A. Taxation of United States Citizens, Residents, and Nonresidents B. Requirements for United States Citizenship, Immigration, and Visas IV. PROPOSALS TO MODIFY TAX TREATMENT OF U.S. CITIZENS AND B. Senate Amendment to H.R. 831 C. Modified Bills Introduced by Senator Moynihan (S. 700) and My name is Ken Kies. I am the Chief of Staff of the Joint Committee on Taxation. It is my pleasure to present the testimony of the Joint Committee at this hearing on the tax treatment of individuals who relinquish their U.S. citizenship or residency. The President's fiscal year 1996 budget proposals submitted on February 6, 1995, included a proposal to impose income tax on unrealized gains of U.S. citizens who relinquish their U.S. citizenship and certain long-term residents of the United States who relinquish their U.S. residency. This proposal was included as section 201 of S. 453 (introduced by Senators Daschle and Moynihan on February 16, 1995). On March 15, 1995, the Committee on Finance approved an amendment to H.R. 831 to adopt a modified version of the Administration proposal with respect to the taxation of U.S. citizens who relinquish their citizenship. The Senate amendment was not included in the bill as enacted; rather, the enacted legislation included a requirement that the staff of the Joint Committee on Taxation complete a study on expatriation tax issues by June 1, 1995. On April 6, 1995, Senator Moynihan introduced a bill (S. 700) that further modified the Administration proposal with respect to the taxation of U.S. citizens and residents who relinquish their citizenship or residency.' On June 9, 1995, following the completion of the Joint Committee staff's study on expatriation tax issues, Representative Archer and Representative Johnson of Connecticut introduced a bill (H.R. 1812) that would expand and strengthen the present-law expatriation tax provisions. The House Committee on Ways and Means approved two amendments to H.R. 1812 on June 13, 1995. First, this testimony describes the present-law tax treatment of U.S. citizens, residents, and nonresident aliens, including the tax treatment of U.S. citizens who relinquish their citizenship. Second, a summary of the findings of the Joint Committee staff's study on expatriation tax issues is provided. Third, the proposals with respect to the taxation of individuals who relinquish their U.S. citizenship or residency are described in detail. Finally, the testimony discusses the revenue estimates with respect to such proposals and explains the estimating methodology of the Joint Committee staff. 1 Representative Gibbons introduced an identical bill (H.R. 1535) on May 2, 1995. 1 1. II. PRESENT LAW A. Taxation of United States Citizens, Residents, and Nonresidents A United States citizen generally is subject to the U.S. individual income tax on his or her worldwide taxable income. All income earned by a U.S. citizen, whether from sources inside or outside the United States, is taxable, whether or not the individual lives within the United States. A non-U.S. citizen who resides in the United States generally is taxed in the same manner as a U.S. citizen if the individual meets the definition of a "resident alien," described below. The taxable income of a U.S. citizen or resident is equal to the taxpayer's total income less certain exclusions, exemptions, and deductions. The appropriate tax rates are then applied to a taxpayer's taxable income to determine his or her individual income tax liability. A taxpayer may reduce his or her income tax liability by any applicable tax credits. When an individual disposes of property, any gain or loss on the disposition is determined by reference to the taxpayer's cost basis in the property, regardless of whether the property was acquired during the period in which the taxpayer was a citizen or resident of the United States. If a U.S. citizen or resident earns income from sources outside the United States, and that income is subject to foreign income taxes, the individual generally is permitted a foreign tax credit against his or her U.S. income tax liability to the extent of foreign income taxes paid on that income. In addition, a United States citizen who lives and works in a foreign country generally 3 is permitted to exclude up to $70,000 of annual compensation from being subject to U.S. income taxes, and is permitted an exclusion or deduction for certain housing expenses.* 2 The determination of who is a U.S. citizen for tax purposes, and when such citizenship is lost, is governed by the provisions of the Immigration and Nationality Act, 8 U.S.C. section 1401, et seq. See Treas. Reg. section 1.1-1(c). 3 See Internal Revenue Code sections ("sections") 901-907. 