INTRODUCTION

In the Fall of 1999, then-Chairman of the House Ways and Means Committee, Representative William Archer, requested the staff of the Joint Committee on Taxation (the "Joint Committee") to review the tax rules related to tax-motivated citizenship relinquishment and residency termination that were enacted as part of the Health Insurance Portability and Accountability Act of 1996, as well as related rules enacted in 1996 restricting visas for taxmotivated former citizens. In particular, Chairman Archer asked the Joint Committee staff to review whether those rules have been applied in the manner intended by the Congress and whether the rules have been effective in deterring tax-motivated citizenship relinquishment and residency termination. The Joint Committee staff also was asked to provide recommendations on ways to improve these rules.

The Joint Committee staff spent extensive time during 1999 and 2000 on its review of the present-law tax and immigration rules relating to citizenship relinquishment and residency termination. Chairman Archer retired in 2000 at the end of the 106th Congress. At that time, the Joint Committee staff had not completed its review. Due to more pressing work, the project was set aside. In 2002, Ranking Member of the House Ways and Means Committee, Representative Charles Rangel, and Representative James Moran, separately requested the Joint Committee staff to produce a report regarding these rules. The Joint Committee staff spent extensive time during 2002 and early 2003 updating and completing its review to reflect, among other things, changes in laws and administrative practices since 2000 that affected the present-law rules under review.

This review' includes several parts: Part I provides an executive summary of the Joint Committee staff's review and recommendations. Part II discusses recent legislative activity with respect to phase-down and repeal of the estate tax and the implications of such changes for this review. Part III describes the methodology of the Joint Committee staff's review. Part IV describes the relevant present-law tax rules, including the alternative tax regime applicable to certain former citizens and former residents. Part V describes the relevant present-law immigration rules, including the special immigration rules applicable to former citizens. Part VI describes the potential purposes of an alternative tax regime applicable to certain former citizens and former residents. Parts VII and VIII focus on the enforcement and effectiveness of the present-law tax rules relating to tax-motivated citizenship relinquishment and residency termination and the related immigration rules. Part IX provides a summary of other countries' special tax regimes and estate, gift and inheritance regimes. Part X describes recent proposals that involve a different approach (known as a "mark to market," or "exit tax" approach) from that of the present-law alternative tax regime. Part XI sets forth several Joint Committee staff recommendations to improve the present-law alternative tax regime and the related immigration

rules.

1 This document may be cited as follows: Joint Committee on Taxation, Review of the Present-Law Tax and Immigration Treatment of Relinquishment of Citizenship and Termination of Long-Term Residency, (JCS-2-03), February 2003.

Overview of tax law

In general

I. EXECUTIVE SUMMARY

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U.S. citizens and noncitizens who are U.S. residents generally are subject to U.S. tax on a worldwide basis for U.S. Federal income, estate, and gift tax purposes. On the other hand, noncitizens who are nonresidents generally are subject to U.S. tax only on income from U.S. sources and income effectively connected with the conduct of a trade or business within the United States. In addition, noncitizens who are nonresidents generally are subject to U.S. estate and gift tax only with respect to U.S.-situated property. Bilateral tax treaties may modify the treatment under these general tax rules.

Alternative tax regime for certain former citizens and former long-term residents

Since 1966, special tax rules have applied to a U.S. citizen who relinquishes U.S. citizenship with a principal purpose of avoiding U.S. taxes. These rules are referred to as the "alternative tax regime." Under the alternative tax regime enacted in 1966,3 a former citizen is subject to an alternative method of income taxation for 10 years following citizenship relinquishment. The alternative tax regime is a hybrid of the tax treatment of a U.S. citizen and a noncitizen who is a nonresident. For the 10-year period following citizenship relinquishment, the former citizen is subject to tax only on U.S.-source income at the rates applicable to U.S. citizens, rather than the rates applicable to noncitizens who are nonresidents. However, for this purpose, U.S.-source income has a broader scope than it does for normal U.S. Federal tax purposes and includes, for example, gain from the sale of U.S. corporate stock or debt obligations. The alternative tax regime applies only if it results in a higher U.S. tax liability than the liability that would result if the individual were taxed as a noncitizen who is a nonresident.

In addition, since 1966, the alternative tax regime has included special estate and gift tax rules. Under these rules, if a former citizen who is subject to the alternative tax regime dies within 10 years of citizenship relinquishment, his or her estate includes the value of certain closely-held foreign stock to the extent that the foreign corporation owns U.S.-situated property. In addition, under the alternative tax regime, the former citizen is subject to gift tax on gifts of U.S.-situated intangibles, such as U.S. stock, made during the 10 years following citizenship relinquishment.

2 The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA") repealed the estate tax for estates of decedents dying after December 31, 2009. However, the Act included a "sunset" provision, pursuant to which EGTRRA's provisions, including estate tax repeal, do not apply to estates of decedents dying after December 31, 2010.

