[Federal Register Volume 64, Number 153 (Tuesday, August 10, 1999)]
[Rules and Regulations]
[Pages 43267-43280]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-19928]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8831]
RIN 1545-AU90
Inbound Grantor Trusts With Foreign Grantors
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains regulations implementing sections
672(f) and 643(h) of the Internal Revenue Code, as amended by the Small
Business Job Protection Act of 1996, which relate to the application of
the grantor trust rules to certain trusts established by foreign
persons. These regulations affect primarily U.S. persons who are
beneficiaries of trusts established by foreign persons. This document
also contains temporary regulations defining the term grantor for
purposes of part I of subchapter J, chapter 1 of the Internal Revenue
Code. The text of these temporary regulations serves as the text of the
proposed regulations set forth in the notice of proposed rulemaking
published elsewhere in this issue of the Federal Register.
DATES: Effective Date: These regulations are effective August 10, 1999.
Applicability Dates: For dates of applicability of Sec. 1.643(h)-1,
see Sec. 1.643(h)-1(h). For dates of applicability of Sec. 1.671-2T(e),
see Sec. 1.671-2T(e)(7). For dates of applicability of Secs. 1.672(f)-1
through 1.672(f)-5, see Secs. 1.672(f)-1(c), 1.672(f)-2(e), 1.672(f)-
3(e), 1.672(f)-4(h), and 1.672(f)-5(c).
FOR FURTHER INFORMATION CONTACT: M. Grace Fleeman (202) 622-3880
concerning the regulations generally, and James A. Quinn (202) 0622-
3060 concerning Sec. 1.671-2T(e) and Sec. 1.672(f)-1 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
On June 5, 1997 (62 FR 37819) Treasury and the IRS published a
notice of proposed rulemaking (REG-252487-96) under sections 643(h),
671, 672(f), and 7701 of the Internal Revenue Code (Code). Comments
responding to the notice were received and a public hearing was held on
August 27, 1997. After consideration of the comments, the proposed
regulations under sections 643(h) and 672(f) are adopted as final
regulations as revised by this Treasury decision. The proposed
regulations under section 671 are issued as revised by this Treasury
decision as temporary regulations. The revisions are discussed below.
The proposed regulations under section 7701 are withdrawn. The
temporary regulations under section 671 are also being issued as
proposed regulations published elsewhere in this issue of the Federal
Register.
[[Page 43268]]
Explanation of Provisions and Revisions
1. Comments and Changes to Sec. 1.643(h)-1: Distributions by Certain
Foreign Trusts Through Intermediaries
Under the proposed regulations, any amount that was derived,
directly or indirectly, by a U.S. person from a foreign trust through
an intermediary generally was deemed to have been transferred directly
by the foreign trust to the U.S. person if any one of three specified
conditions was satisfied. In cases where the transfer from the
intermediary to the U.S. person did not occur in the same taxable year
of the U.S. person as the transfer from the foreign trust to the
intermediary, the proposed regulations looked to generally applicable
agency principles to determine when the transfer to the U.S. person was
deemed to occur.
Commenters said the proposed rules were too broad and could reach
virtually any transfer made to a U.S. person by any person who has
received a distribution from a foreign trust. They suggested that the
basic requirement for treating a transfer to a U.S. person as a
transfer directly from a foreign trust should be the existence of an
intention to avoid U.S. tax. Alternatively, they said there should at
least be a time limitation so that the rule would not apply to a
transfer of property received from a foreign trust more than, for
example, one year before the transfer to the U.S. person. In addition,
they said the proposed rule relying on generally applicable agency
principles for determining whether an intermediary is the agent of the
foreign trust or of the U.S. person would be difficult to apply because
different countries have different laws and the U.S. person should be
taxed prior to receipt only if the intermediary is clearly a nominee or
agent for the U.S. person.
In response to the comments, the final regulations treat any
property (including cash) that is transferred to a U.S. person by an
intermediary who has received property from a foreign trust as property
transferred directly by the foreign trust to the U.S. person if 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. A transfer of property will be deemed to have been made pursuant
to a plan one of the principal purposes of which was the avoidance of
U.S. tax if all of certain specified factors are present. However, the
Commissioner may find that a transfer was made pursuant to a plan one
of the principal purposes of which was the avoidance of U.S. tax
whether or not any of the specified factors is present.
The factors that will cause a transfer to be deemed to have been
made pursuant to a plan one of the principal purposes of which was the
avoidance of U.S. tax are the following: (i) the U.S. person is related
to a grantor of the foreign trust or has another relationship with a
grantor of the foreign trust that establishes a reasonable basis for
concluding that the grantor of the foreign trust would make a
gratuitous transfer to the U.S. person; (ii) the U.S. person receives
from the intermediary, within the period beginning twenty-four months
before and ending twenty-four months after the intermediary's receipt
of property from the foreign trust, either the property the
intermediary received from the foreign trust, proceeds from such
property, or property in substitution for such property; and (iii) the
U.S. person cannot demonstrate to the satisfaction of the Commissioner
that (A) the intermediary has a relationship with the U.S. person that
establishes a reasonable basis for concluding that the intermediary
would make a gratuitous transfer to the U.S. person, (B) the
intermediary acted independently of the grantor and the trustee, (C)
the intermediary is not an agent of the U.S. person under generally
applicable U.S. agency principles, and (D) the U.S. person timely
complied with the reporting requirement of section 6039F, if
applicable, if the intermediary is a foreign person. See Notice 97-34
(1997-1 C.B. 422).
The final regulations also have been modified with respect to the
application of generally applicable agency principles. Under the final
regulations, property is treated as transferred to the U.S. person in
the year it is actually transferred to the U.S. person by the
intermediary unless the Commissioner determines, or the taxpayer can
demonstrate to the satisfaction of the Commissioner, that the
intermediary is an agent of the U.S. person under generally applicable
agency principles, in which case the property will be treated as
transferred to the U.S. person by the trust in the year the property
was transferred to the intermediary by the trust. As a corollary, the
final regulations provide that the fair market value of the property is
determined as of the date of the transfer to the U.S. person, unless
the intermediary is treated as an agent of the U.S. person, in which
case the fair market value will be determined as of the date of the
transfer to the intermediary. Examples illustrate the effect of changes
in the fair market value between the date of the transfer to the
intermediary and the date of the transfer to the U.S. person.
The final regulations clarify that they apply only to gratuitous
transfers. They also clarify that if property is treated as transferred
directly by a foreign trust to a U.S. person pursuant to the
regulations, the same property will not be taken into account in
computing the gross income of the intermediary (if such property would
otherwise be required to be so taken into account).
The final regulations under section 643(h) are applicable to
transfers made to U.S. persons after August 10, 1999.
2. Comments and Changes to Sec. 1.671-2(e): Definition of Grantor
The proposed regulations provided a definition of grantor for
purposes of part I of subchapter J, chapter 1 of the Code. This
document replaces the proposed regulations with temporary regulations
that are effective August 10, 1999. These temporary regulations are
also being issued as proposed regulations published elsewhere in this
issue of the Federal Register. In accordance with section 7805(e)(2),
the temporary regulations will expire before August 12, 2002.
Under the original proposed regulations, a grantor was defined to
include any person to the extent such person either (i) creates a trust
or (ii) directly or indirectly makes a gratuitous transfer to a trust.
Commenters questioned why a nominal creator who has made no transfer to
a trust should be treated as a grantor and asked for an explanation of
the tax significance of such treatment.
Treating a nominal creator as a grantor ensures that someone will
be responsible for reporting the creation of a foreign trust by a U.S.
person even if the trust is not immediately funded. See section
6048(a)(3)(A)(i) and (a)(4)(A). At the same time, Treasury and the IRS
believe that an accommodation grantor, such as an attorney who creates
a trust on behalf of a client, (although a grantor) should not be
treated as an owner of the trust. Accordingly, the temporary
regulations provide that a person who either creates a trust, or funds
a trust with an amount that is directly repaid to such person within a
reasonable period of time, but who makes no other transfers to the
trust that constitute gratuitous transfers, will not be treated as an
owner of any portion of the trust under sections 671 through 677 or
679.
Commenters also questioned a provision in the proposed regulations
that treated a distribution from one trust to another trust that is a
beneficiary of the first trust as a gratuitous transfer,
[[Page 43269]]
with the result that the first trust was a grantor of the second trust.
Under the temporary regulations, if a trust makes a gratuitous transfer
of property to another trust, the grantor of the transferor trust
generally is treated as the grantor of the transferee trust. However,
if a person with a general power of appointment over the transferor
trust exercises that power in favor of another trust, such person is
treated as the grantor of the transferee trust, even if the grantor of
the transferor trust is treated as the owner of the transferor trust
under subpart E of part I, subchapter J, chapter 1 of the Code. (These
rules do not affect the determination of whether or not the gratuitous
transfer from the transferor trust is a distribution subject to
sections 651 or 661.)
The proposed regulations provided that a person who acquires an
interest in a fixed investment trust from a grantor of the trust also
will be treated as a grantor of the trust. In response to comments
received, the temporary regulations extend the same treatment to
persons who acquire an interest in a liquidating trust or an
environmental remediation trust.
The temporary regulations include a new section that applies to
gratuitous transfers to trusts by partnerships and corporations. If the
transfer is entered into for a business purpose of the partnership or
corporation, the partnership or corporation, as the case may be,
generally is treated as the grantor of the trust. However, if the
transfer is not entered into for a business purpose of the partnership
or corporation--for example, if it is for the personal purposes of one
or more of the partners or shareholders--the transfer is treated as a
constructive distribution to such partners or shareholders under
federal tax principles, and the partners or shareholders, as the case
may be, are treated as the grantors of the trust. See, for example,
Epstein v. Commissioner, 53 T.C. 459 (1969), acq. on another issue,
1970-2 C.B. xix.
Commenters asked for guidance concerning the identification of the
grantor when the property contributed to the trust is jointly owned.
These temporary regulations do not provide specific guidance on the
treatment of joint owners that contribute property to a trust. Treasury
and the IRS invite comments with specific examples of areas that may
need clarification, such as, for example, the treatment of community
property or the joint ownership of property by noncitizen spouses.