4 Section 911. Resident aliens In general, a non-U.S. citizen is considered a resident of the United States if the individual (1) has entered the United States as a lawful permanent U.S. resident (the "green card test"); or (2) is present in the United States for 31 or more days during the current calendar year and has been present in the United States for a substantial period of time--183 or more days during a 3-year period weighted toward the present year (the "substantial presence test")." If an individual is present in the United States for fewer than 183 days during the calendar year, and if the individual establishes that he or she has a closer connection with a foreign country than with the United States and has a tax home in that country for the year, the individual generally is not subject to U.S. tax as a resident on account of the substantial presence test. If an individual is present for as many as 183 days during a calendar year, this closer connections/tax home exception is not available. An alien who has an application pending to change his or her status tɔ permanent resident or who has taken other steps to apply for status as a lawful permanent U.S. resident is not eligible for the closer connections/tax home exception. For purposes of applying the substantial presence test, any days that an individual is present as an "exempt individual" are not counted. Exempt individuals include certain foreign government-related individuals, teachers, trainees, students, and professional athletes temporarily in the United States to compete in charitable sports events. In addition, the substantial presence test does not count days of presence of an individual who is physically unable to leave the United States because of a medical condition that arose while he or she was present in the United States, if the individual can establish to the satisfaction of the Secretary of the Treasury that he or she qualifies for this special medical exception. In some circumstances, an individual who meets the definition of a U.S. resident (as described above) could also be defined as a resident of another country under the internal laws of that country. In order to avoid the double taxation of such individuals, most income tax treaties include a set of "tie-breaker" rules to determine the individual's country of residence for income tax purposes. In general, a dual resident is deemed to be a resident of the country in which such person has a permanent home. If the individual has a permanent home available in both countries, the individual's residence is deemed to be the country with which his or her personal and economic relations are closer, i.e., the "center of vital interests." If the country in which such individual has his or her center of vital interests cannot be determined, or if such individual does not have a permanent home available in either country, he or she is deemed to be a resident of the country in which he or she has an habitual abode. If the individual has an habitual abode in both 'The definitions of resident and nonresident aliens are set forth in section 7701(b). The substantial presence test compares 183 days to the sum of (1) the days present during the current calendar year, (2) one-third of the days present during the preceding calendar year, and (3) one-sixth of the days present during the second preceding calendar year. Presence for 122 days (or more) per year over the 3-year period would be sufficient to trigger the test. countries or in neither of them, he or she is deemed to be a resident of the country of which he or she is a citizen. If each country considers the person to be its citizen or if he or she is a citizen of neither of them, the competent authorities of the countries are to settle the question of residence by mutual agreement. b. Income taxation of nonresident aliens Non-U.S. citizens who do not meet the definition of "resident aliens" are considered to be nonresident aliens for tax purposes. Nonresident aliens are subject to U.S. tax only to the extent their income is from U.S. sources or is effectively connected with the conduct of a trade or business within the United States. Bilateral income tax treaties may modify the U.S. taxation of a nonresident alien. 6 A nonresident alien is taxed at regular graduated rates on net profits derived from a U.S. business. Nonresident aliens also are taxed at a flat rate of 30 percent on certain types of passive income derived from U.S. sources, although a lower treaty rate may be provided (e.g., dividends are frequently taxed at a reduced rate of 15 percent). Such passive income includes interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits and income. There is no U.S. tax imposed, however, on interest earned by nonresident aliens with respect to deposits with U.S. banks and certain types of portfolio debt investments.' Gains on the sale of stocks or securities issued by U.S. persons generally are not taxable to a nonresident alien because they are considered to be foreign source income. Nonresident aliens are subject to U.S. income taxation on any gain recognized on the disposition of an interest in U.S. real property. Such gains generally are subject to tax at the 6 Section 871. 7 See sections 871(h) and 871(i)(3). 8 Section 865(a). 9 Sections 897, 1445, 6039C, and 6652(f), known as the Foreign Investment in Real Property Tax Act ("FIRPTA"). Under the FIRPTA provisions, tax is imposed on gains from the disposition of an interest (other than an interest solely as a creditor) in real property (including an interest in a mine, well, or other natural deposit) located in the United States or the U.S. Virgin Islands. Also included in the definition of a U.S. real property interest is any interest (other than an interest solely as a creditor) in any domestic corporation unless the taxpayer establishes that the corporation was not a U.S. real property holding corporation ("USRPHC") at any time during the five-year period ending on the date of the disposition of the interest (sec. 897(c)(1)(A)(ii)). A USRPHC is any corporation, the fair market value of whose U.S. real property interests equals or exceeds 50 percent of the sum of the fair market values of (1) its U.S. real property interests, (2) |