3 The present-law alternative tax regime was first enacted as part of the Foreign Investors Tax Act of 1966, Pub. L. No. 89-809.

In 1996, several significant changes were made to the alternative tax regime. These amendments followed press reports and Congressional hearings indicating that a small number of very wealthy individuals had relinquished their U.S. citizenship to avoid U.S. income, estate, and gift taxes, while nevertheless maintaining significant contacts with the United States.

First, the 1996 amendments extended the application of the alternative tax regime to certain long-term residents who terminate their U.S. residency. Thus, under the 1996 amendments, the alternative tax regime applies both to U.S. citizens who relinquish citizenship and long-term residents who terminate residency with a principal purpose of avoiding U.S. taxes.

Under the 1996 amendments, a U.S. citizen who relinquishes citizenship or a long-term resident who terminates residency is treated as having done so with a principal purpose of tax avoidance (and, thus, generally is subject to the alternative tax regime) if: (1) the individual's average annual U.S. Federal income tax liability for the five taxable years preceding citizenship relinquishment or residency termination exceeds $100,000; or (2) the individual's net worth on the date of citizenship relinquishment or residency termination equals or exceeds $500,000. These amounts are adjusted annually for inflation. Certain categories of individuals can avoid being deemed to have a tax avoidance purpose for relinquishing citizenship or terminating residency by submitting a ruling request to the Internal Revenue Service ("IRS") regarding whether the individual relinquished citizenship or terminated residency principally for tax reasons. This ruling practice is detailed in Notice 97-19 and was modified in Notice 98-34.°

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The 1996 amendments provide for certain anti-abuse rules to prevent circumvention of the alternative tax regime through conversion of U.S.-source income or property to foreignsource income or property. In addition, the 1996 amendments extend the scope of the alternative tax regime by including foreign property acquired in nonrecognition transactions, taxing amounts earned by former citizens and former long-term residents through controlled foreign corporations, and suspending the 10-year liability period during any time at which a former citizen's or former long-term resident's risk of loss with respect to property subject to the alternative tax regime is substantially diminished, among other measures.

The 1996 amendments require individuals to provide certain tax information, including tax identification numbers, upon relinquishment of citizenship or termination of residency. The penalty for failure to provide the required tax information is the greater of $1,000 or five percent of the tax imposed under the alternative tax regime for the year. In addition, the U.S. Department of State ("Department of State") and other governmental agencies are required to provide this information to the IRS.

4

5

Health Insurance Portability and Accountability Act of 1996, Pub. L. No. 104-191.

The inflation-adjusted amounts are $122,000 and $608,000, respectively, for 2003. Rev. Proc. 2002-70, 2002-46 I.R.B. 845.

6

1997-1 C.B. 394 and 1998-2 C.B. 29. See A-166 and A-193.

Overview of immigration law

In general

For immigration purposes, a noncitizen seeking to enter the United States generally is required to present valid documentation, usually a visa and a passport. The Department of State and the Immigration and Naturalization Service (the “INS") form a “double check” system for entry into the United States. The Department of State grants visas, and the INS inspects persons upon arrival at a port of entry and determines whether they will be admitted into the country. There are many grounds on which a person can be denied entry or reentry, some of which can be waived. Even if such grounds cannot be waived, a person may be "paroled" (granted temporary admission) into the United States for emergency or humanitarian reasons.

Special immigration rule for U.S. citizens who renounce citizenship for tax reasons

In 1996, the Congress enacted a special immigration provision applicable to individuals who renounce their U.S. citizenship with the purpose of avoiding taxation. Under this provision, a former citizen is to be denied reentry into the United States if the Attorney General determines that the individual renounced his or her citizenship for the purpose of avoiding U.S. tax. The Attorney General has the authority to waive this prohibition with respect to nonimmigrants (i.e., individuals who do not want to establish permanent residence in the United States). This special provision does not apply to former long-term residents who terminate residence for tax reasons.

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Overview of Joint Committee staff review

The Joint Committee staff conducted an extensive review of the present-law alternative tax regime for certain former citizens and former long-term residents and the related immigration laws. This included a review of the relevant statutes and their legislative history, discussions with the Federal agencies responsible for enforcing these laws, research of articles and commentaries written on the subject of citizenship relinquishment or residency termination, an examination of individual tax return information, and discussions with practitioners who advise individuals wishing to relinquish citizenship or terminate residency."

To assist in this review, the Joint Committee staff requested that the General Accounting Office ("GAO") review the administrative practices of the U.S. Department of the Treasury ("Department of Treasury"), the IRS, the Department of State, and the INS in connection with the collection and processing of information about former citizens and former long-term

7

Illegal Immigration Reform and Immigrant Responsibility Act, Pub. L. No. 104-208, Division C, sec. 352(a), 110 Stat. 3009-641 (1996).

below.

8 Id.

9

For a description of the Joint Committee staff methodology for this review, see Part III.