pears that the levels of expatriation were significantly higher during the 1970's than in the period since 1982. It is possible that the levels of expatriation during the 1970's in part reflect the consequences of U.S. involvement in the war in Vietnam.

Appendix H contains certain information relating to U.S. citizens who expatriated in 1994 and early 1995. The reported numbers of U.S. citizens renouncing their citizenship includes naturalized U.S. citizens who return to their countries of birth. For example, according to the State Department, of the 858 U.S. citizens who relinquished their citizenship in 1994, a significant percentage were Korean Americans returning to their country of birth or ancestry. Under Korean law, an individual is not permitted to hold dual citizenship, which requires Korean Americans to give up their U.S. citizenship in order to return to Korea. According to a recent story in the Washington Post, Korean Americans have experienced difficult economic and cultural problems when they come to the United States. The Washington Post indicated that between 4 and 5 percent of New York City's Korean population (or about a thousand families) are returning to Korea each year.

In 1984, according to State Department records, there were approximately 1.8 million private U.S. citizens living outside the United States.2 In 1993, there were approximately 2.5 million private U.S. citizens residing abroad. The Internal Revenue Service annually receives approximately 1 million Form 1040s filed by citizens residing outside the United States (see Internal Revenue Service letter dated May 12, 1995, Exhibit B). Included in these 1 million returns are tax returns filed by U.S. military and nonmilitary U.S. government employees stationed abroad.

Thus, it appears that fewer than 40 percent of U.S. citizens residing abroad (including U.S. government employees) file annual income tax returns.3

Present law

In general

A U.S. citizen or resident generally is subject to the U.S. individual income tax on his or her worldwide taxable income. All income

1 "Their American Nightmare; Why Korean Entrepreneurs Are Fleeing Our Cities," Washington Post, May 7, 1995, p. C-1.

2 The information was compiled from U.S. Foreign Service Post information. The number of U.S. citizens living abroad does not include U.S. government (military and nonmilitary) employees or their dependents.

3 In 1985, the General Accounting Office ("GAO") testified before the Congress suggesting that the failure of U.S. citizens living abroad to file annual income tax returns was a significant problem. Statement of Johnny C. Finch, Senior Associate Director, General Government Division, Before the Subcommittee on Commerce, Consumer and Monetary Affairs, Committee on Government Operations, House of Representatives, on United States Citizens Living in Foreign Countries and Not Filing Federal Income Tax Returns, United States General Accounting Office, May 8, 1985. In its testimony, the GAO found that only 39 percent of U.S. citizens living abroad were filing annual income tax returns. In response to this testimony, the Congress enacted a provision in the Tax Reform Act of 1986 that requires the filing of an IRS information returnwith a U.S. citizen's passport application and with a resident alien's green card application. It appears that the information return requirement may not have significantly improved the tax return filings of U.S. citizens residing outside the United States. In fact, the GAO issued a followup report in 1993, and did not find significant improvements in the compliance with tax return filing requirements of U.S. citizens living outside the United States. Tax Administration, IRS Activities to Increase Compliance of Overseas Taxpayers, United States General Accounting Office, GAO/GGD 93-93, May 18, 1993. In its May 23, 1995, response to the Joint Committee on Taxation, the Internal Revenue Service stated that it has undertaken efforts to improve the return filing by U.S. citizens residing outside the United States and that its initiatives have resulted in improved voluntary compliance (see Appendix G).

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.

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 U.S. citizen who lives and works in a foreign country generally is permitted to exclude up to $70,000 of annual compensation from being subject to U.S. income taxes.

Nonresident aliens are subject to U.S. taxation 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. U.S. source income generally includes items such as interest and dividends paid by U.S. companies, but does not include gains on the sale of stock or securities issued by U.S. companies.

Special rules

Relinquishing U.S. citizenship with a principal purpose of avoiding tax.—An individual who relinquishes his or her U.S. citizenship with a principal purpose of avoiding U.S. taxes is subject to an alternative method of income taxation for 10 years after expatriation under section 877 of the Code. Under this provision, if the Treasury Secretary establishes that it is reasonable to believe that the expatriate's loss of U.S. citizenship would, but for the application of this provision, result in a substantial reduction in U.S. tax based on the expatriate's probable income for the taxable year, then the expatriate has the burden of proving that the loss of citizenship did not have as one of its principal purposes the avoidance of U.S. income, estate or gift taxes. Section 877 does not apply to resident aliens who terminate their U.S. residency.

