Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

low-income housing tax credits under § 42(j)(6). Under this program, taxpayers may establish a Treasury Direct Account and pledge certain United States Treasury securities to the Internal Revenue Service as security.

This revenue ruling provides in Table 1 the bond factor amounts for calculating the amount of bond considered satisfactory under § 42(j)(6) or the amount of United States Treasury securities to pledge in a Treasury Direct Account under Rev. Proc. 99–11 for dispositions of qualified low-income buildings or interests therein during the period July through September 2001.

Section 42.—Low-Income Hous- ing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Low-income housing credit; satisfac- tory bond; “bond factor” amounts for the period July through September 2001. This ruling announces the monthly bond factor amounts to be used by taxpayers who dispose of qualified low-income buildings or interests therein during the period July through September 2001.

Rev. Rul. 2001–37

In Rev. Rul. 90–60, 1990–2 C.B. 3, the Internal Revenue Service provided guidance to taxpayers concerning the general methodology used by the Treasury Department in computing the bond factor amounts used in calculating the amount of bond considered satisfactory by the Secretary under § 42(j)(6) of the Internal Revenue Code. It further announced that the Secretary would publish in the Internal Revenue Bulletin a table of “bond factor” amounts for dispositions occurring during each calendar month.

Rev. Proc. 99–11, 1999–1 C.B. 275, established a collateral program as an alternative to providing a surety bond for taxpayers to avoid or defer recapture of the

Table 1
Rev. Rul. 2001–37
Monthly Bond Factor Amounts for Dispositions Expressed
As a Percentage of Total Credits

Table 1 (cont’d)
Rev. Rul. 2001–37
Monthly Bond Factor Amounts for Dispositions Expressed
As a Percentage of Total Credits

August 6, 2001 100 2001–32 I.R.B.

For a list of bond factor amounts applicable to dispositions occurring during other calendar years, see: Rev. Rul. 98–3, 1998–1 C.B. 248, and Rev. Rul. 2001–2, 2001–2 I.R.B. 255. For dispositions occurring during the period January through March 2001, see Rev. Rul. 2001–10, 2001–10 I.R.B. 755. For dispositions during the period April through June 2001, see Rev. Rul. 2001–19, 2001–18 I.R.B. 1143.

DRAFTING INFORMATION

The principal author of this revenue ruling is Gregory N. Doran of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. Doran at (202) 622-3040 (not a toll-free call).

Section 280G.—Golden Para- chute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 382.—Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Fol- lowing Ownership Change

The adjusted applicable federal long-term rate is set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 467.—Certain Payments for the Use of Property or Ser- vices

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 468.—Special Rules for Mining and Solid Waste Recla- mation and Closing Costs

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 482.—Allocation of In- come and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 483.—Interest on Cer- tain Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 679.—Foreign Trusts Having One or More United States Beneficiaries

26 CFR 1.679–2: Trusts treated as having a U. S. beneficiary.

T. D. 8955

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Foreign Trusts That Have U.S. Beneficiaries

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations under section 679 of the Internal Revenue Code relating to transfers of property by U.S. persons to foreign trusts having one or more United States beneficiaries. The final regulations affect United States persons who transfer property to foreign trusts.

DATES: Effective Date : These regulations are effective July 20, 2001.

Applicability Date : For dates of applicability, see §1.679–7.

FOR FURTHER INFORMATION CONTACT: Willard W. Yates at (202) 6223880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On August 7, 2000, the IRS and Treasury published a notice of proposed rulemaking (REG–209038–89, 2000–34 I.R.B. 191) in the Federal Register (65 FR 48185) inviting comments relating to the treatment of U.S. persons who transfer property to foreign trusts that have one or more U.S. beneficiaries. Comments responding to the notice of proposed rulemaking were received and a public hearing was held on November 8, 2000. After consideration of all of the comments, the proposed regulations are adopted as revised by this Treasury decision. The revisions are discussed below.

Explanation of Provisions

Comments Relating to §1.679–2: Trusts Treated as Having a U.S. Beneficiary

A. Benefit to a U.S. Person

Under §1.679–2(a)(1) of the proposed regulations, a foreign trust that has received property from a U.S. transferor is treated as having a U.S. beneficiary unless during the taxable year of the U.S. transferor both of the following tests are satisfied: (i) no part of the income or corpus of the trust may be paid or accumulated to or for the benefit of, either directly or indirectly, a U.S. person; and (ii) if the trust is terminated at any time during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of, either directly or indirectly, a U.S. person.

Section 1.679–2(a)(2)(i) of the proposed regulations provides that, for purposes of applying these tests, income or corpus is considered to be paid or accumulated to or for the benefit of a U.S. person during a taxable year of the U.S. transferor if during that year, directly or indirectly, income may be distributed to, or accumulated for the benefit of a U.S. person, or corpus may be distributed to, or held for the future benefit of, a U.S. person. This determination is made without

2001–32 I.R.B. 101 August 6, 2001

regard to whether income or corpus is actually distributed to a U.S. person during that year, and without regard to whether a U.S. person’s interest in the trust income or corpus is contingent on a future event. The proposed regulations provide a narrow exception with respect to certain contingent beneficiaries whose interests in the trust are so remote as to be negligible.

One commenter suggests that §1.679–2(a)(2) of the proposed regulations (specifically, Example 5 of §1.679– 2(a)(2)(iii)) is overly broad. The commenter suggests that a foreign trust should not be treated as having a U.S. beneficiary where the trust’s only asset consists of stock of a foreign corporation, the trust will terminate one year after the death of a U.S. transferor, whereupon distributions of corpus or income may be made to a U.S. person, and the trust receives no income from the corporation during the term of its existence. The commenter argues that because the foreign trust receives no income from the foreign corporation during the trust’s existence, the U.S. person’s status as a beneficiary provides the U.S. person with nothing of value and, therefore, the foreign trust should not be treated as having a U.S. beneficiary.

