Of course, some individuals may try to evade the proposed statute by hiding their assets. However, we believe that most individuals who would be subject to the proposed tax would not wish to commit a tax crime. -.) If these individuals were willing to commit a crime, they could hide their assets in a foreign bank account and retain their U.S. citizenship. However, the individuals who renounce their citizenship for tax purposes generally are trying to avoid tax within the established rules. In sum, the proposal would be much easier to enforce since it avoids the three fundamental problems of current law: it does not rely on tax motivation, it does not apply to a limited class of income, and it generally does not apply to gains triggered long after the taxpayer expatriates. QUESTION 2. APPLICATION OF EXPATRIATION TAX TO INTERESTS IN TRUSTS Assistant Secretary Samuels will address these issues. QUESTION 3. SUBSEQUENT MODIFICATIONS OF TAX ON EXPATRIATION Assistant Secretary Samuels will address these issues. QUESTION 4. PARTICULAR INDIVIDUALS I hope these responses to your questions are helpful. If you need additional information, please contact me or Mike Danilack, of my staff, at (202) 622-5440. Sincerely, MARGARET MILNER RICHARDSON. DEPARTMENT OF THE TREASURY, KENNETH J. KIES, Esq. Chief of Staff, Joint Committee on Taxation, DEAR KEN: I am writing to respond to your letter of April 7, 1995 to Commissioner Richardson and myself requesting information regarding the President's proposal to impose a tax on certain U.S. citizens and residents who expatriate. I am also including in this letter responses to certain inquiries made in your April 4, 1995 letter to Commissioner Richardson. This letter summarizes our views about the merits of the proposals regarding the taxation of expatriates and possible alternatives that have been suggested. Responses to your requests are incorporated throughout this letter. I understand that Commissioner Richardson has responded directly to your letters. To provide you with a comprehensive answer, some aspects of my letter will cover matters discussed in her letter. I. BACKGROUND OF PROPOSAL The Administration developed its expatriate proposal after a detailed review of the operation and effectiveness of existing law. In this review, we determined that existing law had numerous serious defects that are well-known and understood by taxpayers, tax advisors and commentators. We determined that the provision was being circumvented for tax avoidance purposes by very wealthy individuals and marketed by professionals for this purpose. Also, in 1984, Congress recognized that Section 877 had defects and indicated that section 877 should be reexamined in the future. See H.R. Rep. No. 861, 98th Cong., 2d Sess. 967 (1984). We are pleased that revision of section 877 is now receiving serious attention, and believe that the proposed section 877A will prevent U.S. citizens and certain residents from escaping their U.S. tax responsibilities. Based on the seriousness of the defects in existing law, we determined that section 877 needs to be revised to require U.S. citizens and certain long-term permanent residents who expatriate to be treated in a similar manner to those individuals who do not renounce their citizenship or permanent residence status. In developing the Administration's proposals, we reviewed options and concluded that the Administration's proposal represented an appropriate balance of interests. In this regard, we determined that it was appropriate that the new rules would only apply to taxpayers with substantial unrealized gains, that the changes would only apply to income taxes, and that certain significant asset categories (U.S. real estate and certain pensions) would be excluded. We believe that enactment of the proposal is important to the integrity of our tax system and to the goal that American taxpayers feel that their tax system is fair and equitable. Without the changes in the Administration's proposal, questions of fairness and equity will not be properly answered, and taxpayers will continue to believe that wealthy Americans can escape their tax responsibilities by exploiting loopholes in the system. II. DESCRIPTION OF PROPOSAL The Administration's proposal is the product of a great deal of study that began with an analysis of why current law needed revision. The Administration's proposal was considered by a joint task force (the "Foreign Trust Working Group"). The FTWG was organized in May 1994 and involved staff from Treasury's Office of International Tax Counsel, IRS' Office of Associate Chief Counsel (International), and IRS' Office of Assistant Commissioner (International). All of these offices were extensively involved in the legislative proposal. (This paragraph responds to question 1 of your April 7 letter.) I note that the FTWG also considered the Administration's proposals on foreign trusts. We look forward to the comments of the staff of the Joint Committee on Taxation on the foreign trust proposals. We hope that the foreign trust proposals are considered promptly by Congress. A. Evolution of Proposal Under the Administration proposal, if a U.S. citizen or long-term permanent resident expatriates, certain property held by that person would be treated as sold at fair