[Federal Register Volume 62, Number 108 (Thursday, June 5, 1997)]
[Proposed Rules]
[Pages 30785-30796]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-14735]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[REG-252487-96]
RIN 1545-AU90


Inbound Grantor Trusts With Foreign Grantors

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations implementing 
section 672(f) of the Internal Revenue Code, as amended by the Small 
Business Job Protection Act of 1996, which relates to the application 
of the grantor trust rules to certain trusts established by foreign 
persons. The proposed regulations affect primarily United States 
persons who are beneficiaries of trusts established by foreign persons. 
This document also provides notice of a public hearing on these 
proposed regulations.

DATES: Written comments must be received by August 4, 1997. Requests to 
speak (with outlines of oral comments) to be discussed at the public 
hearing scheduled for August 27, 1997, at 10 a.m. must be submitted by 
August 6, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-252487-96), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

[[Page 30786]]

Washington, DC 20044. Submissions may be hand delivered between the 
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-252487-96), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html.
    The public hearing will be held in room 3313, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning Sec. 1.671-2(e), James 
Quinn (202) 622-3060; concerning the remainder of these regulations, M. 
Grace Fleeman (202) 622-3850; concerning submissions and the hearing, 
Michael Slaughter (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 1904 of the Small Business Job Protection Act of 1996 (the 
Act), Public Law 104-188, 110 Stat. 1755 (August 20, 1996), amended 
section 672(f) and certain other sections of the Internal Revenue Code 
(Code). The amendments affect the application of sections 671 through 
679 of the Code (the grantor trust rules) to certain trusts created by 
foreign persons.

1. Prior Law

    Under prior law, a grantor of a trust generally was treated as the 
owner of any portion of the trust over which he retained any of the 
powers or interests described in sections 673 through 677 without 
regard to whether he was a domestic or foreign person. A special rule 
contained in prior section 672(f) generally provided that, if a U.S. 
beneficiary of a trust created by a foreign person transferred property 
to the foreign person by gift, the U.S. beneficiary was treated as the 
grantor of the trust to the extent of the transfer.
    Under the prior rules, if a foreign person created a trust with one 
or more U.S. beneficiaries that was treated as a grantor trust with the 
foreign person as the grantor, a distribution of income from the trust 
to a U.S. beneficiary was treated as a gift and was not subject to U.S. 
income tax in the hands of the beneficiary. See Rev. Rul. 69-70 (1969-1 
C.B. 182). If the income of the trust was not taxable to the foreign 
grantor under section 871 and also not taxable to either the grantor or 
the trust by either the grantor's country of residence or another 
foreign country, the income of the trust was, thus, not subject to tax 
by any jurisdiction.
    A special rule contained in section 665(c) provided generally that 
intermediaries or nominees interposed between certain foreign trusts 
and their U.S. beneficiaries could be disregarded. However, that rule 
applied only to trusts created by U.S. persons.

2. Overview of Changes

    The changes made by section 1904 of the Act are designed to ensure 
that U.S. persons who benefit from offshore trusts created by foreign 
persons (inbound trusts) pay an appropriate amount of U.S. tax. 
Generally, the grantor trust rules now cause a person to be treated as 
the owner of a trust only to the extent such application results, 
directly or indirectly, in an amount being currently taken into account 
in computing the income of a U.S. citizen or resident or a domestic 
corporation. Exceptions are provided for certain revocable trusts, for 
trusts from which the only amounts distributable during the lifetime of 
the grantor are to the grantor or the grantor's spouse, and for certain 
compensatory trusts. There also are grandfather rules for certain 
trusts that were in existence on September 19, 1995.
    As a result of the changes, many inbound trusts that were grantor 
trusts under prior law are now nongrantor trusts. Distributions of 
trust income to the U.S. beneficiaries of such trusts are now taxable 
to U.S. beneficiaries and may be subject to an interest charge on 
accumulation distributions.
    Section 1904 of the Act also includes some special rules. Section 
643(h), which replaces former section 665(c), treats any amount paid to 
a U.S. person that is derived directly or indirectly from a foreign 
trust of which the payor is not the grantor as if the amount is paid by 
the foreign trust directly to the U.S. person. Section 672(f)(4) allows 
the IRS to recharacterize a purported gift or bequest from a 
partnership or foreign corporation when necessary to prevent the 
avoidance of the purpose of section 672(f). Section 672(f)(5), which is 
an expansion of prior section 672(f), generally provides that if a U.S. 
beneficiary of a trust created by a foreign person transfers property 
to the foreign person, the U.S. beneficiary is treated as the grantor 
of the trust to the extent of the transfer.

Explanation of Provisions

1. Section 1.643(h)-1: Distributions by Certain Foreign Trusts Through 
Intermediaries

    The proposed regulations describe the circumstances under which an 
amount of property that is derived, directly or indirectly, by a U.S. 
person from a foreign trust through an intermediary will be deemed to 
have been paid directly by the foreign trust to the U.S. person. This 
rule does not apply if the intermediary is the grantor of the portion 
of the trust from which the amount is distributed. The amount will be 
deemed to have been paid directly by the foreign trust if any one of 
the following conditions is satisfied: (1) The intermediary is related 
(as defined in the regulations) to either the U.S. person or the 
foreign trust and the intermediary transfers to the U.S. person either 
property that the intermediary received from the trust or proceeds from 
the property that the intermediary received from the trust; (2) the 
intermediary would not have transferred the property to the U.S. person 
(or would not have transferred the property on substantially the same 
terms) but for the fact the intermediary received property from the 
foreign trust; or (3) the intermediary received the property from the 
foreign trust pursuant to a plan one of the principal purposes of which 
was the avoidance of U.S. tax.
    The proposed regulations describe the effect of disregarding the 
intermediary. If the intermediary is an agent of either the foreign 
trust or the U.S. person under generally applicable agency principles 
(under the standards set forth in Commissioner v. Bollinger, 485 U.S. 
340 (1988)), the amount is treated as paid by the foreign trust to the 
U.S. person in the year it would be so treated under the general 
principles. Thus, if the intermediary is an agent of the foreign trust, 
the amount is treated as paid to the U.S. person in the year it is paid 
by the intermediary to the U.S. person. If, however, the intermediary 
is an agent of the U.S. person, the amount is treated as paid to the 
U.S. person in the year it is paid by the foreign trust to the 
intermediary.
    If the intermediary is not an agent of either the foreign trust or 
the U.S. person under generally applicable agency principles, the 
intermediary generally will be treated as an agent of the foreign 
trust, and the amount will be treated as paid by the foreign trust to 
the U.S. person in the year the amount is paid by the intermediary to 
the U.S. person. However, the district director may determine, based on 
all the relevant facts and circumstances, that the

[[Page 30787]]

intermediary should be treated as the agent of the U.S. person.
    The regulations provide a de minimis rule for distributions that do 
not exceed in the aggregate $10,000.

2. Section 1.671-2(e): Definition of Grantor

    The proposed regulations provide a definition of grantor that 
applies for purposes of the grantor trust rules generally. A grantor is 
any individual, corporation, or other person to the extent such person 
(i) creates a trust or (ii) directly or indirectly makes a gratuitous 
transfer to a trust. For purposes of the proposed regulations, a 
gratuitous transfer is any transfer other than a transfer for fair 
market value, or a corporate or partnership distribution. Treasury and 
the IRS request comments regarding the appropriate scope of gratuitous 
transfers.
    A grantor includes a person who acquires an interest in a trust in 
a nongratuitous transfer from a person who is a grantor of the trust. A 
grantor also includes an investor who acquires an interest in a fixed 
investment trust from a person who had acquired his interest through a 
direct investment in the trust. Treasury and the IRS request comments 
on the appropriate scope of these rules as they affect fixed investment 
trusts.
    If a person creates or funds any portion of a trust primarily as an 
accommodation for another person, the other person will be treated as a 
grantor with respect to such portion of the trust. See, e.g., Stern v. 
Commissioner, 77 T.C. 614 (1981), rev'd on other grounds, 747 F.2d 555 
(9th Cir. 1984).
    These regulations are not intended to change the result of existing 
law with respect to trusts used for business purposes. See 
Sec. 301.7701-4(e) (environmental remediation trusts); Rev. Rul. 87-
127, 1987-2 C.B. 156 (pre-need funeral trusts); Rev. Proc. 92-64, 1992-
2 C.B. 422 (rabbi trusts). Treasury and the IRS request comments on the 
application of these new rules to trusts used for business purposes.
    A grantor of a trust may or may not be treated as an owner of the 
trust under sections 671 through 677 and 679. A person other than a 
grantor of a trust may be treated as an owner of the trust under 
section 678.