The commenter’s argument overlooks the clear legislative intent underlying section 679 that a foreign trust will be treated as having a U.S. beneficiary even in situations where there exists only the possibility of distribution of income or corpus to or the accumulation of corpus for the benefit of a U.S. person. H.R. Rep. No. 658, 94th Cong., 1st Sess., at 210 (1975). The fact that a foreign trust holds an asset, such as the stock of a foreign corporation, that produces no income during the term of the trust’s existence is of no import for purposes of determining whether the trust will be treated as having a U.S. beneficiary. The determining factor in such a situation is that the trust holds corpus for the future benefit of a U.S. person, regardless of whether the corpus consists of stock with respect to which no dividends have been paid or some other asset that produces no current income. Accordingly, the final regulations adopt the rule of the proposed regulations.

B. Records and Documents

Section 1.679–2(a)(4) of the proposed regulations provides that a trust may be treated as having a U.S. beneficiary by

reference, inter alia, to written and oral agreements and understandings not contained in the trust document, and to whether the terms of the trust instrument are actually or reasonably expected to be disregarded by the parties to the trust. A commenter states that this rule creates new and unclear rules for purposes of determining whether an arrangement constitutes a trust for Federal income tax purposes.

The determination as to whether an arrangement will be treated as a trust is made pursuant to the rules set forth in §301.7701–4 of the regulations. The regulations under section 679 address only the determination of whether a foreign trust will be treated as having a U.S. beneficiary. The final regulations are not intended to provide factors in addition to the rules of §301.7701–4 for purposes of determining whether an arrangement constitutes a trust for federal income tax purposes.

C. Trusts Acquiring a U.S. Beneficiary

The proposed regulations anticipate situations where the beneficiary of a foreign trust may change. Section 1.679–2(c)(1) of the proposed regulations provides that if a foreign trust is not treated as having a U.S. beneficiary (within the meaning of §1.679–2(a)) but subsequently is treated as having a U.S. beneficiary, the U.S. transferor is treated as having additional income in the first taxable year of the U.S. transferor in which the trust is treated as having a U.S. beneficiary. The amount of the additional income is equal to the trust’s undistributed net income, as defined in section 665(a), at the end of the U.S. transferor’s immediately preceding taxable year and is subject to the rules of section 668, providing for an interest charge on accumulation distributions from foreign trusts.

A commenter suggests that the rule treating the U.S. transferor as having additional income in the first year the foreign trust acquires the U.S. beneficiary exceeds the authority of section 679, noting that in most cases the transferor will not have received any income from the trust.

Section 1.679–2(c)(1) of the proposed regulations follows closely the legislative history underlying section 679 regarding the U.S. transferor’s recognition of addi

tional income. The legislative history provides that the amount of the additional income shall be the foreign trust’s undistributed net income, i.e., accumulated income that would be taxable to a beneficiary upon distribution, as of the close of the immediately preceding taxable year. H.R. Rep. No. 658, 94th Cong., 1st Sess., at 211, Fn. 13 (1975). In short, the legislative history provides that the U.S. transferor’s additional income shall receive the same treatment as accumulation distributions to beneficiaries of a foreign trust. Accumulated income distributions to beneficiaries of foreign trusts are subject to the interest charge provided for in section 668. Accordingly, the provision for additional income in §1.679–2(c)(1) of the final regulations, as well as the application of the interest charge provided for in section 668, are necessary to carry out the legislative purpose of section 679. The rule of the proposed regulations is adopted by the final regulations without change.

Comments Relating to §1.679–3: Trans- fers

A. Indirect Transfers - Principal Pur- pose of Tax Avoidance

Section 1.679–3(a) of the proposed regulations broadly defines the term transfer as any direct, indirect, or constructive transfer by a U.S. person to a foreign trust. Section 1.679–3(c) of the proposed regulations provides rules for determining when there is an indirect transfer. Under §1.679–3(c)(1) of the proposed regulations, a transfer to a foreign trust by any person to whom a U.S. person transfers property (referred to as an intermediary) is treated as an indirect transfer by a U.S. person if the transfer is made pursuant to a plan one of the principal purposes of which is the avoidance of U.S. tax. Section 1.679–3(c)(2) of the proposed regulations deems a transfer to have been made pursuant to such a plan if certain conditions are present.

The deemed-principal-purpose test of §1.679–3(c)(2) of the proposed regulations is similar to the deemed-principalpurpose test in §1.643(h)–1(a) of the regulations, which concerns distributions from foreign trusts to U.S. persons through intermediaries, except that the presumption in the proposed regulations applies without regard to the period of time between

August 6, 2001 102 2001–32 I.R.B.

the transfer from the U.S. person to the intermediary and from the intermediary to the foreign trust. In contrast, the deemedprincipal-purpose test of §1.643(h)– 1(a)(2)(ii) applies only if property is distributed to the U.S. person during the period beginning 24 months before and ending 24 months after the intermediary’s receipt of property from the foreign trust. A commenter suggests that a similar time limit should be provided in §1.679–3(c)(2) with respect to outbound transfers.

In the context of section 643(h), Treasury and the IRS weighed the potential for abuse in that area against the possible adverse effect that the deemed-principal-purpose test could have on legitimate transactions, and concluded that a time limitation in §1.643(h)–1(a)(2) was appropriate. However, Treasury and the IRS believe the potential for abuse is greater in the case of outbound transfers to foreign trusts than in the case of inbound trust distributions to U.S. beneficiaries. Congress enacted section 679 in order to prevent the tax-free accumulation of income earned by foreign trusts over long periods of time that provided foreign trusts with an unwarranted advantage over domestic trusts. H.R. Rep. No. 658, 94th Cong., 1st Sess., at 207 (1975). Providing for a time limitation to the application of §1.679–3(c) could allow for easy circumvention of Congress’ purpose in enacting section 679. Treasury and the IRS recognize that some transfers that were not intended to avoid U.S. tax may come within the presumption in the absence of a specific time limit. However, under such circumstances §1.679–3(c)(2)(ii) provides taxpayers with a way to rebut the application of the deemed-principal-purpose test. Therefore, the final regulations do not include a time limitation to the application of §1.679–3(c)(2)(i).

