Checkpoint Contents International Tax Library WG&L International Treatises Lowell, Martin, Donohue & Wells: U.S.

International Taxation: Agreements, Checklists & Commentary Part VI Individual Matters Chapter 21: International Trust and Estate Planning ¶21.05. International Estate Planning Considerations for U.S. Citizens

¶ 21.05 International Estate Planning Considerations for U.S. Citizens
A variety of international estate-planning considerations can be of relevance to U.S. citizens. A U.S. citizen is subject to U.S. estate and gift taxation on a worldwide basis, so that the location of assets in or transfer of assets to offshore locations, where the U.S. citizen retains or is deemed to retain control of the assets, generally does not alter the normal regime of U.S. tax provisions, which will include the assets in the U.S. transfer tax base. 248 Other considerations may, however, make the use of offshore arrangements beneficial in particular circumstances. Where a U.S. citizen contemplates becoming a resident in a foreign country, considerations similar to those previously noted regarding a nonresident emigrating to the United States to become a resident 249 may be appropriate. A U.S. citizen may also find that the transfer and income tax systems of the United States are burdensome and may consider renouncing U.S. citizenship and becoming a citizen of another country that may have a more attractive tax system. 250 In other situations, a U.S. citizen may be the beneficiary of a foreign trust created by other persons, related or unrelated. Tax base considerations have caused the U.S. Congress over the years to enact a variety of regimes in the tax law to deal with the expatriation of economic activity. Matters pertinent for international estate and gift tax planning relating to U.S. citizens are set out as Checklist 21-4.

Checklist 21-4. International Estate and Gift Tax Planning for U.S. Citizens
□ For a U.S. citizens considering establishing an offshore trust, but maintaining U.S. citizenship, determine the nature of the objectives with respect to U.S. estate and gift tax matters.
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Minimizing U.S. estate and gift taxation consequences of proposed transaction Determining any change in U.S. income tax treatment relating to assets to be included in the proposed trust arrangement Determining any desire for anonymity of existence of trust for U.S. tax purposes in light of tax return disclosure and information return requirements

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Establishing anonymity for U.S. tax and legal purposes Utilizing offshore trust or corporate structures already in place Utilizing offshore trust or corporate structures to be established Ascertaining whether there is an basis for concern in the planner or other advisor concerning fraudulent conveyances under applicable U.S. creditor rights laws

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Determining the nature of the property to be transferred to the trust

□ For U.S. citizens considering immigration from the United States (renunciation of citizenship) to become a citizen of a foreign country, determine the nature of the objectives with respect to U.S. estate and gift tax matters.
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Minimizing U.S. estate and gift taxation and the application of the 10-year provision in Section 2107 Minimizing U.S. income taxation and the application of the 10-year provision in Section 877 Minimizing estate and gift taxation in new home country Minimizing income taxation in new home country

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Avoiding international double or multiple estate and gift taxation Establishing anonymity for new home country tax and legal purposes Establishing anonymity for U.S. tax and legal purposes Utilizing offshore trust or corporate structures already in place Utilizing offshore trust or corporate structures to be established Ascertaining whether there is a basis for concern in the planner or other advisor concerning fraudulent conveyances under applicable U.S. creditor rights laws

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□ For U.S. citizens who are beneficiaries of a foreign trust created by other persons, determining the nature of the objectives with respect to U.S. taxation matters
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Minimizing U.S. income, estate and gift taxation consequences of the trust and distributions from it Understanding the U.S. income tax consequences of principal and income distributions from the trust Determining whether the trust could be considered a foreign grantor trust due to indirect or constructive transactions involving the beneficiary

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Determining the relevance to the beneficiary of the circumstances surrounding formation of the trust Determining whether there are any potential transferee liability issues for U.S. or foreign tax purposes Determining whether there are contributions to the trust by the beneficiary potentially beneficial with respect to tax or personal planning considerations

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Evaluating potential U.S. or foreign income tax planning considerations Determining whether renunciation or waiver of interest in the trust is beneficial from personal or tax planning perspectives Minimizing U.S. gift or estate tax consequences of transfer of interests in the trust

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¶ 21.05[1] Applicable Provisions of the Code
The Code contains several provisions intended to limit the U.S. tax benefits that a U.S. citizen can derive from moving income or assets offshore. The normal provisions of the Code are also equally applicable.

¶ 21.05[1][a] Section 679
Section 679 provides that any U.S. person who transfers property to a foreign trust that has a U.S. beneficiary is treated as the owner of the portion of the trust that is attributable to the property transferred by the U.S. person. 251 In 2001, the Service issued final Regulations relating to the circumstances in which a foreign trust will be deemed to have U.S. beneficiaries under Section 679. 252 In order to avoid having U.S. beneficiaries, the trust instrument would, in effect, need to provide that no U.S. person may ever be an actual or potential beneficiary, or even a potential appointee or a member of a class of beneficiaries, and that the trust instrument cannot be amended to include such persons. 253 The Regulations also address the consequences of changes in the status of a beneficiary, 254 indirect beneficiaries, 255 indirect transfers of property to a foreign trust where a principal purpose of the transfer is the avoidance of U.S. tax, 256 and constructive transfers via assumption of trust obligations or otherwise. 257 Congress significantly expanded the provisions relating to foreign trusts in 1997 with the addition of Section 684, which provides that the transfer of property by a U.S. person 258 to a foreign trust or estate will be treated as a sale or exchange of such property for an amount “equal to the fair market value of the property transferred.” 259

¶ 21.05[1][b] Section 1491
Prior to its repeal, Section 1491 imposed a nondeductible excise tax on transfers of appreciated property by U.S. citizens or residents to foreign trusts, as well on some other transfers. 260 The amount of such excise tax was equal to 35 percent of the excess of the fair market value of the property transferred over the sum of the adjusted basis of such property in the hands of the transferor plus the

amount of the gain recognized to the transferor at the time of the transfer. 261 Any such excise tax was due and payable by the transferor at the time of the transfer, and was to be assessed, collected, and paid as provided in Regulations. The Regulations provide, among other things, that every person making a transfer to a foreign trust shall file a return on the day on which the transfer is made and pay the tax due on the transfer. 262 Because of the adverse impact of the excise tax in former Section 1491, transfers to foreign trusts were typically structured as cash transactions, unless there was little or no inherent gain in the assets transferred. The excise tax was not applicable if, at the time of transfer, the foreign trust was a grantor trust, because the grantor was deemed for U.S. tax purposes to continue to own the property.
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In circumstances where a domestic trust became a foreign trust—for example, on the failure of a domestic trust under prior law to satisfy the conditions of the 1996 legislation 264 —the Service stated that former Section 1491 applied, including the reporting obligations of former Section 1494. 265

¶ 21.05[1][c] Section 367
In the case of transfers to foreign corporations, sometimes structured as holding companies, Section 367(a) generally provides that if, in connection with any exchange described in certain of the corporate provisions of the Code, 266 a U.S. person transfers property to a foreign corporation, the foreign corporation will not be treated as a “corporation” for purposes of determining the extent to which gain or loss is recognized on such transfer. The purpose of Section 367(a) is a tax base protection mechanism, which is intended to ensure that the inherent gain in assets transferred offshore is taxed unless one of the exceptions in the statute or Regulations is satisfied. There are two principal exceptions. One is for the transfer of property to be used in the active conduct of a trade or business by the foreign corporate transferee. 267 This exception does not apply to certain types of property, 268 but is not likely to be pertinent in the estate-planning context. A second exception applies if the ownership of the U.S. transferor in the foreign transferee is less than 50 percent and the transferor executes a so-called gain recognition agreement, unless the ownership is less than 5 percent. 269

¶ 21.05[1][d] Section 877
The Code also contains a provision to protect the U.S. income tax base from erosion by citizens who expatriate in order to avoid the U.S. tax base. 270 The purpose of Section 877 is protection of the U.S. income tax base through imposition of U.S. tax on U.S. citizens or certain long-term residents who expatriate from the United States. In its pre-1995 form, Section 877(a) was largely a toothless tiger, because it imposed upon the Service an obligation to prove that an expatriation was undertaken for the principal purpose of avoiding U.S. tax. For post-February 6, 1995, expatriations, however, the situation is reversed. Section 877(a) subjects certain individuals to an expatriation tax without inquiry as their motive for losing their citizenship or residency, but allows certain categories of persons to demonstrate to the Service, through a ruling process. 271

¶ 21.05[1][e] Section 6048
Where a U.S. citizen or resident creates or transfers money or property to a foreign trust, there is an information return requirement.
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On or before the 90th day (or such later day as prescribed in Regulations), after any reportable event, the responsible party shall

provide written notice of such event to the Service. 273 The notice shall include 1. The amount of money or other property transferred to the trust in connection with the reportable event; and 2. The identity of the trust and of each trustee and beneficiary (or class of beneficiaries) of the trust. 274 The term “reportable event” includes the following: 275 1. The creation of any foreign trust by a U.S. person; 2. The transfer of any money or property (directly or indirectly) to a foreign trust by a U.S. person, including a transfer by reason of death (other than a transfer of property to a trust in exchange for consideration of at least the fair market value of the transferred property); and

3. The death of a citizen or resident of the United States if
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The decedent was treated as the owner of any portion of a foreign trust under the grantor trust provisions (Sections 671 through 679); or

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Any portion of a foreign trust was included in the gross estate of the decedent.