3. Section 1.672(f)-1: Foreign Persons Not Treated as Owners

    The proposed regulations prescribe a two-step analysis for 
implementing the general rule of section 672(f). First, the grantor 
trust rules other than section 672(f) (the basic grantor trust rules) 
are applied to determine the worldwide amount and the U.S. amount. 
Then, the trust is treated as partially or wholly owned by a foreign 
person based on an annual year-end comparison of the worldwide amount 
and the U.S. amount.
    The worldwide amount is defined as the net amount of income, gains, 
deductions, and losses that would be taken into account for the current 
year under the basic grantor trust rules in computing the worldwide 
taxable income of any person, whether or not such person is a U.S. 
taxpayer (as defined in the regulation). The worldwide amount is 
determined in accordance with U.S. principles of income taxation, and 
includes amounts that would be attributable to foreign persons, without 
regard to whether such amounts are subject to U.S. income taxation.
    The U.S. amount is defined as the net amount of income, gains, 
deductions, and losses that would be taken into account for the current 
year under the basic grantor trust rules (directly or through one or 
more entities) in computing the taxable income of a U.S. taxpayer. The 
U.S. amount includes amounts such as interest on state or local bonds 
that are not includible in gross income.
    A U.S. taxpayer is defined as any person who is a U.S. citizen, a 
resident alien individual, a domestic corporation, a U.S. person who is 
treated as the owner of a trust under section 679, or a domestic trust 
to the extent such trust actually pays U.S. tax with respect to the 
income, gains, deductions, and losses.
    If the worldwide amount and the U.S. amount are the same, the basic 
grantor trust rules continue to apply without the limitation of section 
672(f). If the worldwide amount is greater than the U.S. amount, 
section 672(f) prevents the basic grantor trust rules from treating a 
person as the owner of that portion of the trust attributable to the 
excess of the worldwide amount over the U.S. amount.

4. Section 1.672(f)-2: Trusts Created by Certain Foreign Corporations

    Section 672(f)(3) provides in part that, except as otherwise 
provided in regulations, a controlled foreign corporation (CFC) shall 
be treated as a domestic corporation for purposes of section 672(f)(1). 
Under the proposed regulations, a CFC that creates and funds a trust 
will be treated as a domestic corporation to the extent that, if the 
basic grantor trust rules were applied, income earned by the trust for 
the taxable year would be subpart F income to the CFC that would be 
currently taken into account in computing the gross income of a U.S. 
citizen or resident or a domestic corporation. However, the CFC will 
not be treated as a domestic corporation to the extent the income of 
the trust would not be subpart F income or to the extent it would be 
subpart F income but would not be taken into account in computing the 
gross income of a U.S. citizen or resident or a domestic corporation 
(e.g., the CFC had no overall earnings and profits).
    The proposed regulations include similar rules for trusts created 
by passive foreign investment companies (PFICs) or foreign personal 
holding companies.
    Section 672(f)(3) also provides that the general rule of section 
672(f)(1) shall not apply for purposes of section 1296. The proposed 
regulations implement this rule by providing that, for purposes of 
determining whether a foreign corporation is a PFIC, the grantor trust 
rules shall be applied as if section 672(f) had not come into effect. 
Consequently, a foreign corporation cannot avoid PFIC status by 
transferring passive assets to a trust that would be treated as a 
nongrantor trust if section 672(f) were applied.

5. Section 1.672(f)-3: Exceptions to General Rule

A. Certain Revocable Trusts
    The proposed regulations provide that the general rule of 
Sec. 1.672(f)-1 does not apply to any portion of a trust if the power 
to revest in the grantor title to such portion is exercisable solely by 
the grantor without the approval or consent of any other person. If the 
grantor can exercise the power only with the approval of a related or 
subordinate party who is subservient to the grantor, such power will be 
treated as exercisable solely by the grantor.
    The exception will not apply unless the power to revest is 
exercisable for a period or periods aggregating 183 days or more during 
the taxable year of the trust. This rule is intended to provide a 
bright line rule for the benefit of both taxpayers and IRS examiners 
that addresses potentially abusive situations in which a power to 
revest is so limited that it is not likely to be exercised. The 183 
days need not be consecutive; thus, a power to revest that is 
exercisable each year from January 1 through May 31 and again from 
September 1 through December 31 would be eligible for the exception.
    Consistent with the statute, the proposed regulations provide a 
grandfather rule for a trust that was treated as owned by the grantor 
under

[[Page 30788]]

section 676 on September 19, 1995. As long as such a trust would 
continue to be so treated under the basic grantor trust rules, the 
trust will be exempt from the general rule of section 672(f), except 
with respect to any portion of the trust attributable to transfers to 
the trust after September 19, 1995. Under the proposed regulations, 
separate accounting is required for amounts transferred to the trust 
after September 19, 1995, together with all income and gains thereof, 
as well as losses and distributions therefrom.
B. Certain Other Trusts
    The proposed regulations provide that the general rule does not 
apply to any trust (or portion of a trust) if the only amounts 
distributable (whether income or corpus) from such trust (or portion of 
a trust) during the lifetime of the grantor are amounts distributable 
to the grantor or the grantor's spouse. For this purpose, payments of 
reasonable nongratuitous amounts, such as reasonable administrative 
expenses, are not considered to be amounts distributable from the 
trust.
    The proposed regulations clarify that amounts distributable in 
discharge of a legal obligation of the grantor or the grantor's spouse 
will generally be treated as amounts distributable to the grantor or 
the grantor's spouse. Thus, it is expected that a reinsurance trust 
that would have been a grantor trust under prior law generally will 
continue to be a grantor trust. (No inference is intended as to whether 
a reinsurance trust constitutes a trust under regulation Sec. 301.7701-
4.) However, a legal obligation will not include an obligation to a 
person who is related (as defined in the regulations) to the grantor or 
the grantor's spouse, unless the obligation was entered into for 
adequate and full consideration in money or money's worth. Trusts from 
which distributions are taxable as compensation for services rendered 
generally will be covered by the exception for compensatory trusts, 
described below.
    Amounts distributable to support a family member will be treated as 
amounts distributable to the grantor or the grantor's spouse only if 
certain requirements are satisfied. Although different jurisdictions 
have different requirements for support obligations, administrative 
simplicity is served by providing one uniform rule on this point. Under 
the proposed regulations, the family member must be an individual who 
would be treated as a dependent of the grantor or the grantor's spouse 
under sections 152(a)(1) through (8), without regard to the requirement 
that half of the individual's support be received from the grantor or 
the grantor's spouse. In addition, the family member must be either 
permanently and totally disabled (within the meaning of section 
22(e)(3)) or, in the case of a son, daughter, stepson, or stepdaughter, 
less than 24 years old.
    Consistent with the statute, the proposed regulations provide a 
grandfather rule for a trust that was treated as owned by the grantor 
under section 677 (other than subsection (a)(3) thereof) on September 
19, 1995. As long as such a trust would continue to be so treated under 
the basic grantor trust rules, the trust will be exempt from the 
general rule, except with respect to any portion of the trust 
attributable to transfers to the trust after September 19, 1995. Under 
the proposed regulations, separate accounting is required for amounts 
transferred to the trust after September 19, 1995, together with all 
income and gains thereof, as well as losses and distributions 
therefrom.
C. Compensatory Trusts
    The proposed regulations implement section 672(f)(2)(B), which 
provides that, except as provided in regulations, the general rule 
shall not apply to any portion of a trust from which distributions are 
taxable as compensation for services rendered. Tracking the language of 
the statute, the proposed regulations list categories of trusts that 
constitute compensatory trusts, without regard to whether they could be 
treated as grantor trusts under the basic grantor trust rules. This 
list is intended to be an exclusive list. However, the proposed 
regulations also provide that additional categories of compensatory 
trusts may be designated later in guidance published in the Internal 
Revenue Bulletin.
    The following categories of trusts are classified as compensatory 
trusts: (i) qualified trusts described in section 401(a), (ii) trusts 
described in section 457(g), (iii) nonexempt employees' trusts 
described in section 402(b), (iv) individual retirement account (IRA) 
trusts that are either simplified employee pensions described in 
section 408(k) or simple retirement accounts described in section 
408(p), (v) IRA trusts to which the only contributions are rollover 
contributions listed in section 408(a)(1), (vi) certain so-called rabbi 
trusts (see Rev. Proc. 92-64 (1992-2 C.B. 422)), and (vii) trusts that 
are welfare benefit funds described in section 419(e) (without regard 
to whether they provide taxable benefits).
    The IRS and Treasury contemplate that the nonexempt employees' 
trusts listed in category (iii) above will be treated as grantor trusts 
only to the extent provided in proposed regulations Sec. 1.671-1(g) and 
Sec. 1.671-1(h), which were published in the Federal Register (61 FR 
50778) on September 27, 1996.
    IRAs that are excluded from the list of compensatory trusts because 
they are funded by individuals, rather than employers, are expected to 
be covered by one or both of the exceptions for revocable trusts or for 
trusts from which the only amounts distributable during the lifetime of 
the grantor are to the grantor or the grantor's spouse.

