§28.2801-5. Foreign trusts.
26 C.F.R. § 28.2801-5
In general. The section 2801 tax is imposed on a U.S. recipient who receives distributions, whether of income or principal, from a non-electing foreign trust to the extent the distributions are attributable to one or more covered gifts or covered bequests made to that foreign trust. See paragraph (d) of this section regarding a foreign trust's election to be treated as a domestic trust for purposes of section 2801.
Distribution defined. For purposes of determining whether a U.S. recipient has received a distribution from a non-electing foreign trust, the term distribution means any direct, indirect, or constructive transfer from a non-electing foreign trust, including a transfer to the extent made for less than full and adequate consideration in money or money's worth. Although section 643(i) of the Code does not apply for the purpose of defining a distribution under this section, certain loans from or uncompensated use of property held by a non-electing foreign trust nevertheless may satisfy the definition of a distribution under this paragraph if the loan or use of trust property would be a gift as defined for purposes of chapter 12 of subtitle B. For purposes of determining whether a U.S. recipient has received a distribution from a non-electing foreign trust, the term distribution also includes each distribution from a non-electing foreign trust pursuant to the exercise, release, or lapse (without regard to the exception in section 2041(b)(2) or 2514(e) of the Code) of a power of appointment, whether or not such power is a general power of appointment. In addition, the term distribution also includes the domestication of a foreign trust, and any sale, encumbering, monetization, or other disposition by the U.S. recipient of the recipient's interest in the trust to the extent of that disposition. See § 28.2801-4(a)(2)(iv). The determination of whether a U.S. recipient has received a distribution is made without regard to whether any portion of the non-electing foreign trust is treated as owned by the U.S. recipient or any other person under subpart E of part I, subchapter J, chapter 1 of the Code (pertaining to grantors and others treated as substantial owners), and without regard to whether the U.S. recipient of the transfer is designated as a beneficiary by the terms of the trust. A U.S. recipient receiving a distribution for purposes of this section must determine whether the information reporting requirements of section 6048(c) apply. See § 28.2801-6(c)(2).
Amount of distribution attributable to covered gift or covered bequest—
Section 2801 ratio—
In general. A foreign trust may have received covered gifts and covered bequests as well as contributions that were not covered gifts or covered bequests. Under such circumstances, the fair market value of the foreign trust at any time consists, in part, of a portion of the trust attributable to the covered gifts and covered bequests it has received (covered portion) and in part of a portion of the 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. For purposes of section 2801, the amount of each distribution from the foreign trust, whether made from the income or principal of the trust, that is considered attributable to the foreign trust's covered gifts and covered bequests is determined on a proportional basis, by reference to the section 2801 ratio (as described in paragraph (c)(1)(ii) of this section), and not by the identification or tracing of particular trust assets. Specifically, this portion of each distribution is determined by multiplying the distributed amount by the percentage of the trust that consists of its covered portion immediately prior to that distribution (section 2801 ratio). Thus, for example, the section 2801 ratio of a foreign trust whose assets are comprised exclusively of covered gifts or covered bequests and the income and appreciation thereon, would be one and the full amount of each distribution from that foreign trust to a U.S. citizen or resident would be attributable to the foreign trust's covered gifts and covered bequests and subject to the imposition of section 2801 tax. Because the non-electing foreign trust itself is not taxed on its receipt of covered gifts and covered bequests, the trust is not entitled to an annual exclusion pursuant to section 2801(c); that exclusion is available only in computing the section 2801 tax payable by the U.S. recipient filing a Form 708, United States Return of Tax for Gifts and Bequests Received from Covered Expatriates.
Computation. The section 2801 ratio, which must be redetermined after each contribution to the foreign trust, is computed by using the following fraction:
Effect of reported transfer and tax payment. With regard to the value of property on which a section 2801 tax has been timely paid, even though that property thereafter remains in a non-electing foreign trust, that value no longer is considered to be, or to be attributable to, a covered gift or covered bequest to that foreign trust for purposes of the computation described in paragraph (c)(1)(ii) of this section. For purposes of the prior sentence, a section 2801 tax is deemed to have been timely paid on amounts for which no section 2801 tax was due, provided those amounts were reported as a covered gift or covered bequest on a timely filed Form 708 or the total covered gifts and covered bequests received in a calendar year do not exceed the section 2801(c) amount. An amount for which no section 2801 tax was due refers to the amount of a covered gift or covered bequest received by an electing foreign trust not in excess of the section 2801(c) amount. See § 28.2801-5(e) (Example 4).