3. Comments and Changes to Sec. 1.672(f)-1: Foreign Persons Not Treated
as Owners
The proposed regulations prescribed 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)
were applied to determine the worldwide amount and the U.S. amount.
Then, the trust was 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. Commenters suggested that the two-step analysis
was unnecessarily complex and questioned whether it might produce
results that were unintended or inconsistent with the statute.
In response to these concerns, the final regulations provide that
the grantor trust rules other than section 672(f) must be applied first
to determine whether, under such rules, any portion of the trust would
be treated as owned by a person other than a U.S. citizen or resident
or domestic corporation. The determination of the portion of the trust
that is treated as owned by a grantor or other person is to be made
based on the terms of the trust and the application of the grantor
trust rules as found in Sec. 1.671-1 et seq. If it is determined that
any portion of the trust would be treated as owned by a person other
than a U.S. citizen or resident or domestic corporation, such person
will be treated as the owner of such portion only if such person is a
foreign corporation described in Sec. 1.672(f)-2(a) or if such portion
of the trust qualifies for one of the exceptions in Sec. 1.672(f)-3.
The final regulations under the general rule are generally
applicable to taxable years of a trust beginning after August 10, 1999.
4. Comments and Changes to Sec. 1.672(f)-2: Certain Foreign
Corporations
Under the proposed regulations, a controlled foreign corporation
(CFC) that created or funded a trust was treated as a domestic
corporation for purposes of section 672(f) only to the extent the
trust's income was subpart F income that was currently taken into
account in computing the gross income of a U.S. citizen, U.S. resident,
or domestic corporation. There were similar rules for passive foreign
investment companies (PFICs) and foreign personal holding companies
(FPHCs). Commenters questioned whether the proposed rules were
consistent with the statutory antideferral regime and the legislative
history. There also were suggestions that the proposed rules should not
apply where a CFC is wholly owned, directly or indirectly, by U.S.
shareholders. In addition, there were requests for simplification of
the rules pertaining to annual fluctuations in the portion of a trust
that is treated as owned by the grantor.
In response to the comments, Treasury and the IRS have developed
rules that are narrowly targeted to potentially abusive situations and
therefore are not inconsistent with the antideferral regime. Under the
final regulations, if the owner of a trust upon application of the
grantor trust rules without regard to section 672(f) is a CFC, PFIC, or
FPHC, the CFC, PFIC, or FPHC, as the case may be, will be treated as a
domestic corporation for purposes of applying the general rule of
Sec. 1.672(f)-1. Consequently, a CFC, PFIC, or FPHC generally will be
treated as an owner of a trust if it would be so treated under sections
671 through 678 without regard to section 672(f). A CFC, PFIC, or FPHC
will be treated as a domestic corporation solely for purposes of
applying the general rule of Sec. 1.672(f)-1. Thus, a CFC, PFIC, or
FPHC will be treated as a foreign corporation for purposes of
Sec. 1.672(f)-4, which is discussed below in part 6 of this
explanation.
If a trust to which a CFC, PFIC, or FPHC has made a gratuitous
transfer makes a gratuitous transfer to a U.S. person, the CFC, PFIC,
or FPHC, as the case may be, will be treated as a foreign corporation
for purposes of determining how the transfer will be treated in the
hands of the U.S. person, and the rules of Sec. 1.672(f)-4(c) will
apply. If a trust that a CFC, PFIC, or FPHC is treated as owning under
section 678 makes a gratuitous transfer to a U.S. person, the rules of
Sec. 1.672(f)-4(c) will apply as if the CFC, PFIC, or FPHC had made a
gratuitous transfer to the trust.
The final regulations for CFCs, PFICs, and FPHCs are generally
applicable to taxable years of shareholders of CFCs, PFICs, and FPHCs
beginning after August 10, 1999 and taxable years of CFCs, PFICs, and
FPHCs ending with or within such taxable years of the shareholders.
5. Comments and Changes to Sec. 1.672(f)-3: Exceptions To General Rule
A. Certain Revocable Trusts
Under the proposed regulations, the general rule of Sec. 1.672(f)-
1(a) did not apply to any portion of a trust if the power to revest
absolutely in the grantor title to such portion was exercisable solely
by the grantor without the approval or consent of any other person
[[Page 43270]]
for a period or periods aggregating 183 days or more during the taxable
year of the trust. The 183-day rule is targeted at potentially abusive
situations in which a power to revest is so limited that it is not
likely to be exercised.
In response to comments received, the final regulations clarify
that if the first or last taxable year of the trust is less than 183
days, the revocable trust exception will apply if the grantor has a
power to revest on each day of the first or last taxable year
(including the year of the grantor's death), as the case may be. The
final regulations also clarify that, consistent with the principle that
statutory exceptions should be construed narrowly, if a trust fails to
qualify for the revocable trust exception in a particular year, the
exception cannot apply in a later year even if the requirements would
otherwise be satisfied in such later year.
Commenters asked whether the revocable trust exception continues to
apply if the grantor becomes incapacitated. The final regulations
provide that the exception will continue to apply if, but only if,
there is a guardian or other person who has unrestricted authority to
exercise the necessary power on the grantor's behalf.
Some commenters disagreed with the result in Sec. 1.672(f)-3(a)(4)
Example 3 of the proposed regulations, which concluded that the
revocable trust exception does not apply where the grantor of the trust
can replace the trustee, who is not a related or subordinate party, at
any time for any reason. They said the example was inconsistent with
the existing grantor trust rules. See, e.g., Sec. 1.674(d)-2(a). After
careful consideration, Treasury and the IRS have concluded that Example
3 is consistent with the purposes of section 672(f) and should be
retained.
Commenters raised a number of issues concerning the grandfather
rules in Sec. 1.672(f)-3 (a)(2) and (b)(4) of the proposed regulations
for certain trusts that were in existence on September 19, 1995. In
response to the comments, the final regulations confirm that physical
separation of amounts that were gratuitously transferred to the trust
after September 19, 1995, is not required. The final regulations
further provide that initial separate accountings may be prepared at
any time up until the due date (including extensions) for the tax
return for the first taxable year of the trust beginning after August
10, 1999. In response to requests for more specific guidance, the final
regulations provide that the grandfather rules apply only if any
amounts that were gratuitously transferred to the trust after September
19, 1995, are treated as a separate portion of the trust that is
accounted for under the rules of Sec. 1.671-3(a)(2).
B. Certain Trusts That Can Distribute Only to the Grantor or the Spouse
of the Grantor
Under the proposed regulations, the general rule of Sec. 1.672(f)-1
did not apply if the only amounts distributable from a trust (or
portion of a trust) during the lifetime of the grantor were amounts
distributable to the grantor or the grantor's spouse. Treasury and the
IRS contemplate that the fact that the grantor and his or her spouse
might someday divorce or legally separate will be disregarded for
purposes of determining whether the exception is applicable.
Under the proposed regulations, amounts distributable in discharge
of a legal obligation of the grantor or the grantor's spouse generally
were treated as amounts distributable to the grantor or the grantor's
spouse. Commenters said these proposed rules were inconsistent with the
manner in which distributions in discharge of obligations are treated
in regulations promulgated under other provisions of the Code. For
example, under sections 677(a) and 662(a)(2), there is no exception for
obligations to family members that are not based on full and adequate
consideration in money or money's worth. Commenters also said the
proposed rules were likely to exclude most trusts from qualification
for the exception because, in most jurisdictions, a trust provision
that permits distributions to a particular person is construed to
permit distributions to be made in satisfaction of that person's
obligations, regardless of the source of the obligations.
Treasury and the IRS believe it is neither necessary nor
appropriate for the regulations promulgated under the statutory
exceptions to section 672(f) to be consistent with the regulations
promulgated under other provisions of part I of subchapter J, chapter 1
of the Code. Section 672(f) reflects a policy determination that
foreign persons should not be allowed ``to affirmatively use the
domestic anti-abuse rules concerning grantor trusts'' to avoid U.S. tax
on trust income distributed to U.S. beneficiaries. Dept. of the
Treasury, General Explanations of the Administration's Revenue
Proposals, at 12 (1995). Section 672(f) operates to implement that
policy determination by providing that the grantor trust rules
generally do not apply where their effect would be to treat a foreign
person as the owner of any portion of a trust. S. Rep. No. 35, 104th
Cong., 1st Sess. 161 (1995). The exceptions in section 672(f)(2) must
be interpreted narrowly to preserve the primary operation of the
general rule. See, for example, Commissioner v. Clark, 489 U.S. 726,
739 (1989) (``In construing provisions * * * in which a general
statement of policy is qualified by an exception, we usually read the
exception narrowly in order to preserve the primary operation of the
provision.'').
The final regulations continue to provide that a trust will not
fail to qualify for the exception solely because amounts are
distributable from the trust in discharge of a legal obligation of the
grantor (or grantor's spouse). An obligation to a related person is not
generally treated as a legal obligation unless it was contracted bona
fide and for adequate and full consideration in money or money's worth.
However, obligations to support certain individuals will be treated as
legal obligations if the individual is either permanently and totally
disabled or less than 19 years old. The final regulations expand the
list of potentially eligible individuals to include certain individuals
who are members of the grantor's (or grantor's spouse's) household and
have as their principal place of abode the grantor's (or grantor's
spouse's) home, but are not related to the grantor (or grantor's
spouse) through one of the relationships listed in section 152(a)(1)
through (8). The fact that amounts might become distributable from a
trust to support an individual who is not described in the regulations
will be disregarded if, at the time the applicability of the exception
is being determined, the potential obligation is not reasonably
expected to arise under the facts and circumstances.
Some commenters said the limitation in proposed Sec. 1.672(f)-
3(b)(2)(ii) for legal obligations to related persons is not needed in
the case of reinsurance trusts because, regardless of the sufficiency
of the consideration for the reinsurance, the funds in a reinsurance
trust can be utilized only to satisfy the legal obligations of the
reinsurer (or will be distributed to the reinsurer). In addition,
commenters pointed out that there already are other provisions, such as
sections 482 and 845, that apply to related-party reinsurance
arrangements.
The final regulations reserve on the application of the related-
party rule to reinsurance trusts. Treasury and the IRS are looking
carefully at this area, and they invite additional comments.
