The Herculean Labors of IRS 2801 Compliance: An Overview of the New Inheritance Tax Regulations

Internal Revenue Code Section 2801 was introduced into U.S. tax law in 2008, creating a U.S.-based inheritance tax, otherwise known as the “§2801 tax.” In January 2025, final regulations were issued implementing the §2801 tax, and in May the Internal Revenue Service (IRS) finally posted a draft of Form 708 on their website. The time has come for accounting professionals to become familiar with the §2801 tax as potentially applicable to clients who are U.S. citizens, U.S. estate and gift tax domiciliaries, and trustees of domestic trusts (U.S. Beneficiaries). 

What is the Applicable Rule?

The §2801 tax imposes a tax on a U.S. Beneficiary who receives a “covered gift or bequest” from a “covered expatriate” at the highest estate or gift tax rate in effect at the time of the transfer (40% in 2025). A “covered gift or bequest” means: (i) any property acquired by gift directly or indirectly from an individual who, at the time of such acquisition, is a covered expatriate; and (ii) any property acquired directly or indirectly by reason of the death of an individual who, immediately before such death, was a covered expatriate. A “covered expatriate” means a U.S. citizen or long-term permanent resident who renounces citizenship or relinquishes a “Green Card” (held for eight of the last 15 years) on or after June 17, 2008, for tax-avoidance purposes. The three objective tests to determine the existence of a tax-avoidance purpose are: (1) having a net worth equal to or exceeding $2,000,000; (2) having an average tax liability for the five taxable years ending before the expatriation date that exceeds $206,000 (the 2025 inflation adjusted number); and (3) having failed to certify compliance with the U.S. tax law for the five preceding taxable years or otherwise failing to submit evidence of such compliance as may be required.

How Does the §2801 Tax Apply to Annual Exclusion Gifts?

The §2801 tax applies to the total value of covered gifts and bequests received by an individual during the calendar year less the annual gift-tax exclusion amount in effect for such calendar year ($19,000 in 2025), regardless of the number of covered expatriates making covered gifts and bequests to such individual in that year. For example, if a covered expatriate father and mother each gifted $50,000 to their U.S. citizen daughter in 2025, the result would be that $81,000 is subject to the §2801 tax.

Finally, a foreign tax credit may be available to reduce the §2801 Tax, subject to certain limitations. 

How Does §2801 Apply to Distributions from Trusts Settled by a Covered Expatriate to U.S. Beneficiaries?

1. Distributions from Foreign Trusts

The distribution to a U.S. Beneficiary from a foreign trust (FT) established by a covered expatriate is treated as a covered gift or bequest. The U.S. Beneficiary is responsible for paying the §2801 tax in the calendar year of the distribution. The amount of the distribution attributable to a covered gift or bequest is determined by multiplying the distribution by a ratio (the §2801 ratio”) that is redetermined after each contribution to the FT. The §2801 ratio effectively tracks the percentage of contributions from covered expatriates to the FT in relation to the entire amount of contributions to the FT. 

The Final Regulations clarify that if the trustee of the FT does not have sufficient books and records to calculate the §2801 ratio, and if the U.S. Beneficiary is unable to obtain the necessary information with regard to the FT, the U.S. Beneficiary must proceed upon the assumption that the entire distribution is attributable to a covered gift or bequest. Additionally, the final regulations clarify that the presumption that a distribution is attributable to a covered gift or bequest is rebuttable, but they do not contain a detailed list of the types of information that may be used to rebut this presumption.

2. Distributions from Domestic Trusts

If a covered expatriate contributes assets to a domestic trust (“DT”), the DT is liable for payment of the §2801 tax in the calendar year in which the contribution is made. In turn, a U.S. Beneficiary who receives a distribution from that DT will not be subject to the §2801 tax. 

The final regulations provide an option for a FT to elect to be treated as a DT for §2801 tax purposes. If such an election is made, the electing trust becomes responsible for paying the §2801 tax, thereby shifting the tax burden away from the U.S. Beneficiary.

3. Income Tax Coordination with Distributions from Trusts

Because a distribution from a trust may carry out income to the U.S. Beneficiary, it is important to note that the Beneficiary is allowed to deduct the §2801 tax paid in a given year from their gross income for that year. Notably, the distribution of accumulated income, known more formally as Undistributed Net Income, from an FT to a U.S. Beneficiary is subject to the §2801 tax, and the full amount of the §2801 tax attributable to such a distribution is not deductible against the “throwback tax” described in Code §§665-668 under the final regulations. As a result, the application of the §2801 tax and the “throwback tax” rules could apply simultaneously, making it possible that the tax in this situation could exceed 100% of the distribution.    

What Are a U.S. Beneficiary’s Compliance Obligations Related to the §2801 Tax?

U.S. Beneficiaries who receive a covered gift or bequest must timely file Form 708. The final regulations indicate that the due date for Form 708, when finalized, is on or before the 15th day of the 18th calendar month following the close of the calendar year in which the covered gift or covered bequest was received. A U.S. Beneficiary is not required to file Form 708 when the total fair market value of all covered gifts and bequests received by that person during a calendar year is less than or equal to the annual gift-tax exclusion amount in effect for such calendar year. Further, the final regulations state that an automatic six-month extension to file Form 708 will be available to taxpayers who elect an extension on the appropriate form, though it’s unclear what form will be used for such a request.