Inadequate information to calculate section 2801 ratio. A U.S. citizen or resident receiving a distribution from a non-electing foreign trust must proceed upon the assumption that the distribution is attributable to a covered gift or covered bequest to the extent the trustee of the foreign trust does not have sufficient books and records to calculate the section 2801 ratio or the taxpayer is unable to obtain the necessary information regarding the foreign trust to calculate the section 2801 ratio. The assumption is rebuttable to the extent the taxpayer can supply information sufficient to persuade the Internal Revenue Service (IRS) that the distribution is not entirely attributable to covered gifts and covered bequests.
Foreign trust treated as domestic trust—
Election required. To be considered an electing foreign trust, so that the foreign trust is treated as a domestic trust solely for purposes of the section 2801 tax, a valid election is required.
Effect of election— . (i) A valid election subjects the electing foreign trust to the section 2801 tax on all covered gifts and covered bequests received by the foreign trust during that calendar year, the portion of the trust attributable to covered gifts and covered bequests received by the trust in prior years, as determined in paragraph (d)(3)(iii) of this section, and all covered gifts and covered bequests received by the foreign trust during calendar years subsequent to the first year in which the election is effective, unless and until the election is terminated. To the extent that covered gifts and covered bequests are subject to the section 2801 tax under the prior sentence, those trust receipts are no longer treated as a covered gift or covered bequest for purposes of determining the portion of the trust attributable to covered gifts and covered bequests. Therefore, upon making a valid election, the foreign trust's section 2801 ratio described in paragraph (c)(1)(ii) of this section will be zero until the effective date of any termination of the election and the subsequent receipt of any covered gift or covered bequest, and a distribution made from the foreign trust while this election is in effect is not taxable under section 2801 to the U.S. recipient.
This election has no effect on any distribution from the foreign trust that was made to a U.S. recipient in a calendar year prior to the calendar year for which the election is made. Thus, even after a valid election is made, a distribution to a U.S. recipient in a calendar year prior to the calendar year for which the election is made that was attributable to one or more covered gifts or covered bequests continues to be a distribution attributable to one or more covered gifts or covered bequests and the section 2801 ratio in place at the time of the distribution continues to apply to that distribution. Furthermore, an election under this section does not relieve the U.S. recipient from the information reporting requirements of section 6048(c). See § 28.2801-6(c)(2).
Time and manner of making the election—
When to make the election. The election is made on a timely filed Form 708 for the calendar year for which the foreign trust seeks to subject itself to the section 2801 tax as described in paragraph (d)(2)(i) of this section. The election may be made for a calendar year whether or not the foreign trust received a covered gift or covered bequest during that calendar year. See § 28.6071-1.
Requirements for a valid election. To make a valid election to be treated as a domestic trust for purposes of section 2801, the foreign trust must timely file a Form 708 and must, on such form—
Make the election, timely pay the section 2801 tax, if any, as determined under paragraph (d)(3)(iii) of this section, and include a computation illustrating how the trustee of the foreign trust calculated both the section 2801 ratio described in paragraph (c)(1)(ii) of this section and the section 2801 tax;
Designate and authorize a U.S. agent as provided in paragraph (d)(3)(iv) of this section;
Agree to timely file Form 708 to report each covered gift and bequest made to the trust in accordance with § 28.2801-5(d)(4);
Identify the amount and year of all prior distributions attributable to covered gifts and covered bequests made to a U.S. recipient, and provide the name, address, and taxpayer identification number of each U.S. recipient;
Provide a copy of the governing instrument of the trust and provide the name, address, and taxpayer identification number of each permissible distributee described in paragraph (d)(3)(ii)(F) of this section; and
Affirm under penalties of perjury that each permissible distributee was notified that the trustee is making (or has made) the election, effective as of January 1 of the calendar year for which the Form 708 on which the election is made is filed. For this purpose, a permissible distributee is any U.S. citizen or resident who:
(1) Currently may or must receive distributions from the trust, whether of income or principal;
(2) May withdraw income or principal from the trust during that year or in a future year, regardless of whether the right arises or lapses upon the occurrence of a future event; and
(3) Would be described in either or both of paragraphs (d)(3)(ii)(F)(1) and (2) of this section upon an immediate termination of either the trust or the interest of any person described in either or both of paragraphs (d)(3)(ii)(F)(1) and (2) of this section.