B. Indirect Transfers - Corporate Distri- butions

One commenter asked about the application of the indirect transfer rules set forth in §1.679–3(c) of the proposed regulations to successive corporate distributions up a chain of wholly-owned corporations to an ultimate shareholder that is a foreign trust. The commenter expressed concern that, if one of the lower-tier corporations were a domestic corporation, §1.679–3(c) of the proposed regulations

could potentially treat the distributions as an indirect transfer from the domestic corporation to the foreign trust that would be subject to the general rule of §1.679–1.

Even if the distributions were characterized as an indirect transfer from a domestic corporation to a foreign trust under §1.679–3(c), the indirect transfer would generally be treated as a transfer for fair market value under the final sentence of §1.679–4(b)(1) and would therefore be excepted from the general rule of §1.679–1 pursuant to §1.679–4(a)(4). Therefore, no special rules have been added to the final regulations to address this situation.

C. Transfers to Entities Owned by For- eign Trusts

Section 1.679–3(f) of the proposed regulations provides specific rules regarding transfers by a U.S. person to an entity owned by a foreign trust if the U.S. person is related to the foreign trust. The transfer is treated as a transfer from the U.S. person to the foreign trust, followed by a transfer from the foreign trust to the entity owned by the foreign trust, unless the U.S. person demonstrates to the satisfaction of the Commissioner that the transfer to the entity is properly attributable to the U.S. person’s ownership interest in the entity. A commenter noted potential conflicts with this rule and judicial doctrines concerning constructive corporate distributions.

Section 1.679–3(f) is not intended to override judicial doctrines concerning constructive corporate distributions. For example, if judicial doctrines would recharacterize a direct transfer of property by a domestic corporation to an entity owned by a foreign trust as a constructive dividend of the property to the domestic corporation’s shareholder followed by a constructive transfer of the property by that shareholder to the foreign trust and a constructive contribution by the foreign trust to the entity owned by the foreign trust, then those judicial doctrines would apply (and §1.679–3(f) would not apply) to the transaction.

Comments Relating to §1.679–4: Excep- tions to General Rule - Transfers to Trusts Described in Section 501(c)(3)

Section 1.679–4(a)(3) of the proposed regulations provides an exception to the

general rule of §1.679–1 for transfers to a foreign trust that has already received a ruling or determination letter from the IRS recognizing the trust’s tax exempt status under section 501(c)(3), provided that the letter has been neither revoked nor modified. Commenters questioned the requirement that a foreign trust obtain a ruling or determination letter from the IRS recognizing the trust’s tax exempt status under section 501(c)(3). They assert that the requirement may interfere with a U.S. person’s ability to make contributions to a foreign charitable entity that may not be familiar with U.S. tax laws and may not have any reason to obtain a determination letter from the IRS. They suggest that the final regulations require only that the U.S. transferor disclose to the IRS, at such time and in such manner as the IRS may provide, that the transfer has been made and that the transferor believes the transferee is an organization described in section 501(c)(3). In response to commenters’ concerns, the final regulations eliminate the requirement that the foreign trust receive a ruling or determination letter from the IRS recognizing the trust’s tax-exempt status under section 501(c)(3). The final regulations provide instead that the general rule of §1.679–1 does not apply to any transfer of property to a foreign trust that is described in section 501(c)(3). However, taxpayers should be aware that, under Notice 97–34 (1997–1 C.B. 422), the U.S. transferor has a reporting obligation on Form 3520 with respect to such a transfer, unless the foreign trust has received a ruling or determination letter from the IRS recognizing the trust’s tax exempt status under section 501(c)(3). Moreover, if the IRS subsequently determines that the foreign trust is not described in section 501(c)(3), the exception will not apply for any taxable year of the U.S. transferor, and the U.S. transferor may be subject to interest and penalties, if applicable.

Clarification Regarding Section 958

The final regulations clarify the language of §1.958–1(b) of the proposed regulations with respect to persons who are treated as owners under sections 671 through 679 of any portion of a foreign trust that includes the stock of a foreign corporation.

2001–32 I.R.B. 103 August 6, 2001

(1) In general. (2) Example. (c) Indirect transfers. (1) Principal purpose of tax avoidance. (2) Principal purpose of tax avoidance

deemed to exist. (3) Effect of disregarding intermediary. (i) In general. (ii) Special rule. (iii) Effect on intermediary. (4) Related parties. (5) Examples. (d) Constructive transfers. (1) In general. (2) Examples. (e) Guarantee of trust obligations. (1) In general. (2) Amount transferred. (3) Principal repayments. (4) Guarantee. (5) Examples. (f) Transfers to entities owned by a for eign trust. (1) General rule. (2) Examples.

§1.679–4 Exceptions to general rule.

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. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Drafting Information

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

• ---

Adoption of Amendments to the Regu- lations

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 1.679–1 also issued under 26 U.S.C. 643(a)(7) and 679(d).

Section 1.679–2 also issued under 26 U.S.C. 643(a)(7) and 679(d).

Section 1.679–3 also issued under 26 U.S.C. 643(a)(7) and 679(d).

Section 1.679–4 also issued under 26 U.S.C. 643(a)(7), 679(a)(3) and 679(d).

Section 1.679–5 also issued under 26 U.S.C. 643(a)(7) and 679(d).

