Firm Suggests Changes to Proposed Regs on Expatriate Gifts

We thank the IRS for proposing regulations under I.R.C. § 2801. This is an area of the law where more clarity will prove useful to both taxpayers and tax preparers. But while the Service's efforts are laudable, the proposed regulations could be improved as discussed below. We invite the IRS to clarify the effective date on which individuals lose U.S. citizenship and suggest modifications to the proposed regulations that will bring them closer to achieving the intended purpose of § 2801.

A. SUMMARY OF RECOMMENDATIONS

In summary, we recommend the IRS:

1. Clarify the effective date on which an individual loses U.S. citizenship for tax purposes for taxpayers who naturalized in another country and those who were dual citizens at birth²

Section 2801 applies to "covered" gifts and bequests received by a U.S. person from a "covered expatriate," as that term is defined in § 877A(g)(1). In light of both the evolving definitions under §§ 877 and 877A, clarification is needed regarding the definition of a "covered expatriate."

Before 2004, an individual's tax citizenship terminated at the same time as his or her citizenship under immigration law. However, Congress changed this in 2004 by introducing the concept of loss of U.S. citizenship for tax purposes under § 7701(n) (repealed 2008). This new tax definition of loss of citizenship was amended in 2008, and survives today in §§ 877A(g)(4) and 7701(a)(50).

It is important to understand manner in which tax citizenship terminates under these two acts because they have different notice provisions, which apply differently depending on when the individual lost his citizenship for nationality purposes. The following analysis addresses solely the date on which U.S. citizenship is lost for tax purposes.

1.a. The American Jobs Creation Act of 2004 (AJCA)³

The AJCA enacted § 7701(n), which provided that an individual would continue to be treated as a U.S. citizen for tax purposes until the individual gave notice that he had committed an expatriating act (with the intent to relinquish citizenship) to the Department of State and the IRS. Specifically, the statute provided that:

Thus, an individual who lost citizenship for nationality purposes after June 3, 2004 would lose his tax-citizenship only after providing the appropriate notice to the Department of State and IRS. Conversely, an individual who lost citizenship for nationality purposes prior to June 3, 2004 would cease to be taxed as a U.S. citizen coincident with his nationality status.

1.b. The Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act)⁴: non-dual citizens at birth

The HEART Act repealed the notice requirements of § 7701(n) and enacted numerous changes to the date on which U.S. citizenship is lost for tax purposes. First, new section 7701(a)(50)(A) provides that an individual shall not cease to be treated as a U.S. citizen before the date on which the individual's citizenship is treated as relinquished under 877A(g)(4).

Second, new § 877A(g)(3) provides that an individual's expatriation date is the date on which he "relinquishes" U.S. citizenship. New § 877A(g)(4) defines "relinquishment" of U.S. citizenship for tax purposes as follows:

First, tax-citizenship is not terminated unless a CLN has been issued. The flush language of § 877A(g)(4) provides that either renouncing U.S. citizenship before a diplomatic or Consular officer; or furnishing a statement confirming the voluntary commitment of one of four expatriating acts⁵ are ineffective to terminate tax-citizenship unless they are approved by the issuance of a CLN.⁶

Second, the HEART Act repealed the obligation to give notice to the IRS in order to terminate tax-citizenship status.⁷

Third, the HEART Act refined the "effective date" for loss of tax-citizenship. Under section 7701(n) tax-citizenship was lost upon giving notice to both the Department of State and the IRS. Because the notice provisions were conjunctive, the later of the two notice provisions established the loss of tax-citizenship. Under the HEART Act, however, tax-citizenship is lost on the earlier of renouncing before a diplomatic or consular officer (provided such results in the issuance of a CLN), delivering a statement confirming a prior expatriating act (provided such results in the issuance of a CLN), or the issuance of a CLN.⁸

At first blush the new rules for termination of tax-citizenship under the HEART Act appear to apply prospectively. However, a close reading of the statue reveals that, for practical purposes, it applies retroactively as well. Under the HEART Act, the new rules for termination of tax-citizenship are effective for individuals whose "expatriation date" is after June 17, 2008.⁹ The individual's "expatriation date" is defined under § 877A(g)(3) as the date on which an individual "relinquishes" U.S. citizenship, and the individual cannot relinquish citizenship without having the United States Department of State or a U.S. court confirm the loss of citizenship -- which may have occurred before the individual gets confirmation.¹⁰ Yet the HEART Act may deem individuals who lost citizenship by committing an expatriating act in the past as U.S. citizens until the date their CLN is issued to them in the mail.¹¹

Thus, the only individuals who are not subject to the new rules for loss of tax-citizenship are those who, before June 17, 2008: (1) received a CLN; or (2) renounced before a diplomatic or consular officer; or (3) submitted a statement confirming a prior expatriating act. Note that for the latter two methods, the renunciation or statement must be confirmed by the issuance of a CLN. For example:

There is a different way to address individuals who were dual citizens at birth. The HEART Act gives the Treasury Department the authority to modify § 877A(g)(4)'s rule on the effective date these individuals' lost tax citizenship.¹² Specifically, the date U.S. citizenship ceases for these dual citizens can be changed by regulation:

2. Remove the rebuttable presumption found in Prop. Treas. Reg. § 28.2801-7(b)(2)

As part of the HEART Act, Congress also added a new tax in § 2801, which was meant to serve as a backstop to the exit tax in § 877A. Importantly, Congress placed responsibility for paying § 2801's special tax on gifts and bequests from covered expatriates squarely on the U.S. citizen or resident recipient.¹⁴ The IRS's wording in the proposed regulations that "it is the responsibility of the [recipient] to ascertain" his or her obligations under § 2801 is consistent with the statute's assignment of tax liability.¹⁵ But the same cannot be said of the rebuttable presumption in Prop. Treas. Reg. § 28.2801-7(b)(2).

There is no language in § 2801 that places any special evidentiary, administrative, or information-gathering burden on recipients of gifts from all expatriates. The IRS has created this presumption without support in the statute or explicit statutory authority to do so. It has broadened mere liability for § 2801 tax to a requirement that all U.S. recipients of gifts from expatriates demand proof of the donor's status as a non-covered expatriate, or that they file a "protective Form 708 [. . .] to start the period for the assessment of any section 2801 tax."¹⁶ While we appreciate the IRS's need to creatively encourage compliance in the face of increasingly limited resources, shifting the burden to taxpayers in this way is not viable when § 2801 does not give the IRS the authority to do so.

In our opinion, such a jump from simple responsibility for payment of tax to a presumption that can only be avoided by a gift recipient insisting on access to the donor's U.S. tax returns is ultra vires the plain language of § 2801 and the rulemaking authority under which the IRS is proposing these regulations. Congress did not mention any special reporting or evidentiary requirements for recipients of covered gifts within the text of § 2801. Indeed, Congress did not even delegate to Treasury any specific rulemaking authority. Accordingly, the IRS is relying only on its general rulemaking authority under § 7805(a), which provides that the Secretary of the Treasury "shall prescribe all needful rules and regulations for the enforcement of this title, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue."

We do not think the rebuttable presumption in the proposed regulations is a "needful regulation" to enforce the Code. Here, the IRS has other tools at its disposal that would allow for effective enforcement of § 2801 with substantially less burden on taxpayers. Although the rebuttable presumption could feasibly help enhance compliance with § 2801, the universal nature of the presumption's intended application has the potential to place a substantial burden on U.S. recipients of gifts from expatriates.

A search of the Treasury regulations revealed only limited instances of the IRS creating rebuttable presumptions against the taxpayer without a specific, related delegation of rulemaking authority from Congress.¹⁷ These do not include rebuttable presumptions against the taxpayer where Congress has delegated specific rulemaking authority that could reasonably be interpreted to include the presumption created in the regulations.¹⁸ They also do not include rebuttable presumptions created in regulations that favor the taxpayer.¹⁹

It is also worth noting that Congress has in other instances created special substantiation requirements in other parts of the Code, something it did not do here.²⁰ Indeed, within the realm of expatriation law, Congress made clear who bears the burden of proof when loss of citizenship is asserted.²¹ It seems doubtful that Congress would not address burdens of production and proof in § 2801, especially if it intended for the IRS to employ a rebuttable presumption as a tool for enforcing the § 2801's special tax.

Furthermore, the IRS has other means of promoting § 2801 compliance that would be substantially less onerous than the rebuttable presumption. Particularly where Congress did not contemplate any special evidentiary burden-shifting or information-gathering requirements, or delegate to Treasury any specific rulemaking authority to enhance enforcement in this area, such a far-reaching presumption seems inappropriate.

Also note that the taxpayer compliance burden estimated in the notice of proposed rulemaking may be substantially understated, particularly given the requirement that recipients retain records indefinitely under Prop. Treas. Reg. § 28.6001-1 (which may cause unnecessary filings of Form 708 to start the statute of limitations). Additionally, we would like to point out that the volume of Forms 708 that may be needed in the case of disbursements from non-U.S. investment vehicles, like Canadian tax free savings accounts with an expatriate contributor and U.S. beneficiary, could be substantial and costly for both taxpayers to prepare and the IRS to review.