Commenters raised a number of issues concerning the grandfather
rules in Sec. 1.672(f)-3(b)(4) of the proposed regulations. These
issues are discussed above in connection with the
[[Page 43271]]
grandfather rules under Sec. 1.672(f)-3(a)(2) of the proposed
regulations.
C. Compensatory Trusts
The proposed regulations listed categories of trusts that
constitute compensatory trusts, without regard to whether any portion
of a particular trust would ever be treated as owned by the grantor or
another person under the grantor trust rules. Treasury and the IRS are
concerned that some taxpayers may find such a comprehensive list
confusing. Accordingly, the final regulations provide that the trusts
to which the compensatory trust exception applies are those to which
the application of section 672(f) is likely to be relevant: (i)
nonexempt employees' trusts described in section 402(b) and (ii) so-
called ``rabbi'' trusts. Treasury and the IRS believe the issue of
whether tax-exempt compensatory trusts can be treated as owned by a
foreign person is moot because there are special statutory rules that
govern those trusts.
Treasury and the IRS contemplate that a nonexempt employees' trust
described in section 402(b) will be treated as owned by a beneficiary
of the trust only to the extent provided in regulations section
1.402(b)-1(b)(6). See also 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, for proposed rules describing when an
employer will be treated as an owner of any portion of a nonexempt
employees' trust described in section 402(b) that is part of a deferred
compensation plan.
The final regulations also provide that the Commissioner may
designate additional categories of trusts to which the compensatory
trust exception applies.
6. Comments and Changes to Sec. 1.672(f)-4: Recharacterization of
Purported Gifts
The proposed regulations provided that a U.S. donee generally must
treat a purported gift from a foreign corporation as a distribution
from the foreign corporation unless the U.S. donee can establish that a
U.S. citizen or resident alien is a shareholder of the transferor and
that the U.S. citizen or resident took the amount into account for U.S.
tax purposes and subsequently made a gift to the U.S. donee. Similar
rules were proposed for purported gifts from partnerships (whether
domestic or foreign). There were exceptions for charitable
contributions to donees described in section 170(c) and for purported
gifts that did not exceed $10,000.
Section 1.672(f)-4(c) of the proposed regulations provided rules
for gratuitous transfers to U.S. donees from trusts created by
partnerships or foreign corporations. Under the proposed regulations,
if the partnership or foreign corporation was treated as the owner of
the trust under the grantor trust rules, the transfer was treated as a
purported gift from the partnership or foreign corporation. If the
partnership or foreign corporation was not treated as the owner of the
trust, the transfer was treated as an accumulation distribution from
the trust unless the resulting U.S. tax liability was less than the
U.S. tax that would be due if the transfer were treated as a purported
gift from the partnership or foreign corporation.
Commenters said the proposed regulations were overly broad and
exceeded the scope of the regulatory authority granted by Congress.
They suggested that a purported gift from a partnership or foreign
corporation should be treated as a deemed distribution to the partner
or shareholder followed by a deemed transfer to the U.S. donee.
Commenters also suggested that purported gifts should not be
recharacterized as taxable distributions unless it appeared, based on
all the facts and circumstances, that the partnership or foreign
corporation was being used principally as a device to avoid U.S. tax.
Treasury and the IRS believe the basic approach taken by the
proposed regulations is both necessary and appropriate to prevent the
avoidance of the purposes of section 672(f). See Code section 672(f)(4)
and (6). A rule that would recharacterize purported gifts only in
situations where the partnership or foreign corporation was being used
principally as a device to avoid U.S. tax would be unadministrable. It
would place a nearly insurmountable burden on the IRS to obtain
information, much of it outside the United States, and to establish
that the partnership or foreign corporation was being used to avoid
U.S. tax. Further, individuals do not normally receive gifts from
partnerships and corporations. See, for example, Commissioner v.
Duberstein, 363 U.S. 278 (1960).
The final regulations leave the basic approach essentially
unaltered, but expand the number of exceptions to the general rule.
They retain the exception for cases where the U.S. donee can establish
that a U.S. citizen or resident alien treated (and reported) the
purported gift for U.S. tax purposes as a distribution from the
partnership or foreign corporation and a subsequent gift to the donee.
In response to the commenters' concerns, they provide an additional
exception for cases where the U.S. donee can establish that a
nonresident alien individual treated and reported the purported gift
for purposes of the tax laws of the country in which the nonresident
alien is resident as a distribution from the partnership or foreign
corporation and a subsequent gift to the donee, provided the U.S. donee
timely complied with the filing requirements of section 6039F, if
applicable. Finally, they provide another new exception for purported
gifts from domestic partnerships that are beneficially owned (within
the meaning of Sec. 1.1441-1(c)(6)) exclusively by U.S. citizens or
residents or domestic corporations.
In response to other comments, the final regulations clarify that a
transfer to a U.S. donee that is a corporation will not be subject to
the general rule of Sec. 1.672(f)-4(a) to the extent the donee can
establish that the transfer was a contribution to capital. The final
regulations also expand the scope of the charitable contribution
exception to include a transfer from a transferor that has received a
ruling or determination letter from the Internal Revenue Service
recognizing its exempt status under section 501(c)(3), provided that
the transfer was made pursuant to the transferor's exempt purpose, the
ruling or determination letter has not been revoked or modified, and
there has been no material change, inconsistent with exemption, in the
character, purpose, or method of operation of the organization.
The final regulations revise the rules for gratuitous transfers to
U.S. donees from trusts to which partnerships or foreign corporations
have made gratuitous transfers. The revisions reflect the fact that,
under U.S. domestic law principles, the partners or shareholders might
be treated as grantors of the trust. See Sec. 1.671-2T(e)(4).
The final regulations also clarify that if the transferring
partnership or foreign corporation receives some consideration from the
U.S. donee, but the consideration is less than the fair market value of
the property transferred, only the excess will be treated as a
purported gift. Further, no portion will be treated as a purported gift
if the U.S. donee can establish that the U.S. donee is neither related
to a partner or shareholder of the transferor within the meaning of
Sec. 1.643(h)-1(e) nor has another relationship with a partner or
shareholder of the transferor such that there is a reasonable basis for
concluding that the partner or shareholder would make a gratuitous
transfer to the U.S. donee.
Commenters said the proposed regulations overturned an early
Supreme Court decision, Bogardus v.
[[Page 43272]]
Commissioner, 302 U.S. 34 (1937), which treated certain payments by an
acquiring corporation in a reorganization that were paid at the
instigation of former shareholders of the target corporation to
employees and former employees of the target corporation as nontaxable
gifts rather than as compensation. The result in Bogardus might well be
different today under section 102(c)(1) (enacted in 1986), which
provides that the exclusion from gross income for the value of property
acquired by gift does not apply to any amount transferred by or for an
employer to, or for the benefit of, an employee. Further, and more
importantly, the payor corporation in Bogardus was a domestic
corporation that did not treat the payments as a deductible expense and
there was no avoidance of U.S. tax. Thus, Bogardus is distinguishable
on its facts from a situation where a foreign corporation transfers
property to a U.S. person who treats the transfer as a gift or bequest
and there will be avoidance of U.S. tax if the purported gift is not
recharacterized.
The final regulations for purported gifts are generally applicable
to transfers made after August 10, 1999 by partnerships or foreign
corporations, or by trusts to which partnerships or foreign
corporations made gratuitous transfers after August 10, 1999.
7. Comments and Changes to Sec. 1.672(f)-5: Special Rules
Section 1.672(f)-5(b) of the proposed regulations provided that,
for purposes of Sec. 1.672(f)-1, where the taxable year of a trust was
different from the taxable year of a person who was taking an amount
into account, the amount was taken into account for the taxable year of
the person that included the last day of the taxable year of the trust.
This rule was deleted from the final regulations, because it is no
longer needed in light of the revisions to Sec. 1.672(f)-1, which are
described above in part 3 of this explanation.
Section 1.672(f)-5(c) of the proposed regulations provided that,
for purposes of Sec. 1.672(f)-4, a wholly owned business entity must be
treated as a corporation, separate from its single owner. Absent this
rule, an entity having a single owner could avoid the purported gift
rule by electing to be disregarded, with the result that the purported
gift would be received from the owner of the entity, rather than from
the entity itself. The final regulations clarify that this special rule
(renumbered as Sec. 1.672(f)-5(b)) applies solely for purposes of
Sec. 1.672(f)-4. Thus, it does not apply for purposes of
Secs. 1.672(f)-1 through 1.672(f)-3 or Sec. 1.672(f)-5 or for purposes
of any other provision of the Code or regulations.
Section 301.7701-2(c)(2)(iii) of the proposed regulations provided
that, solely for purposes of applying the rules of section 672(f)(4), a
wholly owned business entity will be treated as a corporation, separate
from its owner. This provision, which repeated the rule in
Sec. 1.672(f)-5(c) (renumbered as Sec. 1.672(f)-5(b)), is not included
in the final regulations.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 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, the notice of proposed
rulemaking preceding these regulations was submitted to the Small
Business Administration for comment on the regulation's impact on small
business.
Drafting Information. The principal authors of these regulations
are M. Grace Fleeman of the Office of Associate Chief Counsel
(International) and James A. Quinn of the Office of the Assistant Chief
Counsel (Passthroughs and Special Industries). However, other personnel
from the IRS and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is 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 in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.643(h)-1 also issued under 26 U.S.C. 643(a)(7).
Section 1.671-2T 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) and
672(f)(3) and (6).
Section 1.672(f)-3 also issued under 26 U.S.C. 643(a)(7) and
672(f)(2) and (6).
Section 1.672(f)-4 also issued under 26 U.S.C. 643(a)(7) and
672(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--(1) Principal purpose of tax avoidance. Except as
provided in paragraph (b) of this section, for purposes of part I of
subchapter J, chapter 1 of the Internal Revenue Code, and section 6048,
any property (within the meaning of paragraph (f) of this section) that
is transferred to a United States person by another person (an
intermediary) who has received property from a foreign trust will be
treated as property transferred directly by the foreign trust to the
United States person if the intermediary received the property from the
foreign trust pursuant to a plan one of the principal purposes of which
was the avoidance of United States tax.