Section 1.679–6 also issued under 26 U.S.C. 643(a)(7) and 679(d). * * *

Par. 2. Sections 1.679–0, 1.679–1, 1.679–2, 1.679–3, 1.679–4, 1.679–5, 1.679–6, and 1.679–7 are added under the undesignated center heading “Grantors and Others Treated as Substantial Owners” to read as follows:

§1.679–0 Outline of major topics.

This section lists the major paragraphs contained in §§1.679–1 through 1.679–7 as follows:

§1.679–1 U.S. transferor treated as owner of foreign trust.

(a) In general. (b) Interaction with sections 673 through

(c) Definitions. (1) U.S. transferor. (2) U.S. person. (3) Foreign trust. (4) Property. (5) Related person. (6) Obligation. (d) Examples.

§1.679–2 Trusts treated as having a U.S. beneficiary.

(a) Existence of U.S. beneficiary. (1) In general. (2) Benefit to a U.S. person. (i) In general. (ii) Certain unexpected beneficiaries. (iii) Examples. (3) Changes in beneficiary’s status. (i) In general. (ii) Examples. (4) General rules. (i) Records and documents. (ii) Additional factors. (iii) Examples. (b) Indirect U.S. beneficiaries. (1) Certain foreign entities. (2) Other indirect beneficiaries. (3) Examples. (c) Treatment of U.S. transferor upon for eign trust’s acquisition or loss of U.S. beneficiary. (1) Trusts acquiring a U.S. beneficiary. (2) Trusts ceasing to have a U.S. benefi ciary. (3) Examples.

§1.679–3 Transfers.

(a) In general. (b) Transfers by certain trusts.

(a) In general. (b) Transfers for fair market value. (1) In general. (2) Special rule. (i) Transfers for partial consideration. (ii) Example. (c) Certain obligations not taken into ac count. (d) Qualified obligations. (1) In general. (2) Additional loans. (3) Obligations that cease to be qualified. (4) Transfers resulting from failed quali fied obligations. (5) Renegotiated loans. (6) Principal repayments. (7) Examples.

§1.679–5 Pre-immigration trusts.

(a) In general. (b) Special rules. (1) Change in grantor trust status. (2) Treatment of undistributed income. (c) Examples.

§1.679–6 Outbound migrations of do- mestic trusts.

(a) In general. (b) Amount deemed transferred.

August 6, 2001 104 2001–32 I.R.B.

(c) Example.

§1.679–7 Effective dates.

(a) In general. (b) Special rules.

§1.679–1 U.S. transferor treated as owner of foreign trust.

(a) In general . A U.S. transferor who transfers property to a foreign trust is treated as the owner of the portion of the trust attributable to the property transferred if there is a U.S. beneficiary of any portion of the trust, unless an exception in §1.679–4 applies to the transfer.

(b) Interaction with sections 673 through 678 . The rules of this section apply without regard to whether the U.S. transferor retains any power or interest described in sections 673 through 677. If a U.S. transferor would be treated as the owner of a portion of a foreign trust pursuant to the rules of this section and another person would be treated as the owner of the same portion of the trust pursuant to section 678, then the U.S. transferor is treated as the owner and the other person is not treated as the owner.

(c) Definitions . The following definitions apply for purposes of this section and §§1.679–2 through 1.679–7:

(1) U.S. transferor . The term U.S. transferor means any U.S. person who makes a transfer (as defined in §1.679–3) of property to a foreign trust.

(2) U.S. person . The term U.S. person means a United States person as defined in section 7701(a)(30), a nonresident alien individual who elects under section 6013(g) to be treated as resident of the United States, and an individual who is a dual resident taxpayer within the meaning of §301.7701(b)–7(a) of this chapter.

(3) Foreign trust . Section 7701(a) (31)(B) defines the term foreign trust . See also §301.7701–7 of this chapter.

(4) Property . The term property means any property including cash.

(5) Related person . A person is a re- lated person if, without regard to the transfer at issue, the person is—

(i) A grantor of any portion of the trust (within the meaning of §1.671–2(e)(1));

(ii) An owner of any portion of the trust under sections 671 through 679;

(iii) A beneficiary of the trust; or (iv) A person who is related (within the meaning of section 643(i)(2)(B)) to any

grantor, owner or beneficiary of the trust.

(6) Obligation . The term obligation means any bond, note, debenture, certificate, bill receivable, account receivable, note receivable, open account, or other evidence of indebtedness, and, to the extent not previously described, any annuity contract.

(d) Examples . The following examples illustrate the rules of paragraph (a) of this section. In these examples, A is a resident alien, B is A ’s son, who is a resident alien, C is A ’s father, who is a resident alien, D is A ’s uncle, who is a nonresident alien, and FT is a foreign trust. The examples are as follows:

Example 1 . Interaction with section 678 . A creates and funds FT . FT may provide for the education of B by paying for books, tuition, room and board. In addition, C has the power to vest the trust corpus or income in himself within the meaning of section 678(a)(1). Under paragraph (b) of this section, A is treated as the owner of the portion of FT attributable to the property transferred to FT by A and C is not treated as the owner thereof.

Example 2. U.S. person treated as owner of a portion of FT . D creates and funds FT for the benefit of B . D retains a power described in section 676 and §1.672(f)–3(a)(1). A transfers property to FT . Under sections 676 and 672(f), D is treated as the owner of the portion of FT attributable to the property transferred by D . Under paragraph (a) of this section, A is treated as the owner of the portion of FT attributable to the property transferred by A .

§1.679–2 Trusts treated as having a U.S. beneficiary.

(a) Existence of U.S. beneficiary —(1) In general . The determination of whether a foreign trust has a U.S. beneficiary is made on an annual basis. A foreign trust is treated as having a U.S. beneficiary unless during the taxable year of the U.S. transferor—

(i) No part of the income or corpus of the trust may be paid or accumulated to or for the benefit of, directly or indirectly, a U.S. person; and

(ii) If the trust is terminated at any time during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of, directly or indirectly, a U.S. person.