Section 2801 tax payable with the election. To make a valid election to be treated as a domestic trust for purposes of section 2801, the electing foreign trust must timely pay the section 2801 tax on all covered gifts and covered bequests received by the electing foreign trust in the calendar year for which the Form 708 is being filed. In some cases, an electing foreign trust may have received covered gifts or covered bequests in prior calendar years during which no such election was in effect. In those cases, the trustee must also, at the same time, report and pay the tax on the fair market value, determined as of the last day of the calendar year immediately preceding the year for which the Form 708 is being filed, of the portion of the trust attributable to covered gifts and covered bequests received by such trust in prior calendar years (except as provided in paragraph (d)(6)(iii) of this section with regard to an imperfect election). That portion is determined by multiplying the fair market value of the trust, as of the December 31 immediately preceding the year for which the election is made, by the section 2801 ratio in effect on that date, as calculated under paragraph (c)(1)(ii) of this section. The trustee must proceed upon the assumption that the corpus and undistributed income are attributable to covered gifts and covered bequests to the extent the trustee does not have sufficient books and records to determine what amount of the corpus and undistributed income is attributable to prior covered gifts and covered bequests. The assumption is rebuttable by the taxpayer's furnishing information sufficient to persuade the IRS that corpus and undistributed income is not attributable to prior covered gifts or covered bequests. See paragraph (c)(3) of this section.
Designation of U.S. agent—
In general. The trustee of an electing foreign trust must designate and authorize a U.S. person, as defined in section 7701(a)(30) of the Code, to act as an agent for the trust for purposes of section 2801. The designation and authorization are made on a duly filed Form 2848, Power of Attorney and Declaration of Representative, or as may be directed otherwise in IRS forms or publications. By designating a U.S. agent, the trustee of the trust agrees to provide the agent with all information necessary to comply with any information request or summons issued by the Secretary of the Treasury or her delegate (Secretary) that is relevant to the collection or determination of tax under section 2801. Such information may include, without limitation, copies of the books and records of the trust, financial statements, and appraisals of trust property.
Role of designated agent. Acting as an agent for an electing foreign trust for purposes of section 2801 includes serving as the trust's agent for purposes of section 7602 of the Code (Examination of books and witnesses), section 7603 of the Code (Service of summons), and section 7604 of the Code (Enforcement of summons) with respect to—
(1) Any request by the Secretary to examine records or produce testimony related to the proper identification or treatment of covered gifts or covered bequests contributed to the foreign trust and distributions of such contributions and the income therefrom; and
(2) Any summons by the Secretary for records or testimony related to the proper identification or treatment of covered gifts or covered bequests contributed to the foreign trust and distributions of such contributions and the income therefrom.
Effect of appointment of agent. An electing foreign trust that appoints such an agent is not considered to have an office or a permanent establishment in the United States, or to be engaged in a trade or business in the United States, solely because of the agent's activities as an agent pursuant to this section.
Filing requirement. The trustee of an electing foreign trust must timely file a Form 708 to report and pay the section 2801 tax on all covered gifts and covered bequests received by the trust during the calendar year. See § 28.6071-1. Nevertheless, the trustee of an electing foreign trust is not required to file Form 708 for a calendar year in which either the trust received no covered gifts or covered bequests, or the total fair market value of all covered gifts and covered bequests received by the electing foreign trust during that calendar year is less than or equal to the section 2801(c) amount.
Duration of status as electing foreign trust—
In general. A valid election (one that meets all of the requirements of paragraph (d)(3) of this section) is effective as of January 1 of the calendar year for which the Form 708 on which the election is made is filed. The election, once made, applies for all calendar years until the election is terminated as described in paragraph (d)(5)(ii) of this section.