(2) Principal purpose of tax avoidance deemed to exist. For
purposes of paragraph (a)(1) of this section, a transfer will be deemed
to have been made pursuant to a plan one of the principal purposes of
which was the avoidance of United States tax if the United States
person--
(i) Is related (within the meaning of paragraph (e) of this
section) to a grantor of the foreign trust, or has another relationship
with a grantor of the foreign trust that establishes a reasonable basis
for concluding that the grantor of the foreign trust would make a
gratuitous transfer (within the meaning of Sec. 1.671-2T(e)(2)) to the
United States person;
(ii) Receives from the intermediary, within the period beginning
twenty-four months before and ending twenty-four months after the
intermediary's receipt of property from the foreign trust, either the
property the intermediary received from the foreign trust, proceeds
from such property, or property in substitution for such property; and
(iii) Cannot demonstrate to the satisfaction of the Commissioner
that--
(A) The intermediary has a relationship with the United
States person that establishes a reasonable basis for concluding
that the intermediary would make a gratuitous transfer to the United
States person;
(B) The intermediary acted independently of the grantor and the
trustee of the foreign trust;
(C) The intermediary is not an agent of the United States person
under generally applicable United States agency principles; and
[[Page 43273]]
(D) The United States person timely complied with the reporting
requirements of section 6039F, if applicable, if the intermediary is a
foreign person.
(b) Exceptions--(1) Nongratuitous transfers. Paragraph (a) of this
section does not apply to the extent that either the transfer from the
foreign trust to the intermediary or the transfer from the intermediary
to the United States person is a transfer that is not a gratuitous
transfer within the meaning of Sec. 1.671-2T(e)(2).
(2) Grantor as intermediary. Paragraph (a) of this section does not
apply if the intermediary is the grantor of the portion of the trust
from which the property that is transferred is derived. For the
definition of grantor, see Sec. 1.671-2T(e).
(c) Effect of disregarding intermediary--(1) General rule. Except
as provided in paragraph (c)(2) of this section, the intermediary is
treated as an agent of the foreign trust, and the property is treated
as transferred to the United States person in the year the property is
transferred, or made available, by the intermediary to the United
States person. The fair market value of the property transferred is
determined as of the date of the transfer by the intermediary to the
United States person. For purposes of section 665(d)(2), the term taxes
imposed on the trust includes any income, war profits, and excess
profits taxes imposed by any foreign country or possession of the
United States on the intermediary with respect to the property
transferred.
(2) Exception. If the Commissioner determines, or if the taxpayer
can demonstrate to the satisfaction of the Commissioner, that the
intermediary is an agent of the United States person under generally
applicable United States agency principles, the property will be
treated as transferred to the United States person in the year the
intermediary receives the property from the foreign trust. The fair
market value of the property transferred will be determined as of the
date of the transfer by the foreign trust to the intermediary. For
purposes of section 901(b), any income, war profits, and excess profits
taxes imposed by any foreign country or possession of the United States
on the intermediary with respect to the property transferred will be
treated as having been imposed on the United States person.
(3) Computation of gross income of intermediary. If property is
treated as transferred directly by the foreign trust to a United States
person pursuant to this section, the fair market value of such property
is not taken into account in computing the gross income of the
intermediary (if otherwise required to be taken into account by the
intermediary but for paragraph (a) of this section).
(d) Transfers not in excess of $10,000. This section does not apply
if, during the taxable year of the United States person, the aggregate
fair market value of all property transferred to such person from all
foreign trusts either directly or through one or more intermediaries
does not exceed $10,000.
(e) Related parties. For purposes of this section, a United States
person is treated as related to a grantor of a foreign trust if the
United States person and the grantor are related for purposes 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'' is used instead
of ``more than 50 percent'' each place it appears; and
(2) The principles of section 267(b)(10), using ``at least 10
percent'' instead of ``more than 50 percent,'' apply to determine
whether two corporations are related.
(f) Definition of property. For purposes of this section, the term
property includes cash.
(g) 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 and the fair market value of
the property that is transferred exceeds $10,000. The examples are as
follows:
Example 1. Principal purpose of tax avoidance. FT was created in
1980 by A, a nonresident alien, for the benefit of his children and
their descendants. FT's trustee, T, determines that 1000X of
accumulated income should be distributed to A's granddaughter, B,
who is a resident alien. Pursuant to a plan with a principal purpose
of avoiding the interest charge that would be imposed by section
668, T causes FT to make a gratuitous transfer (within the meaning
of Sec. 1.671-2T(e)(2)) of 1000X to I, a foreign person. I
subsequently makes a gratuitous transfer of 1000X to B. Under
paragraph (a)(1) of this section, FT is deemed to have made an
accumulation distribution of 1000X directly to B.
Example 2. United States person unable to demonstrate that
intermediary acted independently. GM and her daughter, M, are both
nonresident aliens. M's daughter, D, is a resident alien. GM creates
and funds FT for the benefit of her children. On July 1, 2001, FT
makes a gratuitous transfer of XYZ stock to M. M immediately sells
the XYZ stock and uses the proceeds to purchase ABC stock. On
January 1, 2002, M makes a gratuitous transfer of the ABC stock to
D. D is unable to demonstrate that M acted independently of GM and
the trustee of FT in making the transfer to D. Under paragraph
(a)(2) of this section, FT is deemed to have distributed the ABC
stock to D. Under paragraph (c)(1) of this section, M is treated as
an agent of FT, and the distribution is deemed to have been made on
January 1, 2002.
Example 3. United States person demonstrates that specified
conditions are satisfied. Assume the same facts as in Example 2,
except that M receives 1000X cash from FT instead of XYZ stock. M
gives 1000X cash to D on January 1, 2002. Also assume that M
receives annual income of 5000X from her own investments and that M
has given D 1000X at the beginning of each year for the past ten
years. Based on this and additional information provided by D, D
demonstrates to the satisfaction of the Commissioner that M has a
relationship with D that establishes a reasonable basis for
concluding that M would make a gratuitous transfer to D, that M
acted independently of GM and the trustee of FT, that M is not an
agent of D under generally applicable United States agency
principles, and that D timely complied with the reporting
requirements of section 6039F. FT will not be deemed under paragraph
(a)(2) of this section to have made a distribution to D.
Example 4. Transfer to United States person less than 24 months
before transfer to intermediary. Several years ago, A, a nonresident
alien, created and funded FT for the benefit of his children and
their descendants. A has a close friend, C, who also is a
nonresident alien. A's granddaughter, B, is a resident alien. On
December 31, 2001, C makes a gratuitous transfer of 1000X to B. On
January 15, 2002, FT makes a gratuitous transfer of 1000X to C. B is
unable to demonstrate that C has a relationship with B that would
establish a reasonable basis for concluding that C would make a
gratuitous transfer to B or that C acted independently of A and the
trustee of FT in making the transfer to B. Under paragraph (a)(2) of
this section, FT is deemed to have distributed 1000X directly to B.
Under paragraph (c)(1) of this section, C is treated as an agent of
FT, and the distribution is deemed to have been made on December 31,
2001.
Example 5. United States person receives property in
substitution for property transferred to intermediary. GM and her
son, S, are both nonresident aliens. S's daughter, GD, is a resident
alien. GM creates and funds FT for the benefit of her children and
their descendants. On July 1, 2001, FT makes a gratuitous transfer
of ABC stock with a fair market value of approximately 1000X to S.
On January 1, 2002, S makes a gratuitous transfer of DEF stock with
a fair market value of approximately 1000X to GD. GD is unable to
demonstrate that S acted independently of GM and the trustee of FT
in transferring the DEF stock to GD. Under paragraph (a)(2) of this
section, FT is deemed to have distributed the DEF stock to GD. Under
paragraph (c)(1) of this section, S is treated as an agent of FT,
and the distribution is deemed to have been made on January 1, 2002.
Example 6. United States person receives indirect loan from
foreign trust. Several years ago, A, a nonresident alien, created
and funded FT for the benefit of her children and their descendants.
A's daughter, B, is a
[[Page 43274]]
resident alien. B needs funds temporarily while she is starting up
her own business. If FT were to loan money directly to B, section
643(i) would apply. FT deposits 500X with FB, a foreign bank, on
June 30, 2001. On July 1, 2001, FB loans 400X to B. Repayment of the
loan is guaranteed by FT's 500X deposit. B is unable to demonstrate
to the satisfaction of the Commissioner that FB has a relationship
with B that establishes a reasonable basis for concluding that FB
would make a loan to B or that FB acted independently of A and the
trustee of FT in making the loan. Under paragraph (a)(2) of this
section, FT is deemed to have loaned 400X directly to B on July 1,
2001. Under paragraph (c)(1) of this section, FB is treated as an
agent of FT. For the treatment of loans from foreign trusts, see
section 643(i).
Example 7. United States person demonstrates that specified
conditions are satisfied. GM, a nonresident alien, created and
funded FT for the benefit of her children and their descendants. One
of GM's children is M, who is a resident alien. During the year
2001, FT makes a gratuitous transfer of 500X to M. M reports the
500X on Form 3520 as a distribution received from a foreign trust.
During the year 2002, M makes a gratuitous transfer of 400X to her
son, S, who also is a resident alien. M files a Form 709 treating
the gratuitous transfer to S as a gift. Based on this and additional
information provided by S, S demonstrates to the satisfaction of the
Commissioner that M has a relationship with S that establishes a
reasonable basis for concluding that M would make a gratuitous
transfer to S, that M acted independently of GM and the trustee of
FT, and that M is not an agent of S under generally applicable
United States agency principles. FT will not be deemed under
paragraph (a)(2) of this section to have made a distribution to S.
Example 8. Intermediary as agent of trust; increase in FMV. A, a
nonresident alien, created and funded FT for the benefit of his
children and their descendants. On December 1, 2001, FT makes a
gratuitous transfer of XYZ stock with a fair market value of 85X to
B, a nonresident alien. On November 1, 2002, B sells the XYZ stock
to a third party in an arm's length transaction for 100X in cash. On
November 1, 2002, B makes a gratuitous transfer of 98X to A's
grandson, C, a resident alien. C is unable to demonstrate to the
satisfaction of the Commissioner that B acted independently of A and
the trustee of FT in making the transfer. Under paragraph (a)(2) of
this section, FT is deemed to have made a distribution directly to
C. Under paragraph (c)(1) of this section, B is treated as an agent
of FT, and FT is deemed to have distributed 98X to C on November 1,
2002.
