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Changing U.S. Tax Jurisdiction: Expatriates, Immigrants, and the Need for a Coherent Tax Policy Fordham Law School FLASH: The Fordham Law Archive of Scholarship and History Faculty Scholarship 1997 Changing U.S. Tax Jurisdiction: Expatriates, Immigrants, and the Need for a Coherent Tax Policy Jeffrey M. Colon Fordham University School of Law, [email protected] Follow this and additional works at: https://ir.lawnet.fordham.edu/faculty_scholarship Part of the Tax Law Commons Recommended Citation Jeffrey M. Colon, Changing U.S. Tax Jurisdiction: Expatriates, Immigrants, and the Need for a Coherent Tax Policy, 34 San Diego L. Rev 1 (1997) Available at: https://ir.lawnet.fordham.edu/faculty_scholarship/402 This Article is brought to you for free and open access by FLASH: The Fordham Law Archive of Scholarship and History. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of FLASH: The Fordham Law Archive of Scholarship and History. For more information, please contact [email protected]. Changing U.S. Tax Jurisdiction: Expatriates, Immigrants, and the Need for a Coherent Tax Policy JEFFREY M. COLON* TABLE OF CONTENTS I. INTRODUCTION ....................................... 003 II. U.S. INCOME AND WEALTH TRANSFER TAXATION ................ 008 A. Income Tax ..................................... 008 1. Citizens and Residents-Residence Basis Taxation ....... 008 2. Nonresidents-Source and Trade or Business Basis Taxation ................................ 010 B. Wealth Transfer Taxation: FederalEstate, Gift, and GenerationSlapping Taxes ........................ 012 1. Citizens and Residents ........................... 012 2. Nonresident Aliens ............................. 015 C. Income and Wealth Transfer Tax Treaties ................. 017 D. The Protection of Residence Basis Taxation ............... 018 1. Income Tax .................................. 018 2. Wealth Transfer Taxes ........................... 022 3. Income Tax Treaties ............................ 024 E. Summary ....................................... 024 III. THE CHALLENGE EXPATRIATION POSES TO RESIDENCE BASIS TAXATION AND A MARK-TO-MARKET SYSTEM FOR * Associate Professor of Law, Fordham University School of Law. B.A., 1983, J.D., 1987, Yale; M.L.T., 1993, Georgetown. I wish to thank Karen Brown, Jill Fisch, Irwin Panitch, Terry Smith, Linda Sugin, and Steve Thel for their thoughtful comments; Jennifer Spiegel for her research assistance; and the Fordham University School of Law for its generous support. HeinOnline -- 34 San Diego L. Rev. 1 1997 TAXPAYERS CHANGING U.S. TAX STATUS .................... 025 A. Mark-to-Market Taxation Would Reduce Economic Inefficiencies .................................... 029 B. Mark-to-Market Taxation Would Reduce Inequities of the CurrentSystem .............................. 030 C. Mark-to-Market Taxation is Consistent With Other Code Provisions ............................. 031 D. Mark-to-Market Taxation for Persons or Property Entering U.S. Residence or Trade or Business Basis Taxation Would Improve the Fairnessof the Current System ........................ 032 E. Mark-to-Market Taxation May Be Easier to Administer Than the CurrentExpatriate System ............ 032 IV. ISSUES RAISED BY A MARK-TO-MARKET REGIME .................. 033 A. Who Should Be Subject to Mark-to-Market Taxation ......... 033 B. What Property Should Be Marked to Market .............. 034 1. General ..................................... 034 2. Illiquid Property and the Deferral of Income Tax ........ 036 3. Inside/Outside Basis Issues ....................... 038 4. Interests in Trusts .............................. 039 5. Gratuitous Transfers of Property Into and Out of U.S. Residence Basis Taxation ..................... 042 6. Interaction of Accrual Taxation and US. Wealth Transfer Taxes ........................... 043 V. EXPATRIATE INCOME AND WEALTH TRANSFER TAX REGIMES ....... 044 A. Income Tax Provisions .............................. 045 1. Persons Subject to the Expatriate Income Tax Provisions ................................ 045 2. U.S. Source Income and Gains ..................... 050 3. Double Taxation ............................... 055 B. Expatriate Wealth Transfer Tax Provisions ................ 056 C. Income Tax Treaties ............................... 058 D. Summary ....................................... 059 VI. U.S. TAX ISSUES THAT ARISE WHEN A PERSON OR PROPERTY BECOMES SUBJECT TO RESIDENCE OR TRADE OR BUSINESS BASIS TAXATION ............................ 060 A. Taxable Year .................................... 061 B. Accounting Methods ............................... 064 C. Income and Deductions ............................. 064 D. Income From Entities .............................. 068 E. Gains and Losses ................................. 