Termination—
Manner of termination. An election to be treated as a domestic trust for purposes of section 2801 is terminated by—
(1) A failure of the foreign trust to timely file a required Form 708 and timely pay the section 2801 tax, as required by paragraph (d)(4) of this section;
(2) A failure of the foreign trust to enter into a closing agreement and to timely pay any additional amount of section 2801 tax (in accordance with the requirements of paragraph (d)(6)(i) of this section) with respect to recalculations described in paragraph (d)(6) of this section (a termination that also results in the conversion of the trust's election to an imperfect election); or
(3) An affirmative revocation of the election made in accordance with the instructions for Form 708.
Effective date of termination. The effective date of the termination of an election to be treated as a domestic trust for purposes of section 2801 is as follows:
(1) For a termination described in paragraph (d)(5)(ii)(A)(1) of this section, the termination is effective as of the first day of the calendar year for which the Form 708 was required under paragraph (d)(4) of this section.
(2) For a termination described in paragraph (d)(5)(ii)(A)(2) of this section, the termination is effective as of the first day of the calendar year for which the Form 708 was filed with respect to which the additional amount of section 2801 tax is claimed to be due by the IRS.
(3) For a termination described in paragraph (d)(5)(ii)(A)(3) of this section, the termination is effective as of the first day of the calendar year for which a Form 708 was filed to affirmatively revoke the election.
Notice requirements upon termination. In the case of a termination of the election, the trustee should notify promptly each permissible distributee of the trust, as defined in paragraph (d)(3)(ii)(F) of this section and determined as of the effective date of the termination of the election, that the foreign trust's election was terminated (or terminated and converted to an imperfect election) and the effective date of the termination, and that each U.S. recipient of a distribution made from the foreign trust on or after the effective date of that termination is subject to the section 2801 tax on the portion of each such distribution that is attributable to covered gifts and covered bequests. See paragraph (d)(6)(iii)(B) of this section for an additional notification requirement in the case of an imperfect election.
Subsequent elections. If a foreign trust's election is terminated under paragraph (d)(5)(ii) of this section, the foreign trust is not prohibited from making another election in a future year, subject to the requirements of paragraph (d)(3) of this section.
Dispute as to amount of section 2801 tax owed by electing foreign trust—
Procedure. If the IRS disputes the value of a covered gift or covered bequest, or otherwise challenges the computation of the section 2801 tax, that is reported on the electing foreign trust's timely filed Form 708 for any calendar year, the IRS will issue a letter (but not a notice of deficiency as defined in section 6212 of the Code) to the trustee of the trust and the appointed U.S. agent that details the disputed information and the proper amount of section 2801 tax as recalculated. The trustee of the foreign trust must pay the additional amount of section 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 with the IRS as described in section 7121 to maintain its election.
Effect of compliance. If the trustee of the foreign trust complies with the requirements of paragraph (d)(6)(i) of this section, then the foreign trust's election to be treated as a domestic trust under paragraph (d) of this section remains in effect. In the absence of fraud, malfeasance, or misrepresentation of a material fact, any value determined in the closing agreement will be deemed to be final and binding on both the IRS and the foreign trust. Subsequently, the IRS will not challenge the amount of section 2801 tax due from either the foreign trust or any of its distributees who are U.S. citizens or residents for the year for which that Form 708 was filed by the foreign trust, except with respect to any covered gifts or covered bequests not reported on that return. In addition, neither the foreign trust nor any of its distributees will be able to file a claim for refund with respect to section 2801 tax paid by the foreign trust on the covered gifts and covered bequests reported on that Form 708.