(2) Benefit to a U.S. person —(i) In general . For purposes of paragraph (a)(1) of this section, income or corpus may be paid or accumulated to or for the benefit of a U.S. person during a taxable year of the U.S. transferor if during that year, directly or indirectly, income may be distributed to, or accumulated for the benefit

of, a U.S. person, or corpus may be distributed to, or held for the future benefit of, a U.S. person. This determination is made without regard to whether income or corpus is actually distributed to a U.S. person during that year, and without regard to whether a U.S. person’s interest in the trust income or corpus is contingent on a future event.

(ii) Certain unexpected beneficiaries . Notwithstanding paragraph (a)(2)(i) of this section, for purposes of paragraph (a)(1) of this section, a person who is not named as a beneficiary and is not a member of a class of beneficiaries as defined under the trust instrument is not taken into consideration if the U.S. transferor demonstrates to the satisfaction of the Commissioner that the person’s contingent interest in the trust is so remote as to be negligible. The preceding sentence does not apply with respect to persons to whom distributions could be made pursuant to a grant of discretion to the trustee or any other person. A class of beneficiaries generally does not include heirs who will benefit from the trust under the laws of intestate succession in the event that the named beneficiaries (or members of the named class) have all deceased (whether or not stated as a named class in the trust instrument).

(iii) Examples . The following examples illustrate the rules of paragraphs (a)(1) and (2) of this section. In these examples, A is a resident alien, B is A ’s son, who is a resident alien, C is A ’s daughter, who is a nonresident alien, and FT is a foreign trust. The examples are as follows:

Example 1. Distribution of income to U.S. per- son . A transfers property to FT . The trust instrument provides that all trust income is to be distributed currently to B . Under paragraph (a)(1) of this section, FT is treated as having a U.S. beneficiary.

Example 2. Income accumulation for the benefit of a U.S. person . In 2001, A transfers property to FT . The trust instrument provides that from 2001 through 2010, the trustee of FT may distribute trust income to C or may accumulate the trust income. The trust instrument further provides that in 2011, the trust will terminate and the trustee may distribute the trust assets to either or both of B and C, in the trustee’s discretion. If the trust terminates unexpectedly prior to 2011, all trust assets must be distributed to C . Because it is possible that income may be accumulated in each year, and that the accumulated income ultimately may be distributed to B, a U.S. person, under paragraph (a)(1) of this section FT is treated as having a U.S. beneficiary during each of A ’s tax years from 2001 through 2011. This result applies even though no U.S. person may receive dis

2001–32 I.R.B. 105 August 6, 2001

trust may be paid or accumulated to or for the benefit of, either directly or indirectly, a U.S. person, and if the trust is terminated, no part of the income or corpus of the trust could be paid to or for the benefit of, either directly or indirectly, a U.S. person, FT is not treated as having a U.S. beneficiary.

Example 13. U.S. beneficiary becomes non-U.S. person . In 2001, A transfers property to FT . The trust instrument provides that, as long as B remains a U.S. resident, no distributions of income or corpus may be made from the trust to B . The trust instrument further provides that if B becomes a nonresident alien, distributions of income (including previously accumulated income) and corpus may be made to him. If B remains a U.S. resident at the time of FT ’s termination, all accumulated income and corpus is to be distributed to C . In 2007, B becomes a nonresident alien and remains so thereafter. Because income may be accumulated during the years 2001 through 2007 for the benefit of a person who is a U.S. person during those years, FT is treated as having a U.S. beneficiary under paragraph (a)(1) of this section during each of those years. This result applies even though B cannot receive distributions from FT during the years he is a resident alien and even though B might remain a resident alien who is not entitled to any distribution from FT . Provided that paragraph (a)(4) of this section does not require a different result and that A establishes to the satisfaction of the Commissioner under paragraph (a)(2)(ii) of this section that no other U.S. persons are reasonably expected to benefit from the trust, FT is not treated as having a U.S. beneficiary under paragraph (a)(1) of this section during tax years after 2007. (3) Changes in beneficiary’s status —(i) In general . For purposes of paragraph (a)(1) of this section, the possibility that a person that is not a U.S. person could become a U.S. person will not cause that person to be treated as a U.S. person for purposes of paragraph (a)(1) of this section until the tax year of the U.S. transferor in which that individual actually becomes a U.S. person. However, if a person who is not a U.S. person becomes a U.S. person for the first time more than 5 years after the date of a transfer to the foreign trust by a U.S. transferor, that person is not treated as a U.S. person for purposes of applying paragraph (a)(1) of this section with respect to that transfer.

(ii) Examples . The following examples illustrate the rules of paragraph (a)(3) of this section. In these examples, A is a resident alien, B is A ’s son, who is a resident alien, C is A ’s daughter, who is a nonresident alien, and FT is a foreign trust. The examples are as follows:

Example 1 . Non-U.S. beneficiary becomes U.S. person . In 2001, A transfers property to FT . The trust instrument provides that all income is to be distributed currently to C and that, upon the termination of FT, all corpus is to be distributed to C . Assume that paragraph (a)(4) of this section is not applicable

tributions from the trust during the tax years 2001 through 2010.

Example 3. Corpus held for the benefit of a U.S. person . The facts are the same as in Example 2, except that from 2001 through 2011, all trust income must be distributed to C . In 2011, the trust will terminate and the trustee may distribute the trust corpus to either or both of B and C, in the trustee’s discretion. If the trust terminates unexpectedly prior to 2011, all trust corpus must be distributed to C . Because during each of A ’s tax years from 2001 through 2011 trust corpus is held for possible future distribution to B, a U.S. person, under paragraph (a)(1) of this section FT is treated as having a U.S. beneficiary during each of those years. This result applies even though no U.S. person may receive distributions from the trust during the tax years 2001 through 2010.