The reporting requirements do not apply to deferred compensation or charitable trusts. 276 The term “responsible party” means 1. The grantor in the case of the creation of an inter vivos trust; 2. The transferor in the case of money or property to a foreign trust other than a transfer by reason of death; and 3. The executor of the decedent's estate in any other case. 277 Where there is a U.S. person who is treated as the grantor of a foreign trust under Sections 671 through 679, such U.S. person is responsible for ensuring the following: 1. Filing a return which sets forth a full and complete accounting of all trust activities and operations for the year, the name of the U.S. agent for such trust, and such other information as the Service may prescribe; and 2. Such information as required by Regulations to each U.S. person who is treated as the owner of any portion of such trust or who receives (directly or indirectly) any distribution from the trust. 278 In the case of a foreign trust that does not have a U.S. agent, the Service is granted authority to determine the amounts required to be taken into account with respect to such trust by U.S. persons for U.S. tax purposes, 279 unless such trust agrees to authorize a U.S. person to act as such trust's agent with respect to request or summons by the Service to examine records or produce testimony relating to the proper amounts required to be taken into by U.S. persons with respect to such trust. 280 In addition to reporting by the transferor, or deemed grantor, of a foreign trust, there is also a reporting obligation by beneficiaries. A U.S. person who receives (directly or indirectly) any distribution from a foreign trust must make a return with respect to such trust for such year that includes: 1. The name of such trust; 2. The aggregate amount of the distributions so received from such trust during such taxable year; and 3. Such other information as the Secretary may prescribe. 281 If adequate records are not provided to enable the Service to determine the proper treatment of any distribution from a foreign trust, such distribution shall be treated as an accumulation distribution. 282 For purposes of these reporting requirements, a trust that is a U.S. person is treated as a foreign trust for purposes of the reporting requirements in Section 6048 if such trust has substantial activities, or holds substantial property, outside the United States. 283 In addition, any U.S. person (other than certain tax-exempt organizations) who receives purported gifts or bequests from foreign sources totaling more than $10,000 during the taxable year must report them to the Service. 284 The threshold for this reporting requirement is indexed for inflation. If the U.S. person fails, without reasonable cause, to report foreign gifts as required, the Service is authorized to determine the tax treatment of the unreported gifts. 285 In addition, the U.S. person is subject to a penalty equal to 5 percent of the amount of the gift for each month that the failure continues, with the total penalty not to exceed 25 percent of such amount. 286

¶ 21.05[2] Offshore Protection of Asset Trusts
One type of arrangement that is useful in a variety of circumstances is an offshore trust that is designed to protect assets from the claims of future creditors. One of the essential traditional functions of all trust arrangements is to protect, conserve, and invest trust

assets.

Illustration 21-13
The situation is the same as in Illustration 21-3, 287 where John Forto is a U.S. citizen who has accumulated a significant net worth through his ownership of the stock of USCo, a U.S. corporation. USCo is in the business of manufacturing optical devices. One of these devices has been evolved into a line of cameras with the trade name Super Camera. The Super Camera has become the runaway best-selling camera in the world. Mr. Forto has accumulated a significant estate, and is concerned that some, presently unforeseen and unknown, claimant could sue him in the U.S. courts for an amount that would put his entire net worth in jeopardy. He desires to hold at least a portion of his net worth in an environment that is as safe from any such creditors as possible. In this type of situation, a foreign trust may provide the safest means of structuring the ownership of assets so that the claims of future creditors cannot reach the assets. Such uses of trusts have received significant publicity over the years, including the attention of U.S. courts in actions seeking recovery of assets placed in offshore trusts. 288 It may also be beneficial in some circumstances to consider the use of offshore partnerships or limited liability companies. 289

¶ 21.05[2][a] Typical Transaction
If Mr. Forto decided to form such a trust, the transaction could be along the following lines. Mr. Forto, and his spouse if appropriate, could transfer certain assets to an offshore financial institution as trustee of an irrevocable trust organized under the laws of the offshore country. While Mr. Forto and his spouse are both living, the trustee will have discretion to distribute income and/or principal to them for their health, support, and maintenance in their accustomed manner of living. The trustee may also distribute net income and/or principal to them for any other purpose, including for their welfare, comfort, happiness, and entrepreneurial ventures or investments. The trustee is also permitted to distribute income and/or principal of the irrevocable trust to any of the Forto children to provide for their health, support, maintenance, and education. Upon the death of either Mr. or Mrs. Forto, the portion of the irrevocable trust attributable to assets contributed to the trust by the deceased spouse will be distributed to a marital trust for the benefit of the surviving spouse (reduced by amounts distributed pursuant to the exercise of a special power of appointment by the deceased spouse). The remaining irrevocable trust assets will be retained by the trustee. The trustee is authorized to distribute income and/or principal to the surviving spouse for his or her health, support, and maintenance in his or her accustomed manner of living, or for any other purpose, including his or her welfare, comfort, happiness, and entrepreneurial ventures or investments. The trustee may also distribute income and/or principal of the irrevocable trust to any of the children to provide for their health, support, maintenance and education. Upon the death of the surviving spouse, the remaining assets in the irrevocable trust and the marital trust are to be distributed to the children or their descendants, or, if none of the children nor their descendants are living upon the death of the surviving spouse, to a contingent remainder beneficiary. The trustee is empowered to terminate the irrevocable trust at any time in its sole discretion. A committee (the protector) created by the trust agreement may have the same power. Upon such termination, all assets of the irrevocable trust are to be distributed to Mr. or Mrs. Forto, if then living (or to the survivor if only one is then living), or, if neither is then living, to the primary beneficiary of the irrevocable trust.

¶ 21.05[2][b] U.S. Tax Consequences
A trust is generally treated as a separate taxable entity and is taxed on its net income. If, however, the grantor or another person is regarded as the owner of any portion of a trust, such grantor or other person must include, in computing taxable income and credit, those items of income, deduction, and credit of the trust that are attributable to the portion of the trust owned by the grantor or other person. 290 Sections 673 through 677 of the Code, the so-called grantor trust rules, determine when trust income is to be taxed to the grantor.

Section 672 provides definitions and special rules. Many of the grantor trust provisions hinge on whether certain rights are exercisable by the grantor or a “nonadverse” party or are exercisable without the consent of an “adverse” party. A nonadverse party is defined as any person who is not an adverse party. 291 The term “adverse party” is defined as any person having a substantial beneficial interest in the trust that would be adversely affected by the exercise or nonexercise of the power that he possesses respecting the trust. 292 A trustee is not an adverse party merely because of his interest as trustee. 293 Accordingly, notwithstanding that the trustee is an unrelated party to the settlors, Mr. and Mrs. Forto in Illustration 21-13, the trustee will not be an adverse party for purposes of Section 672, but will be treated as a nonadverse party. Section 672(e) provides that a grantor will be treated as holding any power or interest held by his or her spouse if, at the time of the creation of such power or interest, the spouse is living with the grantor. Accordingly, any reference herein to a power held by the grantor will also refer to a power held by his or her spouse. Sections 673 through 677 provide that the grantor or another person will be taxed on income of a trust under the following circumstances: 1. If the grantor has retained a reversionary interest in the trust corpus or income with a value greater than 5 percent of the value of the trust; 294 2. If the grantor or a nonadverse party has certain powers over the beneficial interest under the trust; 295 3. If certain administrative powers over the trust exist under which the grantor can or does benefit; 296 4. If the grantor or a nonadverse party has a power to revoke the trust or return the corpus to the grantor; 297 or 5. If the grantor or a nonadverse party has the power to distribute income to or for the benefit of the grantor or the grantor's spouse.
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In the situation in Illustration 21-13, the settlors (Mr. and Mrs. Forto) will not retain a reversionary interest within the meaning of Section 673(assuming the value of the reversionary interest upon termination of the trust in the discretion of the trustee is equal to or less than 5 percent of the value of the trust), nor will they possess any administrative power over the trust within the meaning of Section 675. Further, it appears that the powers of the trustee to control the beneficial enjoyment of the trust income and corpus should not cause Mr. Forto to be treated as the owner of the trust under Section 674. It appears, however, that the trust may be treated as a grantor trust under Section 676 or Section 677. In any event, the transfer of property to the trust should also come within the provisions of Section 679, pursuant to which the grantor will be treated as the owner of the trust for U.S. tax purposes.

¶ 21.05[2][b][i] Power to control beneficial enjoyment—Section 674.
Section 674 provides that the income of a trust will be taxable to the grantor if the grantor or a nonadverse party or both can exercise a power of disposition over the beneficial enjoyment of the trust income or corpus. Section 674(b) sets forth certain exceptions to the general rule. One is that a power to distribute corpus to or for beneficiaries (whether or not income beneficiaries) will not cause the grantor to be taxed on the trust income if the power to distribute is limited by a reasonably definite standard that is set forth in the trust instrument. 299 Section 674(c) provides, however, that the power to distribute, apportion, or accumulate income or to pay out corpus will not be a proscribed power if such power is exercisable, without the consent of any other person, by an independent trustee—that is, if the grantor is not a trustee and no more than half of the trustees are related or subordinate parties who are subservient to the wishes of the grantor, as defined in Section 672(c). Accordingly, the power of the trustee to distribute irrevocable trust corpus to Mr. or Mrs. Forto for their “health, support, and maintenance in [their] accustomed manner of living” or to the children for their “health, support, maintenance, and education” should be treated as being subject to a reasonably definite standard and not a proscribed power under Section 674. The power of the Trustee to distribute Trust corpus to Mr. or Mrs. Forto “for any other purpose including, without limitation, distributions for [their] welfare, comfort, happiness, and entrepreneurial ventures or investments,” however, will likely not be treated as

limited by a reasonably definite standard. However, because such power is exercisable solely by the trustee, who is not a related party nor a subordinate party who is subservient to the wishes of the grantor, such power of the trustee should not cause Mr. and Mrs. Forto to be treated as the owners of the trust pursuant to Section 674.

