Individuals who gave up their US citizenship or long-term tax residency (or will do so) and are deemed to be covered expatriates subject to the US Exit Tax (or will be in the near future), should take great care when making gifts or bequests to US citizens or US resident individuals, including family members, either directly or indirectly, through a US or foreign trust.

When the IRS published final Exit Tax regulations on January 14, 2025, it provided additional detail on when a related tax (the “Section 2801 tax”) applies and does not apply, as well as how it is calculated, reported, and submitted to the IRS.

Whereas the Exit Tax applies to the person expatriating, the related §2801 tax applies to US individuals who receive certain gifts or bequests from someone who has expatriated and been subject to the Exit Tax.

In this post, Part 1 of our series on the final Exit Tax regulations, we cover details that the final regulations provided on the applicability, calculation, and reporting of the §2801 tax.

Individuals Subject to §2801 Tax

The §2801 tax applies to any “US recipient” of a “covered gift or bequest” from a “covered expatriate.”

 A “covered expatriate” is defined as an individual who relinquished their US citizenship—or a long-term lawful permanent resident who relinquished their green card—and who, at the time of expatriation:

  • Had a net worth of more than $2 million, or
  • Had an average US income tax liability exceeding $206,000 (2025 inflation-adjusted amount) over the past 3 years, or
  • Was not fully in compliance with tax return filing and reporting requirements for one or more of the last 5 years, or
  • Was subject to the US Exit Tax in any way, shape, or form.

Per the regulations, “US recipients” include:

  • A US citizen or resident, a domestic trust, or an electing foreign trust that receives a covered gift or covered bequest, whether directly or indirectly, during the calendar year.
  • A US citizen or resident receiving a distribution from a non-electing foreign trust if the distribution is attributable (in whole or in part) to one or more covered gifts or covered bequests received by the non-electing foreign trust.
  • A US citizen or resident shareholder, partner, or other interest-holder (if any) of a business entity that receives a covered gift or covered bequest.

Many of these terms have special definitions. “Domestic trust” and “foreign trust” are defined in §7701(a)(30)(E) and §7701(a)(31)(B), respectively. “Electing foreign trust” is a foreign trust that made a valid election, still in effect, to be treated as a domestic trust for purposes of §2801. A “non-electing foreign trust” is any foreign trust that has (a) not made an election to be an electing foreign trust, or (b) has not migrated into the US and become a US domestic trust, or (c) was an electing foreign trust that had its status revoked by facts and circumstances detailed in the final regulations or by the IRS via written notice.

“Covered Bequests” and “Covered Gifts”

 A “covered bequest” means any property acquired by a recipient on or after June 17, 2008, directly or indirectly by reason of the death of a covered expatriate, regardless of the situs of the property and of whether such property was acquired by the covered expatriate before or after expatriation.

A “covered gift” means any property acquired by a recipient on or after June 17, 2008, by gift directly or indirectly from an individual who is a covered expatriate at the time the property is received by the recipient, regardless of the situs of such property and of whether such property was acquired by the covered expatriate before or after expatriation. Note: Covered gifts may require the filing of IRS Form 708, 709-NA, and 3520, Part IV.

For purposes of determining the US recipient’s basis in property received as a covered gift or covered bequest, see IRC §1015 and §1014, respectively. However, the basis adjustment provided in §1015(d) does not apply to increase the basis in a covered gift to reflect the tax paid under this section.

The same US recipient may be required to pay §2801 tax on both a covered gift and a covered bequest.

Example: Property subject to §2801 tax as both a covered gift and covered bequest

CE, a covered expatriate, transfers an income interest in property to A, a US citizen, while retaining the remainder interest. CE was not required to, and did not, file a gift tax return. Upon CE’s death, A receives full title to the property. The initial transfer of the income interest was a covered gift valued at $1,000,000, upon which A paid the §2801 tax. The value of the property at CE’s death is $4,500,000.

Because the full value of the property would have been included in CE’s gross estate if CE had died as a US citizen, there is a covered bequest at CE’s death. The covered bequest is subject to §2801 tax on the excess of the value of the covered bequest over the value of the covered gift ($4,500,000 minus $1,000,000), or $3,500,000.

Exceptions

Potential Exception for Spouse

Gift or bequests from a covered expatriate to their spouse may qualify for a full or partial exception.

Property transferred from a covered expatriate to the covered expatriate’s spouse (or to a domestic trust of electing foreign trust) generally is not a covered gift or covered bequest to the extent a marital deduction under IRC §2523 or §2056 would have been allowed if the covered expatriate had been a US citizen at the time of the transfer.

Example: Transfer to spouse

In Year 1, CE, a covered expatriate domiciled in Country F, a foreign country with which the US does not have a gift tax treaty, gives $300,000 cash to his spouse, W, a US resident and citizen of Country F. The $100,000 exclusion for a noncitizen spouse, as indexed for inflation in Year 1, is excluded from the definition of a covered gift under §2801 because only that amount of the transfer would have qualified for the gift tax marital deduction if CE had been a US citizen at the time of the gift. See §2801(e)(3), §2523(i), and §2503(b).

The remaining amount ($300,000, less the $100,000 exclusion for a noncitizen spouse, as indexed for inflation) is a covered gift from CE to W. W must timely file Form 708, United States Return of Tax for Gifts and Bequests Received from Covered Expatriates, and timely pay the tax. See §28.6011- 1(a), 28.6071-1(a), and 28.6151-1(a).