6. Section 1.672(f)-4: Recharacterization of Purported Gifts

    The proposed regulations implement the purported gift rule of 
section 672(f)(4), which was enacted as a backstop to section 672(f). 
See Staff of the Joint Committee on Taxation, 104th Cong., 2nd Sess., 
General Explanation of the Tax Legislation Enacted in the 104th 
Congress, at 271 (1996). The purported gift rule prevents taxpayers 
from avoiding the general rule of section 672(f) by using a partnership 
or a foreign corporation as a substitute for a trust.
    As a general rule, if a U.S. donee receives a purported gift or 
bequest directly or indirectly from a partnership, the purported gift 
or bequest must be included in the U.S. donee's income as ordinary 
income. If a U.S. donee receives a purported gift or bequest directly 
or indirectly from a foreign corporation, the purported gift or bequest 
generally must be included in the U.S. donee's gross income as a 
distribution from the foreign corporation. In the latter case, the U.S. 
donee will not be treated as having basis in the foreign corporation, 
and the U.S. donee will be treated as having a holding period in the 
foreign corporation equal to the average holding period (using a 
weighted average) of the actual interest holders.
    However, the gift or bequest will not be recharacterized if the 
donee can establish that a U.S. citizen or resident alien who directly 
or indirectly holds an interest in the partnership or foreign 
corporation treated the purported gift as a distribution from the 
partnership or foreign corporation and a subsequent gift to the donee. 
There also is an exception for charitable contributions to donees 
described in section 170(c).
    The proposed regulations provide rules for gratuitous transfers to 
U.S. donees from trusts created by partnerships or foreign 
corporations. As a result, a partnership or foreign corporation cannot 
avoid the purported gift rule by creating a nongrantor trust that makes 
an immediate nontaxable distribution of trust corpus to a U.S.

[[Page 30789]]

donee. Under the proposed regulations, if the partnership or foreign 
corporation is not treated under the grantor trust rules as the owner 
of the portion of the trust from which property is distributed to a 
U.S. donee in a gratuitous transfer, the distribution will be 
characterized as a distribution from the partnership or foreign 
corporation if such characterization results in a higher U.S. tax 
liability.
    Notwithstanding any other provision, the proposed regulations 
provide that the district director may recharacterize a transfer that 
is subject to the rules of section 672(f)(4) to prevent the avoidance 
of U.S. tax or clearly to reflect income. For example, the district 
director may determine, based upon the facts and circumstances, that a 
distribution from a partnership or foreign corporation is more properly 
treated as a distribution from a trust.
    The proposed regulations provide a de minimis rule for purported 
gifts or bequests that do not exceed in the aggregate $10,000.

7. Section 1.672(f)-5: Special Rules

A. Transfers by Certain Beneficiaries to Foreign Settlor
    The proposed regulations provide that if, but for section 
672(f)(5), a foreign person would be treated as the owner of any 
portion of a trust, any U.S. beneficiary of the trust will be treated 
as the owner of a portion of the trust to the extent the U.S. 
beneficiary directly or indirectly made transfers of property to such 
foreign person in excess of transfers to the U.S. beneficiary from the 
foreign person. (Such a transfer may also constitute an indirect 
transfer from a U.S. person to a foreign trust for purposes of section 
679.) The U.S. beneficiary need not have been a U.S. person at the time 
of the transfer.
    The proposed regulations do not specify a time period within which 
a transfer must have been made to trigger this rule. However, they do 
provide that the rule will not apply to the extent the U.S. beneficiary 
can demonstrate that the transfer was wholly unrelated to any 
transaction involving the trust. In addition, consistent with the 
statute, the proposed regulations provide that a transfer of property 
does not include either a nongratuitous transfer or a gift that would 
be excluded from taxable gifts under section 2503(b).
B. Different Taxable Years
    The proposed regulations provide that if a person has a different 
taxable year from the taxable year of the trust, an amount is currently 
taken into account in computing the income of such person for purposes 
of the general rule if the amount is taken into account for the taxable 
year of such person that includes the last day of the taxable year of 
the trust.
C. Entity Characterization
    The proposed regulations provide that entities generally will be 
characterized under U.S. income tax principles. See regulations 
Secs. 301.7701-1 through 301.7701-4. However, an entity having a single 
owner could avoid the purported gift rule if it could elect to be 
disregarded as a separate entity, because the purported gift or bequest 
would then be received from the owner of the entity, rather than from 
the entity itself. Therefore, the proposed regulations provide that, 
for purposes of section 672(f)(4), a wholly owned business entity must 
be treated as a corporation, separate from its single owner.

8. Section 301.7701-2(c)(2)(iii): Special Rule for Business Entities 
That Make Purported Gifts

    As explained above, an entity having a single owner could avoid the 
purported gift rule if it elected to be disregarded as a separate 
entity under the existing entity classification regulations. Therefore, 
the proposed regulations add a new sentence to the existing regulations 
to provide that, for purposes of section 672(f)(4), a wholly owned 
business entity must be treated as a corporation, separate from its 
owner.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) does not apply to these regulations, and, because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, these regulations will 
be submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (preferably a 
signed original and eight (8) copies) that are submitted timely to the 
IRS. All comments will be available for public inspection and copying.
    A public hearing has been scheduled for August 27, 1997, at 10 
a.m., in room 3313, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington DC. Because of access restrictions, visitors 
will not be admitted beyond the Internal Revenue Building lobby more 
than 15 minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments by August 4, 1997, and submit an outline of the 
topics to be discussed and the time to be devoted to each topic 
(preferably a signed original and eight (8) copies) by August 6, 1997.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is M. Grace Fleeman of 
the Office of Associate Chief Counsel (International). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, ncome 
taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as 
follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.643(h)-1 also issued under 26 U.S.C. 643(a)(7).
    Section 1.671-2(e) also issued under 26 U.S.C. 643(a)(7) and 
672(f)(6).
    Section 1.672(f)-1 also issued under 26 U.S.C. 643(a)(7) and 
672(f)(6).
    Section 1.672(f)-2 also issued under 26 U.S.C. 643(a)(7), 72(f) 
(3) and (6).
    Section 1.672(f)-3 also issued under 26 U.S.C. 643(a)(7), 72(f) 
(2) and (6).

[[Page 30790]]

    Section 1.672(f)-4 also issued under 26 U.S.C. 643(a)(7), 
72(f)(4) and (6).
    Section 1.672(f)-5 also issued under 26 U.S.C. 643(a)(7) and 
672(f)(6). * * *

    Par. 2. Section 1.643(h)-1 is added to read as follows:


Sec. 1.643(h)-1  Distributions by certain foreign trusts through 
intermediaries.

    (a) In general. For purposes of sections 641 through 683, any 
amount of property that is derived, directly or indirectly, by a United 
States person from a foreign trust through another person (an 
intermediary) shall be deemed to have been paid directly by the foreign 
trust to the United States person if any one of the following 
conditions is satisfied--
    (1) The intermediary is related (within the meaning of paragraph 
(e) of this section) to either the United States person or the foreign 
trust and the intermediary transfers to the United States person either 
property that the intermediary received from the foreign trust or 
proceeds from the property that the intermediary received from the 
foreign trust;
    (2) The intermediary would not have transferred the property to the 
United States person (or would not have transferred the property to the 
United States person on substantially the same terms) but for the fact 
that the intermediary received property from the foreign trust; or
    (3) The intermediary received the property from the foreign trust 
pursuant to a plan one of the principal purposes of which was the 
avoidance of U.S. tax.
    (b) Exception for grantor as intermediary. Paragraph (a) of this 
section shall not apply if the intermediary is the grantor of the 
portion of the trust from which the amount is derived. For the 
definition of grantor, see Sec. 1.671-2(e).
    (c) Effect of disregarding intermediary. If an amount is treated as 
paid directly by the foreign trust to a United States person pursuant 
to this section, one of the following rules shall apply:
    (1) Intermediary is agent under general principles. If the 
intermediary is an agent of the foreign trust or the United States 
person under generally applicable agency principles, the payment shall 
be treated as paid by the foreign trust to the United States person in 
the year it would be so treated under such principles. Thus, if the 
intermediary is an agent of the foreign trust, the payment shall be 
treated as paid to the United States person in the year the amount is 
paid by the intermediary to the United States person. If, however, the 
intermediary is an agent of the United States person, the payment shall 
be treated as paid to the United States person in the year the amount 
is paid by the foreign trust to the intermediary.
    (2) Intermediary is not agent under general principles--(i) Agent 
of foreign trust. Except as provided in paragraph (c)(2)(ii) of this 
section, if the intermediary is not an agent of the foreign trust or 
the United States person under generally applicable agency principles--
    (A) The intermediary shall be treated as an agent of the foreign 
trust; and
    (B) The payment shall be treated as paid by the foreign trust to 
the United States person in the year the amount is paid by the 
intermediary to the United States person.
    (ii) Agent of United States person. The district director may 
determine, based on all the relevant facts and circumstances, that the 
intermediary should be treated as the agent of the United States 
person. If the intermediary is treated as the agent of the United 
States person pursuant to this paragraph (c)(2)(ii), the payment shall 
be treated as paid to the United States person in the year the 
intermediary receives the payment from the foreign trust.
    (d) De minimis exception. This section shall not apply if, during 
the taxable year of the United States person, the aggregate amount that 
is transferred to such person from all foreign trusts through one or 
more intermediaries does not exceed $10,000.
    (e) Related parties. For purposes of this section, an intermediary 
shall be treated as related to a United States person or foreign trust 
if the intermediary and the United States person or foreign trust are 
related within the meaning of section 643(i)(2)(B), with the following 
modifications:
    (1) For purposes of applying section 267 (other than section 
267(f)) and section 707(b)(1), ``at least 10 percent'' shall be 
substituted for ``more than 50 percent'' each place it appears;
    (2) The principles of section 267(b)(10), substituting ``at least 
10 percent'' for ``more than 50 percent,'' shall apply to determine 
whether two corporations are related; and
    (3) The principles applicable to trusts shall apply to determine 
whether an estate is related to another person.
    (f) Examples. The following examples illustrate the rules of this 
section. In each example, FT is an irrevocable foreign trust that is 
not treated as owned by any other person. The examples follow:

    Example 1. Related intermediary. I, a nonresident alien who is 
not the grantor of FT, receives a distribution of stock from FT in 
the year 2001. In the year 2002, I sells the stock to an unrelated 
party for its fair market value of 100X and gives the 100X to his 
daughter, B, who is a U.S. resident. I is not an agent of either FT 
or B under generally applicable agency principles. Under paragraphs 
(a)(1) and (c)(2)(i) of this section, FT is deemed to have 
distributed 100X directly to B in the year 2002.
    Example 2. ``But for'' condition. I, a foreign bank that is 
unrelated to any of the parties in these transactions, received a 
deposit of 500X from FT in the year 2001. In the year 2002, I 
transfers 400X to B, a United States person, in a transfer that it 
would not have made but for the fact that I had received 500X from 
FT. I is not an agent of either FT or B under generally applicable 
agency principles. Under paragraphs (a)(2) and (c)(2)(i) of this 
section, FT is deemed to have distributed 400X directly to B in the 
year 2002.
    Example 3. Tax avoidance purpose. FT was created in 1980 by A, a 
nonresident alien. In the year 2001, FT's trustee, T, determines 
that 1000X of accumulated income should be distributed to A's U.S. 
granddaughter, B. Pursuant to a plan with a principal purpose of 
avoiding the interest charge that would be imposed by section 668, T 
causes FT to distribute 1000X to I, an unrelated foreign person. I 
subsequently transfers 1000X to B in the year 2001. Under paragraph 
(a)(3) of this section, B is deemed to have received an accumulation 
distribution from FT in the year 2001.
    Example 4. Amount not derived from foreign trust. W and her 
husband, H, are both nonresident aliens. W's son, S, is a U.S. 
resident. W receives annual income of 5000X from her own 
investments. Several years ago, H created and funded FT using his 
separate property. At the beginning of the year 2001, W receives a 
distribution of 100X from FT. There is no plan with a principal 
purpose of avoiding U.S. tax. At the end of the year 2001, W gives 
100X of her investment income to S. None of the conditions in 
paragraph (a) of this section is satisfied. The transfer to S is 
treated as a nontaxable gift from W and not as an amount derived 
directly or indirectly from FT.

    (g) Effective date. The rules of this section are applicable for 
transfers made by foreign trusts on or after August 20, 1996.
    Par. 3. In Sec. 1.671-2, paragraph (e) is revised to read as 
follows:


Sec. 1.671-2  Applicable principles.

* * * * *
    (e)(1) For purposes of subchapter J of the Internal Revenue Code, a 
grantor includes any person to the extent such person either creates a 
trust, or directly or indirectly makes a gratuitous transfer (within 
the meaning of paragraph (e)(4)(i) of this section) of property to a 
trust.
    (2) A grantor includes a person who acquires an interest in a trust 
from a grantor of the trust if either--

[[Page 30791]]

    (i) The transfer is nongratuitous (within the meaning of paragraph 
(e)(4)(ii) of this section); or
    (ii) The transfer is of an interest in a fixed investment trust.
    (3) If one person creates or funds a trust (or portion of a trust) 
primarily as an accommodation for another person, the other person 
shall be treated as a grantor of the trust (or portion of the trust).
    (4)(i) A gratuitous transfer is any transfer other than a transfer 
for fair market value, or a corporate or partnership distribution. A 
transfer of property to a trust may be considered a gratuitous transfer 
without regard to whether the transfer is a gift for gift tax purposes 
(see chapter 12 of subtitle B of the Internal Revenue Code).
    (A) For purposes of this paragraph (e), a transfer for fair market 
value includes only transfers in consideration for property received 
from the trust, services rendered by the trust, or the right to use 
property of the trust. A transfer is for fair market value only to the 
extent that the value of the property received, services rendered, or 
the right to use property is equal to at least the fair market value of 
the property transferred. For example, rents, royalties, and 
compensation paid to a trust are transfers for fair market value only 
if the payments reflect an arm's length price for the use of the 
property of, or services rendered by, the trust. For purposes of this 
determination, if a person contributes property to a trust (or to 
another entity that subsequently transfers the property (or proceeds 
therefrom) to a trust) in exchange for any type of interest in the 
trust (or other entity), such interest in the trust (or other entity) 
shall be disregarded in determining whether fair market value has been 
received. In addition, a person shall not be treated as making a 
transfer for fair market value merely because the transferor recognizes 
gain on the transaction. For example, if a taxpayer elects to treat a 
transfer of appreciated property to a foreign trust as a deemed sale 
under section 1057, such a transfer will not be treated as a transfer 
for fair market value because the transferor did not receive actual 
fair market value consideration pursuant to the deemed sale.
    (B) For purposes of this paragraph (e), a transfer to a trust is a 
corporate distribution, and therefore not a gratuitous transfer, only 
if it is a distribution described in section 301, 302, 305, 355 or 356. 
Similarly, for purposes of this paragraph (e), a transfer to a trust is 
a partnership distribution, and therefore not a gratuitous transfer, 
only if it is described in section 731. A distribution from one trust 
to another trust that is a beneficiary of the first trust is a 
gratuitous transfer.
    (C) Notwithstanding any other provision of this paragraph (e), the 
district director may determine, based upon the facts and 
circumstances, that a direct or indirect transfer to a trust is more 
properly characterized as a gratuitous transfer if the transfer was 
structured with a principal purpose of avoiding U.S. tax. See, e.g., 
sections 643(a)(7) and 679(d).
    (ii) For purposes of this paragraph (e), any transfer other than a 
gratuitous transfer is a nongratuitous transfer.
    (5) The following examples illustrate the rules of this paragraph 
(e):

    Example 1. A creates and funds a trust, T, for the benefit of 
her children. Under paragraph (e)(1) of the section, A is a grantor 
of T.
    Example 2. A makes an investment in a fixed investment trust, T, 
that is classified as a trust under Sec. 301.7701-4(c)(1) of this 
chapter. B subsequently acquires A's entire interest in T for fair 
market value. Under paragraph (e)(2) of this section, B is a grantor 
of T with respect to such interest.
    Example 3. A, an attorney, creates a trust, T, for the benefit 
of his client, B, and B's children. The trust instrument names A as 
the grantor. A funds T with a nominal contribution out of his own 
funds. A views the contribution as an investment in the generation 
of fees for future legal services. Under paragraph (e)(3) of this 
section, B is a grantor of T.
    Example 4. A, a U.S. citizen, creates and funds a trust, T, for 
the benefit of B. B holds an unrestricted power to withdraw any 
amount contributed to the trust for a period of 60 days after the 
contribution is made. B is treated as an owner of T under section 
678 as a result of the withdrawal power. However, B is not a grantor 
of T under paragraph (e)(1) of this section as a result of the 
withdrawal power, because B neither created T nor made a gratuitous 
transfer to T.
    Example 5. A contributes cash to a trust, T, through a broker, 
in exchange for units in T. The value of the units in T is 
disregarded in determining whether A has received fair market value 
under paragraph (e)(4)(i)(A) of this section. Therefore, A has made 
a gratuitous transfer to T, and, under paragraph (e)(1) of this 
section, A is a grantor of T.
    Example 6. A borrows cash from T, an unrelated trust. Arm's-
length interest payments by A to T will not be treated as gratuitous 
transfers under paragraph (e)(4)(i)(A) of this section. Therefore, 
under paragraph (e)(1) of this section, A is not a grantor of T with 
respect to the interest payments.
    Example 7. A creates and funds a domestic trust, DT. After A's 
death, DT distributes cash to a foreign trust, FT, that is a 
beneficiary of DT. Under paragraph (e)(4)(i)(B) of this section, the 
trust distribution by DT is a gratuitous transfer. Therefore, under 
paragraph (e)(1) of this section, DT is a grantor of FT with respect 
to such transfer.
    Example 8. A creates and funds a trust, T. T owns stock of C, a 
publicly traded company, that pays a dividend to its shareholders, 
including T. The dividend paid by C is a nongratuitous transfer 
under paragraph (e)(4)(i)(B) of this section. Therefore, C is not a 
grantor under paragraph (e)(1) of this section with respect to the 
dividend.
    Example 9. A, a nonresident alien, creates a trust, T, for the 
benefit of her spouse, B, who is a U.S. citizen. T is not treated as 
owned by any other person. A sells property worth $1,000,000 to T in 
exchange for $100,000 in cash. Under paragraph (e)(4)(i)(A) of this 
section, the $900,000 excess is a gratuitous transfer by A. 
Therefore, A is a grantor of T under paragraph (e)(1) of this 
section with respect to such transfer.

    (6) The rules of this paragraph (e) are applicable as of August 20, 
1996.
    Par. 4. Sections 1.672(f)-1, 1.672(f)-2, 1.672(f)-3, 1.672(f)-4, 
and 1.672(f)-5 are added to read as follows:


Sec. 1.672(f)-1  Foreign persons not treated as owners.