¶ 21.05[2][b][ii] Revocable trusts—Section 676.
Under Section 676, the grantor of a trust will be treated as the owner of a portion of a trust if the grantor or a nonadverse party has the power, without the consent of an adverse party, to revest title to such portion in the grantor. If the grantor or a nonadverse party has such a power, the grantor will be treated as the owner whether the power is a power to revoke, to terminate, to alter, or amend. 300 The trustee, a nonadverse party, has the power, in its absolute discretion, to terminate the irrevocable trust at any time, upon which termination the trust assets will be distributed to Mr. or Mrs. Forto if they are then living. Accordingly, Mr. and Mrs. ForTo should be treated as the owners of the irrevocable trust under Section 676. To the extent that a committee is composed of only nonadverse parties, the same would be true with respect to the power of the committee to terminate the irrevocable trust.

¶ 21.05[2][b][iii] Income for benefit of grantor—Section 677.
Section 677(a) provides that income from a trust will be taxable to the grantor when the income is or may be (in the discretion of the grantor, the grantor's spouse, or a nonadverse party) (1) distributed to the grantor, (2) held or accumulated for future distribution to the grantor, or (3) applied to payment of premiums on insurance on the life of the grantor (except policies irrevocably payable to charities). The grantor is taxed as the owner of the trust whether or not the grantor or the grantor's spouse actually receives any distributions from the trust. The mere possibility of such distributions or accumulations is sufficient to trigger Section 677. Further, if income of a trust may be used to any extent in satisfaction of the parental obligations of the grantor, if the discretion to so use the income is not in the grantor or his spouse, acting as such, but in another person, the trustee, or in the grantor acting as trustee or cotrustee, such income will be includable in the grantor's gross income to the extent it is actually so used. 301 The trustee is given broad discretionary authority to distribute or accumulate income of the irrevocable trust. Further, in the discretion of the trustee, such income may be distributed to Mr. or Mrs. Forto. Accordingly, the income of the irrevocable trust should also be taxable to Mr. or Mrs. Forto under Section 677.

¶ 21.05[2][b][iv] Foreign trusts with U.S. beneficiary—Section 679.
As noted above, Section 679 provides that any U.S. person who transfers property to a foreign trust that has a U.S. beneficiary is treated as the owner of the portion of the trust that is attributable to the property transferred by the U.S. person. Accordingly, the trust income attributable to such property is taxable to the transferor under the “grantor trust” rules. Several elements are pertinent in order for Section 679 to apply: 1. The transferor must be a U.S. person. A U.S. person includes a citizen or resident, domestic partnerships, domestic corporations, and estates or trust that are not foreign estates or trusts. 302 2. Property must be transferred to the trust by the U.S. person. Indirect, as well as direct, transfers are covered. 303 3. The trust must be a foreign trust. Although Section 679 does not expressly refer to Section 7701(a)(31), such provision will presumably apply to define the term “foreign trust.” 304 4. The trust must have a U.S. beneficiary. In general, if a U.S. person transfers property to a foreign trust, the trust is presumed to have a U.S. beneficiary for the taxable year unless (1) under the terms of the trust, no part of the income or corpus of the trust may be paid or accumulated during the taxable year to or for the benefit of a U.S. person, and (2) if the trust is terminated at any time during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of a U.S. person. 305 5. There are also several exceptions to the application of Section 679:
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A transfer by reason of the death of the transferor. 306

In Revenue Ruling 87-61, 307 the Service ruled that a transfer of appreciated property to a foreign trust by a U.S. citizen with respect to which the transferor would be treated as the owner of the trust within the meaning of Section 671 was not treated as a transfer to a foreign trust for purposes of Section 1491 because the grantor continued as the owner of the property for federal income tax purposes. The grantor was not treated as having transferred the property for purposes of Section 1491 until the grantor renounced the powers previously retained that had caused him to be treated as the owner for purposes of section 671. If the rationale of Revenue Ruling 87-61 were applied to Section 679, a grantor treated as the owner of a trust under Section 671 would not be treated as the owner under Section 679, but if he were not treated as the owner under Section 671 he would be so treated under Section 679. Although this reasoning appears circuitous, the bottom line is that the grantor of property to a foreign trust meeting all of the requirements of Section 679, as well as qualifying as a “grantor trust” under Sections 671 through 677, should be treated as the owner of the trust under either Section 671 or Section 679.
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A transfer of property to a trust in exchange for consideration of at least the fair market value of the transferred property. 308 Consideration other than cash is taken into account at its fair market value for this purpose, any obligation of the trust, 309 any grantor or beneficiary of the trust, and any person related to any grantor or beneficiary of the trust, obligation or guaranteed by such person, will not be taken into account, except as provided in Regulations. 310 Principal payments by the trust on any such obligation referred will be taken into account in determining the portion of the trust attributable to the property transferred. 311

6. If a domestic trust is formed by a citizen or resident, and such trust becomes a foreign trust while such individual is alive, then the trust shall become subject to Section 679 as if such individual transferred to the trust on the date it became a foreign trust an amount equal to the portion of such trust attributable to the property previously transferred by such individual to the trust. 312 7. Where a foreign person is treated as the owner of any portion of a trust, and such trust has a beneficiary who is a U.S. person, such beneficiary will be treated as the grantor of such portion to the extent that the beneficiary has made a direct or indirect transfer of property (other than in sale for full and adequate consideration) to such foreign person. 313 If a transferee receives a transfer from a foreign corporation or partnership and treats such transfer as a gift or bequest for U.S. tax purposes, the Service may recharacterize such transfer as is determined necessary to prevent the avoidance of Section 672(f). 314 8. The Service has specific authority to prescribe such Regulations as may be necessary or appropriate to carry out the purposes of Section 679. 315 Accordingly, to the extent the transfer of assets by Mr. and Mrs. Forto in Illustration 21-13 is treated as a transfer to a foreign trust, they will be treated as the owner of the portion of the irrevocable trust attributable to such transfer.

¶ 21.05[2][b][v] Transfer of property to a foreign trust.
When a U.S. person 316 transfers property to a foreign trust or estate before January 1, 2010, Section 684(a) generally provides that the transfer will be treated as a sale or exchange of the property for an amount equal to the fair market value of property transferred, and the transferor will recognize gain (but not loss) equal to the excess of the fair market value of the property over its adjusted basis in the hands of the transferor. 317 Section 684(a) is inapplicable to a transfer to a grantor trust as defined in Section 671, including the foreign grantor trust provisions of Section 679. 318 If a domestic trust becomes a foreign trust, the trust is treated as having transferred its assets to a foreign trust immediately before it becomes a foreign trust. 319 Regulations under Section 684 address indirect or constructive transfers to foreign trusts. 320

¶ 21.05[2][c] Transfers of Property Subject to Section 1491
Prior to the repeal of Section 1491, in a transfer of assets to a foreign trust, a 35 percent excise tax potentially applied. 321 Cash and nonappreciated property were obviously not subject to Section 1491, because there was no spread between basis and fair market value. 322 In Revenue Ruling 87-61, 323 the Service discussed whether a trust was to be treated as a foreign trust under Section 7701(a)(31)

(which defines “foreign trust” as a trust whose foreign-source income is not includable in gross income). 324 Such trust was established in, and was administered under, the laws of a foreign country, and the trustee was a foreign entity. Further, the trust corpus was located in the foreign country. Based on those facts, the Service ruled that the trust was a foreign trust. In Revenue Ruling 69-450, 325 the Service ruled that the transfer of appreciated stock to a Bermuda banking corporation as trustee of a Bermuda trust was a transfer subject to the excise tax of Section 1491 even though the grantor was treated as the owner of the entire trust under Sections 671 through 677. Such ruling was revoked by Revenue Ruling 87-61, in which the Service reasoned that because a grantor who was treated as the owner of an entire trust is considered to continue to own the trust assets, a transfer of property to a foreign “grantor trust” was not a transfer subject to the excise tax imposed by Section 1491. However, the grantor will be treated as having transferred property to the foreign grantor trust at the time the grantor ceases to be the owner of the trust. Thus, when the grantor renounces the powers previously retained that causes him to be treated as the owner of the trust corpus, or upon the expiration or lapse of such powers, the grantor will be treated as having made a transfer that was subject to the excise tax imposed by Section 1491 of the Codeand to the reporting requirements of Section 1494 and Regulations thereunder.