Example 4. Distribution upon U.S. transferor’s death . A transfers property to FT . The trust instrument provides that all trust income must be distributed currently to C and, upon A ’s death, the trust will terminate and the trustee may distribute the trust corpus to either or both of B and C . Because B may receive a distribution of corpus upon the termination of FT, and FT could terminate in any year, FT is treated as having a U.S. beneficiary in the year of the transfer and in subsequent years.

Example 5. Distribution after U.S. transferor’s death . The facts are the same as in Example 4, except the trust instrument provides that the trust will not terminate until the year following A ’s death. Upon termination, the trustee may distribute the trust assets to either or both of B and C, in the trustee’s discretion. All trust assets are invested in the stock of X, a foreign corporation, and X makes no distributions to FT . Although no U.S. person may receive a distribution until the year after A ’s death, and FT has no realized income during any year of its existence, during each year in which A is living corpus may be held for future distribution to B, a U.S. person. Thus, under paragraph (a)(1) of this section FT is treated as having a U.S. beneficiary during each of A ’s tax years from 2001 through the year of A ’s death.

Example 6. Constructive benefit to U.S. person . A transfers property to FT . The trust instrument provides that no income or corpus may be paid directly to a U.S. person. However, the trust instrument provides that trust corpus may be used to satisfy B ’s legal obligations to a third party by making a payment directly to the third party. Under paragraphs (a)(1) and (2) of this section, FT is treated as having a U.S. beneficiary.

Example 7. U.S. person with negligible contin- gent interest . A transfers property to FT . The trust instrument provides that all income is to be distributed currently to C, and upon C ’s death, all corpus is to be distributed to whomever of C ’s three children is then living. All of C ’s children are nonresident aliens. Under the laws of intestate succession that would apply to FT, if all of C ’s children are deceased at the time of C ’s death, the corpus would be distributed to A ’s heirs. A ’s living relatives at the time of the transfer consist solely of two brothers and two nieces, all of whom are nonresident aliens, and two first cousins, one of whom, E, is a U.S. citizen. Although it is possible under certain circumstances that E could receive a corpus distribution under the applicable laws of intestate succession, for

each year the trust is in existence A is able to demonstrate to the satisfaction of the Commissioner under paragraph (a)(2)(ii) of this section that E ’s contingent interest in FT is so remote as to be negligible. Provided that paragraph (a)(4) of this section does not require a different result, FT is not treated as having a U.S. beneficiary.

Example 8. U.S. person with non-negligible con- tingent interest . A transfers property to FT . The trust instrument provides that all income is to be distributed currently to D, A ’s uncle, who is a nonresident alien, and upon A ’s death, the corpus is to be distributed to D if he is then living. Under the laws of intestate succession that would apply to FT, B and C would share equally in the trust corpus if D is not living at the time of A ’s death. A is unable to demonstrate to the satisfaction of the Commissioner that B ’s contingent interest in the trust is so remote as to be negligible. Under paragraph (a)(2)(ii) of this section, FT is treated as having a U.S. beneficiary as of the year of the transfer.

Example 9. U.S. person as member of class of beneficiaries . A transfers property to FT . The trust instrument provides that all income is to be distributed currently to D, A ’s uncle, who is a nonresident alien, and upon A ’s death, the corpus is to be distributed to D if he is then living. If D is not then living, the corpus is to be distributed to D ’s descendants. D ’s grandson, E, is a resident alien. Under paragraph (a)(2)(ii) of this section, FT is treated as having a U.S. beneficiary as of the year of the transfer.

Example 10. Trustee’s discretion in choosing beneficiaries . A transfers property to FT . The trust instrument provides that the trustee may distribute income and corpus to, or accumulate income for the benefit of, any person who is pursuing the academic study of ancient Greek, in the trustee’s discretion. Because it is possible that a U.S. person will receive distributions of income or corpus, or will have income accumulated for his benefit, FT is treated as having a U.S. beneficiary. This result applies even if, during a tax year, no distributions or accumulations are actually made to or for the benefit of a U.S. person. A may not invoke paragraph (a)(2)(ii) of this section because a U.S. person could benefit pursuant to a grant of discretion in the trust instrument.

Example 11. Appointment of remainder benefi- ciary . A transfers property to FT . The trust instrument provides that the trustee may distribute current income to C, or may accumulate income, and, upon termination of the trust, trust assets are to be distributed to C . However, the trust instrument further provides that D, A ’s uncle, may appoint a different remainder beneficiary. Because it is possible that a U.S. person could be named as the remainder beneficiary, and because corpus could be held in each year for the future benefit of that U.S. person, FT is treated as having a U.S. beneficiary for each year.

Example 12. Trust not treated as having a U.S. beneficiary . A transfers property to FT . The trust instrument provides that the trustee may distribute income and corpus to, or accumulate income for the benefit of C . Upon termination of the trust, all income and corpus must be distributed to C . Assume that paragraph (a)(4) of this section is not applicable under the facts and circumstances and that A establishes to the satisfaction of the Commissioner under paragraph (a)(2)(ii) of this section that no U.S. persons are reasonably expected to benefit from the trust. Because no part of the income or corpus of the

August 6, 2001 106 2001–32 I.R.B.

(2) Other indirect beneficiaries . For purposes of paragraph (a)(1) of this section, an amount is treated as paid or accumulated to or for the benefit of a U.S. person if the amount is paid to or accumulated for the benefit of a U.S. person through an intermediary, such as an agent or nominee, or by any other means where a U.S. person may obtain an actual or constructive benefit.

