rules with the present-law alternative tax regime. Thus, it is unclear how the House bill would interact with the present-law alternative tax regime, and, if they both apply, how potential double taxation would be addressed. International law issues 571 570 Some have argued that under certain circumstances a mark-to-market tax upon citizenship relinquishment or residency termination might conflict with rights to emigrate or expatriate recognized by U.S. and international law. In addition, potential constitutional issues have been raised with respect to such a tax. The Joint Committee staff requested the CRS to review the constitutionality of the Clinton Budget proposal and the Rangel-Matsui bill (H.R. 3099), and whether these proposals comport with international law. As a general matter, according to the CRS, the possible application of a mark-to-market regime to those retroactively determination is made on a case-by-case basis that is based on the particular facts and circumstances. A former citizen generally would request competent authority assistance from the competent authority of his or her country of residence. The competent authorities may not reach agreement or even if agreement could be reached, the process can be time consuming (and, thus, costly) for the taxpayer. If the gain is attributable to U.S. sources, the foreign country may give a credit against its local tax for the U.S. tax paid. 570 For a discussion of these issues, see the 1995 Joint Committee staff study, supra note 315. The 1995 Joint Committee staff study pointed out that some observers have labeled prior mark-to-market proposals as "exit taxes" that may conflict with rights to emigrate or expatriate recognized under international law. The 1995 Joint Committee staff study stated that it is difficult to conclude that such proposals would be an arbitrary infringement under international law if the mark-to-market proposals are viewed as an attempt to neutralize the tax consequences that flow under U.S. tax laws from the decision to retain or renounce U.S. citizenship. 571 Id. The 1995 Joint Committee staff study described certain potential constitutional issues raised by prior mark-to-market proposals, such as whether the proposals violate the Constitution on the ground that the Sixteenth Amendment contains an implicit requirement that gains be realized before Federal income taxes are imposed, and whether other aspects of such proposals conflict with constitutional principles such as the due process clause of the Fifth Amendment. The 1995 Joint Committee staff study noted that judicial decisions and legal commentary represent a substantial line of authority for the position that the concept of realization is not constitutionally mandated, and that prior mark-to-market tax proposals generally would not appear to lead to a colorable constitutional challenge under the due process clause of the Fifth Amendment. However, it was also pointed out that there may be due process challenges as applied to particular factual settings, such as the case in which a beneficiary of a trust who has merely a contingent interest in the trust is deemed to have income under a mark-tomarket proposal. The study also describes other potential due process challenges that may arise under such proposals, such as the retroactive application of mark-to-market taxes on individuals who have long since relinquished their citizenship under law in effect prior to the enactment of such a regime. continued as U.S. citizens is an issue that is vulnerable to constitutional challenge. addressing these issues, the CRS stated the following: 572 [W]e believe that the [Clinton] Administration proposal calls for replacing We believe that the exit tax in the House proposal is supposed to be on top of the 574 With respect to international law considerations, the CRS stated that a non-confiscatory exit tax would not raise insurmountable international law concerns. However, the CRS concluded that to the extent that the mark-to-market tax is in addition to the present-law alternative tax regime (which may be the case with the House bill), the U.S. assertion of taxing jurisdiction will be seen as that much more outside international norms. 572 See A-63 (May 10, 2000, memorandum II from the CRS). 573 575 On the other hand, they can remain outside the tax system by never appearing before a government official to obtain a CLN. Estate and gift tax rules Under the mark-to-market proposals, the present-law estate and gift tax rules that apply generally to nonresident noncitizens would continue to apply. These individuals would continue to be subject to estate and gift tax on the transfer of U.S.-situated property. However, the Clinton Budget proposal and the Senate amendment would repeal the special estate and gift tax rules that apply to U.S. citizens and long-term residents who give up their U.S. citizenship or resident status with a principal purpose of avoiding U.S. tax. In addition to imposing a mark-to-market tax upon citizenship relinquishment or residency termination, the mark-to-market proposals would impose a second "inheritance type" tax on the property of a former citizen or former long-term resident that is transferred back to a U.S. person. While the proposals are similar, there are differences in scope and application. Under the Clinton Budget proposal and the Senate amendment, the second tax would be imposed on the receipt of property by a U.S. person from a former U.S. citizen or former long-term resident. Under the Clinton Budget proposal, if a former citizen or former long-term resident subsequently makes a gift or bequest to a U.S. person, the value of the property would be treated as "gross income" to the U.S. recipient, taxable at the highest marginal rate applicable to estates and gifts. Under the Senate amendment, the U.S. recipient of the property would include in gross income the value of the property received from the former citizen or former long-term resident (subject to certain exceptions and with no special provision for taxing the recipient at the highest marginal transfer tax rates). Under the House bill, the second tax would be imposed on the receipt of property by a U.S. person from any former U.S. citizen or former long-term resident that was subject to the mark-to-market regime upon citizenship relinquishment or residency termination. Under the proposal, if a former citizen or former long-term resident subsequently makes a gift or bequest to a U.S. person, the property would be