¶ 21.05[2][d] Other U.S. Tax Consequences
Where the grantor trust rules do not apply to a foreign trust, its U.S. beneficiaries generally are taxable on their respective shares of the income of the trust that is required to be distributed, as well as any other income of the trust that is paid, credited or distributed to them. 326 Distributions from a trust in excess of the trust's distributable net income for the taxable year generally are treated as “accumulation distribution” rules. Under these rules, a distribution by a foreign trust of previously accumulated income is generally taxed at the beneficiary's average top marginal rate for the prior five years, plus interest. 327 Interest is computed at a fixed annual rate of 6 percent, with no compounding. 328 If adequate records of the trust are not available to determine the proper application of the rules relating to accumulation distributions to any distribution from a trust, the distribution is treated as an accumulation distribution out of income earned during the first year of the trust. 329 The tax consequences of the use of trust assets by beneficiaries are somewhat uncertain under present law. 330 Any U.S. person who creates a foreign trust or transfers money or property to a foreign trust is required to report that event to the Service on IRS Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, which is set out in Figure 21-1. 331 The form requires reporting of, among other things, the name, address, and identification number (if any) of the transferor, the trust, the fiduciary and trust beneficiaries; the interest of each beneficiary; the location of the trust records; and the value of each item transferred. Any person who fails to file a required report of the creation of or transfer to a foreign trust may be subjected to a penalty of 5 percent of the amount transferred to the foreign trust. 332 Similarly, any person who fails to file a required annual report with respect to a foreign trust with U.S. beneficiaries (on IRS Form 3520-A, Annual Return of Foreign Trust With a U.S. Owner; see Figure 21-2) may be subjected to a penalty of 5 percent of the value of the corpus of the trust at the close of the taxable year. The maximum amount of the penalty imposed under either case may not exceed $1,000. A reasonable cause exception is available. These civil penalties are determined separately from any applicable criminal penalties. The formation of such a foreign trust may also require “checking the box” on the grantor's U.S. income tax return and satisfying the pertinent disclosure requirements with respect to offshore bank accounts and trusts. 333 A common means of structuring offshore trusts, for both U.S. and foreign persons, is the use of corporate trustees with an individual or, in some situations, corporate “protector” to direct the trustee in the exercise of discretion, as in Form 21.01. Interestingly, the Service has stated that a U.S. person who is both protector and a potential beneficiary of such a trust is a U.S. shareholder for purposes of applying the controlled foreign corporation provisions in subpart F of the Code (Section 951 through Section 959), 334 even though the trust is not a grantor trust as relates to such U.S. person. 335

¶ 21.05[2][e] Creditor Rights Issues
The use of offshore trusts for the purpose of protecting assets from the claims of future creditors can raise difficult fraudulent transfer

issues under pertinent U.S. law for the grantor, as well as the grantor's advisors, if there are existing creditors whose interests are adversely affected by the transfer. 336

¶ 21.05[2][f] Documentation of Foreign Trust
In order to form an offshore trust on behalf of a U.S. citizen, a variety of documents must be prepared. A form of offshore trust agreement that would be appropriate to be adapted in the circumstances of Illustration 21-13 337 is set out as Form 21.02. The transfer of property to a foreign trust must also be reported on a return of the transferor, 338 information return with respect to the formation of a foreign trust (filed by the person directly or indirectly creating the trust or transferring assets to it), 339 as well as an annual return of a foreign trust with U.S. beneficiaries (also filed by the person directly or indirectly creating the trust or transferring assets to it). 340

¶ 21.05[3] Expatriation of U.S. Citizens
An interesting range of U.S. tax issues develop when a U.S. citizen determines, for one reason or another, to renounce U.S. citizenship and residence, so that the U.S. transfer tax laws would no longer be applicable, assuming that after expatriation the former citizen, now a nonresident, had no assets that would be subject to U.S. estate or gift tax. 341

Figure 21-1. Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts—IRS Form 3520 Figure 21-2. Annual Return of Foreign Trust with a U.S. Owner—IRS Form 3520-A
An often-cited reason a U.S. citizen may desire to renounce U.S. citizenship concerns avoiding the U.S. tax system. 342 But there are any number of other reasons as well.

Illustration 21-14
The situation is the same as in Illustration 21-3, 343 where John Forto is a U.S. citizen who has accumulated a significant net worth through his ownership of the stock of USCo, a U.S. corporation. USCo manufactures optical devices, one of which has been evolved into a line of cameras with the trade name Super Camera. The Super Camera has become the runaway best-selling camera in the world. The manufacturing facilities are located in Foronia, which has provided USCo with an extremely beneficial incentive package. The business in Foronia has expanded and Mr. Forto is contemplating moving his family to Foronia to concentrate on the worldwide development of this business without having to make the arduous trips to Foronia, located on the other side of the world. One of the elements of the incentive package provided by Foronia is a complete tax amnesty for income, estate, gift, and other taxes in Foronia for Mr. Forto and his family if they became citizens of Foronia. Mr. Forto's family has tired of his long absence from their home in the United States and have decided to move to Foronia. Mr. Forto also desires to take advantage of the tax amnesty. In this illustration, Mr. Forto needs to carefully address the U.S. tax consequences of a relinquishment of his U.S. citizenship, as well as the practical difficulties that may occur in the future if the political situation in Foronia were to deteriorate. Checklist 21-5 itemizes issues concerning U.S. citizens considering expatriation.

Checklist 21-5. Preemigration Planning for U.S. Citizens
□ Determine the country in which the current U.S. citizen desires to seek citizenship and consider the requirements of acquiring in citizenship in such country. □ Determine the country in which the current U.S. citizen desires to seek residency and consider the requirements of acquiring residence in such country.

□ Does the United States have an estate and gift tax treaty with the potential foreign country of citizenship or residency?
q

If so, review the pertinent terms.

□ Determine the objectives of the person planning to emigrate.
q

Minimizing U.S. estate and gift taxation and the application of the 10-year provision in Section 2107 Minimizing U.S. income taxation and the application of the 10-year provision in Section 877 Minimizing estate and gift taxation in new country of citizenship or residence Minimizing income taxation in new country of citizenship or residence Avoiding international double or multiple estate and gift taxation Establishing anonymity for new home country tax and legal purposes Establishing anonymity for U.S. tax and legal purposes Utilizing offshore trust or corporate structures already in place Utilizing offshore trust or corporate structures to be established

q

q

q

q

q

q

q

q

□ Ascertain whether the planner or other advisor should be concerned about fraudulent conveyances under applicable U.S. creditor rights laws. □ Consider the U.S. income tax impact of the expatriation provisions in Section 877.
q

Potential income tax impact Possible deferring of the tax's impact Possible offsetting of losses on other deductions Consequences of any existing trusts. Planning for controlled foreign corporations.

q

q

q

q

¶ 21.05[3][a] Income Tax Considerations
Under the pre-1996 provisions of the Code, the principal U.S. income tax issue posed by expatriation was avoidance of the relatively weak provisions of Section 877, which could cause an expatriate to be subject to U.S. income tax for a period of 10 years if the principal purpose of the expatriation was avoidance of U.S. income tax. 344 The U.S. estate and gift tax concern in renouncing U.S. citizenship was whether the movement would be subject to the limited U.S. tax base defense provisions, contained in Section 2107 for transfer tax purposes. 345 As noted previously, Section 2107 provides special estate tax rules applicable to expatriates who lose U.S. citizenship within 10 years of death unless such loss “did not have for one of its principal purposes the avoidance of [estate, gift, GST, or income] taxes.” 346 The U.S. Congress became concerned about the ability of U.S. citizens to expatriate by renouncing their U.S. citizenship and becoming citizens in a country with a more favorable tax environment. The essential concern was defense of the tax base of the United States. The round of concern with respect to expatriation that resulted in legislation was triggered by the 1996 U.S. budget proposals of the Clinton Administration. 347 The Clinton Administration proposals were included in bills introduced in both houses of the U.S. Congress. 348 The proposals attracted a veritable flood of harsh criticism from commentators, including respected bar groups. 349 An intense political debate in Congress 350 included hearings held by both tax writing Committees 351 and the introduction of alternate proposals. 352 The expatriation provisions of the Code were dramatically changed by the Health Insurance Portability and Accountability Act of 1996.
353

The purpose of the new provisions was to prevent U.S. tax base erosion from the expatriation of U.S. citizens and certain long-term

residents. Specifically, the legislative history notes that some very wealthy individuals each year relinquish their U.S. citizenship for the purpose of avoiding U.S. income, estate, and gift tax. The legislative history also recognizes that citizens of the United States clearly have a basic right under both U.S. and international law not only to leave the United States to live elsewhere, but also to relinquish their U.S. citizenship. The Committee does not believe that the Internal Revenue Code should be used

to stop U.S. citizens or residents from expatriating; however, the Committee also does not believe that the Code should provide a tax incentive for expatriating. 354

¶ 21.05[3][b] Income Taxation of Expatriates—Section 877
The purpose of Section 877 is protection of the U.S. income tax base through imposition of U.S. tax on U.S. citizens or certain longterm residents who expatriate from the United States. In its pre-1995 form, Section 877(a) was largely a toothless tiger, because it imposed upon the Service an obligation to prove that an expatriation was undertaken for the principal purpose of avoiding U.S. tax. 355 tax.TM For expatriations after February 6, 1995, however, the situation is reversed. Section 877(a) subjects certain individuals to an expatriation tax without inquiry as their motive for losing their citizenship or residency, but allows certain categories of persons to demonstrate to the Service, through a ruling process. The provisions of Section 877 do not provide any exclusion for assets or income acquired before the 10-year period, as in the case of residents who expatriate, 356 or for property or income received via gift within the 10-year period. 357