The alternative method of taxation under section 877 modifies the rules generally applicable to the taxation of nonresident aliens in two ways. First, the expatriate is subject to tax on his or her U.S. source income at the rates applicable to U.S. citizens rather than the rates applicable to other nonresident aliens. (Unlike U.S. citizens, however, individuals subject to section 877 are not taxed on any foreign source income.) Second, the scope of items treated as U.S. source income for section 877 purposes is broader than those items generally considered to be U.S. source income under the Code.

Aliens having a break in residency status.-A special rule applies in the case of an individual who has been treated as a resident of the United States for at least three consecutive years, if the individual becomes a nonresident but regains residency status within a three-year period. In such cases, the individual is subject to U.S. tax for all intermediate years under the section 877 rules described above (i.e., the individual is taxed in the same manner as a U.S. citizen who renounced U.S. citizenship with a principal purpose of avoiding U.S. taxes). The special rule for a break in residency status applies regardless of the subjective intent of the individual.

Aliens who physically leave the United States.-Any alien, resident or nonresident, who physically leaves the United States or any possession thereof is required to obtain a certificate from the IRS District Director that he or she has complied with all U.S. income tax obligations. This certificate often is referred to as a “sailing permit". The certificate may not be issued unless all income tax due up until the time of departure has been paid, or an adequate bond or other security has been posted, or the Treasury Secretary finds that the collection of the tax will not be jeopardized by the departure of the alien.

Transfers to foreign corporations.-Certain transfers of property by shareholders to a controlled corporation are generally taxfree if the persons transferring the property own at least 80 percent of the corporation after the transfer. Also, in certain corporate reorganizations, including qualifying acquisitions, and dispositions, shareholders of one corporation may exchange their stock or securities for stock or securities of another corporation that is a party to the reorganization without a taxable event except to the extent they receive cash or other property that is not permitted stock or securities.

Section 367 applies special rules, however, if property is transferred by a U.S. person to a foreign corporation in a transaction that would otherwise be tax-free under these provisions. These special rules are generally directed at situations where property is transferred to a foreign corporation, outside of the U.S. taxing jurisdiction, so that a subsequent sale by that corporation could escape U.S. tax notwithstanding the carryover basis of the asset. In some instances, such a transfer causes an immediate taxable event so that the generally applicable tax-free rules are overridden. In other instances, the taxpayer may escape immediate tax by entering into a gain recognition agreement obligating the taxpayer to pay tax if the property is disposed of within a specified time period after the transfer.

Section 367 also imposes rules directed principally at situations where a U.S. person has an interest in a foreign corporation, such as a controlled foreign corporation ("CFC") meeting specific U.S. shareholder ownership requirements, that could result in the U.S. person being taxed on its share of certain foreign corporate earnings. These rules are designed to prevent the avoidance of tax in circumstances where a reorganization or other nonrecognition transaction restructures the stock or asset ownership of the foreign corporation so that the technical requirements for imposition of U.S. tax under the CFC or other rules are no longer met, thus potentially removing the earnings of the original CFC from current or future U.S. tax or changing the character of the earnings for U.S. tax purposes (e.g., from dividend to capital gain).

The rules of section 367 do not generally apply unless there is a transfer by a U.S. person to a foreign corporation, or unless a foreign corporation of which a U.S. person is a shareholder engages in certain transactions. Because an individual who expatriates is no longer a U.S. person, section 367 has no effect on actions taken by such individuals after expatriation. The Treasury Department has considerable regulatory authority under section 367 to address situations that may result in U.S. tax avoidance. The legislative

history suggests that a principal concern was avoidance of U.S. tax on foreign earnings and profits and it does not appear that the Treasury has either considered application of the current provision to expatriation situations or sought any expansion of regulatory authority. Under the existing regulations and the relevant expatriation sections of the Code, a U.S. person who expatriates, even for a principal purpose of avoiding U.S. tax, may subsequently engage in transactions that involve the transfer of property to a foreign corporation without any adverse consequences under section 367. Similarly, a U.S. person who has expatriated is not considered to be a U.S. person for purposes of applying the rules that address restructurings of foreign corporations with U.S. shareholders. In addition, there may be difficulties enforcing a gain recognition agreement if a U.S. person who has been affected by a transfer under section 367 and has entered such an agreement later expatriates.