Example 9. Intermediary as agent of United States person;
increase in FMV. Assume the same facts as in Example 8, except that
the Commissioner determines that B is an agent of C under generally
applicable United States agency principles. Under paragraph (c)(2)
of this section, FT is deemed to have distributed 85X to C on
December 1, 2001. C must take the gain of 15X into account in the
year 2002.
Example 10. Intermediary as agent of trust; decrease in FMV.
Assume the same facts as in Example 8, except that the value of the
XYZ stock on November 1, 2002, is only 80X. Instead of selling the
XYZ stock to a third party and transferring cash to C, B transfers
the XYZ stock to C in a gratuitous transfer. Under paragraph (c)(1)
of this section, FT is deemed to have distributed XYZ stock with a
value of 80X to C on November 1, 2002.
Example 11. Intermediary as agent of United States person;
decrease in FMV. Assume the same facts as in Example 10, except that
the Commissioner determines that B is an agent of C under generally
applicable United States agency principles. Under paragraph (c)(2)
of this section, FT is deemed to have distributed XYZ stock with a
value of 85X to C on December 1, 2001.
(h) Effective date. The rules of this section are applicable to
transfers made to United States persons after August 10, 1999.
Par. 3. In Sec. 1.671-2, paragraph (e) is revised to read as
follows:
Sec. 1.671-2 Applicable principles.
* * * * *
(e) [Reserved] For further guidance, see Sec. 1.671-2T(e).
Par. 4. Section 1.671-2T is added to read as follows:
Sec. 1.671-2T Applicable principles (temporary).
(a) Athrough (d) [Reserved]. For further guidance, see Sec. 1.671-
2(a) through (d).
(e)(1) For purposes of part I of subchapter J, chapter 1 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)(2) of this
section) of property to a trust. For purposes of this section, the term
property includes cash. If a person creates or funds a trust on behalf
of another person, both persons are treated as grantors of the trust.
(See section 6048 for reporting requirements that apply to grantors of
foreign trusts.) However, a person who creates a trust but makes no
gratuitous transfers to the trust is not treated as an owner of any
portion of the trust under sections 671 through 677 or 679. Also, a
person who funds a trust with an amount that is directly reimbursed to
such person within a reasonable period of time and who makes no other
transfers to the trust that constitute gratuitous transfers is not
treated as an owner of any portion of the trust under sections 671
through 677 or 679. See also Sec. 1.672(f)-5(a).
(2)(i) A gratuitous transfer is any transfer other than a transfer
for fair market value. A transfer of property to a trust may be
considered a gratuitous transfer without regard to whether the transfer
is treated as a gift for gift tax purposes.
(ii) For purposes of this paragraph (e), a transfer is for fair
market value only to the extent of the value of property received from
the trust, services rendered by the trust, or the right to use property
of the trust. For example, rents, royalties, interest, and compensation
paid to a trust are transfers for fair market value only to the extent
that the payments reflect an arm's length price for the use of the
property of, or for the services rendered by, the trust. For purposes
of this determination, an interest in the trust is not property
received from the trust. In addition, a person will not be treated as
making a transfer for fair market value merely because the transferor
recognizes gain on the transaction. See, for example, section 684
regarding the recognition of gain on certain transfers to foreign
trusts.
(iii) For purposes of this paragraph (e), a gratuitous transfer
does not include a distribution to a trust with respect to an interest
held by such trust in either a trust described in paragraph (e)(3) of
this section or an entity other than a trust. For example, a
distribution to a trust by a corporation with respect to its stock
described in section 301 is not a gratuitous transfer.
(3) A grantor includes any person who acquires an interest in a
trust from a grantor of the trust if the interest acquired is an
interest in certain investment trusts described in Sec. 301.7701-4(c)
of this chapter, liquidating trusts described in Sec. 301.7701-4(d) of
this chapter, or environmental remediation trusts described in
Sec. 301.7701-4(e) of this chapter.
(4) If a gratuitous transfer is made by a partnership or
corporation to a trust and is for a business purpose of the partnership
or corporation, the partnership or corporation will generally be
treated as the grantor of the trust. For example, if a partnership
makes a gratuitous transfer to a trust in order to secure a legal
obligation of the partnership to a third party unrelated to the
partnership, the partnership will be treated as the grantor of the
trust. However, if a partnership or a corporation makes a gratuitous
transfer to a trust that is not for a business purpose of the
partnership or corporation but is, e.g., for the personal purposes of
one or more of the partners or shareholders, the gratuitous transfer
will be treated as a constructive distribution to such partners or
shareholders under federal tax principles and the partners or the
shareholders will be treated as the grantors of the trust. For example,
if a partnership makes a gratuitous transfer to a trust that is for the
benefit of a child of a partner, the gratuitous transfer will
[[Page 43275]]
be treated as a distribution to the partner under section 731 and a
subsequent gratuitous transfer by the partner to the trust.
(5) If a trust makes a gratuitous transfer of property to another
trust, the grantor of the transferor trust generally will be treated as
the grantor of the transferee trust. However, if a person with a
general power of appointment over the transferor trust exercises that
power in favor of another trust, then such person will be treated as
the grantor of the transferee trust, even if the grantor of the
transferor trust is treated as the owner of the transferor trust under
subpart E of part I, subchapter J, chapter 1 of the Internal Revenue
Code.
(6) The following examples illustrate the rules of this paragraph
(e). Unless otherwise indicated, all trusts are domestic trusts and all
other persons are United States persons.
The examples are as follows:
Example 1. A creates and funds a trust, T, for the benefit of
her children. B subsequently makes a gratuitous transfer to T. Under
paragraph (e)(1) of this section, both A and B are grantors 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. A is a grantor of T. B subsequently acquires A's entire
interest in T. Under paragraph (e)(3) of this section, B is a
grantor of T with respect to such interest.
Example 3. A, an attorney, creates a foreign trust, FT, on
behalf of A's client, B, and transfers $100 to FT out of A's funds.
A is reimbursed by B for the $100 transferred to FT. The trust
instrument states that the trustee has discretion to distribute the
income or corpus of FT to B, and B's children. Both A and B are
treated as grantors of FT under paragraph (e)(1) of this section. In
addition, B is treated as the owner of the entire trust under
section 677. Because A is reimbursed for the $100 transferred to FT
on behalf of B, A is not treated as transferring any property to FT.
Therefore, A is not an owner of any portion of T under sections 671
through 677 regardless of whether A retained any power over or
interest in T described in sections 673 through 677. A also is not
treated as an owner of any portion of T under section 679. Both A
and B are responsible parties for purposes of the reporting
requirements in section 6048.
Example 4. A creates and funds a trust, T. A is not treated as
an owner of any portion of the trust under subpart E. B holds an
unrestricted power, exercisable solely by B, to withdraw certain
amounts contributed to the trust before the end of the calendar year
and to vest those amounts in B. B is treated as an owner of the
portion of T that is subject to the withdrawal power under section
678(a)(1). However, B is not a grantor of T under paragraph (e)(1)
of this section because B neither created T nor made a gratuitous
transfer to T.
Example 5. A transfers cash to a trust, T, through a broker, in
exchange for units in T. The units in T are not property for
purposes of determining whether A has received fair market value
under paragraph (e)(2)(ii) 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, a trust. A has not made any
gratuitous transfers to T. Arm's length interest payments by A to T
will not be treated as gratuitous transfers under paragraph
(e)(2)(ii) 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, B's brother, creates a trust, T, for B's benefit
and contributes $50,000 to T. The trustee invests the $50,000 in
stock of Company X. C, B's uncle, sells property with a fair market
value of $1,000,000 to T in exchange for the stock when it has
appreciated to a fair market value of $100,000. Under paragraph
(e)(2)(ii) of this section, the $900,000 excess value is a
gratuitous transfer by C. Therefore, under paragraph (e)(1) of this
section, A is a grantor with respect to the portion of the trust
valued at $100,000, and C is a grantor of T with respect to the
portion of the trust valued at $900,000. In addition, A or C or both
will be treated as the owners of the respective portions of the
trust of which each person is a grantor if A or C or both retain
powers over or interests in such portions under sections 673 through
677.
Example 8. G creates and funds a trust, T1, for the benefit of
G's children and grandchildren. After G's death, under authority
granted to the trustees in the trust instrument, the trustees of T1
transfer a portion of the assets of T1 to another trust, T2, and
retain a power to revoke T2 and revest the assets of T2 in T1. Under
paragraphs (e)(1) and (5) of this section, G is the grantor of T1
and T2. In addition, because the trustees of T1 have retained a
power to revest the assets of T2 in T1, T1 is treated as the owner
of T2 under section 678(a).
Example 9. G creates and funds a trust, T1, for the benefit of
B. G retains a power to revest the assets of T1 in G within the
meaning of section 676. Under the trust agreement, B is given a
general power of appointment over the assets of T1. B exercises the
general power of appointment with respect to one-half of the corpus
of T1 in favor of a trust, T2, that is for the benefit of C, B's
child. Under paragraph (e)(1) of this section, G is the grantor of
T1, and under paragraphs (e)(1) and (5) of this section, B is the
grantor of T2.
(7) The rules of this section are applicable to any transfer to a
trust, or transfer of an interest in a trust, on or after August 10,
1999. In accordance with section 7805(e)(2), the rules of this section
will expire before August 12, 2002.
Par. 5. 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--(1) Application of the general rule. Section
672(f)(1) provides that subpart E of part I, subchapter J, chapter 1 of
the Internal Revenue Code (the grantor trust rules) shall apply 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. Accordingly, the grantor trust rules apply
to the extent that any portion of the trust, upon application of the
grantor trust rules without regard to section 672(f), is treated as
owned by a United States citizen or resident or domestic corporation.
The grantor trust rules do not apply to any portion of the trust to the
extent that, upon application of the grantor trust rules without regard
to section 672(f), that portion is treated as owned by a person other
than a United States citizen or resident or domestic corporation,
unless the person is described in Sec. 1.672(f)-2(a) (relating to
certain foreign corporations treated as domestic corporations), or one
of the exceptions set forth in Sec. 1.672(f)-3 is met, (relating to:
trusts where the grantor can revest trust assets; trusts where the only
amounts distributable are to the grantor or the grantor's spouse; and
compensatory trusts). Section 672(f) applies to domestic and foreign
trusts. Any portion of the trust that is not treated as owned by a
grantor or another person is subject to the rules of subparts A through
D (section 641 and following), part I, subchapter J, chapter 1 of the
Internal Revenue Code.