The final regulations also clarify that the §2801 tax will not apply to gifts or bequests received by a U.S. Beneficiary prior to June 17, 2008.

In addition, the final regulations indicate that, when issued, the due date for Form 708 of a FT that made an election to be treated as a DT is the 15th day of the sixth month of the calendar year following the close of the calendar year in which the FT becomes a DT. 

If a taxpayer fails to file Form 708 or pay the §2801 tax, various penalties may be applicable and can become substantial. Notably, a U.S. Beneficiary may request an extension for time to file, but not for time to pay the §2801 tax.

How Does a U.S. Beneficiary Know They Received a Covered Gift or Bequest?

The final regulations place the burden of determining whether the transferor is a covered expatriate, and whether the transfer is a covered gift or covered bequest, on the U.S. Beneficiary.  In limited circumstances, which have yet to be defined, the IRS will disclose to a U.S. Beneficiary whether the donor or decedent was a covered expatriate and whether the transfer was a covered gift or covered bequest. The final regulations contemplate creating a procedure by which an expatriate can authorize the disclosure of certain information – presumably the release of a filed Form 8854 – relevant to determining the applicability of the §2801 tax by the IRS to U.S. Beneficiaries and a corresponding procedure for requesting such information. 

The final regulations create a rebuttable presumption that a donor expatriate is a covered expatriate and that a gift is a covered gift unless a living donor expatriate authorizes the disclosure of the donor expatriate’s relevant return or return information to the U.S. Beneficiary of any gift (which would presumably be obtained through the yet to-be-determined procedure). To the extent that such presumption applies, and information cannot be obtained from the IRS, a U.S. Beneficiary must then undertake a herculean task to prove to the IRS whether a gift does not include assets transferred by a covered expatriate. Although one might think that a copy of the expatriate donor’s Form 8854 and proof of filing might suffice, the final regulations do not clearly advise what is sufficient to prove that the expatriate donor was not a covered expatriate. (At least Hercules could tell that the Augean stables were clean after he diverted the rivers). 
Note that the final regulations do allow a taxpayer who receives a gift or bequest and concludes that such gift or bequest is not a covered gift or covered bequest to file a protective Form 708. The act of filing a protective Form 708 will commence the running of the period of limitations for assessment of tax if the protective return includes all of the information otherwise required on Form 708, along with an affidavit signed under penalty of perjury, setting forth the information on which the U.S. Beneficiary relied in concluding that the donor or decedent was not a covered expatriate or that the transfer to a trust was not a covered gift or covered bequest. The U.S. Beneficiary taxpayer must also attach a copy of the completed Part III of IRS Form 3520 for all trust distributions, or Part IV of Form 3520 for all gifts and bequests when applicable. 

Given the parameters outlined above, and unless reliable information is obtained from the IRS, it’s at least worth considering whether to file a protective Form 708 with respect to every gift or bequest received from a foreign donor in order to start the clock on the statute of limitations.

Key Takeaways 

Accounting professionals should assist clients in creating additional due diligence items for the trusts clients manage. For example, a trustee of an FT will have to track and compute the §2801 ratio and provide U.S. Beneficiaries with the ratio upon making distributions so that the beneficiaries can determine the §2801 tax liability. By contrast, when assisting trustees of a DT, accounting professionals will need to be cognizant of Form 708 and the deadlines for filing and paying the tax. Either way, trustee clients need to provide information regarding whether or not the settlor of a trust or any other party otherwise contributing property to a trust is a covered expatriate. 

Accounting professionals will likewise need to inquire as to whether their clients who are recipients of gifts or bequests received such gifts from individuals they know are covered expatriates for purposes of timely filing Form 708 (and applicable Form 3520). For those clients who are recipients of gifts or bequests from individuals they are not aware are covered expatriates, or who receive distributions from a trust that they are not aware was funded by a covered expatriate, tax preparers should determine whether they should file Form 708 (or a protective Form 708) for such a gift, bequest or distribution from that trust. With a due date that is 18 months following the end of the tax year of the gift (with an additional six-month extension being available), accounting professionals should – hopefully – have enough time to either obtain records from the IRS or otherwise help a U.S. Beneficiary obtain enough information to overcome any potential rebuttable presumption. 

Accounting professionals should also note the importance of understanding the interaction of the §2801 tax with the “accumulation throwback tax” rules. As noted above, the ability of a U.S. Beneficiary to deduct the §2801 tax attributable to an accumulation distribution is limited under the final regulations. As noted above and stressed again here, the aggregate amount of the §2801 Tax and the “throwback tax” could exceed the amount of the distribution.  

Finally, if you have assisted clients in expatriating after 2008, consider how to assist those clients with maintaining records, so that their beneficiaries have access to information relating to whether or not they are covered expatriates.

*This was republished with permission from the Florida CPA Today Magazine. Click to access the publication.