Interests in trusts

Under the Administration proposal, any trust interest held by an expatriating individual would be deemed to be sold immediately prior to the expatriation. This provision would require that trust interests be valued specifically for this purpose. For example, a trust instrument may provide that one individual (the "income beneficiary") is entitled to receive the income from the trust assets for the next 10 years, at which time the trust will terminate and another individual (the "remainderman") will be entitled to receive the assets. If either the income beneficiary or the remainderman expatriates, a value would need to be placed on their respective interests, and the expatriate would be subject to tax on the value of the expatriate's interest. It is unclear in this context what value would be placed on a nontransferable interest in a trust (e.g., a "spendthrift" trust that prohibits the trust beneficiary from assigning or transferring the trust interest). If nontransferable interests were to be valued at zero (because they cannot be sold), they would not be taxed under the proposal, thus rendering the proposal inapplicable with respect to such interests. An additional issue is raised by the fact that the trust instrument is not likely to provide the beneficiaries with access to the trust assets in order to pay the tax. Therefore, in many cases, the resulting tax liability could exceed the assets available to the beneficiary to pay the tax.

A beneficiary's interest in a trust would be determined on the basis of all facts and circumstances. These include the terms of the trust instrument itself, any letter of wishes or similar document, historical patterns of trust distributions, the role of any trust protector or similar advisor, and anything else of relevance. Under the Administration proposal, the Treasury Department would be expected to issue regulations providing guidance as to the determination of trust interests for purposes of the expatriation tax, and such regulations would be expected to disregard de minimis interests in trusts, such as an interest of less than a certain percentage of the trust as determined on an actuarial basis, or a contingent remainder interest that has less than a specified likelihood of occurrence. In the event that any beneficiaries' interests in the trust could not be determined on the basis of the facts and circumstances, the beneficiary with the closest degree of family relationship to the settlor would be presumed to hold the remaining interests in the trust. Each beneficiary would be required to disclose on his or her tax return the methodology used to determine that beneficiary's interest in the trust, and whether that beneficiary knows (or has reason to know) that any other beneficiary of the trust uses a different method.

For purposes of this provision, grantor trusts would continue to be treated as under present law---the grantor of the trust would be treated as the owner of the trust assets for tax purposes. Therefore, a grantor who expatriates would be treated as selling the assets held by the trust for purposes of computing the tax on expatriation. Correspondingly, a beneficiary of a grantor trust who is not treated as an owner of the trust (or any portion thereof) under the grantor trust rules would not be considered to hold an interest in the trust for purposes of the expatriation

tax.

Date of relinquishment of citizenship

Under the Administration proposal, a U.S. citizen would be treated as having relinquished his citizenship on the date that the State Department issues a CLN, even though the individual may have ceased to be a U.S. citizen at a substantially earlier date. In cases where a naturalized U.S. citizen has his or her naturalization revoked (e.g., where the naturalization was obtained illegally, through the concealment of a material fact, or by willful misrepresentation), the individual would be treated as relinquishing citizenship on the date that a U.S. court cancels the certificate of naturalization, even though, for all other purposes, the individual would not be considered to have ever been a U.S. citizen. These new definitions of when citizenship is deemed to be relinquished for tax purposes would also apply in determining when an expatriating individual ceases to be taxed as a U.S. citizen. Under the Administration proposal, an expatriating individual would be subject to U.S. tax as a citizen of the United States until a CLN is issued or a certificate of naturalization is revoked, regardless of when citizenship has actually been lost through the commission of an expatriating act.

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Long-term residents who terminate their U.S. residency

Under the Administration proposal, the tax on expatriation would apply to certain "long-term residents" who terminate their residency in the United States. A long-term resident would be any individual who has been a lawful permanent resident of the United States (i.e., a "green card" holder) in at least 10 of the prior 15 taxable years. 35 For this purpose, any year in which the individual was taxed as a resident of another country under a treaty tie-breaker rule would not be considered. 36 The proposal would not apply to individuals who were treated as U.S. residents under the "substantial presence" test, regardless of the amount of time the individual was present in the United States.