Effect of failing to comply (imperfect election— )—(A) In general. If the foreign trust fails to enter into the closing agreement and to timely pay any of the additional amount of section 2801 tax (with interest and penalties, if any) determined to be due by the IRS in accordance with the procedure in paragraph (d)(6)(i) of this section, then the foreign trust's valid election is terminated and is converted to an imperfect election. The conversion to an imperfect election is retroactive to the first day of the calendar year (subject year) for which the Form 708 was filed with respect to which the additional amount of section 2801 tax is claimed to be due by the IRS. The trust will be a non-electing foreign trust for the subject year and for each subsequent year until another valid election (if any) is made by the trust. However, the value the foreign trust reported on the Form 708 for the subject year and each other year during the interim period described in paragraph (d)(6)(iii)(D) of this section, and on which the trust paid the section 2801 tax, is no longer considered to be attributable to covered gifts or covered bequests when computing the section 2801 ratio (described in paragraph (c)(1)(ii) of this section) that will be applicable to distributions made by the foreign trust to U.S. recipients during the subject year and thereafter until the effective date of any subsequent election meeting the requirements of paragraph (d)(3) of this section. The U.S. recipients of distributions from the foreign trust, however, should take into consideration the additional value determined by the IRS, on which the foreign trust did not timely pay the section 2801 tax, when computing the section 2801 ratio to be applied to a distribution from the trust. See paragraph (c) of this section. Any disagreement with regard to that additional value will be an issue to be resolved as part of the review of that U.S. recipient's own Form 708 reporting a distribution.
Notice to permissible distributees. If the trustee of the foreign trust fails to enter into the closing agreement and to remit, by the due date specified or otherwise agreed to by the IRS, the additional section 2801 tax, including all interest and penalties, in accordance with the procedure in paragraph (d)(6)(i) of this section, the trustee should notify promptly each permissible distributee, as defined in paragraph (d)(3)(ii)(F) of this section:
(1) That the foreign trust's election was terminated and the effective date of the termination (see paragraph (d)(5)(ii)(B)(2) of this section);
(2) Of the amount of additional value on which the foreign trust did not timely pay the section 2801 tax as determined or otherwise agreed to by the IRS, which value the IRS thus deems to be attributable to covered gifts and covered bequests; and
(3) That each U.S. recipient of a distribution made from the foreign trust on or after that termination date is subject to the section 2801 tax on the portion of each such distribution attributable to covered gifts and covered bequests.
Reasonable cause. If a U.S. recipient received a distribution from the foreign trust on or after January 1 of the year for which the election was terminated and the election became an imperfect election, provided the U.S. recipient files a Form 708 and pays the section 2801 tax within a reasonable period of time after being notified by the trustee of the foreign trust or otherwise becoming aware that a valid election was not in effect when the distribution was made, the U.S. recipient's failure to timely file and pay are due to reasonable cause and not willful neglect for purposes of section 6651. For this purpose, a reasonable period of time is not more than six months after the U.S. recipient is notified by the trustee or otherwise becomes aware that a valid election is not in effect.
Interim period. If a foreign trust's valid election is terminated and becomes an imperfect election, there is a period of time (interim period) that begins on the effective date of the termination of the election (see paragraph (d)(5)(ii)(B) of this section) during which both the foreign trust and its U.S. beneficiaries are likely to continue to comply with section 2801 as it applies to an electing foreign trust with a valid election in place. The interim period ends on the earlier of December 31 of the calendar year during which the additional amount of section 2801 tax was due to be paid, as described in paragraph (d)(6)(i) of this section, or the effective date of a subsequent valid election to be treated as a domestic trust for purposes of section 2801. As described in paragraph (d)(6)(iii)(A) of this section regarding imperfect elections, the value of the covered gifts and covered bequests received by the foreign trust during this interim period, which the foreign trust has reported on one or more filed Forms 708 and on which the foreign trust has paid the section 2801 tax, is no longer considered to be attributable to covered gifts and covered bequests for purposes of computing the section 2801 ratio described in paragraph (c)(1)(ii) of this section as it applies to distributions made by non-electing foreign trusts to their U.S. beneficiaries. In addition, each distribution made by the foreign trust to a U.S. citizen or resident during this interim period must be reported on that U.S. recipient's Form 708 by applying the section 2801 ratio to that distribution. If, once the interim period has ended, the foreign trust has no election in place, the rules of section 2801(e)(4)(B)(i) will apply until the foreign trust subsequently (if ever) makes another valid election to be treated as a domestic trust for purposes of section 2801.
