Written by Salem Desir
The One Big Beautiful Bill Act (OBBBA) introduced many favorable or unfavorable changes. The determination of favorability, of course, depends on who you ask. If I were to inherit $15 million from my mother’s estate, I would determine the OBBBA’s changes to be quite favorable. The OBBBA allows for a $15 million exemption on domestic wealth transfer. However, if my mother was a covered expatriate at the time of the transfer, I wouldn’t care at all about this OBBBA exemption. Pursuant to Internal Revenue Code (IRC) §2801, effective January 2025, a 40% tax is now imposed on U.S. recipients of gifts or bequests from covered expatriates. Many advisors don’t know this exists but should.
The Cross-Border Oversight
If my mother relinquished her U.S. citizenship or ceased to be a lawful permanent resident after June 16, 2008, and she either:
A. Had an average annual net income liability of more than $206,000 for the 5 tax years ending before she expatriated, or
B. Had a net worth of $2 million or more on the date of her expatriation, or
C. Failed to certify on Form 8854 that she complied with all federal tax obligations for the 5 tax years preceding the date of her expatriation,
she would be a covered expatriate as defined by the IRC.
As a covered expatriate, the bequests of $15 million I received from my mother’s estate may be subject to the §2801 tax because I am a U.S. citizen or resident. As the recipient of such bequests, I would be responsible for paying the tax unless some exemption or exclusion exists. If the $15 million bequest was:
A. Reported by my mother on a timely filed U.S. gift tax return as a taxable gift, or
B. Included in my mother’s gross estate and shown on a timely filed U.S. estate tax return, or
C. If I was her spouse or a charity. (Clearly this exception would not apply in this scenario, however, it is noted for completeness.)
Currently, the annual exclusion amount is $19,000. Here, my tax liability on the $15 million bequest would be $5.99 million (40% of $15 million minus $19,000).
High-net-worth clients who expatriated in the 2017 Tax Cuts and Jobs Act (TCJA) era are now making transfers to U.S. family members. Advisors must not overlook the separate §2801 tax sitting on top of the $15 million exemption while running estate projections.
The Foreign Trusts Reporting Trap
Now, if my mother’s estate transferred the $15 million into a foreign trust with me as the beneficiary, there are more rules to consider.
– Forms 3520 & 3520-A: If my mother was not an expatriate, the executor of her estate would need to file Form 3520 because she created or transferred money/property to a foreign trust or otherwise was the party responsible for a reportable event. Furthermore, the filing would be necessary because she would’ve been treated as an owner of the foreign trust. Form 3520 failures tied to transfers to a foreign trust or distributions from a foreign trust generally trigger a penalty equal to the greater of $10,000 or 35% of the gross reportable amount.
On the other hand, if I happened to be an owner of the trust as well as a beneficiary, I would be responsible for the filing of form 3520-A. More specifically, I would be responsible for ensuring that the trust files the 3520-A and furnishes the required owner and beneficiary statements. In the event that this is not accomplished, I would need to file a substitute Form 3520-A by attaching it to my 3520 to avoid the penalty for the trust’s failure to file.
Though, before any of that, me or the trustee to my mother’s estate would need to determine whether the trust would be considered a foreign trust under U.S. tax law. Every trust is foreign unless it is a U.S. person. Under the Court Test, if a U.S. court is able to exercise primary supervision over the trust’s administration, it would be considered a foreign trust. Under the Control Test, if one or more U.S. persons have the authority to control all substantive decisions of the trust, it would be considered a foreign trust.
As a client, I will find it useful if financial advisors have an annual-review questionnaire that focuses on whether the I actually received constructive, or may soon receive a foreign-trust distribution whether the trust is grantor or non-grantor for U.S. tax purposes. Some specific questions financial advisors should ask clients with an actual or potential foreign-trust bequest are:
1. Threshold identification and trust characterization:
“Are you currently named, or could you possibly become named as a beneficiary of any non-U.S. trust, estate-like arrangement, foundation usufruct arrangement, or family holding structure?”
2. Actual receipt, constructive receipt, and timing:
“Did you receive any cash, securities, real property, artwork, partnership interests, corporate shares, debt forgiveness, or other property from a foreign trust during the year?”
3. Loan and use of trust property:
“Did you, your spouse, children, parents, siblings, or any related U.S. person borrow cash or marketable securities from a foreign trust?”
4. Documentation from the trust
“Did you receive a Foreign Grantor Trust Beneficiary Statement, Foreign Non-grantor Trust Beneficiary Statement, or other trust statement for the year?”
5. Grantor versus non grantor trust status
“Who funded the trust originally, and were there later additions?”
6. Covered expatriate/ §2801 screening
“Was the decedent or donor ever a U.S. citizen or long-term green card holder who expatriated?”
7. IRC § 6039F vs. IRC § 6048 reporting
“Was the amount received directly from a foreign individual or foreign estate, or from a foreign trust?”
8. Asset-level and downstream reporting
“What assets does the trust hold: foreign corporations, PFICs, foreign partnerships, foreign accounts, life insurance wrappers, real estate, or disregarded?”
9. Procedural and penalty-risk questions
“Was Form 3520 filed for each foreign trust involved?”
Potential Pitfalls of A Business-Minded Son
Pursuant to IRC § 679, if I transfer property to a foreign trust, I will be treated as the owner of the portion of the trust attributable to that property because I would be a U.S. beneficiary of the trust. Here, since I am a U.S. transferor, I would be treated as the grantor-owner of that portion of the foreign trust for U.S. income tax purposes under the grantor trust rules. A great advisor would inform me that this action of moving assets offshore via this estate planning structure would not allow me to circumvent U.S. taxes.
Protecting the Mother’s Son
A foreign-connections onboarding and annual-review questionnaire should be designed to surface not only obvious foreign trust interest, but also indirect or constructive transfers, foreign gifts and bequests, covered expatriate transfers, loans, use of trust property, and facts that can cause a foreign trust to be treated as having a U.S. beneficiary. Some questions my advisor should ask so that they can better protect me are:
1. “Do you have parents, grandparents, spouse, former spouse, children, siblings, or other close relatives who are not U.S. persons?”
2. “Have you ever signed trust documents, letters of wishes, side letters, indemnities, or acknowledgments relating to a foreign trust?”
3. “Did you transfer cash, securities, partnership interest, LLC interest, real estate, artwork, insurance contracts, or other property to a foreign trust directly or indirectly?”
4. “Did you transfer property to a foreign trust that has, or may have, a U.S. beneficiary?”
5. “Did you receive anything indirectly through a nominee, intermediary, related entity, domestic trust, partnership, corporation, or family member?”
6. “Was any third-party loan guaranteed by a foreign trust?”
7. “Did you receive any gifts/bequest from a foreign individual or foreign estate, including related foreign persons, that all together have a value that exceeds $100,000?”
8. “Was your mother a former U.S. citizen or long-term resident?”
9. “Did you receive or hold interest in foreign corporations, PFICs, partnerships, or disregarded entities through a trust?”
To say the least, financial advisors should loop in a tax attorney prior to any structure involving foreign trusts or expatriate family members. Furthermore, advisors should not assume the $15 million exemption solves the problem for globally connected clients.
The OBBBA brought clarity to domestic estate planning. But for cross-border clients, complexity didn’t go away, it just got repackaged. Advisors who ask the right questions now will protect both their clients and themselves.