(2) Determination of portion based on application of the grantor
trust rules. The determination of the portion of a trust treated as
owned by the grantor or other person is to be made based on the terms
of the trust and the application of the grantor trust rules and section
671 and the regulations thereunder.
(b) Example. The following example illustrates the rules of this
section:
Example. (i) A, a nonresident alien, funds an irrevocable
domestic trust, DT, for the benefit of his son, B, who is a United
States citizen, with stock of Corporation X. A's brother, C, who
also is a United States citizen, contributes stock of Corporation Y
to the trust for the benefit of B. A has a reversionary interest
within the meaning of section 673 in the X stock that would cause A
to be treated as the owner of the X stock upon application of the
grantor trust rules without regard to section 672(f). C has a
reversionary interest within the meaning of section 673 in the Y
stock that would cause C to be treated as the owner of the Y stock
upon application of the grantor trust rules without regard to
section 672(f). The trustee has discretion to accumulate or
currently distribute income of DT to B.
[[Page 43276]]
(ii) Because A is a nonresident alien, application of the
grantor trust rules without regard to section 672(f) would not
result in the portion of the trust consisting of the X stock being
treated as owned by a United States citizen or resident. None of the
exceptions in Sec. 1.672(f)-3 applies because A cannot revest the X
stock in A, amounts may be distributed during A's lifetime to B, who
is neither a grantor nor a spouse of a grantor, and the trust is not
a compensatory trust. Therefore, pursuant to paragraph (a)(1) of
this section, A is not treated as an owner under subpart E of part
I, subchapter J, chapter 1 of the Internal Revenue Code, of the
portion of the trust consisting of the X stock. Any distributions
from such portion of the trust are subject to the rules of subparts
A through D (641 and following), part I, subchapter J, chapter 1 of
the Internal Revenue Code.
(iii) Because C is a United States citizen, paragraph (a)(1) of
this section does not prevent C from being treated under section 673
as the owner of the portion of the trust consisting of the Y stock.
(c) Effective date. The rules of this section are applicable to
taxable years of a trust beginning after August 10, 1999.
Sec. 1.672(f)-2 Certain foreign corporations.
(a) Application of general rule. Subject to the provisions of
paragraph (b) of this section, if the owner of any portion of a trust
upon application of the grantor trust rules without regard to section
672(f) is a controlled foreign corporation (as defined in section 957),
a passive foreign investment company (as defined in section 1297), or a
foreign personal holding company (as defined in section 552), the
corporation will be treated as a domestic corporation for purposes of
applying the rules of Sec. 1.672(f)-1.
(b) Gratuitous transfers to United States persons--(1) Transfer
from trust to which corporation made a gratuitous transfer. If a trust
(or portion of a trust) to which a controlled foreign corporation,
passive foreign investment company, or foreign personal holding company
has made a gratuitous transfer (within the meaning of Sec. 1.671-
2T(e)(2)), makes a gratuitous transfer to a United States person, the
controlled foreign corporation, passive foreign investment company, or
foreign personal holding company, as the case may be, is treated as a
foreign corporation for purposes of Sec. 1.672(f)-4(c), relating to
gratuitous transfers from trusts (or portions of trusts) to which a
partnership or foreign corporation has made a gratuitous transfer.
(2) Transfer from trust over which corporation has a section 678
power. If a trust (or portion of a trust) that a controlled foreign
corporation, passive foreign investment company, or foreign personal
holding company is treated as owning under section 678 makes a
gratuitous transfer to a United States person, the controlled foreign
corporation, passive foreign investment company, or foreign personal
holding company, as the case may be, is treated as a foreign
corporation that had made a gratuitous transfer to the trust (or
portion of a trust) and the rules of Sec. 1.672(f)-4(c) apply.
(c) Special rules for passive foreign investment companies--(1)
Application of section 1297. For purposes of determining whether a
foreign corporation is a passive foreign investment company as defined
in section 1297, the grantor trust rules apply as if section 672(f) had
not come into effect.
(2) References to renumbered Internal Revenue Code section. For
taxable years of shareholders beginning on or before December 31, 1997,
and taxable years of passive foreign investment companies ending with
or within such taxable years of the shareholders, all references in
this Sec. 1.672(f)-2 to section 1297 are deemed to be references to
section 1296.
(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 are as follows:
Example 1. Application of general rule. CFC creates and funds
FT. CFC is the grantor of FT within the meaning of Sec. 1.671-2T(e).
CFC has a reversionary interest in FT within the meaning of section
673 that would cause CFC to be treated as the owner of FT upon
application of the grantor trust rules without regard to section
672(f). Under paragraph (a) of this section, CFC is treated as a
domestic corporation for purposes of applying the general rule of
Sec. 1.672(f)-1. Thus, Sec. 1.672(f)-1 does not prevent CFC from
being treated as the owner of FT under section 673.
Example 2. Distribution from trust to which CFC made gratuitous
transfer. A, a nonresident alien, owns 40 percent of the stock of
CFC. A's brother B, a resident alien, owns the other 60 percent of
the stock of CFC. CFC makes a gratuitous transfer to FT. FT makes a
gratuitous transfer to A's daughter, C, who is a resident alien.
Under paragraph (b)(1) of this section, CFC will be treated as a
foreign corporation for purposes of Sec. 1.672(f)-4(c). For further
guidance, see Sec. 1.672(f)-4(g) Example 2 through Example 4.
(e) Effective date. The rules of this section are generally
applicable to taxable years of shareholders of controlled foreign
corporations, passive foreign investment companies, and foreign
personal holding companies beginning after August 10, 1999, and taxable
years of controlled foreign corporations, passive foreign investment
companies, and foreign personal holding companies ending with or within
such taxable years of the shareholders.
Sec. 1.672(f)-3 Exceptions to general rule.
(a) Certain revocable trusts--(1) In general. Subject to the
provisions of paragraph (a)(2) of this section, the general rule of
Sec. 1.672(f)-1 does not apply to any portion of a trust for a taxable
year of the trust if the power to revest absolutely in the grantor
title to such portion is exercisable solely by the grantor (or, in the
event of the grantor's incapacity, by a guardian or other person who
has unrestricted authority to exercise such power on the grantor's
behalf) 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 is
treated as exercisable solely by the grantor. For the definition of
grantor, see Sec. 1.671-2T(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. A trust (or portion of a
trust) that fails to qualify for the exception provided by this
paragraph (a) for a particular taxable year of the trust will be
subject to the general rule of Sec. 1.672(f)-1 for that taxable year
and all subsequent taxable years of the trust.
(2) 183-day rule. For purposes of paragraph (a)(1) of this section,
the grantor is treated as having a power to revest for a taxable year
of the trust only if the grantor has such power for a total of 183 or
more days during the taxable year of the trust. If the first or last
taxable year of the trust (including the year of the grantor's death)
is less than 183 days, the grantor is treated as having a power to
revest for purposes of paragraph (a)(1) of this section if the grantor
has such power for each day of the first or last taxable year, as the
case may be.
(3) Grandfather rule for certain revocable trusts in existence on
September 19, 1995. Subject to the rules of paragraph (d) of this
section (relating to separate accounting for gratuitous transfers to
the trust after September 19, 1995), the general rule of Sec. 1.672(f)-
1 does not apply to any portion of 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 thereafter. However, the
preceding sentence does not apply to any portion of the trust
attributable to gratuitous transfers to the trust after September 19,
1995.
(4) Examples. The following examples illustrate the rules of this
paragraph (a):
[[Page 43277]]
Example 1. Grantor is owner. FP1, a foreign person, creates and
funds a revocable trust, T, for the benefit of FP1's children, who
are resident aliens. 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.
The trust instrument contains no standard that FB must apply in
determining whether to approve or consent to the revocation of T.
There are no facts that would suggest that FB is not subservient to
FP1. Therefore, the exception in paragraph (a)(1) of this section is
applicable.
Example 2. Death of 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, the exception in paragraph (a)(1) of this section is no
longer applicable, because FP2 is not a grantor of T within the
meaning of Sec. 1.671-2T(e).
Example 3. Trustee is not related or subordinate party. Assume
the same facts as in Example 1, except that neither FP1 nor any
member of FP1's 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 with a related or
subordinate party 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, the exception in paragraph
(a)(1) of this section is not applicable.
Example 4. Unrelated trustee will consent to revocation. FP, a
foreign person, creates 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 beneficiaries of T,
including FP. Even if FB would in fact distribute all the trust
property to FP if requested to do so by FP, the exception in
paragraph (a)(1) of this section is not applicable, because FP does
not have the power to revoke T.
(b) Certain trusts that can distribute only to the grantor or the
spouse of the grantor--(1) In general. The general rule of
Sec. 1.672(f)-1 does not apply to any trust (or portion of a trust) if
at all times during the lifetime of the grantor the only amounts
distributable (whether income or corpus) from such trust (or portion
thereof) are amounts distributable to the grantor or the spouse of the
grantor. For purposes of this paragraph (b), payments of amounts that
are not gratuitous transfers (within the meaning of Sec. 1.671-
2T(e)(2)) are not amounts distributable. For the definition of grantor,
see Sec. 1.671-2T(e).
(2) Amounts distributable in discharge of legal obligations--(i) In
general. A trust (or portion of a trust) does not fail to satisfy
paragraph (b)(1) of this section solely because amounts are
distributable from the trust (or portion thereof) in discharge of a
legal obligation of the grantor or the spouse of the grantor. Subject
to the provisions of paragraph (b)(2)(ii) of this section, an
obligation is considered a legal obligation for purposes of this
paragraph (b)(2)(i) if it is enforceable under the local law of the
jurisdiction in which the grantor (or the spouse of the grantor)
resides.
(ii) Related parties--(A) In general. Except as provided in
paragraph (b)(2)(ii)(B) of this section, an obligation to a person who
is a related person for purposes of Sec. 1.643(h)-1(e) (other than an
individual who is legally separated from the grantor under a decree of
divorce or of separate maintenance) is not a legal obligation for
purposes of paragraph (b)(2)(i) of this section unless it was
contracted bona fide and for adequate and full consideration in money
or money's worth (see Sec. 20.2043-1 of this chapter).