market value immediately before such expatriation. Property treated as sold would include all items of property that would be in the individual's gross estate under the Federal estate tax rules. In addition, certain trust interests would be subject to the new rules. The proposal contains important exceptions. First, gains up to $600,000 would be exempt from tax. Second, U.S. real estate and interests in certain retirement plans would not be treated as sold. On March 15, 1995, the Senate Finance Committee's version of the legislation restoring the health insurance deduction for self-employed individuals (H.R. 831) included a modified version of the expatriation proposal. The Senate version excluded lawful permanent residents ("green card holders") from the provision and made several other changes described below. The expatriation provision was approved by the Senate. However, this provision was dropped when the House-Senate conference met on March 28, 1995. At that time, the staff of the Joint Committee on Taxation was asked by Congress to prepare a study of the expatriation issue by June 1, 1995. On April 6, 1995, Senator Moynihan introduced S. 700, a revised version of the Senate bill. Senator Moynihan's version made several modifications to the Senate version, such as: (i) including green card holders within the scope of the provision; (ii) allowing an individual who immigrates to the United States to establish a fair market value basis in property owned by the individual as of the date of immigration; (iii) allowing a taxpayer to elect, on an asset-by-asset basis, to continue to be taxed as a U.S. citizen; and (iv) allowing deferral of tax on expatriation in all cases where estate taxes would be deferred. B. Scope of Proposal Expatriation by U.S. citizens who avoid a significant amount of U.S. tax is a serious problem and is the principal focus of the Administration's proposal. As you know, only a very small number of U.S. citizens expatriate every year. The proposal was designed to apply to that even smaller subgroup of expatriating individuals who are avoiding significant U.S. income tax liability. The proposed exemption amount of $600,000 of unrealized gain and exclusion of certain assets was designed to achieve this goal. A Treasury press package stated: "The Administration proposal is intended to apply only to a small number of wealthy persons. The proposal applies only if an expatriate has more than $600,000 in gains (not $600,000 in gross assets) without regard to retirement plans or real estate holdings. Therefore, the proposal would rarely apply to an individual whose gross assets are less than $5 million." In context, the $5 million gross asset amount flows from the previous sentence which explains the various exceptions for $600,000 of unrealized gains ($1.2 million for a married couple) plus U.S. real estate and certain pension benefits to the tax on expatriation. The $5 million number emphasized that the proposal is designed to apply to persons with substantial assets and substantial unrealized gains since the avoidance of tax by those taxpayers raises questions of fairness with our tax system. (This paragraph responds to question 5a of your April 4 letter.) You have asked about the expectation that about two dozen taxpayers with substantial unrealized gains would be affected by the proposed rules. On average, we have identified a few departures of extremely wealthy taxpayers per year. Treasury complied information on expatriating individuals from news media accounts and from lists of expatriations given to us by the Department of State (regarding individuals who renounced citizenship from 1993 forward) and the Immigration and Naturalization Service (regarding long-term residents who abandoned that status in the last five years). In the course of compiling this information, we obtained information on some of the individuals you noted, and identified other individuals. We understand that you will be receiving the Department of State data directly from that Department (although you have not requested data from 1993 which we used in our analysis). Based on all the data available to us, and not wanting to understate the number of individuals affected by the proposal, we have expected that approximately two dozen wealthy individuals would be affected by the expatriation tax in any year. This includes both individuals who would pay the tax on expatriation and individuals who would choose to stay in the United States as a result of the proposal. (These paragraphs respond to question 5a of your April 4 letter and question 4 of your April 7 letter.) When the Treasury examined the existing expatriation rules, information was obtained from published interviews and informal conversations with practitioners. However, since we cannot independently verify this information, we have not incorporated our conversations with practitioners into this letter. However, this information suggests that the above expectations are conservative. A substantial revenue loss can occur if only one extremely wealthy taxpayer expatriates each year. Assume for purposes of illustration that: (i) absent the proposal a 70-year-old U.S. citizen would expatriate, (ii) the taxpayer has been paying $40 million per year in income taxes, (iii) the