(3) Examples . The following examples illustrate the rules of this paragraph (b). Unless otherwise noted, A is a resident alien. B is A ’s son and is a resident alien. FT is a foreign trust. The examples are as follows:

Example 1. Trust benefitting foreign corporation . A transfers property to FT . The beneficiary of FT is FC, a foreign corporation. FC has outstanding solely 100 shares of common stock. B owns 49 shares of the FC stock and FC2, also a foreign corporation, owns the remaining 51 shares. FC2 has outstanding solely 100 shares of common stock. B owns 49 shares of FC2 and nonresident alien individuals own the remaining 51 FC2 shares. FC is a controlled foreign corporation (as defined in section 957(a), after the application of section 958(a)(2)). Under paragraphs (a)(1) and (b)(1)(i) of this section, FT is treated as having a U.S. beneficiary.

Example 2. Trust benefitting another trust . A transfers property to FT . The terms of FT permit current distributions of income to B . A transfers property to another foreign trust, FT2 . The terms of FT2 provide that no U.S. person can benefit either as to income or corpus, but permit current distributions of income to FT . Under paragraph (a)(1) of this section, FT is treated as having a U.S. beneficiary and, under paragraphs (a)(1) and (b)(1)(iii) of this section, FT2 is treated as having a U.S. beneficiary.

Example 3. Trust benefitting another trust after transferor’s death . A transfers property to FT . The terms of FT require that all income from FT be accumulated during A ’s lifetime. In the year following A ’s death, a share of FT is to be distributed to FT2, another foreign trust, for the benefit of B . Under paragraphs (a)(1) and (b)(1)(iii) of this section, FT is treated as having a U.S. beneficiary beginning with the year of A ’s transfer of property to FT .

Example 4. Indirect benefit through use of debit card . A transfers property to FT . The trust instrument provides that no U.S. person can benefit either as to income or corpus. However, FT maintains an account with FB, a foreign bank, and FB issues a debit card to B against the account maintained by FT and B is allowed to make withdrawals. Under paragraphs (a)(1) and (b)(2) of this section, FT is treated as having a U.S. beneficiary.

Example 5. Other indirect benefit . A transfers property to FT . FT is administered by FTC, a foreign trust company. FTC forms IBC, an international business corporation formed under the laws of a foreign jurisdiction. IBC is the beneficiary of FT . IBC maintains an account with FB, a foreign bank. FB issues a debit card to B against the account maintained by IBC and B is allowed to make with

under the facts and circumstances and that A establishes to the satisfaction of the Commissioner under paragraph (a)(2)(ii) of this section that no U.S. persons are reasonably expected to benefit from the trust. Under paragraph (a)(3)(i) of this section, FT is not treated as having a U.S. beneficiary during the tax years of A in which C remains a nonresident alien. If C first becomes a resident alien in 2004, FT is treated as having a U.S. beneficiary commencing in that year under paragraph (a)(3) of this section. See paragraph (c) of this section regarding the treatment of A upon FT ’s acquisition of a U.S. beneficiary.

Example 2. Non-U.S. beneficiary becomes U.S. person more than 5 years after transfer . The facts are the same as in Example 1, except C first becomes a resident alien in 2007. FT is treated as not having a U.S. beneficiary under paragraph (a)(3)(i) of this section with respect to the property transfer by A . However, if C had previously been a U.S. person during any prior period, the 5-year exception in paragraph (a)(3)(i) of this section would not apply in 2007 because it would not have been the first time C became a U.S. person.

(4) General rules —(i) Records and documents . Even if, based on the terms of the trust instrument, a foreign trust is not treated as having a U.S. beneficiary within the meaning of paragraph (a)(1) of this section, the trust may nevertheless be treated as having a U.S. beneficiary pursuant to paragraph (a)(1) of this section based on the following—

(A) All written and oral agreements and understandings relating to the trust;

(B) Memoranda or letters of wishes; (C) All records that relate to the actual distribution of income and corpus; and

(D) All other documents that relate to the trust, whether or not of any purported legal effect.

(ii) Additional factors . For purposes of determining whether a foreign trust is treated as having a U.S. beneficiary within the meaning of paragraph (a)(1) of this section, the following additional factors are taken into account—

(A) If the terms of the trust instrument allow the trust to be amended to benefit a U.S. person, all potential benefits that could be provided to a U.S. person pursuant to an amendment must be taken into account;

(B) If the terms of the trust instrument do not allow the trust to be amended to benefit a U.S. person, but the law applicable to a foreign trust may require payments or accumulations of income or corpus to or for the benefit of a U.S. person (by judicial reformation or otherwise), all potential benefits that could be provided to a U.S. person pursuant to the law must

be taken into account, unless the U.S. transferor demonstrates to the satisfaction of the Commissioner that the law is not reasonably expected to be applied or invoked under the facts and circumstances; and

(C) If the parties to the trust ignore the terms of the trust instrument, or if it is reasonably expected that they will do so, all benefits that have been, or are reasonably expected to be, provided to a U.S. person must be taken into account.

(iii) Examples . The following examples illustrate the rules of paragraph (a)(4) of this section. In these examples, A is a resident alien, B is A ’s son, who is a resident alien, C is A ’s daughter, who is a nonresident alien, and FT is a foreign trust. The examples are as follows:

Example 1. Amendment pursuant to local law . A creates and funds FT for the benefit of C . The terms of FT (which, according to the trust instrument, cannot be amended) provide that no part of the income or corpus of FT may be paid or accumulated during the taxable year to or for the benefit of any U.S. person, either during the existence of FT or at the time of its termination. However, pursuant to the applicable foreign law, FT can be amended to provide for additional beneficiaries, and there is an oral understanding between A and the trustee that B can be added as a beneficiary. Under paragraphs (a)(1) and (a)(4)(ii)(B) of this section, FT is treated as having a U.S. beneficiary.

Example 2. Actions in violation of the terms of the trust . A transfers property to FT . The trust instrument provides that no U.S. person can receive income or corpus from FT during the term of the trust or at the termination of FT . Notwithstanding the terms of the trust instrument, a letter of wishes directs the trustee of FT to provide for the educational needs of B, who is about to begin college. The letter of wishes contains a disclaimer to the effect that its contents are only suggestions and recommendations and that the trustee is at all times bound by the terms of the trust as set forth in the trust instrument. Under paragraphs (a)(1) and (a)(4)(ii)(C) of this section, FT is treated as having a U.S. beneficiary.