¶ 21.05[3][b][i] General application.
In general, Section 877(a) now provides in general that every nonresident who, within the 10-year period immediately preceding the close of the taxable year, lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of U.S. income taxes, 358 shall be taxable for such taxable year in the manner provided in Section 877(b) if the tax imposed thereunder exceeds the tax that would otherwise be applicable under Section 871. 359 For this purpose, an individual is treated as having a principal purpose to avoid such taxes if 1. The average annual net income tax of such individual for the period of five taxable years ending before the date of the loss of U.S. citizenship is greater than $100,000; or 2. The net worth of the individual as of such date is $500,000 or more. In the case of the loss of U.S. citizenship in any calendar year after 1996, such $100,000 and $500,000 amounts shall be increased by cost-of-living adjustment. 360 This subjective tax standard was eliminated in 2004 361 in favor of specific rules for determining the date of expatriation. In addition, the scope of taxation of certain expatriates maintaining significant contacts with the United States was expanded and new reporting requirements were imposed. The expatriation provisions were further revised in 2008 in the Heroes Earnings Assistance and Relief Tax Act of 2008 (the HEART Act). 362 These provisions apply to a citizen who relinquishes citizenship or a permanent resident terminating U.S. residency after June 16, 2008, if such person: 1. Has an average annual net income tax liability for the five preceding years ending before the date of loss of citizenship or residency of $124,000; 2. Has a net worth of $2 million or more on date of expatriation; or 3. Fails to certify, under penalties of perjury, that he has complied with all U.S. federal tax obligations for the five preceding years.
363

The HEART Act enacted a deemed market-to-market exit tax that applies to net unrealized gain if assets were sold at fair market value on the day prior to expatriation and the gain exceeds $600,000, indexed for inflation. 364 The tax may be deferred on posting adequate security. 365 The Service has provided guidance on the treatment of specific items, including deferred compensation, services performed outside the United States, tax deferred accounts, and interests in non-grantor trusts. 366

¶ 21.05[3][b][ii] Special sourcing provisions.
For purposes of applying the provisions of Section 877(b), special sourcing provisions are embraced. The following types of income are treated as U.S. sources: 1. Gains on the sale or exchange of property (other than stock or debt obligations) located in the United States. 367

2. Gains on the sale or exchange of stock issued by a domestic corporation or debt obligations of U.S. persons or of the United States, a state or political subdivision thereof, or the District of Columbia; 368 3. Income or gain derived from a controlled foreign corporation
q

If the individual losing U.S. citizenship owned or is considered as owning 369 at any time during the two-year period ending on the date of the loss of U.S. citizenship, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such corporation, or the total value of the stock of such corporation, and

q

To the extent such income or gain does not exceed the earnings and profits attributable to such stock that were earned or accumulated before the loss of citizenship and during periods that such ownership requirements are met. 370

¶ 21.05[3][b][iii] Exchanges of property.
In the case of exchanges of property, notwithstanding any other provision in the Code, 371 such property is treated as if it had been sold for its fair market value and any gain recognized, 372 unless the individual enters a gain recognition agreement with the Service as to the sourcing of income from property acquired in the exchange. 373 The Service may also require recognition of gain, in Regulations to be issued, where the removal of appreciated tangible property from the United States or any other occurrence could result in a change in the source of income or gain from within to without the United States. 374

Illustration 21-15
This situation 375 is the same as in Illustration 21-14, except that Mr. Forto loses his U.S. citizenship on January 1, 1996, and is subject to Section 877. On June 30, 1997, Mr. Forto transfers the stock he owns in a U.S. corporation, USCo, to a wholly owned foreign corporation, ForCo, in a transaction that qualifies for tax-free treatment under Section 351. 376 At the time of such transfer, Mr. Forto's basis in the stock of USCo is $100,000 and the fair market value of the stock is $150,000. If Mr. Forto does not enter into a gain recognition agreement with the Service, he will be deemed to have sold the USCo stock for $150,000 on the date of the transfer, and would be subject to U.S. tax in 1997 on the $50,000 of gain realized. Alternatively, if Mr. Forto enters into a gain recognition agreement, he would not be required to recognize for U.S. tax purposes in 1997 the $50,000 of gain realized upon the transfer of the USCo stock to ForCo. However, under the gain recognition agreement, for the 10-year period ending on December 31, 2005, any income (e.g., dividends) or gain with respect to the ForCo stock would be treated as U.S. source, and therefore Mr. Forto would be subject to tax on such income or gain under Section 877. If Mr. Forto disposes of the USCo stock on January 1, 2002, Mr. Forto's gain recognition agreement would terminate on such date, and Mr. Forto would be required to recognize as U.S.-source income at that time the $50,000 of gain that he previously deferred under the gain recognition agreement. (The amount of gain required to be recognized by Mr. Forto in this situation would not be affected by any changes in the value of the USCo stock since his June 30, 1997, transfer of such stock to ForCo.)

¶ 21.05[3][b][iv] Tolling of 10-year period where “risk of loss” eliminated.
For purposes of applying the 10-year period of Section 877(a), the period is suspended for any period during which the individual's risk of loss with the respect to the property is substantially diminished by 1. The holding of a put with respect to such property (or similar property); 2. The holding by another person of a right to acquire the property; or 3. A short sale or other transaction. 377

Illustration 21-16
The situation is the same as in Illustration 21-14. Forto loses his citizenship on January 1, 1996, and is subject to Section 877. On that date Mr. Forto owns 10,000 shares of stock of a U.S. corporation, USCo, with a value of $1 million. On the same date, Mr. Forto enters into an equity swap with respect to such USCo stock with a five-year term. Under the transaction, Mr. Forto will transfer to the counter-party an amount equal to the dividends on the USCo stock

and any increase in the value of the USCo stock for the five-year period. The counter-party will transfer to Mr. Forto an amount equal to a market rate of interest on $1 million and any decrease in the value of the USCo stock for the same period. Mr. Forto's risk of loss with respect to the USCo stock is substantially diminished during the five-year period in which the equity swap is in effect, and therefore, the 10-year period under Section 877 is suspended during such period. Accordingly, if Mr. Forto sells his USCo stock for a gain on January 1, 2010, such gain would be treated as U.S.-source income taxable to Mr. Forto under Section 877. 378

¶ 21.05[3][b][v] Transfers of property.
In addition, Section 877 contains a broad series of provisions intended to prevent an individual from transferring property that did or would have produced U.S.-source income. In the case of transfers of property to a foreign corporation that would be a controlled foreign corporation if the individual were a U.S. citizen, any income or gain on such property (or any other property that has a basis determined in whole or part by reference to such property) received or accrued by the foreign corporation will be treated as received or accrued directly by such individual and not by such corporation. 379 If stock in such corporation or any other stock that has a basis determined in whole or part by reference to such stock is disposed of during the 10-year period and while such property is held by such corporation, a pro rata share of such property (determined on the basis of the value of such stock) will be treated as sold by the corporation immediately before such disposition. 380 Predictably, a set of anti-abuse rules authorize the Service to prescribe such Regulations as may be necessary to prevent the avoidance of the purposes of these provisions by transfer of property to foreign corporations, including where the property is sold to the corporation and the property taken into account is sold by the corporation. 381 The Service will also require such information reporting as is deemed necessary to carry out the purposes of this provision. 382

¶ 21.05[3][b][vi] Relationship to treaties.
In enacting the changes to Section 877, the legislative history notes that issues may arise with respect to the consistency of the amendments to existing treaty provisions. While the legislative history indicates that it is believed that the expatriation tax provisions are “generally consistent with the underlying principles of income tax treaties” to the extent [that] a foreign tax credit [is provided] for items taxed by another country, it is intended that the purpose of the expatriation tax provisions not be defeated by any treaty provision. Accordingly, the Treasury Department is to review all outstanding treaties to determine whether the expatriation tax provisions, as revised, potentially conflict with treaty provisions and to “eliminate any such potentially conflicts through renegotiation of the affected treaties as necessary.” Beginning on the tenth anniversary of enactment, any conflicting treaty provisions that remain in force will take precedence over the expatriation tax provisions as revised. 383

¶ 21.05[3][b][vii] Burden of proof.
As a further means of mitigating the adverse consequences to the fisc of prior law, Congress also included in Section 877 a provision placing the burden of proof on the principal purpose issue on the expatriate. Section 877(f) provides that if the Service establishes that it is “reasonable to believe” that an individual's loss of U.S. citizenship would, but for Section 877, result in a substantial reduction for the taxable year in the taxes on his probable income for such year, the burden of proving that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes is on the individual. 384

