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high basis assets is theoretically possible, we have not identified very wealthy U.S. citizens who have recently expatriated as being in this category.) Thus, relative to current law, S. 700 is unlikely to provide any additional incentive that would be strong enough to cause acceleration of expatriations.

In addition, H.R. 1812 has similar incentives to those alleged in S. 700. Under H.R. 1812, a recent heir could contribute his high-basis U.S. property to a foreign corporation and incur little or no tax. As a result, the expatriate's U.S. assets would be treated as foreign assets under H.R. 1812 because they are held through a foreign corporation. However, if the recent heir waited until his assets appreciated to expatriate, to the extent he does not plan around the provisions of H.R. 1812, he would trigger a larger amount of U.S. tax when he contributed his then-appreciated U.S. property to the foreign corporation. Thus, to the extent H.R. 1812 is effective, a recent heir has similar incentives to accelerate his expatriation to those he has under S. 700.

H.R. 1812 may provide incentives to accelerate expatriation among a different group of taxpayers. If H.R. 1812 is effective in requiring individuals to pay U.S. tax for ten years after their expatriation, individuals who intend to sell their business when they retire, or give the business to their children, have an incentive to expatriate ten years prior to such transaction. Under current law, they may be able to avoid U.S. tax and delay their expatriation until immediately before the transaction. These same incentives would apply to individuals who intend to expatriate to avoid U.S. estate taxes. S. 700 does not contain this same incentive to accelerated expatriation, because it does not continue to impose U.S. income tax for ten years after expatriation.

On this point, I would like to submit for the record a letter from three law professors at Harvard University: Bernard Wolfman, Reuven Avi-Yonah, and Diane Ring. Their letter indicates that S. 700 is unlikely to increase expatriations, and notes that if it were to cause increased expatriations, H.R. 1812 would be likely to have the same effect. Their letter also makes the point that those with appreciated assets will have substantially more incentives to accelerate their expatriation under H.R. 1812 than under S.700. They conclude: "We believe that a tax imposed on accrued gains at the time of expatriation (such as the Administration proposal) is superior to an approach which attempts to assess tax for ten years following expatriation. The latter proposal seems to provide more incentives to expatriate than the former."

2.

TREATMENT OF LAWFUL PERMANENT RESIDENTS.

H.R. 1812 imposes continuing income, gift and estate tax obligations for ten years on any individual who has been a lawful permanent resident of the United States for eight years. Some might view it as unusual to subject these people to continued U.S. taxation for a longer period after they expatriate than the period that they were a U.S. resident.

The JCT Report states: "The Administration proposal would have an unfair effect on U.S. long-term residents who have been in the United States for more than 10 years and who have had no notice that they would be taxed on unrealized gains upon departure from the United States." We do not agree with this analysis. Congress has the right to change the taxation of long-term residents and has done so in the past (e.g., 1984 changes to definition of "resident" of the United States under section 7701(b)). Thus, long-term residents have no right to assume that our tax laws will not change, especially when the change mirrors a provision applicable to U.S. citizens.

Finally, we note that H.R. 1812 is only effective for long-term residents who expatriate after June 13, 1995. We believe that the effective date for any proposal should be consistent with the date used for citizens: February 6, 1995. Also, this effective date for long-term residents was set forth in the Administration's proposal.

II. THE JOINT COMMITTEE ON TAXATION EXPATRIATION REPORT.

In response to the Committee's request to testify at this hearing, the discussion below addresses a few of the points made by the JCT Report.

A.

IMPORTANCE OF TAX AVOIDANCE THROUGH EXPATRIATION.

We believe that the available evidence demonstrates that tax avoidance by expatriates is an important problem which needs to be resolved. A group of wealthy individuals are taking advantage of a loophole in existing law which results in a significant revenue loss. Recent media interest as well as the attention devoted by the Congress and its staffs demonstrate a keen interest in this problem and the need to ensure that our tax code is perceived as fair. We have all dealt with reverse situations affecting a few taxpayers and the nominal revenue when the assertion is made that the tax laws were deemed to bite inappropriately. Thus, this issue needs to be resolved as a matter of fairness and public perception, regardless of the exact number of individuals affected or revenue raised.

The JCT Report found that expatriation to avoid tax was not a significant or growing problem.10 We agree that there are relatively few persons involved, but the revenue involved is not insignificant to either the taxpayer or the Treasury.

The JCT Report states that the Department of State was only able to identify four individuals who had expatriated out of approximately one thousand who were on the

9 JCT Report at p. 4.

10 JCT Report at 1, 61, 65.

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Forbes 400 list over the prior ten years." This does not seem to be compelling evidence of an insignificant problem for several reasons. The Department of State was unable to check a substantial portion of the Forbes 400 list because, due to the limitations of their data, the JCT was not able to provide precise names of individuals who are members of 203 families that were included in the Forbes 400.12

There are many wealthy individuals in the United States who are not included in the Forbes 400. Thus, assessing the magnitude of the problem by focusing on this list does not give an accurate measure of the problem. Since the Administration proposal was released in February, Treasury has continued to gather data on the incidence of tax avoidance through expatriation. We are presently able to identify 68 citizens or longterm residents by name who have expatriated in the last five years and are wealthy enough to be affected potentially by H.R. 1812. In attempting to identify these expatriates, we have experienced some of the same frustrations that the JCT has encountered in trying to identify wealthy expatriates by name. We too have found transcription errors and difficulties matching expatriation records with our tax files. Therefore, we believe that we have not identified all wealthy expatriates during this period.