No overpayment caused solely by virtue of defect in election. Any remittance of section 2801 tax made by an electing foreign trust does not become an overpayment solely by virtue of a defect in the election. Instead, if at some subsequent time the IRS determines that the election was not in fact a valid election, then the election shall be considered valid only with respect to the value of the covered gifts or covered bequests on which the section 2801 tax was paid by the foreign trust and such value on which the section 2801 tax has been paid is no longer treated as attributable to a covered gift or covered bequest for purposes of determining the portion of the foreign trust attributable to covered gifts and covered bequests. See paragraphs (d)(2)(i) and (6)(iii) of this section.
Examples. The provisions of this section are illustrated by the following examples.
Example 1: Computation of section 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 section 2801. The section 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 section 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 U.S. recipient is subject to the section 2801 tax until the next contribution is made to the trust. If the trustee distributes $40,000 to C, a U.S. citizen, before the trust receives any other contributions, then $20,000 ($40,000 × 0.5) is a covered gift to C.
Example 2: Distribution to spouse. In Year 1, A contributes $300,000 to a foreign trust. A is a covered expatriate. B, A's U.S. citizen spouse, and A's issue may receive discretionary distributions of income and principal. The transfer would not have qualified for the gift tax marital deduction if A had been a U.S. citizen or resident at the time of the gift; therefore, A's contribution is a covered gift. See sections 2801(e)(3) and 2523. No one pays foreign gift taxes on A's contribution. The trustee of the trust does not make a valid election to have the trust treated as a domestic trust for purposes of section 2801. The section 2801 ratio immediately after A's contribution is one. The highest gift tax rate is 40 percent, and the section 2801(c) amount is $17,000. The trustee distributes $200,000 to B in Year 1. The entire amount is a covered gift to B. See section 28.2801-3(c)(5). This is the only covered gift B receives in Year 1. B receives no covered bequests in Year 1. B's section 2801 tax for Year 1 is computed by multiplying B's net covered gift by 40 percent. B's net covered gift for Year 1 is $183,000, which is determined by reducing B's covered gift received during Year 1 by the section 2801(c) amount. B's section 2801 tax liability for Year 1 is $73,200 ($183,000 × 0.4).
Example 3: Computation of section 2801 ratio when multiple contributions are made to foreign trust.
In 2005, A, a U.S. citizen, established and funded an irrevocable foreign trust with $200,000. On January 1 of each of the following three years (2006 through 2008), A contributed an additional $100,000 to the foreign trust. A reported A's contributions to the foreign trust as completed gifts on timely filed Forms 709, for calendar years 2005 through 2008. None of these contributions is a covered gift because the gifts predated the effective date of section 2801. On August 8, 2008, a date after the effective date of section 2801 (June 17, 2008), A expatriated and became a covered expatriate. On January 1 of a year after 2008 (Year X), A makes an additional $100,000 contribution to the trust. The aggregate $600,000 contributed to the trust by A, both before and after expatriation, are the only contributions to the trust. The trustee of the foreign trust does not make a valid election to have the trust treated as a domestic trust for purposes of section 2801. Each year, the trustee of the foreign trust provides beneficiary B, a U.S. citizen, with an accounting of the trust showing each receipt and disbursement of the trust during that year, including the date and amount of each contribution by A.
The fair market value of the trust was $610,000 immediately prior to A's contribution to the trust on January 1, Year X. Therefore, upon the Year X contribution of A's first and only covered gift, the portion of the trust attributable to covered gifts and covered bequests (covered portion) changed from zero to 0.14 (([section 2801 ratio of 0 × $610,000 fair market value pre-contribution) plus the $100,000 covered gift]/$710,000 fair market value post-contribution). See paragraph (c) of this section.
In February of Year X, B received a distribution of $225,000 from the foreign trust. Although A contributed a total of $600,000 to the foreign trust, only $100,000 of that total was a covered gift, being the only contribution made by A both after the enactment of section 2801 and after A's expatriation. Under paragraph (c) of this section, the portion of the $225,000 distribution from the foreign trust attributable to a covered gift is $31,500 ($225,000 × 0.14 (section 2801 ratio)) because the distribution is made proportionally from the covered and non-covered portions of the trust. See paragraph (c)(1) of this section. Accordingly, B received a covered gift of $31,500.
Pursuant to the terms of the foreign trust, the trust made a terminating distribution on August 5, Year X, when B turned 35, and B received the balance of the appreciated trust, $505,000. The portion of this distribution attributable to covered gifts and covered bequests is $70,700 ($505,000 × 0.14). Therefore, B has received covered gifts from the foreign trust during Year X in the total amount of $102,200 ($31,500 + $70,700).