¶ 21.05[3][b][viii] Information reporting.
A U.S. citizen who loses his or her citizenship is required to provide a statement to the State Department (or other designated government entity) that includes the individual's Social Security number, forwarding foreign address, new country of residence and citizenship and, in the case of individuals with a net worth of at least $500,000, a balance sheet. 385 The entity to which this statement is to be provided is required to provide to the Treasury copies of all statements received and the names of individuals who refuse to provide such statements. 386 An individual's failure to provide the required statement results in the imposition of a penalty for each year the failure continues equal to the greater of (1) 5 percent of the individual's expatriation tax liability for such year, or (2) $1,000. 387 The State Department is required to provide the Treasury with a copy of each certificate of loss of nationality (CLN) approved by the State Department. Similarly, the agency administering the immigration laws is to provide the Treasury with the name of each individual

whose status as a lawful permanent resident has been revoked or has been determined to have been abandoned. The Treasury must also publish in the Federal Register the names of all former U.S. citizens from whom it receives the required statements or whose names it receives under the foregoing information-sharing provisions. Section 6039C authorizes the Service to publish the names of individuals who gave up their citizenship during each fiscal quarter of the government. Such a list is published quarterly. For example, the list for the quarter ending June 30, 1998, contains a list of about 100 individuals. 388 There may be a variety of troublesome, practical consequences of a person's name appearing on the expatriation list aside from the obvious tax matters. 389

¶ 21.05[3][b][ix] Ruling as to principal purpose.
In order to minimize the burdens of Section 877 and related provisions in situations where the taxpayer believes that he or she does not have a principal purpose of tax avoidance, the Service has promulgated procedures for obtaining an appropriate ruling. The ruling requirements were modified in Notice 98-34 390 to facilitate a procedure whereby the taxpayer need not obtain a substantive ruling that he or she did not have a principal purpose of tax avoidance. Under the modified ruling practice, an individual may overcome the presumption of tax avoidance by submitting a request for a ruling as to whether the individual's expatriation had as its principal purpose the avoidance of U.S. taxes, provided that the ruling request is complete and in good faith. Notice 98-34 spells out 24 categories of information that must be submitted in order to be considered a “complete and good faith submission.” 391

¶ 21.05[3][c] Estate Taxation of Expatriates—Section 2107
As was the case with Section 877 prior to amendment, 392 its estate tax counterpart, Section 2107, was applicable in the case of expatriations found to involve a principal purpose to avoid U.S. estate tax. 393 Section 2107 was also amended in 1996 to replace this subjective test with an objective test in the absence of the individual obtaining an appropriate ruling from the Service. 394 In the case of individuals losing their U.S. citizenship after February 6, 1995, Section 2107(a) provides that a tax computed in accordance with the table contained in Section 2001 is imposed on the transfer of the taxable estate (determined as provided in Section 2106) of every decedent nonresident not a U.S. citizen if the date of death occurs during a tax year with respect to which the decedent is subject to tax under Section 877(b). 395 The tax imposed is credited with the amount of any estate, inheritance, legacy, or succession taxes actually paid to any foreign country. 396 As is the case with Section 877, if the Service establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for Section 2107, result in a substantial reduction in the estate, inheritance, legacy, and succession taxes in respect of the transfer of his estate, the burden of proving that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes is on the executor of such individual's estate. 397

¶ 21.05[4] Estate and Gift Tax Considerations for U.S. Citizens Residing in or Moving to Offshore Jurisdictions
When a U.S. citizen resides in an offshore jurisdiction, there are also a variety of estate and gift tax considerations that must be taken into account. In order to coordinate planning between the offshore jurisdiction and the United States, there are a number of issues that will need to be considered, including the following: 1. What property is subject to tax in the offshore jurisdiction? 2. Are employee benefit plan benefits applicable to the U.S. citizen subject to transfer tax in the offshore jurisdiction? 3. What planning techniques are available to minimize the assets that are potentially subject to tax in the offshore jurisdiction? 4. Do employee benefit plans allow sufficient flexibility for appropriate planning arrangements? Another initial consideration will be whether the United States has an estate and gift tax treaty with the jurisdiction. If so, the treaty will provide considerable guidance with respect to double taxation issues. The length of the period of residence in the offshore jurisdiction may be important.

¶ 21.05[5] Repatriation by Former U.S. Citizens
Where a U.S. citizen has expatriated and avoided the restrictions in the Code on expatriation for the purpose of avoiding U.S. taxes,
398

the time may come when the former citizen (now nonresident) seeks to reacquire U.S. citizenship. In such a situation, the planning

context will be similar to that of a nonresident emigrating to the United States for the first time 399 with the interesting overlay of the U.S. expatriation provisions.

Illustration 21-17
The situation is the same as in Illustration 21-3, 400 where John Forto has decided to emigrate to Foronia. It is now several years later and Mr. Forto and his family have decided to return to the United States. Over the years, Mr. Forto's company, once a U.S. corporation named USCo, also became a Foronian company, by the name of ForonCo. Mr. Forto owns all the stock in ForonCo. In such a situation, the former citizen, now nonresident, Mr. Forto would have a significant incentive to restructure his asset holdings before once again becoming a U.S. citizen. For example, he could consider forming a foreign trust before renouncing Foronian citizenship and accepting U.S. citizenship. Such a transaction would be subject to the provisions noted previously with respect to nonresidents. 401 It may also be subject to the provisions of the Code designed to protect the U.S. tax base from expatriation of its citizens. 402 As part of its efforts to deter tax-motivated expatriations, 403 Congress, in 1996, also classified as excludable for reentry into the United States any former U.S. citizen who is found by the Attorney General to have renounced U.S. citizenship for tax avoidance purposes. 404

¶ 21.05[6] Planning Where the Decedent Had Undisclosed, and Unreported, Foreign Assets (Including Trust Accounts)
An entirely different type of planning may be required where a U.S. decedent is discovered to have owned foreign assets, often as a grantor of a foreign trust, but has never satisfied U.S. reporting obligations. 405
248

See supra ¶ 21.02[6].
249

See supra ¶ 21.03[3].
250

See infra ¶ 21.05[3].
251

IRC § 679(a), which is discussed at infra ¶ 21.05[2][b][iv].
252

TD 8955, 66 Fed. Reg. 37886 (July 20, 2001). See “U.S. IRS Issues Final Regulations on Foreign Trusts with U.S. Beneficiaries, ”2001 WTD 140-39 (July 19, 2001). Rules relating to Section 501(c)(3) tax-exempt status of foreign trusts were modified in response to commentaters to not require rulings, though there will be U.S. transferor notice filing requirements.
253

See generally Harrington, “Planning for U.S. Beneficiaries of Foreign Trusts Under Recent Regs.,” 28 Est. Plan. 258 (June 2001).
254

Treas. Reg. § 1.679-2(a)(3).
255

Treas. Reg. § 1.679-2(b).
256

Treas. Reg. § 1.679-3(c). The related subject of gain recognition on deemed transfers of assets to a foreign trust is addressed in the Regulations under Section 684. See ¶ 21.05[3][b][ix].
257

Treas. Reg. § 1.679-3(d).
258

The term “U.S. person” is defined in Section 7701(a)(30) to include a citizen or resident, and a domestic partnership, corporation, estate or trust, or nonresident alien electing to be treated as a resident under Section 6013(g).
259

IRC § 684(a). Section 684 was enacted in the Small Business Job Protection Act of 1996.
260

The Taxpayer Relief Act of 1997, Pub. L. No. 105-34, 111 Stat. 983 (1997), repealed the excise tax in Sections 1491 through 1494 with respect to transfers of property to foreign partnerships, replacing it with a notice requirement with respect to such transfers occurring after August 5, 1997. See ¶ 5.04[1].
261

Former IRC § 1491(a). See ¶ 3.04[2][f]. Former IRC § 1492 provided an exception for, among other things, taxpayers who elected under former IRC § 1057 to treat such a transfer as a sale or exchange of property for an amount equal to the fair market value of the property transferred and to currently recognize the gain.
262

Treas. Reg. § 1.1494-1(a).
263

Rev. Rul. 87-61, 1987-2 CB 219, discussed at infra ¶ 21.05[2][b][iv].
264

See supra ¶ 21.03[1][d].
265

See Notice 96-65, 1996-2 CB 232; IRS Notice 96-60, 1996-2 CB 227.
266

In this context, such provisions are principally IRC §§ 354 (transfer to controlled corporation) and 361 (reorganization). See U.S. International Transfer Pricing ¶ 17.06.
267

IRC § 367(a)(3).
268

These types of property include property described in IRC §§ 1221(a)(1) or 1221(a)(3) (relating to inventory and copyrights, and the like); installment obligations, accounts receivable, or similar property; foreign currency or other property denominated in foreign currency; intangible property; or property with respect to which the transferor is a lessor at the time of the transfer, except that this clause shall not apply if the transferee was the lessee. IRC§ 367(a)(3)(B).
269

See ¶ 19.03.
270

IRC § 877. These provisions are discussed in detail at infra ¶ 21.05[3].
271

See Notice 97-19, 1997-1 CB 227 (providing detailed guidance with respect to IRC §§ 877, 2501, and 2107 pending issuance of Regulations); Notice 96-60, 1996-2 CB 227 (setting out, inter alia, initial guidance on ruling requests under IRC § 877).
272