W also must report the transfer on Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, and any other required form. See §28.2801-6(c)(1).

Exception for Foreign Trusts

A foreign trust that receives a covered gift or covered bequest is not liable for payment of the §2801 tax unless the trust makes an election to be treated as a domestic trust solely for purposes of §2801 as provided in §28.2801-5(d).

Absent such an election, each US recipient is liable for payment of the §2801 tax on that person’s receipt, either directly or indirectly, of a distribution from the foreign trust to the extent that the distribution is attributable to a covered gift or covered bequest made to the foreign trust. It should be noted that IRS Form 3520, Part III may be required to be filed in addition to Form 708 in this circumstance.

To calculate the §2801 tax, the taxpayer must first determine the §2801 ratio. To calculate the §2801 ratio, one must determine:

  • The fair market value of the portion of the foreign trust attributable to the covered gifts and covered bequests the trust has received (covered portion), and
  • The fair market value of the portion of the foreign trust attributable to other contributions (non-covered portion).

The covered portion of the trust includes the ratable portion of appreciation and income that has accrued on the foreign trust’s assets from the date of the contribution of the covered gifts and covered bequests to the foreign trust.

Example: Computation of §2801 ratio

A and B each contribute $100,000 to a new foreign trust. A (but not B) is a covered expatriate and A’s contribution is a covered gift. The trustee of the trust does not make a valid election to have the trust treated as a domestic trust for purposes of §2801.

The §2801 ratio immediately after these two contributions is 0.50, computed as follows: the pre-contribution value of the trust ($0) multiplied by the pre-contribution §2801 ratio (0), plus the current covered gift ($100,000), divided by the post-contribution fair market value of the trust ($200,000). See §28.2801-5(c).

Therefore, 50 percent of each distribution from the trust to a US recipient is subject to the §2801 tax until the next contribution is made to the trust. If the trustee distributes $40,000 to C, a US citizen, before the trust receives any other contributions, then $20,000 ($40,000 x 0.5) is a covered gift to C.

Reductions to §2801 Tax for Foreign Gift, Estate, or Inheritance Taxes Paid

The §2801 tax is reduced by the amount of any gift or estate tax paid to a foreign country with respect to the covered gift or covered bequest. No reduction is allowed for interest and penalties paid in connection with those foreign taxes. To claim the reduction of §2801 tax, the US recipient must attach to the Form 708 a copy of the foreign gift or estate tax return and a copy of the receipt or cancelled check for payment of the foreign gift or estate tax.

Filings Required by US Recipients

Timely Filing of Form 708

 US recipients must file IRS Form 708 on or before the fifteenth day of the eighteenth calendar month following the close of the calendar year in which the covered gift or covered bequest was received. The IRS will allow an automatic 6-month extension (total of 24 months) to file. The automatic 6-month extension is not an extension of time to pay the tax. Section 6651 applies for the penalty for the failure to file Form 708, or the failure to pay the §2801 tax.

IRS Recalculates the §2801 Tax and Provides Timely Notice

If there is a dispute related to the §2801 tax, taxpayers are advised to pay the additional amount of §2801 tax including interest and penalties, if any, on or before the due date specified in the letter (or other date agreed to by the IRS) and enter into a closing agreement after resolving the dispute.

Protective Filing of Form 708

A taxpayer who reasonably concludes that a gift or bequest is not subject to §2801 may file a protective Form 708 to start the period of limitations for the assessment of any §2801 tax. See §28.6011-1(b), which provides safe harbor procedures for filing a protective Form 708.

To obtain the safe harbor, the taxpayer must attach a copy of a completed Part III of Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, for all trust distributions, or Part IV of Form 3520 for all gifts and bequests.

Uncertainty with Respect to the Final Exit Tax Regulations

Regulatory Freeze

On January 20, 2025, the President of the United States issued an Executor Order freezing all United States Government agency regulations. The Executive Order requires the following:

  • No new proposed or final regulations.
  • Immediate withdrawal of any rules that have been sent to the OFR but not published in the Federal Register
  • Postponement of the effective date of regulations published in the Federal Register, or any rules that have been issued in any manner but have not taken effect.

Due to the timing of the final regulations for §2801, it is unknown whether these regulations will be withdrawn, delayed from implementation, and/or postponed until a later date. As of this writing, the regulations are final and carry the force of law. Taxpayers should monitor continuing developments related to this Executive Order.

Recommendations

Individuals who are classified as covered expatriates should take great care with the treatment of gifts and bequests to US citizen or resident individuals, including family members, either directly or indirectly through a US or foreign trust.

This blog post does not fully cover all of the aspects of US domestic trust treatment, detailed nuances to the §2801 tax, other exceptions to covered gifts and bequests, and related issues to the timely filing and payment of the §2801 tax.

Individuals who are considering expatriation and covered expatriates should consult with a qualified, experienced US tax practitioner on their specific facts and circumstances to truly understand the ramifications of the final §2801 regulations.

See Part 2 of this series on the Final Exit Tax Regulations for more information on recordkeeping requirements for covered expatriates and US recipients, as well as tax preparer liability for filing Form 708.

See Part 3 of this series for more information on changes to the Exit Tax Form 8854 and other miscellaneous Exit Tax updates.