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Tax-free gifts to reduce net worth
Phil Hodgen
Attorney, Principal
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Hi from Phil Hodgen.This is the last Expatriation Only newsletter of 2015. I send these out every other Tuesday, and you are getting this because you signed up for it. You can easily stop these emails from coming -- just click the Unsubscribe link at the bottom.
Gifts and the Net Worth Test
This week's email is about gifts and the net worth test.If your personal net worth is $2,000,000 or more on the day you renounce your U.S. citizenship, then you are a covered expatriate. Covered expatriate status is something to be avoided, if at all possible: it can trigger brutal tax bills now and in the future.I received an email from a gentleman who wants to expatriate but needs to bring his net worth down before he does so. He plans to do this by making gifts -- either to his U.S. citizen wife, or to his non-citizen daughter, or both.Side note: this is a situation where the entire family is renouncing U.S. citizenship, one at a time. I just want to highlight this because the Congress is to be commended for being so family-oriented. LOL.He raised a question about timing of gifts made to reduce his net worth below $2,000,000. Specifically, he wondered about using the unlimited marital deduction (a U.S. citizen can move infinite amounts of wealth to a U.S. citizen spouse) and/or the unified credit to make these gifts nontaxable.
The Quest
If your objective is to renounce your U.S. citizenship and not pay any of the brutal taxes associated with being a covered expatriate, you certainly would like to do so. Paying a gift tax in order to avoid covered expatriate status? That probably doesn't pencil out.So someone who is expatriating will want to:- Make a gift that the IRS will believe is really a gift (i.e., the asset really truly does not belong to you); while
- Not paying any gift tax (filing a gift tax return is OK); and
- Ending up with a personal net worth below $2,000,000 after it's all done.
"Completed" Gift
Your net worth includes anything that you own on the day you renounce U.S. citizenship. In order to not own something, you must either sell it (and get cash in return, so you have not reduced your net worth), or you must give it away.A gift is not a gift until, says the Internal Revenue Code, it is a "completed" gift. Ownership must shift entirely from you to the recipient -- no strings attached.There is a world of tax metaphysics involved in interpreting this concept of a "completed gift". As you might guess, taxpayers try to push things to the edge, attempting simultaneously to not "own" an asset, yet simultaneously hold onto as much of the economic benefit and control over that asset as they can.Don't do this. Your Primary Purpose is to expatriate cleanly. Make your gift a really-truly gift. The asset should belong entirely to the other person. Don't get cute.The easiest way to do this is to make a transfer of cash. Be sure that the recipient cashes the check, and that the money goes into an account that your name isn't on.Get some help if you need it, but make sure that you have a completed gift.Oh. One more thing. If the government sees a "wink, wink, nudge, nudge" agreement between you and the recipient to return the asset to you in the future, it won't be a completed gift. It will be a "Hold my beer while I . . . " stunt.reddit.com/r/holdmybeer contains many instructional videos to help you understand this concept.No Gift Tax: Transfer to U.S. Spouse
Gifts you make before renunciation will be potentially taxable. The normal exceptions apply: $14,000 or less is OK, as are gifts to pay educational expenses or tuition.By far the biggest way to make a tax-free gift is to give something to your U.S. citizen spouse. Transfers between spouses will never trigger a gift tax, regardless of the amount transferred.That principle is easy to understand for people who are and remain citizens, but what about people who renounce their U.S. citizenship? What if you make a gift to your U.S. citizen spouse on January 31, 2016, and renounce your U.S. citizenship on March 1, 2016. Can you claim the unlimited marital deduction so that your pre-renunciation gift to your spouse is tax-free?Survey says . . . no problem. You can use the unlimited marital deduction.Look at Internal Revenue Code Section 2523 to see the rules for making gifts to spouses completely tax-free. Specifically, Section 2523(a) says:Where a donor transfers during the calendar year by gift an interest in property to a donee who at the time of the gift is the donor's spouse, there shall be allowed as a deduction in computing taxable gifts for the calendar year an amount with respect to such interest equal to its value. [Emphasis added.]The key point -- the unlimited marital deduction either works or does not work based on citizenship and marital status at the time of the gift. If you and your spouse are both U.S. citizens, the gift will qualify for the unlimited marital deduction (assuming you also satisfy all of the other fine print).
No Gift Tax: Transfer to Noncitizen Spouse
For transfers to noncitizen spouses, the unlimited marital deduction will not work. IRC § 2523(i). Instead, you can transfer a semi-large(ish) amount to your noncitizen spouse tax-free. For 2016, the amount is $148,000. Rev. Proc. 2015-53, 2015-44 I.R.B. 615, §3.35(2).No Gift Tax: Unified Credit
The final way that a U.S. citizen can give away assets (to reduce net worth in order to renounce citizenship without being a covered expatriate) is to use the unified credit.The first $5,450,000 of gifts (or bequests) that you make will not be subjected to U.S. gift or estate tax. This is the amount for gifts or deaths in 2016. Rev. Proc. 2015-53, 2015-44 I.R.B. 615, §3.33. This is a cumulative amount, including taxable gifts and bequests over your entire lifetime. Well, technically, bequests . . . . yeah. :-)What this means, for example, is that my correspondent could give up to $5,450,000 to his non-citizen daughter, file a gift tax return, and claim the unified credit. Lots of paperwork, but no gift tax.Again we come to the timing question. You make the gift while you are a U.S. citizen. Then you renounce your citizenship, and then after that you file your gift tax return (Form 709) for the year in which you made the gift. Does that negate your use of the unified credit?Survey say . . . no problem. You get the unified credit. I think. :-)Here is the rule, from the Treasury Regulations:Section 2505(a) allows a citizen or resident of the United States a credit against the tax imposed by section 2501 for each calendar year. The allowable credit is the applicable credit amount in effect under section 2010(c) that would apply if the donor died as of the end of the calendar year, reduced by the sum of the amounts allowable as a credit against the gift tax due for all preceding calendar periods. See §§25.2505-2, 20.2010-1, and 20.2010-2 for additional rules and definitions related to determining the applicable credit amount in effect under section 2010(c).Treas. Regs. § 25.2505-1(a).The first sentence says if you are a citizen, you get a credit against your gift tax liability. Simple. You were a citizen when you made the gift, so you get a credit.The second sentence creates the uncertainty:
The allowable credit is the applicable credit amount in effect under section 2010(c) that would apply if the donor died as of the end of the calendar year . . . .That could mean two things:
- You made the gift while you were still a citizen, so you get the credit (first sentence). The only question is how big a credit you get (second sentence). You figure that out by pretending you die at the end of the year and looking at what the law was on that date. Your status as a citizen or noncitizen on the last day of the year is irrelevant; only the dollar amount of the unified credit is relevant.
- You made the gift while you were still a citizen, so you get the credit (first sentence). The only question is how big a credit you get (second sentence). You figure that out by pretending you die at the end of the year and looking at what the law was on that date. Your status as a citizen or noncitizen on the last day of the year is relevant, and because you were a noncitizen on the last day of the year, your unified credit amount is zero.