IRC § 6048(a).
273

IRC § 6048(a)(1), added by the Small Business Job Protection Act of 1996, HR 3448, 104th Cong., 2d Sess. (1996). See generally Bruce, “Foreign Trust Tax Compliance: Don't Panic,” 9 J. Int'l Tax'n 24 (Jan. 1998); Lederman & Hirsh, “New Tax Liabilities and Reporting Obligations Imposed on Expatriates,” 84 J. Tax'n 325 (1996); Perry, “New Law Changes Rules on Cross-Border Trusts, Toughens Reporting,” 7 J. Int'l Tax'n 436 (1996). Prior to amendment, IRC § 6048(a) required the grantor in the case of an inter vivos trust, the fiduciary in the case of a testamentary trust, or the transferor, as the case may be, to file an information return as required by the Regulations. IRC § 6048(b). The civil penalty for nonfiling of the required return was 5 percent of the transfer to the trust, but not more than $1,000, unless it was shown that the failure was due to reasonable cause. The criminal penalty for failure to file was set out in IRC § 7203. In addition, any trust subject to IRC § 679—formed by a U.S. citizen or resident and having U.S. beneficiaries—had to file a return as

required by Regulations. IRC § 6048(c). The civil penalty for nonfiling of the required return was 5 percent of the value of the corpus of the trust at the end of the taxable year, but not more than $1,000, unless it was shown that the failure was due to reasonable cause. The criminal penalty for failure to file was set out in IRC § 7203.
274

IRC § 6048(a)(2).
275

IRC § 6048(a)(3)(A).
276

IRC § 6048(a)(3)(B).
277

IRC § 6048(a)(4).
278

IRC § 6048(b)(1).
279

IRC § 6048(b)(2)(A).
280

IRC § 6048(b)(2)(B). The appointment of such an agent is not, alone, to be considered as a U.S. trade or business of the trust. Id.
281

IRC § 6048(c)(1).
282

IRC § 6048(c)(2).
283

IRC § 6048(d)(4).
284

IRC § 6039F(a). The definition of a gift to a U.S. person for this purpose excludes amounts that are qualified tuition or medical payments made on behalf of the U.S. person, as defined for gift tax purposes (IRC § 2503(e)(2)), and amounts that are distributions to a U.S. beneficiary of a foreign trust if such amounts are properly disclosed under the reporting requirements. IRC § 6039F(b).
285

IRC § 6039F(c)(1)(A). It is intended that the Treasury secretary's exercise of its authority to make such a determination will be subject to judicial review under an arbitrary or capricious standard, which provides a high degree of deference to such determination.
286

IRC § 6039F(c)(1)(A).
287

See supra ¶ 21.01.
288

See FTC v. Affordable Media LLC, 179 F3d 1228 (9th Cir. 1999) (married couple held in contempt of court for failing to return assets held in a foreign asset protection trust located in the Cook Islands).
289

See generally Azad, “Asset Protection Planning with Offshore Trusts and Offshore Corporations,” 12 Tax Notes Int'l 500 (Feb. 12, 1996); Bruce & Gray, “Offshore Protection-of-Assets Trusts,” U.S. Taxation of International Operations: Tax Ideas (P-H) ¶ 13,518 (1988); Marty-Nelson, “Offshore Asset Protection Trusts: Are They Tax Neutral?” 7 J. Int'l Tax'n 107 (1966).
290

IRC § 671.
291

IRC § 672(b).
292

IRC § 672(a).
293

Treas. Reg. § 1.672(a)-1(a).
294

IRC § 673.
295

IRC § 674.
296

IRC § 675.
297

IRC § 676.
298

IRC § 677.
299

IRC § 674(b)(5). The Regulations provide that “a power to distribute corpus for the education, support, maintenance, or health of the beneficiary; for his reasonable support and comfort; or to enable him to maintain his accustomed standard of living; or to meet an emergency, would be limited to a reasonably definite standard.” Treas. Reg. § 1.674(b)-1(b)(5)(i). The Regulations further provide, however, that “a power to distribute corpus for the pleasure, desire, or happiness of the beneficiary is not limited by a reasonably definite standard.” Id.
300

Treas. Reg. § 1.676(a)-1.
301

IRC § 677(b); Treas. Reg. § 1.677(b)-1(a).
302

IRC § 7701(a)(30). The definition of a foreign trust is discussed at supra ¶ 21.03[1][d].
303

IRC § 679(a)(1).
304

IRC § 7701(a)(31) defines “foreign trust” as a trust whose foreign source income is not includable in gross income. See supra ¶ 21.03[1][d]. It appears that if a trust is established in, and administered under, the laws of a foreign country, the trustee is a foreign entity, and the trust corpus is located in the foreign country, the trust will be a foreign trust. See Rev. Rul. 87-61, 1987-2 CB 219.
305

IRC § 679(c)(1).
306

IRC § 679(a)(2)(A).
307

Rev. Rul. 87-61, 1987-2 CB 219.
308

IRC § 679(a)(2)(B), added by the Small Business Job Protection Act of 1996, HR 3448, 104th Cong., 2d Sess. (1996), effective in the case of transfers after February 6, 1995.
309

IRC §§ 679(a)(3)(A)(i), 679(a)(3)(C). For this purpose, the term “related” is as defined in IRC § 643(i)(2)(B).
310

IRC § 679(a)(3)(A).
311

IRC § 679(a)(3)(B).
312

IRC § 679(a)(5).
313

IRC § 672(f)(5), added by the Small Business Job Protection Act of 1996, HR 3448, 104th Cong., 2d Sess. (1996).
314

IRC § 672(f)(4).
315

IRC § 679(d).

316

See ¶ 21.02.
317

IRC § 684(a). In the case of transfers after December 31, 2009, the statutory language is similar except that it includes a nonresident alien as a transferee. The provisions of Section 684 are expanded in Treas. Reg. § 1.684-1, TD 8956, 65 Fed. Reg. 48198 (Aug. 7, 2000). See “IRS Issues Final Regs on Gain Recognition Rules for Transfers to Foreign Trusts,” 2001 WTD 140-40 (July 19, 2001). See generally Harrington, “Planning for U.S. Beneficiaries of Foreign Trusts under Recent Regs,” 28 Est. Plan. 258 (June 2001).
318

IRC § 684(b). See ¶ 21.05[2][b].
319

IRC § 684(c).
320

Treas. Reg. §§ 1.684-2(a) and 1.684-2(c).
321

The Taxpayer Relief Act of 1997, Pub. L. No. 105-34, 111 Stat. 983 (1997), repealed the excise tax in Sections 1491 through 1494 with respect to transfers of property to foreign partnerships, replacing it with a notice requirement with respect to such transfers occurring after August 5, 1997. See ¶ 21.05[1][b].
322

This could occur, however, if non-U.S. currency were transferred to the trust because of exchange rate fluctuations over time.
323

Rev. Rul. 87-61, 1987-2 CB 219.
324

See supra ¶ 21.03[1][d].
325

Rev. Rul. 69-450, 1969-2 CB 168.
326

IRC §§ 652, 662.
327

IRC §§ 666, 667.
328

IRC § 668.
329

Treas. Reg. § 1.666(d)-1A(b)(1).
330

Compare HB Plant v. Comm'r, 30 BTA 133 (1934), aff'd, 76 F2d 8 (2d Cir. 1935) (holding that a beneficiary's mere right to occupy trust property did not mean that the trust's payment of maintenance expenses should be treated as distributions to the beneficiary) with Alfred I. DuPont Test. Tr. v. Comm'r, 66 TC 761 (1976), aff'd, 574 F2d 1332 (5th Cir. 1978) (calling into question the rationale of Plant, while reaching a similar conclusion).
331

IRC § 6048(a).
332

IRC § 6677.
333

Schedule B, Line 11 of Form 1040, and the filing of Forms 3520, 3520-A, or 926.
334

See ¶ 7.02[4].
335

FSA 199952014 (Dec. 29, 1999). Income of a trust established to hold stock of an acquired company, in order to meet regulatory requirements, is attributed to the grantor, the beneficiary of the trust for subpart F purposes (controlled foreign corporation purposes).

Textron Inc. v. Comm'r, 117 TC 67 (2001) . See ¶ 7.02[4].
336

F.T.C. v. Affordable Media, LLC, 179 F3d 1228 (9th Cir. 1999) (upholding contempt imposed on grantors of foreign trust for failure to turn over assets as ordered by court), discussed in Asinoff, “Ruling in West May Chill Use of Offshore Trusts,” Wall St. J., July 12, 1999, at A24.
337

See supra ¶ 21.05[2].
338

IRS Form 926, which is set out as Figure 3-1.
339

IRS Form 3520, set out as Figure 21-1.
340

IRS Form 3520-A, set out as Figure 21-2.
341

See supra ¶ 21.02[3][b].
342

This is discussed in detail at infra ¶ 21.05[3][a].
343

See supra ¶ 21.01.
344

See ¶¶ 21.05[1][d] supra and 21.05[1][b] infra.
345

See generally McCaffrey, “Tax Advantaged Traveling for You and Your Money: Expatriation and Foreign Trusts,” 1996 U. Miami Inst. on Est. Planning ch. 5.
346

See supra ¶ 21.02[5].
347

For background on the evolution of the issues, see Turro, “Clinton Administration Proposes Anti-Abuse Provisions for Foreign Trusts, Expatriates,” 10 Tax Notes Int'l 511 (Feb. 13, 1995).
348

HR 980 and 981, 104th Cong., 1st Sess (1995); S. 452 and 453, 104th Cong., 1st Sess. (1995). An extensive background document was prepared by the Joint Committee on Taxation. Joint Committee on Taxation, “Issues Presented by Proposals to Modify the Tax Treatment of Expatriation,” Staff, Joint Committee on Taxation (June 2, 1995).
349

