Can Gifting Avoid Exit Tax For High-Net Worth Expatriates?

For many U.S. Taxpayers, the main reason they may be considered a covered expatriate at the time that they expatriate from the United States is because they meet the net worth test. Surprisingly, unlike the net income average tax liability test, the net worth test does not adjust annually for inflation. As a result, many U.S. Taxpayers who may not necessarily be high-income earners but acquired assets many years ago such as stock in companies such as Apple or Tesla — or purchased a home before the recent bubble – may unexpectedly meet the $2M net worth test. Especially for Taxpayers who may have acquired property in northern or southern California many years ago, the value of their home may have increased exponentially, and the ~$900,000 exclusion amount will not be sufficient to avoid exit tax on the mark-to-market gain. Let’s look at some common gifting situations that Taxpayers have to deal with and how the facts may impact the gifting situation.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

The ’3-Year Gift Pull-Back’

The three-year pullback rule applies to Taxpayers at expatriation as well as death. Thus, if the Taxpayer gives gifts within three years before expatriating, the value of those gifts is still considered part of the estate — even though the asset was gifted to another person. In other words, those gifts are pulled back into the estate so that Taxpayers cannot quickly give gifts to reduce the value of their estate. However, some Taxpayers may be able to avoid this harsh outcome when issuing gifts to spouses.

IRC Section 2035

- (a) Inclusion of certain property in gross estate If—

- - - (1) the decedent made a transfer (by trust or otherwise) of an interest in any property, or relinquished a power with respect to any property, during the 3-year period ending on the date of the decedent’s death, and
    - (2) the value of such property (or an interest therein) would have been included in the decedent’s gross estate under section 2036, 2037, 2038, or 2042 if such transferred interest or relinquished power had been retained by the decedent on the date of his death, the value of the gross estate shall include the value of any property (or interest therein) which would have been so included.
- (b) Inclusion of gift tax on gifts made during 3 years before decedent’s death

- - - The amount of the gross estate (determined without regard to this subsection) shall be increased by the amount of any tax paid under chapter 12 by the decedent or his estate on any gift made by the decedent or his spouse during the 3-year period ending on the date of the decedent’s death.

- (c) Other rules relating to transfers within 3 years of death

- - - (1) In general: For purposes of— (A)section 303(b) (relating to distributions in redemption of stock to pay death taxes), (B)section 2032A (relating to special valuation of certain farms, etc., real property), and (C)subchapter C of chapter 64 (relating to lien for taxes), the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, during the 3-year period ending on the date of the decedent’s death.
    - (2) Coordination with section 6166 An estate shall be treated as meeting the 35 percent of adjusted gross estate requirement of section 6166(a)(1) only if the estate meets such requirement both with and without the application of subsection (a).
    - (3) Marital and small transfers Paragraph (1) shall not apply to any transfer (other than a transfer with respect to a life insurance policy) made during a calendar year to any donee if the decedent was not required by section 6019 (other than by reason of section 6019(2)) to file any gift tax return for such year with respect to transfers to such donee.

- (d) Exception

- - - Subsection (a) and paragraph (1) of subsection (c) shall not apply to any bona fide sale for an adequate and full consideration in money or money’s worth. (e)Treatment of certain transfers from revocable trusts.
    - For purposes of this section and section 2038, any transfer from any portion of a trust during any period that such portion was treated under section 676 as owned by the decedent by reason of a power in the grantor (determined without regard to section 672(e)) shall be treated as a transfer made directly by the decedent.

Non-Expatriating U.S. Citizen Spouse (Situation 1)

- - David has been a lawful permanent resident for 14 years. His wife is a U.S. citizen and also plans on moving overseas with David but is not formally expatriating from the U.S. David wants to give up his long-term lawful permanent resident status but wants to bring his net worth below $2M so that he is not a covered expatriate. Therefore, David gifts a high-value asset to his spouse and brings his net worth below $2M. Since David’s wife is a U.S. citizen David can transfer the gift to his wife and avoid the three-year pullback rule.

How Much Can Be Transferred to U.S. Citizen Spouse?

Since David’s wife is a U.S. citizen, he can gift her an unlimited amount of money and assets (usually) without any tax implications.

Non-Expatriating Lawful Permanent Resident Spouse (Situation 2)

- - Peter is a U.S. citizen who wants to expatriate but needs to gift assets to his spouse to reduce his net worth to under $2M and not be considered a covered expatriate. Peter’s wife is a lawful permanent resident who is not expatriating. Peter can transfer a certain amount of assets to his spouse — at the current time (~$190,000 – without having to file documentation. However, since his spouse is not a U.S. Citizen, the unlimited exception does not apply. Depending what happens with the new presidency and whether the increased gift and estate amounts remain intact will impact just how much Peter can gift before exhausting his exclusion amount.

Non-U.S. Person Spouse (Situation 3)

- - Brian is a U.S. Citizen who is currently married to a non-resident alien. Brian wants to reduce his net worth to avoid being considered a covered expatriate when he gives up his long-term lawful permanent resident status (LTR). Brian wants to gift a large amount of money to his spouse, but because his spouse is a non-U.S. Citizen, he is also limited to the amount that he can gift each year and may have to begin filing Form 709 with the gift amounts being applied against his lifetime exemption after his exclusion is exhausted.

NRAs with U.S. Property (Be Careful)

One important to keep in mind is that Non-Resident Aliens only have a $60,000 estate tax exemption for their U.S. property (some exceptions apply). So before gifting high-value U.S. assets to an NRA spouse, Taxpayers should be cognizant of their ultimate goal of the U.S. property and consider planning to avoid unforeseen issues (for example, creating a QDOT for the NRA).

Non-Spousal Gifts

Unfortunately, gifts to non-spouses are typically pulled back into the Taxpayer’s estate for purposes of evaluating the net worth at the time of expatriation. Therefore, gifting large sums of money or assets at the time of expatriation will not usually reduce the value of the estate. Likewise, if the Taxpayer is not considered a U.S. person at the end of the year, then t the gift rules would not apply anyway, so gifting in the year of expatriation may not be beneficial — and result in other tax complications.

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