(B) Exceptions--(1) Amounts distributable in support of certain
individuals. Paragraph (b)(2)(ii)(A) of this section does not apply
with respect to amounts that are distributable from the trust (or
portion thereof) to support an individual who--
(i) Would be treated as a dependent of the grantor or the spouse of
the grantor under section 152(a)(1) through (9), without regard to the
requirement that over half of the individual's support be received from
the grantor or the spouse of the grantor; and
(ii) Is either permanently and totally disabled (within the meaning
of section 22(e)(3)), or less than 19 years old.
(2) Certain potential support obligations. The fact that amounts
might become distributable from a trust (or portion of a trust) in
discharge of a potential obligation under local law to support an
individual other than an individual described in paragraph
(b)(2)(ii)(B)(1) of this section is disregarded if such potential
obligation is not reasonably expected to arise under the facts and
circumstances.
(3) Reinsurance trusts. [Reserved]
(3) Grandfather rule for certain section 677 trusts in existence on
September 19, 1995. Subject to the rules of paragraph (d) of this
section (relating to separate accounting for gratuitous transfers to
the trust after September 19, 1995), the general rule of Sec. 1.672(f)-
1 does not apply to any portion of 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 thereafter. However, the preceding sentence does not apply to
any portion of the trust attributable to gratuitous transfers to the
trust after September 19, 1995.
(4) 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 is 70
years old, and W is 65. H and W have a 30-year-old child, C, a
resident alien. There is no reasonable expectation that H or W will
ever have an obligation under local law to support C or any other
individual. H creates and funds an irrevocable trust, FT, using only
his separate property. H is the grantor of FT within the meaning of
Sec. 1.671-2T(e). Under the terms of FT, the only amounts
distributable (whether income or corpus) from FT as long as either H
or W is alive are amounts distributable to H or W. Upon the death of
both H and W, C may receive distributions from FT. During H's
lifetime, the exception in paragraph (b)(1) of this section is
applicable.
Example 2. Effect of grantor's death. Assume the same facts as
in Example 1. H predeceases W. Assume that W would be treated as
owning FT under section 678 if the grantor trust rules were applied
without regard to section 672(f). The exception in paragraph (b)(1)
of this section is no longer applicable, because W is not a grantor
of FT within the meaning of Sec. 1.671-2T(e).
Example 3. Amounts temporarily distributable to person other
than grantor or grantor's spouse. Assume the same facts as in
Example 1, except that C (age 30) is a law student at the time FT is
created 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 is alive will be amounts distributable to H or W. Even
assuming there is an enforceable obligation under local law for H
and W to support C while he is in school, distributions from FT in
payment of C's expenses cannot qualify as distributions in discharge
of a legal obligation under paragraph (b)(2) of this section,
because C is neither permanently and totally disabled nor less than
19 years old. The exception in paragraph (b)(1) of this section is
not applicable. After C graduates from law school, the exception in
paragraph (b)(1) still will not be applicable, because amounts were
distributable to C during the lifetime of H.
Example 4. 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. Under the
terms of DT, the only amounts that are distributable from FC's
portion of DT are amounts distributable to FC. The exception in
paragraph (b)(1) of this section is applicable to FC's portion of
DT.
Example 5. Reinsurance trust. A domestic insurance company, DI,
reinsures a portion of its business with an unrelated foreign
insurance company, FI. To satisfy state regulatory requirements, FI
places the premiums in an irrevocable domestic trust, DT. The trust
funds are held by a United States bank and may be used only to pay
claims arising out of the reinsurance policies, which are legally
enforceable under the local
[[Page 43278]]
law of the jurisdiction in which FI resides. On the termination of
DT, any assets remaining will revert to FI. Because the only amounts
that are distributable from DT are distributable either to FI or in
discharge of FI's legal obligations within the meaning of paragraph
(b)(2)(i) of this section, the exception in paragraph (b)(1) of this
section is applicable.
Example 6. Trust that provides security for loan. FC, a foreign
corporation, borrows money from B, an unrelated bank, 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 while the loan is outstanding are amounts
distributable to B in the event that FC defaults on its loan from B.
When FC repays the loan, the trust assets will revert to FC. The
loan is a legal obligation of FC within the meaning of paragraph
(b)(2)(i) of this section, because it is enforceable under the local
law of the country in which FC is incorporated. Paragraph (b)(2)(ii)
of this section is not applicable, because B is not a related person
for purposes of Sec. 1.643(h)-1(e). The exception in paragraph
(b)(1) of this section is applicable.
(c) Compensatory trusts--(1) In general. The general rule of
Sec. 1.672(f)-1 does not apply to any portion of--
(i) A nonexempt employees' trust described in section 402(b),
including a trust created on behalf of a self-employed individual;
(ii) A trust, including a trust created on behalf of a self-
employed individual, 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
(iii) Any additional category of trust that the Commissioner may
designate in revenue procedures, notices, or other guidance published
in the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this
chapter).
(2) Exceptions. The Commissioner may, in revenue rulings, notices,
or other guidance published in the Internal Revenue Bulletin (see
Sec. 601.601(d)(2) of this chapter), designate categories of
compensatory trusts to which the general rule of paragraph (c)(1) of
this section does not apply.
(d) Separate accounting for gratuitous transfers to grandfathered
trusts after September 19, 1995. If a trust that was treated as owned
by the grantor under section 676 or 677 (other than section 677(a)(3))
on September 19, 1995, contains both amounts held in the trust on
September 19, 1995, and amounts that were gratuitously transferred to
the trust after September 19, 1995, paragraphs (a)(3) and (b)(3) of
this section apply only if the amounts that were gratuitously
transferred to the trust after September 19, 1995, are treated as a
separate portion of the trust that is accounted for under the rules of
Sec. 1.671-3(a)(2). If the amounts that were gratuitously transferred
to the trust after September 19, 1995 are not so accounted for, the
general rule of Sec. 1.672(f)-1 applies to the entire trust. If such
amounts are so accounted for, and without regard to whether there is
physical separation of the assets, the general rule of Sec. 1.672(f)-1
does not apply to the portion of the trust that is attributable to
amounts that were held in the trust on September 19, 1995.
(e) Effective date. The rules of this section are generally
applicable to taxable years of a trust beginning after August 10, 1999.
The initial separate accounting required by paragraph (d) of this
section must be prepared by the due date (including extensions) for the
tax return of the trust for the first taxable year of the trust
beginning after August 10, 1999.
Sec. 1.672(f)-4 Recharacterization of purported gifts.
(a) In general--(1) Purported gifts from partnerships. Except as
provided in paragraphs (b), (e), and (f) of this section, and without
regard to the existence of any trust, if a United States person (United
States 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
United States donee's gross income as ordinary income.
(2) Purported gifts from foreign corporations. Except as provided
in paragraphs (b), (e), and (f) of this section, and without regard to
the existence of any trust, if a United States donee directly or
indirectly receives a purported gift or bequest (as defined in
paragraph (d) of this section) from any foreign corporation, the
purported gift or bequest must be included in the United States donee's
gross income as if it were a distribution from the foreign corporation.
If the foreign corporation is a passive foreign investment company
(within the meaning of section 1297), the rules of section 1291 apply.
For purposes of section 1012, the United States donee is not treated as
having basis in the stock of the foreign corporation. However, for
purposes of section 1223, the United States donee is treated as having
a holding period in the stock of the foreign corporation on the date of
the deemed distribution equal to the weighted average of the holding
periods of the actual interest holders (other than any interest holders
who treat the portion of the purported gift attributable to their
interest in the foreign corporation in the manner described in
paragraph (b)(1) of this section). For purposes of section 902, a
United States donee that is a domestic corporation is not treated as
owning any voting stock of the foreign corporation.
(b) Exceptions--(1) Partner or shareholder treats transfer as
distribution and gift. Paragraph (a) of this section does not apply to
the extent the United States donee can demonstrate to the satisfaction
of the Commissioner that either--
(i) A United States citizen or resident alien individual who
directly or indirectly holds an interest in the partnership or foreign
corporation treated and reported the purported gift or bequest for
United States tax purposes as a distribution to such individual and a
subsequent gift or bequest to the United States donee; or
(ii) A nonresident alien individual who directly or indirectly
holds an interest in the partnership or foreign corporation treated and
reported the purported gift or bequest for purposes of the tax laws of
the nonresident alien individual's country of residence as a
distribution to such individual and a subsequent gift or bequest to the
United States donee, and the United States donee timely complied with
the reporting requirements of section 6039F, if applicable.
(2) All beneficial owners of domestic partnership are United States
citizens or residents or domestic corporations. Paragraph (a)(1) of
this section does not apply to a purported gift or bequest from a
domestic partnership if the United States donee can demonstrate to the
satisfaction of the Commissioner that all beneficial owners (within the
meaning of Sec. 1.1441-1(c)(6)) of the partnership are United States
citizens or residents or domestic corporations.
(3) Contribution to capital of corporate United States donee.
Paragraph (a) of this section does not apply to the extent a United
States donee that is a corporation can establish that the purported
gift or bequest was treated for United States tax purposes as a
contribution to the capital of the United States donee to which section
118 applies.
(4) Charitable transfers. Paragraph (a) of this section does not
apply if either--
(i) The United States donee is described in section 170(c); or
(ii) The transferor has received a ruling or determination letter,
which has been neither revoked nor modified, from the Internal Revenue
Service recognizing its exempt status under section 501(c)(3), and the
transferor made the transfer pursuant to an exempt
[[Page 43279]]
purpose for which the transferor was created or organized. For purposes
of the preceding sentence, a ruling or determination letter recognizing
exemption may not be relied upon if there is a material change,
inconsistent with exemption, in the character, the purpose, or the
method of operation of the organization.
(c) Certain transfers from trusts to which a partnership or foreign
corporation has made a gratuitous transfer--(1) Generally treated as
distribution from partnership or foreign corporation. Except as
provided in paragraphs (c)(2) and (3) of this section, if a United
States donee receives a gratuitous transfer (within the meaning of
Sec. 1.671-2T(e)(2)) from a trust (or portion of a trust) to which a
partnership or foreign corporation has made a gratuitous transfer, the
United States donee must treat the transfer as a purported gift or
bequest from the partnership or foreign corporation that is subject to
the rules of paragraph (a) of this section (including the exceptions in
paragraphs (b) and (f) of this section). This paragraph (c) applies
without regard to who is treated as the grantor of the trust (or
portion thereof) under Sec. 1.671-2T(e)(4).