    (a) General rule. Section 672(f)(1) provides that sections 671 
through 679 (the grantor trust rules) shall cause a person to be 
treated as the owner of any portion of a trust only to the extent such 
application results in an amount (if any) being currently taken into 
account (directly or through one or more entities) in computing the 
income of a citizen or resident of the United States or a domestic 
corporation. Section 672(f)(1) may apply only to a trust that would be 
treated as owned, in whole or in part, by a foreign person under the 
grantor trust rules without regard to section 672(f). For rules 
describing the application of this section, see paragraph (b) of this 
section. For definitions regarding the rules of this section, see 
paragraph (c) of this section. For examples illustrating the 
application of this section, see paragraph (d) of this section. For the 
effective date of the rules of this section, see paragraph (e) of this 
section.
    (b) Application of general rule--(1) Initial determination. To 
determine whether a trust is treated as owned by a foreign person, the 
taxpayer should first apply the grantor trust rules without regard to 
section 672(f) (the basic grantor trust rules) to determine the 
worldwide amount (as defined in paragraph (c)(1) of this section) and 
the U.S. amount (as defined in paragraph (c)(2) of this section).
    (2) Result. The trust is treated as owned by a foreign person based 
on an annual comparison at the end of the trust's taxable year of the 
worldwide amount and the U.S. amount. If there is a worldwide amount 
and such amount is greater than the U.S. amount, under

[[Page 30792]]

section 672(f) the foreign person shall not be treated as the owner of 
the portion of the trust attributable to the excess of the worldwide 
amount over the U.S. amount. Otherwise, the basic grantor trust rules 
shall apply without the limitation of section 672(f). For examples, see 
paragraph (d) of this section.
    (c) Definitions--(1) Worldwide amount. The worldwide amount is the 
net amount of income, gains, deductions, and losses that would be taken 
into account for the current year under the basic grantor trust rules 
in computing the worldwide taxable income of any person, whether or not 
such person is a U.S. taxpayer (as defined in paragraph (c)(3) of this 
section). The worldwide amount is computed in accordance with U.S. 
principles of income taxation and includes amounts that would be 
attributable to foreign persons, without regard to whether such amounts 
are subject to U.S. income tax.
    (2) U.S. amount. The U.S. amount is the net amount of income, 
gains, deductions, and losses that would be taken into account for the 
current year under the basic grantor trust rules (directly or through 
one or more entities) in computing the taxable income of a U.S. 
taxpayer (as defined in paragraph (c)(3) of this section). The U.S. 
amount includes amounts that would be attributable to the U.S. taxpayer 
even if the amount would not be includible in gross income (e.g., tax-
exempt interest described in section 103(a)).
    (3) U.S. taxpayer. A U.S. taxpayer is any person who is a U.S. 
citizen, a resident alien individual, a domestic corporation, a U.S. 
person who is treated as the owner of a trust under section 679, or a 
domestic trust to the extent such trust actually pays U.S. tax with 
respect to its income, gains, deductions, and losses.
    (d) Examples. The following examples illustrate the rules of this 
section:

    Example 1. U.S. amount equals worldwide amount. A, a citizen of 
the United States, creates and funds an irrevocable foreign trust, 
FT, for the benefit of his U.S. son, B. Under the basic grantor 
trust rules (see section 679), A would be treated as the owner of 
FT. For the taxable year ending December 31, 1999, FT has ordinary 
income of 100X, long-term capital gain of 200X, deductions of 20X, 
and short-term capital losses of 15X. Under paragraph (c)(1) of this 
section, the worldwide amount is 265X (100X+200X-20X-15X). Under 
paragraph (c)(2) of this section, the U.S. amount also is 265X. 
Consequently, under paragraph (b)(2) of this section, because the 
worldwide amount is equal to the U.S. amount, the basic grantor 
trust rules apply without the limitation of section 672(f) to treat 
A as the owner of FT.
    Example 2. No U.S. amount. A, a nonresident alien, funds an 
irrevocable domestic trust, DT, for the benefit of his U.S. son, B.A 
has a reversionary interest within the meaning of section 673. If 
the basic grantor trust rules were applied, A would be treated as 
the owner of DT, and any distributions to B would be considered 
nontaxable gifts from A to B. Under paragraph (c)(2) of this 
section, there is no U.S. amount, because no amount is taken into 
account for the current year under the basic grantor trust rules in 
computing the taxable income of a U.S. taxpayer. Under paragraph 
(c)(1) of this section, the worldwide amount is equal to DT's net 
income. Under paragraph (b)(2) of this section, A is not treated as 
the owner of any portion of DT. Consequently, DT is a separate 
taxable entity, and distributions from DT to B must be taken into 
account in computing B's income.
    Example 3. U.S. amount less than worldwide amount. FP is a 
foreign partnership for U.S. income tax purposes. FP has two 
partners: C, a nonresident alien, and D, a U.S. citizen. The 
partnership agreement provides that all income, gains, losses, 
deductions, and credits are allocated 50 percent to each partner. FP 
contributed cash to an irrevocable foreign trust, FT, primarily for 
the benefit of E, D's U.S. brother. FP can control the beneficial 
enjoyment of the trust assets within the meaning of section 674. If 
the basic grantor trust rules were applied, FT would be treated as 
the owner of FP. Because D's 50 percent distributive share of FP's 
income would be currently taken into account in computing the income 
of a U.S. citizen, the U.S. amount computed under paragraph (c)(2) 
of this section is equal to one half of the worldwide amount 
computed under paragraph (c)(1) of this section. Therefore, under 
paragraph (b)(2) of this section, FP is not treated as the owner of 
the portion of FT attributable to C's interest in FP. Such portion 
of FT will be treated as a separate taxable entity, and 
distributions by FT to E with respect to that portion of the trust 
will be considered distributions to E under section 662 and may be 
subject to the section 668 interest charge on accumulation 
distributions. (In addition, distributions from FP to E may be 
subject to recharacterization as purported gifts under 
Sec. 1.672(f)-4.)
    Example 4. No worldwide amount. USC is a U.S. corporation with a 
wholly owned foreign subsidiary, FC. USC funds an irrevocable 
foreign trust, FT, that cannot benefit any U.S. person. USC retains 
no power or interest that would cause it to be treated as the owner 
of FT under the basic grantor trust rules. However, FC is given a 
power of appointment such that FC would be treated as the owner of 
FT under section 678. FT acquires a note issued by FC. FT has no 
items of income, deduction, losses, or credit other than income from 
the note. Under U.S. income tax principles, if the basic grantor 
trust rules were applied, FC would be treated as the owner of FT. 
Thus, FC would be treated as both the debtor and the creditor with 
respect to the note, and the note would be disregarded. Under 
paragraph (c)(1) of this section, there is no worldwide amount. 
Under paragraph (c)(2) of this section, there is no U.S. amount. 
Consequently, under paragraph (b)(2) of this section, the basic 
grantor trust rules apply without the limitation of section 672(f) 
to treat FC as the owner of FT.
    Example 5. Deemed contribution on effective date. Assume the 
same facts as in Example 2. DT was created in 1990. On August 20, 
1996, DT held accumulated income. Prior to August 20, 1996, A was 
treated as the owner of DT. A is deemed to have contributed the 
assets that were held in DT on August 20, 1996 to a new trust on 
that date.

    (e) Effective date. The rules of this section are applicable as of 
August 20, 1996.


Sec. 1.672(f)-2  Trusts created by certain foreign corporations.

    (a) Controlled foreign corporations. A controlled foreign 
corporation (as defined in section 957) that creates and funds a trust 
shall be treated as a domestic corporation for purposes of 
Secs. 1.672(f)-1 through 1.672(f)-5 to the extent that, if the grantor 
trust rules without regard to section 672(f) (the basic grantor trust 
rules) were applied, income earned by the trust for the taxable year 
would be currently taken into account pursuant to section 951 in 
computing the gross income of a citizen or resident of the United 
States or a domestic corporation.
    (b) Passive foreign investment companies--(1) In general. A passive 
foreign investment company (as defined in section 1296) that creates 
and funds a trust shall be treated as a domestic corporation for 
purposes of Secs. 1.672(f)-1 through 1.672(f)-5 to the extent that, if 
the basic grantor trust rules were applied, income earned by the trust 
for the taxable year would be currently taken into account pursuant to 
section 1293 in computing the gross income of a citizen or resident of 
the United States or a domestic corporation.
    (2) Application of section 1296. For purposes of determining 
whether a foreign corporation is a passive foreign investment company 
as defined in section 1296, the grantor trust rules shall be applied as 
if section 672(f) had not come into effect.
    (c) Foreign personal holding companies. A foreign personal holding 
company (as defined in section 552) that creates and funds a trust 
shall be treated as a domestic corporation for purposes of 
Secs. 1.672(f)-1 through 1.672(f)-5 to the extent that, if the basic 
grantor trust rules were applied, income earned by the trust for the 
taxable year would be currently taken into account pursuant to section 
551 in computing the gross

[[Page 30793]]

income of a citizen or resident of the United States or a domestic 
corporation.
    (d) Examples. The following examples illustrate the rules of this 
section. In each example, FT is an irrevocable foreign trust, and CFC 
is a controlled foreign corporation. The examples follow:

