Congress's end game of catching wealthy expatriators.
The idea of having a special "alternative tax regime" apply to individuals who relinquish their U.S. citizenship with a principal purpose of avoiding U.S. tax is nothing new. As early as the 1960s, legislators searched for ways to discourage individuals from relinquishing citizenship as a way to avert U.S. taxation. Congress passed the Foreign Investors Tax Act of 1966, subjecting individuals who relinquish their citizenship with a principal purpose of avoiding tax to a 10-year period of tax at the regular graduated rates on certain U.S.-source income. However, the Act proved fruitless because individuals still found ways to achieve these goals.
The ineffectiveness of the Foreign Investors Tax Act of 1966 led to numerous amendments, the most significant being the Health Insurance Portability and Accountability Act of 1996 (HIPAA). The HIPAA extended the alternative tax regime to long-term U.S. residents and provided both objective and subjective tests to determine whether an individual who had renounced his or her citizenship or residency did so with a principal purpose to avoid taxation. The objective test under Sec. 877(a)(2) provides that an individual is deemed to be doing that if his or her (1) average annual U.S. Federal income tax liability for the five tax years preceding citizenship relinquishment or residency termination exceeds $100,000; or (2) net worth on the date of citizenship relinquishment or residency termination is at least $500,000.
Individuals meeting the objective test are automatically subject to an alternative tax regime for 10 years after relinquishing citizenship or long-term resident status. Additionally, the HIPAA amendments expanded the types of income subject to taxation (e.g., foreign property acquired in nonrecognition transactions and amounts earned through controlled foreign corporations).
Although the amendments appeared foreboding, relief was provided in the form of a subjective test. Certain categories of individuals could request a ruling on whether their circumstances would deem them to have a principal purpose of tax avoidance. Congress and the IRS felt confident that the new amendments were sufficiently stringent to discourage individuals from relinquishing citizenship or residency to avoid U.S. taxation.
Recently Proposed Legislation and the JCT Report
Several legislators have proposed additional amendments to the Sec. 877 tax regime to reach an even broader scope of individuals deemed to be expatriating to avoid U.S. taxation. Perhaps the first bill to make any real waves in Congress was HR 3099, introduced by Reps. Charles Rangel (D-NY) and Robert Matsui (D-CA). HR 3099 sought to impose a tax on the unrealized appreciation of an expatriate's assets, with an exemption for the first $600,000 for an individual and $1.2 million for a married couple. In response, Rep. Bill Archer (R-TX), Chairman of the House Ways and Means Committee, requested the Staff of the Joint Committee on Taxation (JCT) to report on the effectiveness of the 1996 legislation and provide recommendations for improvement. The report was issued in February 2003.
The JCT report states that there is little or no enforcement of the special tax rules applicable to tax-motivated citizenship relinquishment and residency termination. Further, for 2000 and 2001, only 76 former citizens either provided information statements identifying themselves as meeting one or more of the monetary thresholds or included a Social Security number. Without a Social Security number, the IRS cannot match the former citizen or long-term resident to databases without conducting a labor-intensive manual search.
Of those 76 identifiable individuals, the JCT report found that the Service does not attempt to monitor and enforce the 10-year return-filing requirements. In light of this apparent ineffectiveness, the JCT did not suggest any fundamental changes to the current alternative tax regime (e.g., a mark-to-market exit tax), but it recommended eliminating the subjective individual ruling and replacing it with certain objective tests.
Based on the recommendations and the objective rules provided by the JCT report, an amendment introduced by Rep. Nancy L. Johnson (R-CT) was included in HR 878, the Armed Services Tax Fairness Act of 2003. The provision amends Sec. 877(a) and eliminates the ruling request option. HR 878 imposes an expatriation tax on individuals (1) whose average annual income tax exceeds $122,000 (indexed for inflation after 2003); (2) whose net worth exceeds $2 million; or (3) who fail to certify compliance with U.S. tax law over the past five years. Individuals meeting those requirements would be subject to tax for 10 years following expatriation. Long-term residents (those who have held a green card in at least eight of the prior 15 years) would continue to be subject to the expatriation tax in the same manner as U.S. citizens who renounced their citizenship.
Although it is uncertain whether HR 878 will pass, the bill represents Congress's intention to amend the expatriation provisions and follow the JCT recommendations. The recommendations that have subsequently been incorporated into HR 878 are especially harsh for certain long-term residents. By eliminating the option for individuals to request a subjective revenue ruling, certain long-term residents who are simply employed in the U.S. for a number of years before returning to their home countries may now meet the new objective test.
For nearly four decades, Congress has tried to fortify expatriate tax provisions in an effort to retain as much income in the U.S. as possible: As is manifested in the JCT report, these efforts have apparently been largely ineffective. However, the recent influx of proposed amendments indicates that legislators have their pens ready and are waiting to sign a more comprehensive bill into law.
FROM TISHA S. ILLINGWORTH, J.D., LL.M., WASHINGTON, DC
David Madden, J.D., LL.M.
Washington National Tax Service
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|Publication:||The Tax Adviser|
|Date:||Jun 1, 2003|
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