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US citizenship renunciation could mean a steep inheritance tax

Renouncing US citizenship or giving up one’s long-held green card does not necessarily mean forever severing all ties with the US. Many former Americans, especially those in neighbouring Canada and Mexico, also have family and friends who are still US residents or US citizens, and to whom they want to eventually gift or bequeath assets. Under section 2801 of the Internal Revenue Code, US citizens or US residents who received gift or inheritance from “covered expatriates” (as defined in 877) are subject to an inheritance tax imposed at 40% of the value of the gift or inheritance. Regulations recently proposed by the US Treasury have clarified how and when this tax will be imposed. The new proposed regulations underscore the importance of carefully planning renunciations, gifts, and bequests.

The law behind the proposed regulations is not new, but the precise dimensions of how it could be enforced are. Congress created the requirement that recipients pay tax on gifts from “covered expatriates” in 2008, but the provision has not yet been enforced because the Treasury Department had not, until recently, issued any implementing regulations.1  What is perhaps most striking about the proposed regulations is they create a rebuttable presumption that places the onus on the recipient of the gift or inheritance to demonstrate to the IRS that gifts received did not come from former Americans deemed “covered expatriates” by one of three tests in the Internal Revenue Code.2 The alternative is for the recipient to pay 40% tax, 3 and the regulations to not provide for a de minimus exception that would allow small gifts from a “covered expatriate” to go unreported and untaxed.4

Both gifts (made while the donor is living) and bequests (made through a will) are subject to this proposed regime if the regulations are issued in final or temporary form.5 Whether or not the rules apply would be determined at the time the gift is received by a US citizen, resident, or green card holder, and not at the time the former American expatriated or if he acquired the property before or after turning in his US passport or green card.6 The gift recipient is permitted to file a “protective return” to start the running of the statute of limitations, but the regulations indicate that this new protective return will require essentially the same amount of information as the donor himself would be required to provide.7 There are exceptions for transfers between spouses,8 to charities,9 and for certain qualified disclaimers,10 however gifts that would otherwise be exempt from tax and reporting because they are below an inflation-adjusted annual threshold are not excluded by the new rules.11

When the regulations become final, the new rules will be felt especially hard by families where one member has renounced US citizenship and other family members have not. There are many such possibilities. Think, for instance, of a dual citizen mother who opened an RESP for her child and later decided to renounce her US citizenship. If the child is not old enough to renounce or wants to keep dual citizenship so that he has the option of working in the US someday, gifts to that child would be subject to the reporting requirement. Such gifts likely include distributions from the RESP,12 meaning the child would have the burden of demonstrating to the IRS why contributions made by his mother to his RESP were not from a “covered expatriate.”

Alternatively, imagine the scenario of a marriage where one spouse was born and raised in the US, ended up marrying a Canadian and living most of her adult life in Canada, and built a successful business here. If that individual eventually decided to renounce her US citizenship but wanted to later pass some of her wealth to family back in the US, the US recipients of her property would need to demonstrate to the IRS that the gifts did not come from a “covered expatriate.” If the property were to be passed by will, untangling the former American’s affairs to determine whether she expatriated properly could prove to be a factual impossibility.

It is important to emphasize that these are proposed regulations only. Not only is it possible the rules will change based on public comments in January,13 but the IRS also has not included a proposed effective date.14 There are a great number of regulations that have languished in a sort of “proposal purgatory” for decades.15 Further, taxpayers are never required to abide by proposed regulations until the date they are finalized and adopted, and the IRS is not proposing that taxpayers would have to apply these rules retroactively: the proposed regulations state that “taxpayers may rely upon the final rules of this part for the period beginning June 17, 2008” (emphasis added).16

Still, the fact that Treasury has finally issued the proposed regulations and is taking them through notice and comment may indicate that the IRS is serious about adopting them and attempting to ensure they are followed. These regulations would be considered “interpretative” rather than “legislative” because there is no specific delegation of rulemaking authority from Congress to Treasury in § 2801.17 Under the US Administrative Procedure Act, interpretive regulations do not technically require public notice and comment before they can be adopted.18 But interpretative regulations that do go through notice and comment are generally afforded greater deference by the courts.19 So, by sending these regulations through public notice and comment procedures rather than just adopting them or issuing them in temporary form, the IRS may be demonstrating its intent to make the regulations binding law.

Those who have given up their US citizenship, are considering giving up their US citizenship, or relinquishing a long-held green card need to be aware of these proposed rules and their consequences. The detail of these rules, the manner in which they have been introduced, and the presumptions they raise, signals the continued importance of planning carefully to avoid unintended consequences. Giving indeed may be better than receiving, but former Americans thinking about cross-border wealth transfers will likely need to be increasingly careful to make sure their gifts are not accompanied by inadvertent tax bills.

1. I.R.S. Announcement 2009-57 (July 20, 2009).

2. I.R.C. § 877(a)(2).

3. Prop. Treas. Reg. § 28.2801-7(b)(2).

4. Prop. Treas. Reg. § 28.2801-3(c)(1).

5. Prop. Treas. Reg. § 28.2801-2(f-g).

6. Id.

7. Prop. Treas. Reg. § 28.6011-1(b).

8. Prop. Treas. Reg. § 28.2801-3(c)(4).

9. Prop. Treas. Reg. § 28.2801-3(c)(3).

10. Prop. Treas. Reg. § 28.2801-3(c)(5).

11. Prop. Treas. Reg. § 28.2801-3(c)(1).

12. See, e.g., Rev. Proc. 2014–55, which exempts RRSPs and RRIFs from information reporting requirements but is silent as to RESPs and TFSAs.

13. For dates of the notice and comment period, see Guidance Under Section 2801 Regarding the Imposition of Tax on Certain Gifts and Bequests From Covered Expatriates, 80 Fed. Reg. 54,447 (proposed Sept. 10, 2015) (to be codified at 28 C.F.R. pt. 28).

14. Id.

15. See, e.g., Treas. Prop. Reg. § 1.898-1, published in 1993 (para. 151,485 Preamble to Prop. Regs., 1/5/93, Fed. Reg. Vol. 58, No. 2, p. 290).

16. Prop. Treas. Reg. § 28.2801-1(b).

17. This means that Treasury’s authority to prescribe regulations for § 2801 comes from § 7805(a)’s mandate that “the Secretary shall prescribe all needful rules and regulations as may be necessary for the enforcement” of the I.R.C. in general.

18. 5 U.S.C. § 553(b)(3)(A) (2015).

19. See Mayo Found. for Med. Educ. & Research v. United States, 131 S. Ct. 704, 714 (2011)