    Example 1. Controlled foreign corporation without ultimate U.S. 
ownership. Two nonresident aliens, A and B, create a domestic 
partnership, DP. DP's only asset is all the stock of CFC. CFC 
creates and funds FT to benefit A's U.S. daughter, C. CFC retains an 
administrative power over the trust as described in section 675. 
Thus, if the basic grantor trust rules were applied, CFC would be 
treated as the owner of FT, and distributions from FT to C would not 
be taxed as distributions under section 662. However, under 
paragraph (a) of this section, CFC is not treated as a domestic 
corporation for purposes of Sec. 1.672(f)-1. Although CFC is a 
controlled foreign corporation (because CFC is owned by DP, a 
domestic person), no income earned by CFC will be included in the 
income of a U.S. taxpayer. Consequently, there is no U.S. amount 
under Sec. 1.672(f)-1(c)(2). Under Sec. 1.672(f)-1(b)(2), the basic 
grantor trust rules do not apply to treat CFC as the owner of FT. 
Transfers from FT to C are considered to be distributions to C under 
section 662 and may be subject to the section 668 interest charge on 
accumulation distributions. (In addition, distributions to C from 
DP, CFC, or FT may be subject to recharacterization as purported 
gifts under Sec. 1.672(f)-4.)
    Example 2. Trust income is all subpart F income. CFC is wholly 
owned by USC, a domestic corporation. CFC creates and funds FT for 
the benefit of USC. CFC can control the beneficial enjoyment of the 
trust assets within the meaning of section 674. All of FT's income 
is of the type that is subpart F income (as defined in section 952). 
FT does not distribute any income. Without regard to income earned 
by FT, CFC has a significant amount of earnings and profits. If the 
basic grantor trust rules were applied, CFC would be treated as the 
owner of FT, and all items of income of FT would be currently taken 
into account in computing the income of USC, a domestic corporation. 
Consequently, under paragraph (a) of this section, CFC is treated as 
a domestic corporation for purposes of Sec. 1.672(f)-1. Under 
Sec. 1.672(f)-1(b)(2), the basic grantor trust rules apply without 
the limitation of section 672(f) to treat CFC as the owner of FT. 
Distributions from FT to USC are treated as distributions from CFC 
to USC.
    Example 3. Portion of trust income is subpart F income. Assume 
the same facts as in Example 2, except that FT also owns all of the 
stock of S, a corporation that is incorporated in the same country 
as CFC and that uses a substantial part of its assets in a trade or 
business in such country. Thus, dividends from S are not subpart F 
income. In the taxable year ending December 31, 1999, FT's only 
income is subpart F income of 200X and dividends from S of 50X. FT 
has no deductions or losses for 199X. Under paragraph (a) of this 
section, CFC is treated as a domestic corporation for purposes of 
computing the U.S. amount under Sec. 1.672(f)-1(c)(2) only to the 
extent FT's income is of the type that is subpart F income. 
Consequently, the U.S. amount is 200X. Under Sec. 1.672(f)-1(c)(1), 
the worldwide amount is 250X. Under Sec. 1.672(f)-1(b)(2), CFC is 
not treated as the owner of the portion of FT attributable to the 
excess of the worldwide amount over the U.S. amount. Such portion of 
FT will be treated as a separate taxable entity. Distributions to 
USP with respect to such portion of FT will be included in USP's 
income under section 662 and may be subject to the section 668 
interest charge on accumulation distributions.
    Example 4. Reduction in portion of trust treated as nongrantor 
trust. Assume the same facts as in Example 3. For each of the years 
2001 through 2010, FT receives dividend income of 2X from S, none of 
which is distributed. In the year 2011, at a time when FT's basis in 
the stock of S is 80X, S sells its business and invests the proceeds 
in assets that generate subpart F income. CFC will now be treated as 
the owner of the portion of FT that had previously been treated as a 
separate taxable entity. FT will be deemed to have distributed 80X 
(the stock of S) to CFC. CFC will be required to include 20X of 
undistributed net income (2X a year for 10 years) in its income.

    (d) Effective date. The rules of this section are applicable as of 
August 20, 1996.


Sec. 1.672(f)-3  Exceptions to general rule.

    (a) Certain revocable trusts--(1) In general. The general rule of 
Sec. 1.672(f)-1(a) shall not apply to any portion of a trust if the 
power to revest absolutely in the grantor title to such portion is 
exercisable solely by the grantor without the approval or consent of 
any other person. If the grantor can exercise such power only with the 
approval of a related or subordinate party who is subservient to the 
grantor, such power will be treated as exercisable solely by the 
grantor. The grantor will be treated as having a power to revest only 
if the grantor has such power for a period or periods aggregating 183 
days or more during the taxable year of the trust. See section 
643(a)(7). For the definition of grantor, see Sec. 1.671-2(e). For the 
definition of related or subordinate party, see Sec. 1.672(c)-1. For 
purposes of this paragraph (a), a related or subordinate party is 
subservient to the grantor unless the presumption in the last sentence 
of Sec. 1.672(c)-1 is rebutted by a preponderance of the evidence.
    (2) Grandfather rule--(i) In general. The general rule of 
Sec. 1.672(f)-1 shall not apply to a trust that was treated as owned by 
the grantor under section 676 on September 19, 1995, as long as the 
trust would continue to be so treated under the basic grantor trust 
rules. However, such a trust will be subject to the general rule of 
Sec. 1.672(f)-1 with respect to any portion of the trust attributable 
to transfers to the trust after September 19, 1995.
    (ii) Separate accounting for transfers after September 19, 1995. In 
the case of a revocable trust that contains both amounts held in the 
trust on September 19, 1995, and amounts that were transferred to the 
trust after September 19, 1995, paragraph (a)(2)(i) of this section 
shall apply only if the amounts that were held in the trust on 
September 19, 1995, together with all income, gains, and losses derived 
therefrom (less all post-September 19, 1995, distributions therefrom) 
are separately accounted for from the amounts that were transferred to 
the trust after September 19, 1995, together with all income, gains, 
and losses derived therefrom (less all distributions therefrom). If 
there is no separate accounting, the general rule of Sec. 1.672(f)-1 
shall apply to the trust. If there is separate accounting, the general 
rule of Sec. 1.672(f)-1 shall not apply to the portion of the trust 
that is attributable to amounts that were held in the trust on 
September 19, 1995.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (a):

    Example 1. Owner is grantor. After September 19, 1995, FP1, a 
foreign person, creates and funds a revocable trust, T, for the 
benefit of FP1's children, who are U.S. residents. The trustee is a 
foreign bank, FB, that is owned and controlled by FP1 and FP2, who 
is FP1's brother. The power to revoke T and revest absolutely in FP1 
title to the trust property is exercisable by FP1, but only with the 
approval or consent of FB. There are no facts that would suggest 
that FB is not subservient to FP1. Therefore, under paragraph (a)(1) 
of this section, T is not subject to the general rule of 
Sec. 1.672(f)-1. FP1 is treated as the owner of T.
    Example 2. Owner not grantor. Assume the same facts as in 
Example 1, except that FP1 dies. After FP1's death, FP2 has the 
power to withdraw the assets of T, but only with the approval of FB. 
There are no facts that would suggest that FB is not subservient to 
FP2. However, under paragraph (a)(1) of this section, T is now 
subject to the general rule of Sec. 1.672(f)-1, because FP2 is not a 
grantor of T. FP2 is not treated as the owner of T.
    Example 3. Trustee not related or subordinate party. Assume the 
same facts as in Example 1, except that neither FP1 nor any member 
of his family has any substantial ownership interest or other 
connection with FB. FP1 can remove and replace FB at any time for 
any reason. Although FP1 can replace FB if FB refuses to approve or 
consent to FP1's decision to revest the trust property in himself, 
FB is not a related or subordinate party. Therefore, under paragraph 
(a)(1) of this section, T is subject to the general rule of 
Sec. 1.672(f)-1. FP1 will not be treated as the owner of T.
    Example 4. Unrelated trustee will consent to revocation. FP, a 
foreign person, creates

[[Page 30794]]

and funds an irrevocable trust, T. The trustee is a foreign bank, 
FB, that is not a related or subordinate party within the meaning of 
Sec. 1.672(c)-1. FB has the discretion to distribute trust income or 
corpus to any person, including FP. Even if FB would in fact 
distribute all the trust property to FP if requested to do so by FP, 
under paragraph (a)(1) of this section, T is subject to the general 
rule of Sec. 1.672(f)-1, because FP does not have the power to 
revoke T. FP will not be treated as the owner of T.
    Example 5. Husband treated as holding power held by wife. H and 
his wife, W, both nonresident aliens, create and fund a trust, T, 
using community property. The power to revoke T and revest 
absolutely in H and W title to the trust property is exercisable 
either by W acting alone or by H with the consent of W. W has 
advised H that she will not consent to any decision by H to revoke 
T. Although W is a related or subordinate party to H within the 
meaning of Sec. 1.672(c)-1, the presumption that W is subservient to 
H is rebutted by a preponderance of the evidence. However, pursuant 
to section 672(e), H is treated as holding the power to revest that 
is held by W. Therefore, under paragraph (a)(1) of this section, T 
is not subject to the general rule of Sec. 1.672(f)-1. H and W are 
treated as the owners of T.
    Example 6. U.S. grantor of trust revocable by foreign person. A, 
a nonresident alien, creates a revocable foreign trust, FT, and 
funds FT with $5,000 cash. The only possible beneficiary of FT is a 
foreign person. B, a U.S. citizen, contributes $1,000,000 of 
appreciated property to FT. B retains no powers that would cause B 
to be treated as an owner of any portion of FT under the grantor 
trust rules. Although A has the power to revest absolutely in itself 
title to the appreciated property, A is not a grantor of FT with 
respect to the appreciated property. See Sec. 1.671-2(e). Therefore, 
under paragraph (a)(1) of this section, the portion of FT that is 
attributable to the appreciated property is subject to the general 
rule of Sec. 1.672(f)-1. A is not treated as the owner of such 
portion.