Similar issues exist under section 1491 of the Code. Section 1491 imposes a 35-percent tax on otherwise untaxed appreciation when appreciated property is transferred by a U.S. citizen or resident, or by a domestic corporation, partnership, estate or trust, to certain foreign entities in a transaction not covered by section 367. As in the case of section 367, an individual who has expatriated is no longer a U.S. citizen and may also no longer be à U.S. resident and, thus, a transfer by such a person would be unaffected by section 1491.

Administration proposal

President Clinton's fiscal year 1996 budget proposal was submitted to the Congress on February 6, 1995.4 On February 16, 1995, certain of the revenue provisions in the President's budget submission were included in the "Tax Compliance Act of 1995," introduced (by request) as H.R. 981 by Representatives Gephardt and Gibbons and as S. 453 by Senators Daschle and Moynihan. Among the provisions of H.R. 981 and S. 453 was a proposal to modify the tax treatment of U.S. citizens who relinquish their citizenship and of certain long-term resident aliens who terminate their U.S. residency status.

The Treasury Department issued a press release on February 6, 1995, stating that the Clinton Administration was proposing legislation aimed at "stopping U.S. multimillionaires from escaping taxes by abandoning their citizenship or by hiding their assets in foreign tax havens."5 The Treasury Department press release also stated that a few dozen of the 850 people who relinquished their citizenship in 1994 did so to avoid paying tax on the appreciation in value that their assets accumulated while the individuals "enjoyed the benefits of U.S. citizenship." The Treasury Department press release included an example of how a U.S. citizen could expatriate but continue to have a residence and driver's license in the United States and continue to travel on a U.S. passport.

4 A copy of the description of the Administration's proposal addressing the tax treatment of expatriation as submitted on February 6, 1995, is included as Appendix D. The Administration submitted no statutory language as part of its February 6, 1995, submission.

5 Department of the Treasury, Treasury News, "Clinton Offers Plan to Curb Offshore Tax Avoidance," RR-54, February 6, 1995.

Under the Administration proposal, U.S. citizens who relinquish their U.S. citizenship and certain long-term resident aliens who terminate their U.S. residency status generally would be treated as having sold all of their property at fair market value immediately prior to the expatriation or cessation of residence. Gain or loss from the deemed sale would be recognized at that time, generally without regard to other provisions of present law. Any net gain on the deemed sale would be recognized only to the extent it exceeds $600,000 ($1.2 million in the case of married individuals filing a joint return, both of whom expatriate).

Under the Administration proposal, a U.S. citizen would be treated as having relinquished his or her citizenship on the date that the State Department issues a certificate of loss of nationality (or, for a naturalized U.S. citizen, the date that a U.S. court cancels the certificate of naturalization), and would be subject to U.S. tax as a citizen of the United States until that time. A long-term resident who ceases to be taxed as a U.S. resident would be subject to the proposal at the time of such cessation.

The Administration proposal would be effective for U.S. citizens who relinquish their citizenship as otherwise defined in the proposal (i.e., with respect to those U.S. citizens who obtain a certificate of loss of nationality) on or after February 6, 1995, and for long-term residents who terminate their U.S. residency on or after February 6, 1995. Present law would continue to apply to persons who received a certificate of loss of nationality prior to February 6, 1995. However, the Administration proposal would apply to individuals who had performed acts of expatriation before February 6, 1995 (and, therefore, who had lost citizenship under the Immigration and Nationality Act), but who obtained a certificate of loss of nationality on or after February 6, 1995, because of the manner in which the Administration proposal redefines the date of relinquishment of citizenship for purposes of applying the tax on expatriation. It should be noted, however, that the Administration proposal does not change applicable Federal law controlling when the actual loss of U.S. citizenship occurs.

Senate amendment to H.R. 831

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. The Senate bill modified the Administration proposal in several ways. First, the Senate bill would apply 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 would modify 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 would make 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.