34 As drafted, there is some uncertainty as to how the Administration proposal would affect an individual who had committed an expatriating act prior to February 6, 1995, but who never applies for a CLN. To the extent the State Department eventually does issue a CLN with respect to the individual (whether upon the State Department's initiative or upon the individual's request), the individual clearly would be covered by the new provisions.

35 If a long-term resident surrenders his green card, such a person may still be treated as a resident for U.S. income tax purposes if he has a "substantial presence" within the United States. (See sec. 7701(b)(3).) The proposal would not apply so long as such a person continues to be treated as a tax resident under the substantial-presence test.

36 Most treaties include "tie-breaker" rules for determining the residency of an individual who would otherwise be considered to be a resident of both the U.S. and the treaty partner under the internal laws of each country. In general, these tie-breaker rules provide that an individual will be taxed as a resident of only one country, based on factors such as the country in which the individual has a permanent home or closer personal and economic ties.

Solely for purposes of this provision of the Administration proposal, a special election would permit long-term residents to determine the tax basis of certain assets using their fair market value at the time the individual became a U.S. resident, rather than their historical cost. The election, if made, would apply to all assets within the scope of the proposal that were held on the date the individual first became a U.S. resident and the fair market value would be determined as of such date.

A long-term resident who terminates his or her U.S. residency would be subject to the Administration proposal at the time the individual ceases to be taxed as a resident of the United States (as determined under present law).

Other special rules

Under the Administration proposal, the tax on expatriation generally would apply notwithstanding other provisions of the Code. For example, gain that would be eligible for nonrecognition treatment if the property were actually sold would be treated as recognized for purposes of the tax on expatriation. Also, the exclusions from gross income generally provided to bona fide residents of U.S. possessions or commonwealths (e.g., secs. 931 and 933) would not be applicable for purposes of calculating the expatriation tax.

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Other special rules of the Code would affect the characterization of amounts treated as realized under the Administration proposal. For example, in the case of stock in a foreign corporation that was a CFC at any time during the five-year period ending on the date of the deemed sale, the gain recognized on the deemed sale would be included in the shareholder's income as a dividend to the extent of certain earnings of the foreign corporation.3

38

Under the Administration proposal, any period during which recognition of income or gain generally is deferred would terminate on the date of the relinquishment, causing any deferred U.S. tax to become due and payable. For example, where an individual has disposed of certain property in a transaction for which deferral is conditioned on the purchase of certain replacement property (e.g., property that qualifies for like-kind exchange treatment under sec. 1031 or that qualifies as a principal residence under sec. 1034), but has not yet acquired the replacement property, the relevant period in which to acquire any replacement property would be deemed to terminate upon expatriation and the individual would be taxed on the gain from the original sale.

37 Native-born residents of U.S. territories and possessions are citizens of the United States, thus it was not intended that the provision be "mirrored" for application in the U.S. territories and possessions that employ the mirror code. However, a rule could be provided to extend the Administration proposal to long-term residents of U.S. territories or possessions who are not citizens of the United States.

38 See section 1248.

Under the Administration proposal, the present-law provisions with respect to individuals who expatriate with a principal purpose of avoiding tax (sec. 877) and certain aliens who have a break in residency status (sec. 7701(b)(10)) would not apply to any individual who is subject to the new expatriation tax provisions. The special estate and gift tax provisions with respect to individuals who expatriate with a principal purpose of avoiding tax (secs. 2107 and 2501(a)(3)), however, would continue to apply.

The Administration proposal authorizes the Treasury Department to issue regulations necessary to carry out the purposes of the provision.

Effective date

The Administration proposal would be effective for U.S. citizens who obtain a CLN, or have a certificate of naturalization cancelled, on or after February 6, 1995 (regardless of when the individual actually lost his or her U.S. citizenship), and for long-term residents who terminate their U.S. residency on or after February 6, 1995. Present law would continue to apply to U.S. citizens who obtained a CLN prior to February 6, 1995, and to long-term residents who terminated their residency prior to February 6, 1995.