subject to a new inheritance tax regime. Under this regime, the property received by a U.S. person would be subject to tax at the highest marginal rate applicable to estates and gifts. Under the mark-to-market proposals, property could be taxed twice - once, based on gain upon citizenship relinquishment or residency termination, and again, based on value upon receipt by a U.S. person. Under present law, property also may be taxed multiple times. For example, property sold at a gain may be subject to income tax at one point and, subsequently, may be subject to estate or gift tax on its entire value. However, applying a similar regime to former U.S. citizens and former long-term residents would be a departure from the present-law alternative tax regime. In some instances, property that is subject to both income and estate and gift tax could be taxed at combined rates significantly higher under the mark-to-market proposals than under present law. Enforcement of the present-law estate and gift tax rules for former citizens and former long-term residents during a 10-year period presents difficulties. However, the mark-to-market proposals, which would assess an estate and gift tax any time property flows back to a U.S. person from a former citizen or former long-term resident, would present enforcement problems of their own. For example, the new inheritance-type estate and gift tax would apply to property that flows back to a U.S. person at any time after citizenship relinquishment or residency termination. Moreover, it may be difficult to track whether a former U.S. citizen or former longterm resident made a gift or bequest of property for the benefit of a U.S. person. Immigration rules The Clinton Budget proposal and the Senate amendment would make certain modifications to the immigration rules with respect to former citizens.576 The proposals would eliminate the present-law requirement that the individual's citizenship relinquishment be taxmotivated before denying the former citizen reentry into the United States. The proposals also would coordinate the modified immigration provision with the new mark-to-market income tax rules described above and would deny former citizens reentry into the United States if they did not comply with their tax obligations under the mark-to-market regime. Some argue that this type of coordination between the immigration and tax rules would enhance enforcement and collection of the mark-to-market tax. They argue that the ability of former citizens to reenter the United States should be conditioned on satisfaction of their obligations (including tax obligations) upon leaving the United States. On the other hand, the original purpose of the present-law immigration provision was to prevent tax-motivated former citizens from reentering the United States. Thus, some may question the appropriateness of applying such a provision across the board for all former citizens regardless of motive. 576 These proposed modifications are not contained in the House bill. XI. JOINT COMMITTEE STAFF RECOMMENDATIONS The Joint Committee staff believes that the recommendations contained in this Part of the study will improve and rationalize the present-law rules relating to the tax and immigration treatment of citizenship relinquishment and residency termination. With respect to the present-law tax provisions, the Joint Committee staff believes that certain of the problems inherent in present law can be addressed through modifications that would provide: (1) objective standards for determining whether former citizens or former longterm residents are subject to the alternative tax regime; (2) tax-based (instead of immigrationbased) rules for determining when an individual is no longer a U.S. citizen or long-term resident for U.S. Federal tax purposes; (3) a sanction for individuals who are subject to the alternative tax regime and who return to the United States for extended periods; (4) imposition of U.S. gift tax on gifts of certain closely-held stock of foreign corporations that hold U.S.-situated property; and (5) an annual return-filing requirement for individuals who are subject to the alternative tax regime, for each of the 10 years following citizenship relinquishment or residency termination. The Joint Committee staff also believes that certain changes to the present-law immigration provisions are necessary to improve the administrability of the special immigration rule relating to tax avoidance. These changes would promote greater coordination and information-sharing between the IRS and the agencies responsible for the immigration laws and would resolve certain inconsistencies between the tax and immigration provisions of present law. Consistent with its mandate in connection with this study, the Joint Committee staff has focused on potential improvements to the operation of the present-law rules. Thus, the staff's recommendations are designed to fit within the basic framework of the present-law alternative tax regime, and to make this regime work as well as possible. The Joint Committee staff does not take a position as to more fundamental changes that might be considered, such as replacing the present-law alternative tax regime with a mark-to-market exit-tax system, or eliminating altogether the tax regime specific to former citizens and former long-term residents. 577 While the Joint Committee staff believes that its recommendations would improve the effectiveness and administration of the present-law rules, it should be noted that, even if the Congress were to enact the Joint Committee staff recommendations, tax incentives for citizenship relinquishment and residency termination would remain. An alternative tax regime that is limited to U.S.-source income and, in the case of the estate and gift taxes, to U.S.-situated assets (albeit with expanded definitions of such income and assets) cannot eliminate the tax incentives to relinquish citizenship or terminate residency in cases in which an individual owns significant foreign-situated property. Similarly, an alternative tax regime that applies for a 10year period following citizenship relinquishment or residency termination will not be effective with respect to individuals who are willing to wait the 10-year period prior to disposing of assets that would be subject to tax under the alternative tax regime. Perhaps most fundamentally, any 577 See Part X, above, for a discussion of alternative approaches to the tax treatment of former citizens and former long-term residents. |