See “Preliminary Comments on Expatriation, Foreign Trust Proposals—Comments of the American Bar Ass'n, Section of Taxation,” 95 TNT 59-49 (Mar. 27, 1995); “New York State Bar Ass'n Reports on Expatriate Tax Proposals,” 95 TNT 118-6 (June 19, 1995).
350

See Loube, “Expatriate Taxation: Politics Obscures Technical Issues,” 10 Tax Notes Int'l 1377 (Apr. 17, 1995).
351

Background documents for the hearings were extensive. See Joint Committee on Taxation, “Description of Background and Issues Relating to Taxation of U.S. Citizens Who Relinquish Citizenship and Long-Term Resident Aliens Who Relinquish U.S. Residency,” Staff, Joint Committee on Tax'n (Mar. 27, 1995), reprinted at BNA Daily Tax Rep., Mar. 27, 1995, at L-2. The background of the legislation is discussed in Abreu, “Taxing Exits,” 73 Tax Notes 359 (Oct. 21, 1996).
352

See HR 1812, 104th Cong., 1st Sess. (1995) (Rep. Archer); S. 700, 104th Cong, 1st Sess. (1995) (by Sen. Moynihan).
353

Pub. L. No. 104-191 (HR 3103).
354

HR Rep. No. 736, 104th Cong., 2d Sess. (1996), reprinted in RIA's Complete Analysis of the Small Business, Health Insurance and Welfare Reform Acts of 1996 at 1542 (Research Institute of America 1996). The modifications of IRC § 877 are effective in the case of

individuals losing U.S. citizenship on or after February 6, 1995.
355

See supra ¶ 21.05[1][d].
356

See supra ¶ 21.05[3].
357

See HR Rep. No. 736, 104th Cong., 2d Sess. (1996), reprinted in RIA's Complete Analysis of the Small Business, Health Insurance and Welfare Reform Acts of 1996 at 1544–1545 (Research Institute of America 1996).
358

Specifically, IRC § 877(a) is applicable to Subtitle A of the Code, which is the income tax, and Subtitle B, which is the estate and gift tax. IRC § 877(a)(1).
359

IRC § 877(a)(1). IRC §871 is discussed at supra ¶ 21.02.
360

IRC § 877(a)(2) (flush language). The cost-of-living adjustment is as provided in IRC § 1(f)(3), rounded to the nearest $1,000.
361

See American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418 (2004).
362

Pub. L. No. 110-245, 122 Stat. 1624 (2008). See generally Arsenault, “Surviving a HEART Attack: Expatriation and the Tax Policy Implications of the New Exit Tax,” 24 Akron Tax L. J. 37, 48-50 (2009).
363

IRC § 877A(g)(1)(A), referring to IRC § 877(a)(2). There are exceptions for citizens with dual citizenship or persons renouncing citizenship prior to age 18.5. IRC § 877A(g)(1)(B).
364

IRC § 877A(a)(1).
365

IRC § 877A(b).
366

See Notice 2009-85, 2009-45 IRB ; “IRS Releases Guidance on Expatriates Covered Pursuant to HEART Act of 2008,” BNA Daily Tax Rep., Oct. 16, 2009, at G-3.
367

IRC § 877(d)(1)(A).
368

IRC § 877(d)(1)(B).
369

Using the stock attribution provisions of IRC § 958. See ¶ 7.02[2].
370

IRC § 877(d)(1)(C).
371

For example, like-kind exchanges (IRC § 1031), reorganizations (IRC § 368(a)), or transfers to controlled corporations (IRC § 351) or partnerships (IRC § 721).
372

IRC § 877(d)(2)(A). In order for this provision to be applicable to property exchanged within the 10-year period (or 15 years under Regulations to be issued), the gain would otherwise have not been recognized, income from the property exchanged would have been U.S. source, and income derived from the property acquired would be from sources outside the United States. IRC § 877(d)(2)(B).
373

IRC § 877(d)(2)(C).
374

IRC § 877(d)(2)(E). The legislative history notes, for example, that this provision could apply to a former U.S. citizen who removes appreciated artwork from the United States. HR Rep. No. 736, 104th Cong., 2d Sess. (1996), reprinted in RIA's Complete Analysis of

the Small Business, Health Insurance and Welfare Reform Acts of 1996 at 1545 (Research Institute of America 1996).
375

HR Rep. No. 736, 104th Cong., 2d Sess. (1996), reprinted in RIA's Complete Analysis of the Small Business, Health Insurance and Welfare Reform Acts of 1996 at 1545-1546 (Research Institute of America 1996).
376

See ¶ 12.03[1].
377

IRC § 877(d)(3).
378

HR Rep. No. 736, 104th Cong., 2d Sess. (1996), reprinted in RIA's Complete Analysis of the Small Business, Health Insurance and Welfare Reform Acts of 1996 at 1546 (Research Institute of America 1996).
379

IRC § 877(d)(4)(a)(ii).
380

IRC § 877(d)(4)(C).
381

IRC § 877(d)(4)(D).
382

IRC § 877(d)(4)(E).
383

HR Rep. No. 736, 104th Cong., 2d Sess. (1996), reprinted in RIA's Complete Analysis of the Small Business, Health Insurance and Welfare Reform Acts of 1996 at 1547 (Research Institute of America 1996).
384

IRC § 877(f).
385

IRC §§ 6039F(a) and 6039F(b).
386

IRC § 6039F(c).
387

IRC § 6039F(d).
388

See “Quarterly Publication of Individuals Who Have Chosen to Expatriate as Required by Section 6039G,” Tax Analysts Doc. 9825350 (Aug. 10, 1998).
389

Newman, “How Do You Quit Being an American? With Great Difficulty,” Wall St. J., Dec. 28, 1998, at A2.
390

Notice 98-34, 1998-2 CB 29.
391

The Service has also issued several private letter rulings. See Priv. Ltr. Ruls. 199927032 (July 19, 1999); 200219033 (Feb. 12, 2002) (principal purpose to evade U.S. tax not presumed); 200217043 (Jan. 24, 2002) (loss of long-term resident status); 200210005 (Mar. 8, 2002) (loss of U.S. citizenship by naturalized citizen); (definitive ruling that expatriation following employer transfer did not have a tax avoidance motive under Section 877); 199927013 (July 19, 1999) (no tax-avoidance motive under Section 877 where person who always lived in foreign country renounces U.S. citizenship and citizenship was by virtue of having U.S. citizen mother); 199926031 (July 19, 1999) (no tax-avoidance motive under Section 877 where dual citizen living in foreign country renounces U.S. citizenship). See also Priv. Ltr. Ruls. 9752007 (Sept. 19, 1997), 9735014 (May 29, 1997), and 9724021 (Mar. 18, 1997). In FSA 199947009 (Nov. 26, 1999), an examination team was advised that survivor benefits received by a German-born taxpayer after she renounced U.S. citizenship would be exempt from federal income tax under the U.S.–German treaty provided that her renunciation did not have a tax-avoidance purpose.
392

See supra ¶ 21.05[3][b].
393

The preamendment version of IRC § 2107 is discussed at supra ¶ 21.02[5].
394

See HR Rep. No. 736, 104th Cong., 2d Sess. (1996), reprinted in RIA's Complete Analysis of the Small Business, Health Insurance and Welfare Reform Acts of 1996 at 1542–1543 (Research Institute of America 1996).
395

IRC § 2107(a).
396

IRC § 2107(c)(2).
397

IRC § 2107(e). See Notice 97-19, 1997-1 CB 394 (providing detailed guidance with respect to IRC §§ 877, 2501, and 2107 pending issuance of Regulations). See generally Lederman & Hirsh, “New Reporting Rules for Departing U.S. Persons and Property After IRS Guidance and TRA '97,” 87 J. Tax'n 149 (1997).
398

See supra ¶ 21.05[3][a].
399

See supra ¶ 21.03[3].
400

See supra ¶ 21.01.
401

See supra ¶ 21.03[1].
402

See supra ¶ 21.05[1][a]. In this connection, see Ltr. Rul. 9527025, which involved a former citizen who had allowed more than 10 years to expire before repatriating. The Service ruled that IRC § 2501(a)(3), concerning transfers made within 10 years of losing U.S. citizenship, was inapplicable. It also found that the formation of a foreign trust and transfer of foreign company stock, where the beneficiaries were the grantor's family, and the grantor retained the voting rights on the transferred stock, was not subject to IRC § 2036(b).
403

See supra ¶¶ 21.04[2] (U.S. residents), 21.05[3][b], and 21.05[3][c].
404

Illegal Immigration Reform and Responsibility Act of 1996, Pub. L. No. 104-208 (Sept. 30, 1996) (effective in the case of expatriations occurring after September 29, 1996). This provision is criticized at Tilevitz & Czapiewska, “Getting the Tax-Free Boot: Tax Motivated Expatriation May Preclude U.S. Visa,” 70 Tax Notes 1715 (Mar. 31, 1997). See also Martin, “U.S. Law Targeting Tax-Dodging Expatriates May Have Loophole,” 14 Tax Notes Int'l 833 (Mar. 10, 1997). A private letter ruling has been issued under Section 877(c). Priv. Ltr. Rul. 9724021 (Mar. 18, 1997) (initial dual citizen who married a foreign spouse).
405

See supra ¶ 21.05[1][e].
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