased to be lawful permanent residents of the United States on or after June 17, 2008 and were “covered expatriates” as defined by the Statute.

IRC Section 2801 Explained

Section 2801 was added to the Internal Revenue Code by The Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART Act”).  In passing the HEART Act Congress determined that it was appropriate and in the interests of tax equity to impose a tax on U.S. citizens and lawful residents who receive from an expatriate a gift or bequest that would otherwise not be subject to U.S. estate and gift tax.  Under Section 2801 the receipt of covered gifts or covered bequests by U.S. citizens or residents from covered expatriates is subject to tax.  For purposes of calculation of the tax on the gift or bequest, the amount of the gift is its fair market value as of the date of receipt and the tax imposed is the highest applicable gift and estate tax rate (currently 40 percent).

Section 2801 is distinctive in that it imposes the tax on the recipient of the gift or bequest, rather than the donor or estate of the decedent.  The tax will be imposed whether the donor or decedent acquired the property transferred before or after expatriation.  The tax will not apply to those gifts that do not exceed the gift tax annual exclusion amount for the year.   The tax is also reduced by the amount of any gift or estate tax paid to a foreign country with respect to a covered gift or bequest.

Previous Guidance from the IRS

On July 20, 2009 the Treasury Department and the IRS issued Announcement 2009-57.  This Announcement states that the IRS intends to issue guidance under Section 2801.  The Announcement further provides that tax payments and filing requirements of the statute are deferred pending the issuance of final regulations.

The Proposed Regulations

The Proposed Regulations amend Title 26 by adding Part 28, “Imposition of Tax on Gifts and Bequests from Covered Expatriates.”  The proposed Regulations are divided into seven sections and include Sections 28.2801-1 to 28.2801-7.  See Internal Revenue Bulletin 2015-39.

Section 28.2801-1 sets forth the general rule of liability for the tax, that the tax is imposed on U.S. citizens or residents who receive covered gifts or covered bequests from a covered expatriate.  Domestic trusts and foreign trusts electing to be treated as domestic trusts are treated in the same manner as U.S. citizens. Section 28.2801-2 provides definitions for Section 2801, including important terms such as “covered expatriate,” “covered bequest,” “domestic trust,” “foreign trust” and “power of appointment.”  “Covered expatriate” is defined by reference to Section 877A(g)(1). Section 877A(g)(1) generally defines a “covered expatriate” as an individual who expatriates on or after June 17, 2008, and whose average annual net income for the period five taxable years before expatriation exceeds $124,000 (subject to a cost of living adjustment), or whose net worth as of expatriation is $2 million, or who cannot certify that they have complied with filing requirements for the five taxable years before expatriation, subject to certain exceptions.

Section 28.2801-3 addresses rules and exceptions applicable to the definitions of covered gift and covered bequest.  In general, the following transfers are excluded from such definitions: qualified disclaimers of property made by the covered expatriate; taxable gifts reported on a covered expatriate’s timely filed gift tax return and property included in the covered expatriate’s gross estate and reported on such expatriate’s timely filed estate tax return, provided that the gift and estate tax due is timely paid; donations to a charitable organization that would be deductible for gift or estate tax purposes; or transfers to a U.S. citizen spouse if such transfer would otherwise qualify for the gift or estate tax marital deduction.

Section 28.2801-4 provides specific rules regarding who is liable for the payment of the Section 2801 tax as well as how to compute the tax. As outlined above, a U.S. citizen or resident who receives a covered gift or a covered bequest is liable for the tax.  A domestic trust that receives a covered gift or covered bequest is treated as a U.S. citizen and is thus liable for the tax.  Of note, a non-electing foreign trust is not liable for the Section 2801 tax.  Thus, a U.S. citizen or resident who receives a distribution from a non-electing foreign trust is liable for the Section 2801 tax to the extent the distribution is attributable to covered gifts or covered bequests.  This Section also provides rules for contributions to charitable remainder trusts (CRTs) made by covered expatriates for the benefit of one or more charitable organizations and the benefit of a U.S. citizen or resident other than the charitable organization. The value of the charitable organization’s remainder interest in a CRT is excluded from the definition of a covered gift or covered bequest.  The value of the interest of the non-charitable U.S. citizen or resident in such contributions to the CRT is a covered gift or bequest and thus taxable, unless otherwise excluded.

Section 28.2801-5 provides guidance on the treatment of foreign trusts.  If a covered gift or covered bequest is made to a foreign trust, the tax applies to any distribution from that trust to a recipient who is a U.S. citizen or resident. The section also discusses how a foreign trust can elect to be a U.S. trust for purposes of Section 2801.

Section 28.2801-6 addresses how the basis rules under Sections 1014, 1015(a) and 1022 impact the determination of the U.S. recipient’s basis in the covered gift or the covered bequest.  This Section also clarifies the applicability of the GST tax to some Section 2801 transfers, among other special rules and cross-references.  Of note, unlike Section 1015(d), which generally allows gift tax paid on the gift to be added to the donee’s basis, Section 2801 does not provide for a similar basis adjustment.

Section 28.2801-7 provides guidance on the responsibility of a U.S. recipient to determine if a tax under Section 2801 is due.  The Treasury Department and IRS recognize that because the tax imposed by Section 2801 is on the recipient, rather than the donor or the estate of the decedent (that has access to the information related to whether the donor or decedent is a covered expatriate), U.S. taxpayers may have difficulty determining whether a tax is due. To aid the taxpayer, the IRS may disclose returns and return information upon request.

December 9, 2015 is the deadline for written or electronic comments to the above regulations.