Example 4: Termination of election.
In Year 1, A contributes $200,000 and B contributes $100,000 to Trust, a foreign trust. A and B are covered expatriates. A's and B's contributions are covered gifts. No one pays foreign gift taxes on A's and B's contributions. The trustee of Trust makes a valid election to have Trust treated as a domestic trust for purposes of section 2801. The highest gift tax rate is 40 percent, and the section 2801(c) amount is $17,000. The section 2801 tax for Year 1 is computed by multiplying the net covered gifts and covered bequests by 40 percent. The net covered gifts and covered bequests for Year 1 total $283,000, determined by reducing the covered gifts and covered bequests received by Trust during Year 1, $300,000, by the section 2801(c) amount, $17,000. Trust's 2801 tax liability for Year 1 is $113,200 ($283,000 × 0.4). Any distributions made to U.S. recipients before the trust receives another contribution have a section 2801 ratio of zero and are not subject to the section 2801 tax. See paragraph (d)(2)(i) of this section.
In Year 2, A contributes $100,000 to Trust, all of which is a covered gift. The trustee of Trust fails to timely file a Form 708 for Year 2 and timely pay the section 2801 tax. The fair market value of Trust was $400,000 immediately prior to A's contribution. The section 2801 ratio immediately after A's contribution is 0.20, computed as follows: the pre-contribution value of Trust ($400,000) multiplied by the section 2801 ratio in effect immediately prior to the Year 2 contribution (0), plus the fair market value of the Year 2 contribution that constitutes a covered gift ($100,000), divided by the fair market value of Trust after the Year 2 contribution ($500,000). See paragraph (c)(1) and (2) of this section. If the trustee distributes $40,000 to C, a U.S. citizen, after the contribution in Year 2, then $8,000 ($40,000 × 0.20) is a covered gift to C. In Year 2, C also receives a covered gift of $50,000 directly from B. No one pays foreign gift taxes on B's covered gift. C receives no covered bequests in Year 2. C's section 2801 tax for Year 2 is computed by multiplying C's net covered gifts and covered bequests by 40 percent. C's net covered gifts and covered bequests for Year 2 total $41,000, determined by reducing the covered gifts and covered bequests received by C during Year 2, $58,000 ($8,000 + $50,000), by the section 2801(c) amount, $17,000. C's section 2801 tax liability for Year 2 is $16,400 ($41,000 × 0.4).
Example 5: Imperfect election of foreign trust.
In Year 1, CE, a covered expatriate, gives a 20 percent limited partnership interest in a closely held business to a foreign trust created for the benefit of CE's child, A, who is a U.S. citizen. The limited partnership interest is a covered gift. The trustee of the foreign trust makes a valid election to have the trust treated as a domestic trust for purposes of section 2801, trustee timely files a Form 708, reports the fair market value of the covered gift as $500,000, and timely pays the section 2801 tax on the reported fair market value of the covered gift. Later in Year 1, the trust makes a $100,000 distribution to A.
In Year 2, CE contributes $200,000 in cash to the foreign trust. The cash is a covered gift. The trustee of the foreign trust timely files a Form 708 reporting the transfer and pays the section 2801 tax. The trust does not make a distribution to any beneficiary during Year 2. In Year 3, the IRS disputes the reported value of the partnership interest transferred in Year 1 and determines that the proper valuation on the date of the gift was $800,000. In Year 3, the IRS issues a letter to the trustee of the foreign trust detailing its finding of the increased valuation and of the resulting additional section 2801 tax including accrued interest, if any, due on or before a later date in Year 3 specified in the letter. The foreign trust fails to pay the additional section 2801 tax liability on or before that due date.