Also, there is a well-known cottage industry of tax advisors who advise on these types of tax planning techniques. Books are published and seminars are regularly presented on these issues. This industry would not exist without a reasonable level of expatriation activity. In addition, based on extensive discussions with practitioners, we believe that recent publicity of the expatriation tax loophole is causing many individuals who had never seriously considered the possibility to begin the process in earnest.

Finally, the JCT revenue estimate, although much lower than the Administration's estimate, confirms the seriousness of the problem. The JCT estimates that the Administration proposal would raise $1.9 billion over ten years. (The revenue estimates are discussed in more detail below.) Even based on the JCT's assessment of the number of individuals involved, a tax loophole that allows these individuals, however many, to save such a significant amount demands attention and action.

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The JCT Report complains that the IRS has not exerted adequate resources in trying to enforce current law. However, the JCT agrees that current law is so flawed

13

11 JCT Report at pp. 65-66.

12 In addition, the Department of State was unable to verify at least one person on the Forbes 400, Kenneth Dart, because of a transcription error in the data it received.

13 JCT Report at p. 2.

that any such enforcement efforts would have only been effective with respect to those taxpayers who engaged in poor tax planning. The JCT Report concludes: "Because of the limitations in the scope of present law, an individual may be able to achieve significant tax savings through expatriation, even if the person is found to have had a tax avoidance motive, and is thus subject to the special expatriation tax rules."14

We believe that, given the inadequacies of current law, the IRS over the last 29 years has devoted appropriate resources to tax avoidance by expatriates.

Information provided to the JCT indicates that the IRS has identified approximately twenty individuals who are wealthy expatriates. The IRS pursued claims against many of these individuals, but existing law has not proven adequate to impose an appropriate amount of U.S. tax.

For example, one individual expatriated several days before he earned several hundred million dollars of foreign source income. In addition, if that individual had remained a U.S. citizen, the taxpayer would have owed more than one billion dollars in U.S. tax on subsequent transactions. Despite extensive IRS resources devoted to this case, it appears that no U.S. tax will be collected on transactions after the taxpayer's expatriation.

We conclude that the infirmities of current law are so serious that additional enforcement efforts by the IRS would have been nearly futile.

C. PURPOSE OF EXPATRIATION PROPOSALS.

In evaluating the proposals, we believe that the principal goal should be to move the Internal Revenue Code closer to tax neutrality for preexpatriation gains of an individual that is currently subject to tax as a citizen and facing the choice of whether or not to expatriate. To the extent possible, expatriation should not allow a U.S. citizen or resident to escape tax otherwise due on income or wealth accrued while a citizen or resident. In this regard, proposals should attempt to develop a system where an expatriate is not treated more favorably than a U.S. citizen who does not expatriate.15

Many of the recommendations of the JCT Report are contrary to the goal of moving closer to tax neutrality and achieving fairness. For example, the JCT Report suggests that the United States should not tax gains of expatriates on foreign assets.

14 JCT Report at p. 69.

15

H.R. Rep. No. 145, 104th Cong., 1st Sess. 24 (1995). We shall refer to this document hereafter as the "Ways and Means Committee Report".

16

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However, to achieve tax neutrality, the expatriation proposal should apply to foreign source income earned by expatriates because the United States generally taxes U.S. citizens on their worldwide income, exempting the foreign source income of expatriates retains the incentive to expatriate. In contrast, a proposal that taxes worldwide gains unrealized at the time of expatriation would provide much less incentive to expatriate.

In addition, the JCT Report questions whether the expatriation proposal should apply to U.S. citizens who were not born in the United States or who have not lived in the United States for a period of time.17 However, the United States has taxed its citizens who do not reside in the United States since the enactment of the Internal Revenue Code. The reason the United States taxes nonresidents is that they enjoy substantial benefits of U.S. citizenship. If Congress were to determine that a nonresident citizen does not enjoy enough benefits of U.S. citizenship to justify U.S. taxation of his worldwide income, he should not be subject to any U.S. income taxes. As long as current law provides for taxation of nonresident citizens, the expatriation proposal should also apply to these individuals.

A comprehensive tax at the time of expatriation on accrued worldwide gains, such as S. 700, comes closest to the ideal of tax neutrality. This approach would eliminate a substantial portion of the tax savings that otherwise would result from a decision to expatriate. In this regard, the motive for expatriation should be irrelevant. Further, the expatriation tax provisions should not exempt any accrued gains that would be subject to tax if realized as a citizen. Finally, the comprehensive accrued income approach would not reach beyond the economic income the taxpayer earned while subject to the U.S. tax system. Proposals like H.R. 1812 that tax U.S. source gains accrued after expatriation will encourage citizens to engage in behaviors to avoid U.S. source income after expatriation. This is the experience of current law.

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You have asked for our comments on the revenue estimates of the various expatriation proposals. Treasury estimates that H.R. 1812 would generate approximately $0.10 billion over five years without a treaty override or $0.45 billion over five years with a treaty override, as compared to S. 700 which Treasury estimates would generate approximately $1.68 billion over five years. A summary of Treasury's revenue estimates for the various expatriation proposals follows.

17 JCT Report at p. 2.

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