B. Senate Amendment to H.R. 831

In general

The Senate amendment to H.R. 831 ("the Senate bill") adopted a modified version of the Administration proposal with respect to the taxation of U.S. citizens and residents who relinquish their citizenship or residency.39 The Senate bill modified the Administration proposal in several ways. First, the Senate bill applies the expatriation tax only to U.S. citizens who relinquish their U.S. citizenship, not to long-term resident aliens who terminate their U.S. residency. Second, the Senate bill modifies the date when an expatriating citizen is treated as relinquishing U.S. citizenship, such that most expatriating citizens are treated as relinquishing their citizenship at an earlier date than under the Administration proposal. The Senate bill also makes some technical modifications to the Administration proposal, including a provision to prevent double taxation in the case of certain property that remains subject to U.S. tax jurisdiction.

Property taken into account; Interests in trusts

The types of property that would be taken into account in determining the tax liability of an expatriate under the Senate bill generally are the same as under the Administration proposal.

39 The Senate amendment to H.R. 831 was not included in the conference agreement on H.R. 831, nor as the bill was enacted (P.L. 104-7, signed by the President on April 11, 1995). Instead, the enacted legislation included a requirement that the staff of the Joint Committee on Taxation complete a study of the expatriation tax issues by June 1, 1995.

The rules with respect to interests in trusts, however, are modified in the Senate bill. Under the Administration proposal, an individual holding an interest in a trust would be deemed to have sold that trust interest immediately prior to expatriation. Under the Senate bill, a beneficiary's interest in a trust would be determined in the same manner as under the Administration proposal. However, a trust beneficiary would be deemed to be the sole beneficiary of a separate trust consisting of the assets allocable to his or her share of the trust, in accordance with his or her interest in the trust. The separate trust would be treated as selling its assets for fair market value immediately before the beneficiary relinquishes his or her citizenship, and distributing all resulting income and corpus to the beneficiary. The beneficiary would be treated as subsequently recontributing the assets to the trust. Consequently, the separate trust's basis in the assets would be stepped up and all assets held by the separate trust would be treated as corpus. The Senate bill also adds a constructive ownership rule with respect to a trust beneficiary that is a corporation, partnership, trust or estate. In such cases, the shareholders, partners or beneficiaries of the entity that is the trust beneficiary would be deemed to be the direct beneficiaries of the trust for purposes of applying these provisions.

Date of relinquishment of citizenship

Under the Administration proposal, an individual would be deemed to have lost U.S. citizenship on the date that a CLN is issued by the State Department or a certificate of naturalization is canceled by a court. The Senate bill would modify these rules to treat an individual as relinquishing his or her citizenship on an earlier date, specifically, the date that the individual first presents himself or herself to a diplomatic or consular officer of the United States as having voluntarily relinquished citizenship through the performance of an expatriating act. Under the Senate bill, a U.S. citizen who relinquishes citizenship by formally renouncing his or her U.S. nationality before a diplomatic or consular officer of the United States40 would be treated as having relinquished citizenship on that date, provided that the renunciation is later confirmed by the issuance of a CLN. (For these individuals, the date on which the individual would be deemed to lose his or her citizenship for tax purposes is the same as the date on which the individual has actually lost such citizenship under existing U.S. law.) A U.S. citizen who furnishes to the State Department a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an expatriating act11 would be treated as having relinquished his or her citizenship on the date the statement is so furnished (regardless of the date of performance of the expatriating act that caused the actual loss of U.S. citizenship to occur), provided that the voluntary relinquishment is later confirmed by the issuance of a CLN. If neither of these circumstances exist, the individual would be treated as having relinquished citizenship on the date the CLN is

40 Section 349(a)(5) of the Immigration and Nationality Act (8 U.S.C. sec. 1481(a)(5)) provides for the relinquishment of citizenship through renunciation.

41

The Senate bill would apply to any expatriating act specified in section 349(a)(1) - (4) of the Immigration and Nationality Act (8 U.S.C. sec. 1481(a)(1) - (4)).