November 1, 2013 - Phil Hodgen

Why Section 2801 is dumb

Section 2801 is the part of the Internal Revenue Code that says:

  • If you are a covered expatriate, and
  • You give money to a U.S. person, or you die and leave an inheritance to a U.S. person,
  • Then the U.S. person pays a whacking big tax for receiving the money from you.

There are a couple of minor exceptions to this rule.

At the moment there are no Treasury Regulations issued, and no published guidance from the IRS. I am sure it is coming. ((Memo to all personnel: it is NEVER good for taxpayers when the IRS publishes guidance. Even when you think it is. Life becomes harder and more expensive for taxpayers. The IRS is the pit boss in this casino.))

Section 2801 may be one of the dumbest things in the Internal Revenue Code, and that’s saying a lot. It deliberately stops money from returning to the United States. It deliberately prevents assets from entering the tax system to generate income, gift, and estate tax.

Bloated Plutocrat

Let’s take the random bloated plutocrat who expatriates. All of you who give up your U.S. passport fall in that category, right? You spend your day swilling brandy, smoking cigars, and kicking widows, orphans, and kittens that you happen to see on the street. Oh. And you’re unpatriotic.

When those years of fine living outside the United States finally catch up with Mr. Plutocrat, he dies. Let’s say his net worth is $50 million. His children are all U.S. citizens. If his will leaves all of his money to his U.S. kids, the $50 million re-enters the U.S. tax system, generating income tax, and (when his kids die) presumably generating estate tax.

Section 2801 gives our bloated plutocrat a reason to not leave the $50 million to his kids. The reason is a $20 million tax bill.

What happens in real life? Two possible results: Mr. Plutocrat gives nothing to his kids. “Let the Young Plutocrats make their own fortune and find their own baby seals to club to death!” Or–and this is what I see–the entire family chooses to expatriate. Bloated Plutocrat, Mrs. Plutocrat, and the Plutocrat offspring. Gone.

And as a result, $50 million of capital has permanently left the United States. The income tax generated on that capital has permanently left the United States. The jobs created by investing that capital–they don’t exist.

The money that wasn’t invested. The jobs that were not created. The entrepreneurial spirit and energy that blossomed and bore fruit outside the United States instead of inside the United States. This is the cost of Section 2801.

I often think that the current U.S. immigration policy is dumb. And it is. People who voluntarily leave their home countries to come to the United States have pre-selected themselves into the category of those who have drive, determination, dreams, and ambition to make a better life for themselves and their children. They are precisely the people you want as a neighbor, as a citizen.

Use that same perspective to look at the exit tax rules generally–and Section 2801 in particular. Has Congress created a reason for us to export extremely valuable humans to other countries?

Thanks, @bubblebustin, for the comment that triggered this blog post.