    (b) Certain other trusts--(1) In general. The general rule of 
Sec. 1.672(f)-1(a) shall not apply to any trust (or portion of a trust) 
during the lifetime of the grantor if the only amounts distributable 
(whether income or corpus) from such trust (or portion of a trust) 
during the lifetime of the grantor are amounts distributable to the 
grantor or the spouse of the grantor. This paragraph (b) shall not 
apply to that portion of a trust from which, at any time after October 
20, 1996, any amounts are distributable to any person other than the 
grantor or the spouse of the grantor. For purposes of this paragraph 
(b), payments of nongratuitous amounts (within the meaning of 
Sec. 1.671-2(e)(4)(ii)) will not be considered amounts distributable. 
For the definition of grantor, see Sec. 1.671-2(e).
    (2) Amounts distributable in discharge of legal obligation--(i) In 
general. Subject to the provisions of paragraph (b)(2)(ii) of this 
section, amounts that are distributable from a portion of a trust in 
discharge of a legal obligation of the grantor or the spouse of the 
grantor shall be treated as amounts distributable to the grantor or the 
spouse of the grantor for purposes of paragraph (b)(1) of this section. 
For this purpose, an obligation is considered a legal obligation if it 
is enforceable under the local law of the jurisdiction in which the 
grantor (or the spouse of the grantor) resides.
    (ii) Legal obligation to related person. For purposes of paragraph 
(b)(2)(i) of this section, the term legal obligation does not include 
an obligation to a related person except to the extent the obligation 
was contracted bona fide and for adequate and full consideration in 
money or money's worth (see Sec. 20.2043-1 of this chapter). For this 
purpose, a related person is a person described in Sec. 1.643(h)-1(e).
    (3) Amounts distributable in discharge of support obligation. 
Amounts that are distributable from a portion of a trust in discharge 
of the grantor's or the grantor's spouse's obligation to support a 
family member shall be treated as amounts distributable to the grantor 
or the spouse of the grantor only if the family member is an individual 
who would be treated as a dependent of the grantor or the grantor's 
spouse under sections 152(a) (1) through (8), without regard to the 
requirement that half of the individual's support be received from the 
grantor or the grantor's spouse, and the family member is either--
    (i) Permanently and totally disabled (within the meaning of section 
22(e)(3)); or
    (ii) In the case of a son, daughter, stepson, or stepdaughter, less 
than 24 years old.
    (4) Grandfather rule--(i) In general. The general rule of 
Sec. 1.672(f)-1 shall not apply to a trust that was treated as owned by 
the grantor under section 677 (other than section 677(a)(3)) on 
September 19, 1995, as long as the trust would continue to be so 
treated under the basic grantor trust rules. However, such a trust will 
be subject to the general rule of Sec. 1.672(f)-1 with respect to any 
portion of the trust attributable to transfers to the trust after 
September 19, 1995.
    (ii) Separate accounting for transfers after September 19, 1995. In 
the case of a trust that contains both amounts held in the trust on 
September 19, 1995, and amounts that were transferred to the trust 
after September 19, 1995, paragraph (b)(4)(i) of this section shall 
apply only if the amounts that were held in the trust on September 19, 
1995, together with all income, gains, and losses derived therefrom 
(less all post-September 19, 1995, distributions therefrom) are 
separately accounted for from the amounts that were transferred to the 
trust after September 19, 1995, together with all income, gains, and 
losses derived therefrom (less all distributions therefrom). If there 
is no separate accounting, the general rule of Sec. 1.672(f)-1 shall 
apply to the trust. If there is separate accounting, the general rule 
of Sec. 1.672(f)-1 shall not apply to the portion of the trust that is 
attributable to amounts that were held in the trust on September 19, 
1995.
    (5) Examples. The following examples illustrate the rules of this 
paragraph (b):

    Example 1. Amounts distributable only to grantor or grantor's 
spouse. H and his wife, W, are both nonresident aliens. H and W have 
a child, C, who is a U.S. resident. H creates and funds an 
irrevocable trust, FT, using only his separate property. The only 
amounts distributable (whether income or corpus) from FT as long as 
either H or W are alive are amounts distributable to H or W. Upon 
the death of both H and W, C may receive distributions from FT. 
Under paragraph (b)(1) of this section, FT is not subject to the 
general rule of Sec. 1.672(f)-1 during H's lifetime. H is treated as 
the owner of FT.
    Example 2. Amounts temporarily distributable to person other 
than grantor or grantor's spouse. Assume the same facts as in 
Example 1, except that C is a 30-year old law student at the time FT 
is created, FT is created after October 20, 1996, and the trust 
instrument provides that as long as C is in law school amounts may 
be distributed from FT to pay C's expenses. Thereafter, the only 
amounts distributable from FT as long as either H or W are alive 
will be amounts distributable to H or W. C's expenses are not 
treated as legal obligations of H or W under paragraph (b)(2)(ii) of 
this section or as support obligations under paragraph (b)(3) of 
this section. Therefore, under paragraph (b)(1) of this section, FT 
is subject to the general rule of Sec. 1.672(f)-1(a). H is not 
treated as the owner of FT. After C graduates from law school, the 
general rule of Sec. 1.672(f)-1 still will be applicable, and H 
still will not be treated as the owner of FT.
    Example 3. Grantor predeceases spouse. Assume the same facts as 
in Example 1. H predeceases W. Under paragraph (b)(1) of this 
section, FT will become subject to the general rule of 
Sec. 1.672(f)-1 upon H's death, because W is not a grantor. 
Accordingly, FT will be treated as a separate taxable entity upon 
H's death.
    Example 4. Effect of divorce. H creates and funds a trust, FT, 
from which the only amounts distributable are amounts distributable 
to himself and A. At the time FT is created, A is H's wife. However, 
the trust document refers to A only by her name. H and A divorce. 
Under paragraph (b)(1) of this section, FT will be subject to the 
general rule of Sec. 1.672(f)-1 after the divorce, because amounts 
will still be distributable to A, and

[[Page 30795]]

A will no longer be the spouse of the grantor. After the divorce, FT 
will be treated as a separate taxable entity.
    Example 5. Fixed investment trust. FC, a foreign corporation, 
invests in a domestic fixed investment trust, DT, that is classified 
as a trust under Sec. 301.7701-4(c)(1) of this chapter. The only 
amounts that are distributable from the portion of DT that is owned 
by FC are amounts distributable to FC. Under paragraph (b)(1) of 
this section, such portion of DT is exempt from the general rule of 
Sec. 1.672(f)-1. FC is treated as the owner of its portion of DT.
    Example 6. Reinsurance trust. A domestic insurance company, I, 
reinsures a portion of its business with a foreign insurance 
company, FI. FI creates and funds an irrevocable domestic trust, DT, 
in the United States as security for its obligations under the 
reinsurance agreement. The trust funds are held by a U.S. bank and 
may be used only to pay claims arising out of the reinsurance 
policies. On the termination of DT, any assets remaining will revert 
to FI. The only amounts that are distributable from DT are 
distributable in discharge of FI's legal obligation. Therefore, 
under paragraph (b)(1) of this section, DT is exempt from the 
general rule of Sec. 1.672(f)-1. FI is treated as the owner of DT.
    Example 7. Asset securitization trust. A foreign corporation, 
FC, borrows money from a bank, B, to finance the purchase of an 
airplane. FC creates a foreign trust, FT, to hold the airplane as 
security for the loan from B. The only amounts that are 
distributable from FT are amounts distributable to B in the event 
that FC defaults on its loan from B. Thus, the only amounts 
distributable from FT are in discharge of FC's legal obligation to 
B. When FC repays the loan, the trust assets will revert to FC. 
Under paragraph (b)(1) of this section, FT is exempt from the 
general rule of Sec. 1.672(f)-1. FC is treated as the owner of FT.

    (c) Compensatory trusts--(1) In general. Except as provided in 
paragraph (c)(4) of this section, Sec. 1.672(f)-1 does not apply to any 
portion of a trust distributions from which are taxable as compensation 
for services rendered. A trust described in this paragraph (c)(1) is 
referred to in this section as a compensatory trust.
    (2) Trusts classified as compensatory trusts. The following types 
of trusts are the only types of trusts that shall be classified as 
compensatory trusts within the meaning of paragraph (c)(1) of this 
section--
    (i) A qualified trust described in section 401(a) (but see 
Sec. 1.641(a)-0(a));
    (ii) A trust described in section 457(g);
    (iii) A nonexempt employees' trust described in section 402(b) (see 
Sec. 1.671-1(g) and (h));
    (iv) A trust that is an individual retirement account described in 
section 408(k) or 408(p);
    (v) A trust that is an individual retirement account the only 
contributions to which are rollover contributions listed in section 
408(a)(1);
    (vi) A trust that would be a nonexempt employees' trust described 
in section 402(b) but for the fact that the trust's assets are not set 
aside from the claims of creditors of the actual or deemed transferor 
within the meaning of Sec. 1.83-3(e); and
    (vii) A trust that is a welfare benefit fund described in section 
419(e).
    (3) Other individual retirement accounts. For rules that apply to 
individual retirement accounts (within the meaning of section 408(a)) 
that are not compensatory trusts within the meaning of paragraph (c)(1) 
of this section, see paragraphs (a) and (b) of this section.
    (4) Exceptions. The Commissioner may, in revenue rulings, notices, 
or other guidance published in the Internal Revenue Bulletin (see 
Sec. 601.601(d)(2)(ii)(b)), designate categories of compensatory trusts 
to which the general rule of paragraph (c)(1) of this section does not 
apply.
    (d) Effective date. Except as provided in paragraph (b)(1) of this 
section, the rules of this section are applicable as of August 20, 
1996.