(2) Alternative rule. Except as provided in paragraph (c)(3) of
this section, if the United States tax computed under the rules of
paragraphs (a) and (c)(1) of this section does not exceed the United
States tax that would be due if the United States donee treated the
transfer as a distribution from the trust (or portion thereof),
paragraph (c)(1) of this section does not apply and the United States
donee must treat the transfer as a distribution from the trust (or
portion thereof) that is subject to the rules of subparts A through D
(section 641 and following), part I, subchapter J, chapter 1 of the
Internal Revenue Code. For purposes of paragraph (f) of this section,
the transfer is treated as a purported gift or bequest from the
partnership or foreign corporation that made the gratuitous transfer to
the trust (or portion thereof).
(3) Exception. Neither paragraph (c)(1) of this section nor
paragraph (c)(2) of this section applies to the extent the United
States donee can demonstrate to the satisfaction of the Commissioner
that the transfer represents an amount that is, or has been, taken into
account for United States tax purposes by a United States citizen or
resident or a domestic corporation. A transfer will be deemed to be
made first out of amounts that have not been taken into account for
United States tax purposes by a United States citizen or resident or a
domestic corporation, unless the United States donee can demonstrate to
the satisfaction of the Commissioner that another ordering rule is more
appropriate.
(d) Definition of purported gift or bequest--(1) In general.
Subject to the provisions of paragraphs (d)(2) and (3) of this section,
a purported gift or bequest for purposes of this section is any
transfer of property by a partnership or foreign corporation other than
a transfer for fair market value (within the meaning of Sec. 1.671-
2T(e)(2)(ii)) to a person who is not a partner in the partnership or a
shareholder of the foreign corporation (or to a person who is a partner
in the partnership or a shareholder of a foreign corporation, if the
amount transferred is inconsistent with the partner's interest in the
partnership or the shareholder's interest in the corporation, as the
case may be). For purposes of this section, the term property includes
cash.
(2) Transfers for less than fair market value--(i) Excess treated
as purported gift or bequest. Except as provided in paragraph
(d)(2)(ii) of this section, if a transfer described in paragraph (d)(1)
of this section is for less than fair market value, the excess of the
fair market value of the property transferred over the value of the
property received, services rendered, or the right to use property is
treated as a purported gift or bequest.
(ii) Exception for transfers to unrelated parties. No portion of a
transfer described in paragraph (d)(1) of this section will be treated
as a purported gift or bequest for purposes of this section if the
United States donee can demonstrate to the satisfaction of the
Commissioner that the United States donee is not related to a partner
or shareholder of the transferor within the meaning of Sec. 1.643(h)-
1(e) or does not have another relationship with a partner or
shareholder of the transferor that establishes a reasonable basis for
concluding that the transferor would make a gratuitous transfer to the
United States donee.
(e) Prohibition against affirmative use of recharacterization by
taxpayers. A taxpayer may not use the rules of this section if a
principal purpose for using such rules is the avoidance of any tax
imposed by the Internal Revenue Code. Thus, with respect to such
taxpayer, the Commissioner may depart from the rules of this section
and recharacterize (for all purposes of the Internal Revenue Code) the
transfer in accordance with its form or its economic substance.
(f) Transfers not in excess of $10,000. This section does not apply
if, during the taxable year of the United States donee, the aggregate
amount of purported gifts or bequests that is transferred to such
United States donee directly or indirectly from all partnerships or
foreign corporations that are related (within the meaning of section
643(i)) does not exceed $10,000. The aggregate amount must include
gifts or bequests from persons that the United States donee knows or
has reason to know are related to the partnership or foreign
corporation (within the meaning of section 643(i)).
(g) Examples. The following examples illustrate the rules of this
section. In each example, the amount that is transferred exceeds
$10,000. The examples are as follows:
Example 1. Distribution from foreign corporation. FC is a
foreign corporation that is wholly owned by A, a nonresident alien
who is resident in Country C. FC makes a gratuitous transfer of
property directly to A's daughter, B, who is a resident alien. Under
paragraph (a)(2) of this section, B generally must treat the
transfer as a dividend from FC to the extent of FC's earnings and
profits and as an amount received in excess of basis thereafter. If
FC is a passive foreign investment company, B must treat the amount
received as a distribution under section 1291. B will be treated as
having the same holding period as A. However, under paragraph
(b)(1)(ii) of this section, if B can establish to the satisfaction
of the Commissioner that, for purposes of the tax laws of Country C,
A treated (and reported, if applicable) the transfer as a
distribution to himself and a subsequent gift to B, B may treat the
transfer as a gift (provided B timely complied with the reporting
requirements of section 6039F, if applicable).
Example 2. Distribution of corpus from trust to which foreign
corporation made gratuitous transfer. FC is a foreign corporation
that is wholly owned by A, a nonresident alien who is resident in
Country C. FC makes a gratuitous transfer to a foreign trust, FT,
that has no other assets. FT immediately makes a gratuitous transfer
in the same amount to A's daughter, B, who is a resident alien.
Under paragraph (c)(1) of this section, B must treat the transfer as
a transfer from FC that is subject to the rules of paragraph (a)(2)
of this section. Under paragraph (a)(2) of this section, B must
treat the transfer as a dividend from FC unless she can establish to
the satisfaction of the Commissioner that, for purposes of the tax
laws of Country C, A treated (and reported, if applicable) the
transfer as a distribution to himself and a subsequent gift to B and
that B timely complied with the reporting requirements of section
6039F, if applicable. The alternative rule in paragraph (c)(2) of
this section would not apply as long as the United States tax
computed under the rules of paragraph (a)(2) of this section is
equal to or greater than the United States tax that would be due if
the transfer were treated as a distribution from FT.
Example 3. Accumulation distribution from trust to which foreign
corporation made gratuitous transfer. FC is a foreign corporation
that is wholly owned by A, a nonresident alien. FC is not a passive
foreign
[[Page 43280]]
investment company (as defined in section 1297). FC makes a
gratuitous transfer of 100X to a foreign trust, FT, on January 1,
2001. FT has no other assets on January 1, 2001. Several years
later, FT makes a gratuitous transfer of 1000X to A's daughter, B,
who is a United States resident. Assume that the section 668
interest charge on accumulation distributions will apply if the
transfer is treated as a distribution from FT. Under the alternative
rule of paragraph (c)(2) of this section, B must treat the transfer
as an accumulation distribution from FT, because the resulting
United States tax liability is greater than the United States tax
that would be due if the transfer were treated as a transfer from FC
that is subject to the rules of paragraph (a) of this section.
Example 4. Transfer from trust that is treated as owned by
United States citizen. Assume the same facts as in Example 3, except
that A is a United States citizen. Assume that A treats and reports
the transfer to FT as a constructive distribution to himself,
followed by a gratuitous transfer to FT, and that A is properly
treated as the grantor of FT within the meaning of Sec. 1.671-2T(e).
A is treated as the owner of FT under section 679 and, as required
by section 671 and the regulations thereunder, A includes all of
FT's items of income, deductions, and credit in computing his
taxable income and credits. Neither paragraph (c)(1) nor paragraph
(c)(2) of this section is applicable, because the exception in
paragraph (c)(3) of this section applies.
Example 5. Transfer for less than fair market value. FC is a
foreign corporation that is wholly owned by A, a nonresident alien.
On January 15, 2001, FC transfers property directly to A's daughter,
B, a resident alien, in exchange for 90X. The Commissioner later
determines that the fair market value of the property at the time of
the transfer was 100X. Under paragraph (d)(2)(i) of this section,
10X will be treated as a purported gift to B on January 15, 2001.
(h) Effective date. The rules of this section are generally
applicable to any transfer after August 10, 1999, by a partnership or
foreign corporation, or by a trust to which a partnership or foreign
corporation makes a gratuitous transfer after August 10, 1999.
1.672(f)-5 Special rules.
(a) Transfers by certain beneficiaries to foreign grantor--(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 United States
beneficiary of the trust is treated as the grantor of a portion of the
trust to the extent the United States beneficiary directly or
indirectly made transfers of property to such foreign person (without
regard to whether the United States beneficiary was a United States
beneficiary at the time of any transfer) in excess of transfers to the
United States beneficiary from the foreign person. The rule of this
paragraph (a) does not apply to the extent the United States
beneficiary can demonstrate to the satisfaction of the Commissioner
that the transfer by the United States beneficiary to the foreign
person was wholly unrelated to any transaction involving the trust. For
purposes of this paragraph (a), the term property includes cash, and a
transfer of property does not include a transfer that is not a
gratuitous transfer (within the meaning of Sec. 1.671-2T(e)(2)). In
addition, a gift is not taken into account to the extent such gift
would not be characterized as a taxable gift under section 2503(b). For
a definition of United States 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 A's 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 A's family move to the
United States. Under paragraph (a)(1) of this section, A is treated
as a grantor of FT. (A may also be treated as an owner of FT under
section 679(a)(4).)
Example 2. B, a United States citizen, makes a gratuitous
transfer of $1 million to B's uncle, C, a nonresident alien. C
creates a foreign trust, FT, for the benefit of B and B's 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 a grantor of FT.
(B also would be treated as an owner of FT as a result of section
679.)
(b) Entity characterization. Entities generally are characterized
under United States tax principles for purposes of Secs. 1.672(f)-1
through 1.672(f)-5. See Secs. 301.7701-1 through 301.7701-4 of this
chapter. However, solely for purposes of Sec. 1.672(f)-4, a transferor
that is a wholly owned business entity is treated as a corporation,
separate from its single owner.
(c) Effective date. The rules in paragraph (a) of this section are
applicable to transfers to trusts on or after August 10, 1999. The
rules in paragraph (b) of this section are applicable August 10, 1999.
John M. Dalrymple,
Acting Deputy Commissioner of Internal Revenue.
Approved: July 23, 1999.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 99-19928 Filed 8-5-99; 2:09 pm]
BILLING CODE 4830-01-P