Under paragraph (d)(6)(iii) of this section, the foreign trust's election for Year 1 is terminated and converted into an imperfect election as of January 1 of Year 1. In computing the foreign trust's section 2801 ratio for Year 1, the $500,000 of value on which the section 2801 tax was timely paid is no longer considered to be attributable to a covered gift. See paragraph (d)(6)(iii) of this section. When the trustee advises A of the letter from the IRS, A must file a late Form 708 reporting the portion of the Year 1 distribution attributable to covered gifts and covered bequests. Although A may owe section 2801 tax and interest, A will not owe any penalties under section 6651 as long as A files the Form 708 and pays the tax within six months after A receives notice of the termination of the election from the trustee of the foreign trust or otherwise becomes aware of the termination of the election. See paragraph (d)(6)(iii)(C) of this section.
When A files a Form 708 to report the Year 1 distribution, the IRS will verify whether A treated the $300,000 undervaluation claimed by the IRS as a covered gift in computing the section 2801 ratio. As with any other item reported on that return, A has the burden to prove the value of the covered gift to the foreign trust, and the IRS may challenge that value. If A treats the $300,000 as a covered gift to the trust, under paragraph (c)(1)(ii) of this section, the section 2801 ratio after the Year 1 contribution is 0.375 ($0 + ($300,000)/$800,000)). Thus, 37.5 percent of all distributions made to A from the foreign trust during Year 1 are subject to the section 2801 tax (plus interest from the due date of the tax as if reported on a Form 708 that was timely filed as to Year 1).
Although the foreign trust timely filed the Form 708 for Year 2 and timely paid the section 2801 tax shown on that return, and although the foreign trust's election had not yet been terminated and converted into an imperfect election during Year 2, the foreign trust nevertheless did not have a valid election for Year 2 because the trust did not timely pay the section 2801 tax on all covered gifts and covered bequests received in prior years as required in paragraph (d)(3) of this section, specifically, the tax on the additional $300,000 of value of the Year 1 transfer. However, under paragraph (d)(6)(iii)(D) of this section, because the foreign trust timely filed the Form 708 and paid the section 2801 tax on the Year 2 covered gift of $200,000, the $200,000 amount is no longer considered a covered gift for purposes of computing the section 2801 ratio after that contribution.
Example 6: Subsequent election after termination of election. The facts are the same as in paragraph (e)(5) of this section (Example 5). In Year 3, the foreign trust does not receive a covered gift or covered bequest. However, the trustee decides that making another election to be treated as a domestic trust would be in the best interests of the trust's beneficiaries. Accordingly, by the due date for the Form 708 for Year 3, the trustee timely files the return and pays the section 2801 tax on the portion of the trust attributable to covered gifts and covered bequests. See paragraph (d)(5)(iii) of this section. The trustee calculates the portion of the trust attributable to covered gifts and covered bequests received by the trust in prior calendar years by multiplying the fair market value of the trust on December 31, Year 2, by the section 2801 ratio in effect on that date. See paragraph (d)(3)(iii) of this section. The foreign trust is an electing foreign trust in Year 3.
Applicability date. This section applies to covered gifts or covered bequests received on or after January 1, 2025.
Notes, amendments, and revision history
Source
Source: 90 FR 3395, Jan. 14, 2025, unless otherwise noted.
Authority
Authority: 26 U.S.C. 7805. Section 28.2801-0 through 28.2801-7 also issued under 26 U.S.C. 2801. Section 28.6001-1 also issued under 26 U.S.C. 6001. Section 28.6011(a)-1 also issued under 26 U.S.C. 6011 and 6011(a). Section 28.6060-1 also issued under 26 U.S.C. 6060 and 6060(a). Section 28.6071(a)-1 also issued under 26 U.S.C. 6071 and 6071(a). Section 28.6081-1 also issued under 26 U.S.C. 6081 and 6081(a). Section 28.6091-1 also issued under 26 U.S.C. 6091 and 6091(a). Section 28.6101-1 also issued under 26 U.S.C. 6101. Section 28.6107-1 also issued under 26 U.S.C. 6107 and 6107(c). Section 28.6109-1 also issued under 26 U.S.C. 6109 and 6109(a). Section 28.6151-1 also issued under 26 U.S.C. 6151. Section 28.6694-1 through 28.6694-4 also issued under 26 U.S.C. 6694. Section 28.6695-1 also issued under 26 U.S.C. 6695. Section 28.6696-1 also issued under 26 U.S.C. 6696 and 6696(c). Section 28.7701-1 also issued under 26 U.S.C. 7701.