3. Clarify the recipient-U.S. taxpayer's record keeping requirements in Prop. Treas. Reg. § 28.6001-1

Finally, the recipients of covered gifts are subject to excessive recordkeeping requirements under the proposed regulations.²² The proposed regulations require these individuals to keep documents used to prepare Form 708 forever even though the IRS is generally subject to a three-year or six-year statute of limitations.²³ Thus, the IRS should consider clarifying the recipient-U.S. taxpayer's recordkeeping requirements under the final regulations.

C. CONCLUSION

We are pleased to have the opportunity to contribute to this important discussion, look forward to discussing this at the public hearing, and hope that our comments are helpful.

• Clarification of the effective date on which an individual loses U.S. citizenship for tax purposes for taxpayers who naturalized in another country and those who were dual citizens at birth -- 10 minutes

• Deletion of the rebuttable presumption in Prop. Treas. Reg. § 28.2801-7(b)(2) -- 5 minutes

• Clarification of the recipient-U.S. taxpayer's record keeping requirements in Prop. Treas. Reg. § 28.6001-1 -- 5 minutes

• Sincerely,

   

   

  Roy Berg, JD, LLM (us TAX)

   

  Direct Phone: 403.693.5120

   

  Email: rberg@moodysgartner.com

   

   

  Paul Barba, JD, LLM (us TAX)

   

  Direct Phone: 403.693.5125

   

  Email: pbarba@moodysgartner.com

   

² The issues and analysis of this section are consistent with other tax practitioners. E.g., Michael Pfeifer, The Current State of Expatriation, International Trust and Estate Planning, American Law Institute (Oct. 20, 2014); Michael J. Miller and Ellen Seiler Brody, Expats Live In Fear of Malevolent Time Machine, 12 INT'L TAX J. 213 (Mar. 5, 2013); Michael J. Miller, Comments on the Tax Status of Certain Expatriates, American Bar Association Section of Taxation, Letter to Hon. John Koskinen, Commissioner of Internal Revenue(Mar. 2, 2015); Patrick Martin, Accidental Americans Rush to Renounce U.S. Citizenship to Avoid the Ugly U.S. Tax Web, 38:6 INT'L TAX J. 49 (Nov.-Dec. 2012).

³American Jobs Creation Act of 2004, Pub. L. No. 108-357, section 804.

⁴Heroes Earnings Assistance and Relief Tax Act of 2008, Pub. L. No. 110-245, section 501(a).

⁵ § 877A(g)(4)(B), referring to the expatriating acts listed in 8 U.S.C. 1481(a)(1), (2), (3), or (4). Those acts are (1) becoming naturalized in a foreign country, (2) formally declaring allegiance to a foreign country, (3) serving in a foreign army, and (4) serving in certain types of foreign government employment if the individual is a national of the foreign country or takes an oath of allegiance to that foreign country.

⁶ The only exception to the requirement of a CLN would be when a U.S. court cancels a naturalized citizen's certificate of naturalization. § 877A(g)(4)(D). While an important section for those who obtained U.S. citizenship by naturalization we will not discuss it herein.

⁷ Note that under § 877(a)(2)(c), the individual must provide a certification to the IRS in order to avoid status as a "covered expatriate" and therefore the expatriation tax. But this requirement does not affect the termination of his tax-citizenship status.

⁸ §§ 7701(a)(50), 877A(g)(4).

⁹ § 877(h).

¹⁰ § 877A(g)(4)

¹¹ § 877A(g)(4)(C).

¹² § 7701(a)(50)(B).

¹³Id.

¹⁴ § 2801(b).

¹⁵ Prop. Treas. Reg. § 28.2801-7(a).

¹⁶ Prop. Treas. Reg. § 28.2801-7(b)(2).

¹⁷ Treas. Reg. §§ 1.165-13T (straddle transaction losses), 1.861-9T (allocation of interest expenses for foreign currency borrowings), 56.4911-2(b)(5)(ii) (political lobbying by charities).

¹⁸ Treas. Reg. § 1.469-2(c)(2)(ii) (principal purpose of acquiring property for passive activity losses), delegation in § 469(l); Treas. Reg. § 1.884-1(d)(3)(ii)(B) (treating partner's proportionate shares as U.S. assets for branch profits tax), delegation in § 884(c)(2); Treas. Reg. § 1.6050P-1(b)(iv) (information on when indebtedness has been discharged), delegation in § 6050P(a) and (e).

¹⁹See, e.g., Treas. Reg. §§ 1.401(a)(4)-11(d)(2)(iv)(2) (presumption crediting service for qualified pension, profit-sharing, and stockbonus plans), 53.4958-6 (presumption that a transaction is not an excess benefit transaction).

²⁰See, e.g., § 274(d) (deductions of entertainment expenses).

²¹ 8 U.S.C. § 1481(b).

²² Prop. Treas. Reg. § 1.6001-1.

²³ Prop. Treas. Reg. § 1.6001-1(a).