Sec. 1.672(f)-4  Recharacterization of purported gifts.

    (a) In general--(1) Purported gifts from partnerships.
    Except as provided in paragraphs (b) and (f) of this section, and 
without regard to the existence of any trust, if a United States person 
(U.S. donee) directly or indirectly receives a purported gift or 
bequest (as defined in paragraph (d) of this section) from a 
partnership, the purported gift or bequest must be included in the U.S. 
donee's gross income as ordinary income.
    (2) Purported gifts from foreign corporations. Except as provided 
in paragraphs (b) and (f) of this section, and without regard to the 
existence of any trust, if a U.S. donee directly or indirectly receives 
a purported gift or bequest (as defined in paragraph (d) of this 
section) from a foreign corporation, the purported gift or bequest must 
be included in the U.S. donee's gross income as if it were a 
distribution from the foreign corporation. For purposes of section 
1012, the U.S. donee will not be treated as having basis in the foreign 
corporation. However, for purposes of section 1223, the U.S. donee will 
be treated as having a holding period in the foreign corporation on the 
date of the deemed distribution equal to the weighted average of the 
holding periods of the actual interest holders.
    (b) Exceptions--(1) U.S. partner or shareholder treats transfer as 
distribution and gift. Paragraph (a) of this section shall not apply if 
the U.S. donee can establish that a U.S. citizen or resident alien who 
directly or indirectly holds an interest in the partnership or foreign 
corporation treated the purported gift as a distribution to the U.S. 
partner or shareholder and a subsequent gift to the U.S. donee.
    (2) Charitable contributions. Paragraph (a) of this section shall 
not apply to U.S. donees that are described in section 170(c).
    (c) Certain distributions from trusts created by partnerships or 
foreign corporations. If a partnership or foreign corporation is 
treated as the owner, under sections 671 through 679, of a portion of a 
trust from which property is distributed to a U.S. donee in a 
gratuitous transfer, the U.S. donee must treat the amount as a 
distribution from the partnership or foreign corporation. If a 
partnership or foreign corporation is not treated as the owner, under 
sections 671 through 679, of the portion of a trust from which property 
is distributed to a U.S. donee in a gratuitous transfer, the U.S. donee 
shall be taxable in the manner provided in paragraph (a) of this 
section only if the U.S. tax computed under that section exceeds the 
U.S. tax that would be due if the U.S. donee treats the amount as a 
distribution from the trust.
    (d) Definition of purported gift or bequest. For purposes of this 
section, a purported gift or bequest is any transfer by a partnership 
or foreign corporation (other than a transfer for fair market value) to 
a person who is not a partner in the partnership or shareholder of the 
foreign corporation.
    (e) Effect on U.S. partner or shareholder. This section applies 
only to computations of the U.S. donee's gross income. This section 
does not affect the U.S. tax treatment of a U.S. partner in the 
partnership or a U.S. shareholder of the foreign corporation.
    (f) Recharacterization by district director. Notwithstanding any 
other provision in this section, if a U.S. donee receives a transfer 
that is subject to the rules of this section, the district director may 
recharacterize such transfer to prevent the avoidance of U.S. tax or 
clearly to reflect income. For example, the district director may 
determine, based upon the facts and circumstances, that a distribution 
from a partnership or foreign corporation is more properly 
characterized as a distribution from a trust.
    (g) De minimis exception. This section shall not apply if, during 
the taxable year of a U.S. donee, the aggregate amount of purported 
gifts or bequests that is transferred to such U.S. donee

[[Page 30796]]

directly or indirectly from a partnership or foreign corporation does 
not exceed $10,000. The aggregate amount must include gifts or bequests 
from persons that the U.S. donee knows or has reason to know are 
related to the partnership or foreign corporation (within the meaning 
of section 643(i)).
    (h) Examples. The following examples illustrate the rules of this 
section:

    Example 1. FC is a foreign corporation that is wholly owned by 
A, a nonresident alien. FC distributes property directly to A's U.S. 
daughter, B, purportedly as a gift. Under paragraph (a)(2) of this 
section, B must treat the distribution as a dividend from FC. 
(However, if B can establish that the distribution exceeded FC's 
earnings and profits, B must treat such excess as an amount received 
in excess of basis under section 301(c)(3).) If FC is a passive 
foreign investment company, B must treat the amount as a 
distribution under section 1291. B will be treated as having the 
same holding period as A.
    Example 2. FC is a foreign corporation that is wholly owned by 
A, a nonresident alien. FC creates and funds a revocable foreign 
trust, FT, from which a gratuitous transfer is made immediately to 
A's U.S. daughter, B. Thus, the transfer is out of trust corpus. FC 
is not treated as the owner of FT under sections 671 through 679. 
Under paragraph (c) of this section, B must treat the transfer as a 
dividend from FC, rather than a distribution from FT, if such 
treatment results in a higher U.S. tax liability.

    (i) Effective date. The rules of this section are applicable for 
any transfer by a partnership or foreign corporation on or after August 
20, 1996.


Sec. 1.672(f)-5  Special rules.

    (a) Transfers by certain beneficiaries to foreign settlor--(1) In 
general. If, but for section 672(f)(5), a foreign person would be 
treated as the owner of any portion of a trust, any U.S. beneficiary of 
such trust shall be treated as the owner of a portion of the trust to 
the extent the U.S. beneficiary directly or indirectly made transfers 
of property to such foreign person (without regard to whether the U.S. 
beneficiary was a U.S. beneficiary at the time of any transfer) in 
excess of transfers to the U.S. beneficiary from the foreign person. 
The rule of this paragraph will not apply to the extent the U.S. 
beneficiary can demonstrate to the satisfaction of the district 
director that the transfer by the U.S. beneficiary to the foreign 
person was wholly unrelated to any transaction involving the trust. For 
purposes of this paragraph, a transfer of property does not include a 
nongratuitous transfer. See Sec. 671-2(e)(4)(ii). In addition, a gift 
shall not be taken into account to the extent such gift would not be 
characterized as a taxable gift under section 2503(b). For a definition 
of U.S. beneficiary, see section 679.
    (2) Examples. The following examples illustrate the rules of this 
section:

    Example 1. A, a nonresident alien, contributes property to FC, a 
foreign corporation that is wholly owned by A. FC creates a foreign 
trust, FT, for the benefit of A and his children. FT is revocable by 
FC without the approval or consent of any other person. FC funds FT 
with the property received from A. A and his family move to the 
United States. Under paragraph (a)(1) of this section, A is treated 
as the owner of FT.
    Example 2. B, a U.S. citizen, makes a gratuitous transfer of $1 
million to his uncle, C, a nonresident alien. C creates a foreign 
trust, FT, for the benefit of B and his children. FT is revocable by 
C without the approval or consent of any other person. C funds FT 
with the property received from B. Under paragraph (a)(1) of this 
section, B is treated as the owner of FT. (B also would be treated 
as the owner of FT as a result of section 679.)

    (b) Different taxable years. If a person has a different taxable 
year (as defined in section 7701(a)(23)) from the taxable year of the 
trust, an amount is currently taken into account in computing the 
income of such person for purposes of Sec. 1.672(f)-1 if the amount is 
taken into account for the taxable year of such person that includes 
the last day of the taxable year of the trust.
    (c) Entity characterization. Entities generally shall be 
characterized under U.S. income tax principles. See Secs. 301.7701-1 
through 301.7701-4 of this chapter. However, for purposes of 
Sec. 1.672(f)-4, a transferor that is a wholly owned business entity 
shall be treated as a corporation, separate from its single owner. See 
Sec. 301.7701-2(c)(2)(iii) of this chapter.
    (d) Effective date. The rules of this section are generally 
applicable as of August 20, 1996. However, the rules in paragraph (c) 
of this section shall not be applicable until [date of publication as a 
final regulation in the Federal Register].

PART 301--PROCEDURE AND ADMINISTRATION

    Par. 5. The authority citation for part 301 is amended by adding an 
entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 301.7701-2(c)(2)(iii) also issued under 26 U.S.C. 
643(a)(7), 672(f)(4) and (6).

    Par. 6. Section 301.7701-2 is amended by adding paragraph 
(c)(2)(iii) to read as follows:


Sec. 301.7701-2  Business entities; definitions.

* * * * *
    (c) * * *
    (2) * * *
    (iii) Special rule for foreign business entities that make 
purported gifts. For the purposes of applying the rules of section 
672(f)(4), a wholly owned business entity shall be treated as a 
corporation, separate from its single owner.
* * * * *
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
[FR Doc. 97-14735 Filed 6-4-97; 8:45 am]
BILLING CODE 4830-01-U