taxpayer has assets worth $4 billion ($3 billion of which is accrued capital gains), and (iv) the taxpayer plans to leave half of his estate to charity. The revenue effect of this taxpayer staying in the United States for one additional year is approximately $73 million-$40 million in income taxes plus $33 million in estate taxes ($4 billion estate less $2 billion given to charity multiplied by the 55 percent estate tax rate multiplied by the probability that he will die next year (about 3%)). If the proposal were to cause one additional individual who would otherwise have expatriated (or several individuals who cumulatively generate a similar amount of revenue) to remain in the United States each year, the six-year revenue effect for the total of six individuals affected during the six-year period would be $1.5 billion ($73 million in year one, $146 million in year two, $219 million in year three, $292 million in year four, $365 million in year five, $438 million in year six). Note that if the taxpayers in this illustration were to expatriate and pay the tax on expatriation, the revenue effect over six years would be about $5 billion ($840 million each year for six years). III. TRUST ISSUES One aspect of the proposal deals with interests in trusts. In developing the proposal, we considered the appropriateness of taxing interests in trusts, particularly remote or contingent interests. We concluded that since assets held in trust represent valuable interests that an expatriate removes from the U.S. income, estate and gift tax systems when he leaves the country, trust interests should be included in the proposal. In developing the proposal, we recognized that the proposal is in some respects more favorable to taxpayers than existing estate and gift tax rules because the proposal determines ownership interest in a trust on the basis of all the facts and circumstances. Thus, a taxpayer may show that he or she has no actual interest in a trust even if he or she is a potential beneficiary of the trust. The Senate Finance Committee report elaborates on this rule: "It is intended that such regulations disregard de minimis interests in trusts, such as an interest of less than a certain percentage of the trust as determined on an actuarial basis, or a contingent remainder interest that has less than a certain likelihood of occurrence." We adopted this approach in order to allow taxpayers to demonstrate that the trust interest should not be subject to the proposal. Generally, in determining how to deal with the issue of interests in trusts, we consulted other areas of the Code which impose a tax before assets are sold—in particular, estate and gift taxes. Congress has considered liquidity problems in this context and decided on the appropriate flexibility that should be permitted to taxpayers facing these problems. Treasury looked to decisions that Congress had previously made in the estate tax area for guidance on the payment of tax on expatriation. Thus, as provided in existing section 6166 for the estate tax, the Administration's proposal allows a taxpayer to defer payment of the tax on expatriation with respect to interests in closely-held businesses. In addition, pursuant to current authority for closing agreements, the Commissioner may permit deferral of the payment of tax on expatriation under appropriate agreements. We believe that these provisions should be reasonably satisfactory to those very small number of taxpayers who have liquidity problems. The bill passed by the Senate expanded the extension of time provision by deleting reference to section 6166 (allowing deferral of tax for five years for interests in closely-held businesses) and substituting section 6161 which allows the Commissioner to defer the payment of estate tax on any asset for up to ten years. On April 6, Senator Moynihan introduced a bill providing for a revised version of the tax on expatriation. Senator Moynihan's version gives even more flexibility to taxpayers with illiquid assets. First, it allows deferral of tax in all circumstances where payment of the estate tax would be deferred. Therefore, in addition to the relief provided by both section 6161 (general extension of time to pay) and 6166 (for closely-held businesses) payment of the tax on expatriation also could be extended for reversionary or remainder interests in property as provided in section 6163. Payment of tax liabilities also could be extended under section 6159 to facilitate collection of tax liabilities. Second, Senator Moynihan's bill allows the Commissioner to extend the time for payment of the tax on expatriation for any period. Third, Senator Moynihan's bill adds a new provision which allows a taxpayer to elect to continue to be taxed as a U.S. citizen on assets that the taxpayer designates. The taxpayer would therefore not be subject to U.S. tax on the asset that he designates until the asset was disposed of or the taxpayer transfers the asset through gift or death. We believe that this approach addresses questions raised during the consideration of H.R. 831. The issue of whether a contingent beneficiary who ultimately receives no distribution from a trust would be entitled to a refund of the tax on expatriation is resolved in the same way that Congress resolved the issue