Today’s post, Part II, was written with my colleague John Richardson, J.D.
Part I of this blog post discussed President Biden’s Green Book proposal that would change the tax rules for unrealized capital gains when assets are gifted or passed at death. To recap, the major thrust of the Green Book proposal is to treat gifts and bequests as “deemed sales at fair market value” triggering a capital gains tax which would be payable with respect to the year of the transfer. The net investment income tax / 3.8% surcharge looks as if it can certainly apply in addition to the capital gains tax (full detail on the 3.8% surcharge is here). The Green Book contains no proposals to eliminate or change the current Estate and Gift Tax rules. Conceivably, both regimes can apply to the same transaction (although it appears there will be some kind of recognition of income tax paid when calculating the Estate/Gift tax). We believe that taxing gifts and bequests from an income tax perspective while keeping the Estate and Gift Tax regime in place is a recipe for undue complications and ultimately, a tax disaster.
Today’s post, Part II, examines how the proposal will particularly impact the American abroad, its exemptions and carve-outs and how it complicates tax planning for individuals wishing to give up their US citizenship or green card.
For Americans abroad the impact of the Green Book proposal is at least four-fold:
First, Americans abroad may be subject to a taxable gain recognition event for US purposes, and no income recognition event in the country where they live. This would be similar to the effect of the Subpart F, GILTI, Transition Tax and 877A Exit Tax rules, all of which create “pretend” income requiring the payment of tax even though no actual income has been received by the taxpayer.
Second, the proposal may impact those seeking to avoid “covered expatriate” status when they relinquish US citizenship or green cards held for a significant time. These individuals may no longer be able to use the gifting strategy as effectively in order to reduce their net worth below 2 million USD to avoid “covered expatriate” status. Depending on the facts, they may have to recognize “deemed” capital gain on this gifting transaction and further, may have separate Gift Tax exposure.
Third, while the Green Book proposes an exemption from the deemed capital gain tax for gifts made to US citizen spouses, there is no equivalent for gifts to spouses who are not US citizens. It comes as no surprise that non-citizen spouses are treated differently under the US tax laws since the law seeks to prevent asset appreciation completely escaping US tax (which can happen when assets are transferred to a non-citizen spouse who is not treated as a US “resident” for Gift and Estate tax purposes). It will be recalled, for example, that an unlimited marital deduction is not allowed, but only a “super-annual” gift tax exclusion for gifts made to non-citizen spouses is permitted. (Currently this super-annual exclusion is USD 164,000). With the Green Book proposal there is no exclusion whatsoever and all appreciation will be taxed to the donor.
Fourth, the proposal will have a profound impact on estate planning for appreciated assets and carries negative implications for many commonly used estate planning techniques involving transfers to trusts. While this affects all taxpayers, those living abroad are often more sharply impacted as they try to navigate not only the laws of the US, but also the laws of foreign countries where they live or hold assets, with much of the planning involving trust structures.
As always, the proposal contains complexity, carve-outs and dollar thresholds which impact its application. Some of these are discussed below.
Green Book Carve-outs, Complexity and Overall Confusion
As can be seen, the Green Book proposal changes things dramatically in the tax world. In a nutshell, gift donors and decedents will be taxed on the appreciation and will pay tax on capital gain upon a transfer to a donee-recipient or heir, as applicable. The tax would be based on the difference between the donor/decedent’s basis in the asset and the asset’s fair market value at the time of gift transfer/death. A decedent would be permitted to use capital losses and carry-forwards to offset such capital gains. The recipient’s basis in the transferred property, whether received by gift or by reason of the decedent’s death, would be the property’s fair market value at the time of the gift or the decedent’s death.
In addition to an exclusion for assets transferred to US citizen spouses, those made to charities would also be excluded from capital gains taxation. Most likely this will be clarified to mean only qualified US charities and not any foreign charities (thus constraining to a certain extent, the charity choice for an American overseas).
There would be a US$5 million per-person exclusion (as adjusted for inflation) from the imposition of capital gains taxes on transfers during lifetime or at death. This exclusion would be “portable” to the decedent’s surviving spouse under the current rules regarding “portability” for estate and gift tax purposes. Ideally this could result in a married couple having an aggregate US$10 million exclusion. A noncitizen spouse generally does not qualify for the portability of the deceased US spouse’s unused estate tax exemption. Again, no surprise there.
Hurry Up! Don’t Wait
The proposals provide an effective date of January 1, 2023, unlike President Biden’s prior proposal which had retroactive effect. It appears there is still a window of time for those considering lifetime transfers. For US persons considering expatriation, time is not on your side, especially since getting an appointment at a US Embassy or Consulate is extremely difficult and in some cases, impossible!
The points raised in this blog post about the Green Book proposals are not the only problems for Americans abroad. The Green Book raises many other troublesome issues for them, as discussed in a previous post here.
For those wishing to listen to a podcast in which John Richardson and I discuss the proposal, it can be accessed here.
Posted April 21, 2022
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