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November 17, 2014 - Phil Hodgen

Expatriate, then get a U.S. inheritance

You should subscribe to the Expatriation Only email list. You’ll get a weekly email that usually answers someone’s question about expatriation. The subject is always expatriation. This is the email that went out earlier today.


This Week’s Question

This week’s question comes from correspondent B. O. Here is his question:

I was wondering if any of your blogs cover the question about non-resident alien (me, I renounced in 2010) inheritance from a US parent (my mother). The amount in the parent’s estate is 2 million US, some of which will probably go to my two children, both US citizens. I looked through your blogs but couldn’t find an answer to that specific question.

Short answer: there is no impediment to you receiving an inheritance. The fact that you expatriated will not matter. Even if you were a covered expatriate, it will not matter.

From Covered Expatriate Back to the USA? Tax It

Most of our time is spent with the income tax problems that expatriation causes. But for covered expatriates, the estate and gift tax implications are important.

A special rule (found at Internal Revenue Code Section 2801) imposes an unusual tax. If a covered expatriate gives money to a U.S. person, or if the covered expatriate dies and leaves an inheritance to a U.S. person, the recipient must pay a tax. The tax is at the highest gift tax rate–currently 40%.

This is upside down from the normal way that the U.S. estate and gift tax system works. Normally, the tax (if any) is paid on the giver’s side, and the recipient gets the gift or inheritance tax-free. The tax rate is the highest possible gift tax rate that exists at the time the gift or inheritance is received.

There are a variety of exceptions to the rule, but these are not important to answering B. O.’s question.

From Expatriate Back to the USA?  No Tax

Note that Section 2801 only imposes this tax on gifts or inheritances received from covered expatriates. The tax is imposed on “covered gifts” and “covered gifts” are defined as money coming from live or dead “covered expatriates”. See Section 2801(e)(1).

Covered expatriates are people who, when they expatriate, have a net worth above $2,000,000, had high average tax liability over the prior five years (for 2014 expatriations, the number is $157,000), or (most commonly in my experience) have some (ahem) things that need to be cleaned up with their tax returns for the previous five years.

These are the “net worth test”, the “net tax liability test”, and the “certification test”, respectively. Successfully pass these tests (by being poor and having your tax paperwork in order) and you are merely an expatriate. You are not a covered expatriate.

If you are not a covered expatriate, your gifts are not “covered gifts”.  Nor are inheritances that you leave to U.S. persons.

[Odd that the IRS defines “covered gifts” as transfers of wealth at death. There is quite a well-known and robust set of technical tax terms for getting money and property from a dead person to an heir. These are even found embedded in the Internal Revenue Code, the Holy Bible of tax. Why did the IRS decide, here in Section 2801, to define a bequest as a gift?]

[But I digress. As I frequently do.]

This points to the importance of avoiding covered expatriate status. If you renounce your U.S. citizenship but your kids are still U.S. citizens, you are going to either leave them an inheritance at 100 cents on the dollar (if you’re an expatriate) or 60 cents on the dollar (if you’re a covered expatriate).

And who wants to donate 40 cents on the dollar to Uncle Sam after you’ve gone to the effort of expatriating?

Covered

Incidentally I had a pleasant email from a gent in Australia. In his email he said:

I come from a career in animal agriculture where the term “covered” generally refers to the male of a species covering a female. It seems that the IRS are onto the same theme albeit without regard to gender.

Ooookay. 🙂 Let’s move on, without comment.

Answer the Question, Phil

Note that Section 2801 only applies to transfers (by gift or bequest) FROM covered expatriates TO U.S. citizens or residents.

B. O.’s question is the reverse. He is an expatriate (I don’t know whether he is a covered expatriate or not). He will receive an inheritance from his U.S. citizen parents. Money is flowing out of the United States, not into the United States.

In this case, Section 2801 does not apply. There is no tax imposed on B. O. as the recipient of a bequest, simply because of his expatriate status.

And this is logical. If there is estate tax to be paid, it will be paid by his parents’ estate. Whatever money is left over has been fully taxed. It can then be sent to anyone on the planet. Including expatriates like B. O.

But Still

But still, it’s a bit odd. The United States has a rule (Section 2801) to actively deter inbound flows of capital from former citizens, but happily allows outbound flows of capital TO former citizens, even covered expatriates. I’m not sure about the economic benefits of such policies but I’m there is immense political hay to be harvested here by our fine politicians.

Anyway, B. O. . . .

You’ll get the money from your parents’ estate. The only U.S. tax you are likely to face is your share of the taxable income generated while the estate was being administered: the interest and dividends, etc. that came in between the time of death of your parents and the time the estate was settled.

2 a.m. in Toronto

This missive is coming to you from lovely Toronto, specifically Room 1438 of the Intercontinental Toronto Centre, at approx. 2 a.m. I landed shortly before midnight on Monday from Los Angeles and will be flying home at 8:15 p.m. on Tuesday. This weekly newsletter has been going out every Tuesday and I don’t want to break the chain, so I’m up late writing this. And I think I will cap it off with a Jell-O Shot (hint: go subscribe if you haven’t) to celebrate. I have to be up at 7 a.m. anyway. Go to your favorite search engine and search for the phrase “don’t break the chain” to see Jerry Seinfeld’s secret of success.)

Now of course is a prudent moment to remind you that this is not legal advice. Get competent advice from someone. Don’t run your life based on email newsletters composed in the middle of the night.

Expatriation