in the estate and gift tax area. In that area, the decedent or donor is generally required to value the asset as of the date of transfer. If the asset subsequently turns out to be worth a different amount (either more or less than the estimate on the date of death), there is no adjustment to the estate or gift taxes paid. Senator Moynihan's bill gives an expatriate an additional alternative that is not available for estate and gift tax purposes. The Moynihan bill allows an expatriate to defer the taxable event until the asset is sold or transferred. Thus, an expatriate is faced with a choice: he or she can pay the expatriation tax up front, or he or she can elect to defer tax until he realizes income from the trust. We do not anticipate that the provisions relating to interests in trusts could be used to avoid application of the expatriation proposal. The proposal determines trust ownership on the basis of all the facts and circumstances. Therefore, if an expatriate tries to avoid application of the tax on expatriation by contributing his assets to a trust from which he will benefit, the facts and circumstances determination should be able to determine his ownership interest in the trust assets. If he were to contribute his assets to a trust from which he would not benefit, he would pay U.S. gift tax on that transfer-a tax that could be larger than the tax on expatriation would have been. (These paragraphs respond to questions 2 and 3 of your April 7 letter.) IV. SUGGESTED ALTERNATIVES TO THE PROPOSAL Two alternatives have been suggested to the Administration proposal. In our view, these alternatives do not adequately deal with tax avoidance by expatriates. A. Proposal To Retain Tax Motivation Requirement It is essential that the tax motivation requirement of section 877 be eliminated. Although a tax motivation requirement may be appropriate in some circumstances, in this context, the Administration believes that fairness of the tax laws requires tax to be imposed on an expatriate's appreciated assets without regard to tax motivation. Allowing expatriates with substantial unrealized gains to avoid all tax on these assets creates the perception of an unfair tax system for those who remain. Remaining taxpayers will either pay income tax when they sell their assets or estate tax when they die. Even if this fundamental assumption is rejected, and the provision were designed only to tax those who expatriate to avoid tax, the tax motivation requirement would fail to achieve this purpose. Many tax-motivated individuals that Congress had in fact targeted would escape taxation because of the government's proof problems in this context. To demonstrate that a taxpayer has a tax avoidance motive, the IRS generally must investigate the taxpayer's personal motivations regarding expatriation, compile family histories, and examine the tax regime of the new country or countries of residence. Such an examination is tedious and requires the cooperation of taxpayers who no longer live in the United States and who generally are no longer otherwise subject to U.S. law. We believe that this difficulty of administration is understood by taxpayers who exploit the weaknesses with current law. The difficulty of administering this requirement is further compounded by the fact that taxpayers who expatriate rarely admit tax avoidance as their reason for renouncing U.S. citizenship. Moreover, well-advised taxpayers can be expected to deny the tax avoidance intent. We understand that those taxpayers are routinely advised not to volunteer to pay tax under section 877. See Langer, The Tax Exile, 1993– 94 at 99. Indeed, we understand that the IRS is not aware of any taxpayers who have voluntarily filed returns indicating that they are subject to section 877. Thus, the operation of section 877 requires the IRS to detect expatriates with potential section 877 liability, conduct an audit, successfully sustain the contention that there was tax avoidance, and assess and collect a tax deficiency. There is precedence for the proposition that a tax avoidance motive should not be required when appreciated assets are transferred out of U.S. taxing jurisdiction. Congress has previously dealt with similar issues in section 367 of the Code, which required a tax avoidance motive before transfers of appreciated assets outside the tax jurisdiction of the United States were taxed. Prior to 1985, section 367 applied to the outbound transfer of assets to a related foreign corporation if one of the principal purposes of the transfer was to avoid U.S. tax. In response to Dittler Bros., Inc. v. Comm'r, 72 T.C. 896 (1979), and subsequent cases, Congress in 1984 decided to eliminate tax motivation from section 367. See Joint Comm. on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 at 427 ("1984 Blue Book"). Consequently, Congress understood the inappropriateness of applying the subjective intent test in the context of section 367 when assets are potentially removed from the U.S. taxing jurisdiction and, in the legislative history to that law, Congress indicated that section 877 needed to be reexamined. In considering the issue of perceived fairness and application of a subjective intent in the expatriation context, it is noteworthy that the tax literature suggests that |