074 1. Determining the Basis of NondepreciableProperty That Becomes Subject to U.S. Tax ................... 074 a. General .................................. 074 b. Taxpayers With Qualified Business Units ........... 076 2. Determining the Basis of Depreciable Property That Becomes Subject to U.S. Tax ................... 079 3. Owners of PFICs That Change U.S. Tax Status ......... 082 4. Losses ...................................... 085 F Summary ....................................... 087 VII. FURTHER THOUGHTS ON ACCRUAL BASIS TAXATION ............... 088 HeinOnline -- 34 San Diego L. Rev. 2 1997 [VOL. 34: 1, 1997] Changing U.S. Tax Jurisdiction SAN DIEGO LAW REVIEW A. Expatriation and U.S. Wealth Transfer Taxes .............. 088 B. The Accumulated Earnings of Foreign Corporations That Become Subject to U.S. Tax Jurisdiction ............. 090 C. State Tax Issues .................................. 090 VIII. CONCLUSION .. ........................................ 091 I. INTRODUCTION One of the most contentious tax legislative battles of the 104th Congress erupted over the Clinton administration's proposal to amend the U.S. tax rules applicable to expatriates.! The administration proposed taxing the abandonment of either U.S. citizenship or long-term U.S. tax residency.2 The administration's proposal responded to a number of articles in the popular press that described the U.S. tax benefits of expatriation and divulged the names of well-heeled expatri- ates. Proponents claimed that Congress needed to revise the taxation of expatriates to prevent "billionaire Benedict Arnolds" from avoiding "their fair share" of U.S. income taxes.4 Opponents argued that the Clinton proposal would affect foreign investment in the United States 1. For purposes of this Article, "expatriate" refers to a U.S. citizen who renounces her citizenship or a U.S. resident alien who abandons her U.S. residency and thereafter becomes, for a period of time, a nonresident alien for U.S. income and transfer tax purposes. 2. Any property held by the expatriate at the time of expatriation would be deemed to be sold for its fair market value, and any net gain in excess of $600,000 from the deemed sales would be subject to U.S. income tax. Office of Management and Budget, Budget of the United States Government, Fiscal Year 1996, as released on Feb. 6, 1995, available in LEXIS, Fedtax Library, TNT File, 95 TNT 25-28; see also, Treasury Department General Explanation of Revenue Proposals in Clinton Administration'sFY 1996 Budget Request, Feb. 6, 1995, available in LEXIS, Fedtax Library, DTR File, DTR 25 d85. 3. Nancy Loube, Expatriate Taxation: Politics Obscures Technical Issues, 10 TAX NOTES INT'L 1377 (Apr. 17, 1995). The article was probably Robert Lenzner's and Philippe Mao's, The New Refugees, FORBES, Nov. 21, 1994, at 131. For some reason, the expatriate issue especially captivated the editors of Forbes as this was the second article on expatriation to appear in Forbes in 1994. The first was Brigid McMenamin, Flight Capital, FORBES, Feb. 28, 1994, at 55. 4. Remarks of Rep. Neil Abercrombie on House Floor (Mar. 30, 1995), available in LEXIS, Fedtax Library, TNT File, 95 TNT 70-27 ("What we have here are not expatriates, what we have here are Benedict Amolds, Benedict Amolds who would sell out their citizenship, sell out their country in order to maintain their wealth."). HeinOnline -- 34 San Diego L. Rev. 3 1997 and compared it to the loathed exit tax imposed by the former Soviet Union on emigrants.' After the introduction of the administration's expatriate provisions,6 a legislative debate ensued.7 The Senate favored the administration's approach, under which an expatriate's property would be deemed to be sold for its fair market value-marked to market-on the date of expatriation. The House, however, generally favored retaining the existing expatriate regime, under which a tax-motivated expatriate is taxed like a citizen on income from the United States for ten years following expatriation! The House version passed Congress as part of the Health Insurance Portability and Accountability Act of 1996 and was signed into law on August 21, 1996.9 5. Testimony of William K. Norman at Committee on Ways and Means Oversight Subcommittee Hearing on Expatriate Tax, Mar. 27, 1995, available in LEXIS, Fedtax Library, TNT File, 95 TNT 60-23 ("Exit tax on certain U.S. citizens who renounce their citizenship is bad tax policy with likely detrimental economic consequences."); Testimony of Rabbi Jack Moline at Ways and Means Oversight Subcommittee Hearing on Expatriate Tax, Mar. 27, 1995, available in LEXIS, Fedtax Library, TNT File, 95 TNT 60-27; Testimony of Professor Robert F. Turner, Naval War College, at Ways and Means Oversight Subcommittee Hearing on Expatriate Tax, Mar. 27, 1995, available in LEXIS,
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