(b) Indirect U.S. beneficiaries —(1) Certain foreign entities . For purposes of paragraph (a)(1) of this section, an amount is treated as paid or accumulated to or for the benefit of a U.S. person if the amount is paid to or accumulated for the benefit of—

(i) A controlled foreign corporation, as defined in section 957(a);

(ii) A foreign partnership, if a U.S. person is a partner of such partnership; or

(iii) A foreign trust or estate, if such trust or estate has a U.S. beneficiary (within the meaning of paragraph (a)(1) of this section).

2001–32 I.R.B. 107 August 6, 2001

is made pursuant to a plan one of the principal purposes of which is the avoidance of United States tax.

(2) Principal purpose of tax avoidance deemed to exist . For purposes of paragraph (c)(1) of this section, a transfer is deemed to have been made pursuant to a plan one of the principal purposes of which was the avoidance of United States tax if—

(i) The U.S. person is related (within the meaning of paragraph (c)(4) of this section) to a beneficiary of the foreign trust, or has another relationship with a beneficiary of the foreign trust that establishes a reasonable basis for concluding that the U.S. transferor would make a transfer to the foreign trust; and

(ii) The U.S. person cannot demonstrate to the satisfaction of the Commissioner that—

(A) The intermediary has a relationship with a beneficiary of the foreign trust that establishes a reasonable basis for concluding that the intermediary would make a transfer to the foreign trust;

(B) The intermediary acted independently of the U.S. person;

(C) The intermediary is not an agent of the U.S. person under generally applicable United States agency principles; and

(D) The intermediary timely complied with the reporting requirements of section 6048, if applicable. (3) Effect of disregarding intermedi- ary —(i) In general . Except as provided in paragraph (c)(3)(ii) of this section, if a transfer is treated as an indirect transfer pursuant to paragraph (c)(1) of this section, then the intermediary is treated as an agent of the U.S. person, and the property is treated as transferred to the foreign trust by the U.S. person in the year the property is transferred, or made available, by the intermediary to the foreign trust. The fair market value of the property transferred is determined as of the date of the transfer by the intermediary to the foreign trust.

(ii) Special rule . If the Commissioner determines, or if the taxpayer can demonstrate to the satisfaction of the Commissioner, that the intermediary is an agent of the foreign trust under generally applicable United States agency principles, the property will be treated as transferred to the foreign trust in the year the U.S. person transfers the property to the interme

drawals. Under paragraphs (a)(1) and (b)(2) of this section, FT is treated as having a U.S. beneficiary.

(c) Treatment of U.S. transferor upon foreign trust’s acquisition or loss of U.S. beneficiary—(1) Trusts acquiring a U.S. beneficiary . If a foreign trust to which a U.S. transferor has transferred property is not treated as having a U.S. beneficiary (within the meaning of paragraph (a) of this section) for any taxable year of the U.S. transferor, but the trust is treated as having a U.S. beneficiary (within the meaning of paragraph (a) of this section) in any subsequent taxable year, the U.S. transferor is treated as having additional income in the first such taxable year of the U.S. transferor in which the trust is treated as having a U.S. beneficiary. The amount of the additional income is equal to the trust’s undistributed net income, as defined in section 665(a), at the end of the U.S. transferor’s immediately preceding taxable year and is subject to the rules of section 668, providing for an interest charge on accumulation distributions from foreign trusts.

(2) Trusts ceasing to have a U.S. benefi- ciary . If, for any taxable year of a U.S. transferor, a foreign trust that has received a transfer of property from the U.S. transferor ceases to be treated as having a U.S. beneficiary, the U.S. transferor ceases to be treated as the owner of the portion of the trust attributable to the transfer beginning in the first taxable year following the last taxable year of the U.S. transferor during which the trust was treated as having a U.S. beneficiary (unless the U.S. transferor is treated as an owner thereof pursuant to sections 673 through 677). The U.S. transferor is treated as making a transfer of property to the foreign trust on the first day of the first taxable year following the last taxable year of the U.S. transferor during which the trust was treated as having a U.S. beneficiary. The amount of the property deemed to be transferred to the trust is the portion of the trust attributable to the prior transfer to which paragraph (a)(1) of this section applied. For rules regarding the recognition of gain on transfers to foreign trusts, see section 684.

(3) Examples . The rules of this paragraph (c) are illustrated by the following examples. A is a resident alien, B is A ’s son, and FT is a foreign trust. The examples are as follows:

Example 1. Trust acquiring U.S. beneficiary . (i) In 2001, A transfers stock with a fair market value of

$100,000 to FT . The stock has an adjusted basis of $50,000 at the time of the transfer. The trust instrument provides that income may be paid currently to, or accumulated for the benefit of, B and that, upon the termination of the trust, all income and corpus is to be distributed to B . At the time of the transfer, B is a nonresident alien. A is not treated as the owner of any portion of FT under sections 673 through 677. FT accumulates a total of $30,000 of income during the taxable years 2001 through 2003. In 2004, B moves to the United States and becomes a resident alien. Assume paragraph (a)(4) of this section is not applicable under the facts and circumstances.

(ii) Under paragraph (c)(1) of this section, A is treated as receiving an accumulation distribution in the amount of $30,000 in 2004 and immediately transferring that amount back to the trust. The accumulation distribution is subject to the rules of section 668, providing for an interest charge on accumulation distributions.

(iii) Under paragraphs (a)(1) and (3) of this section, beginning in 2005, A is treated as the owner of the portion of FT attributable to the stock transferred by A to FT in 2001 (which includes the portion attributable to the accumulated income deemed to be retransferred in 2004).

Example 2. Trust ceasing to have U.S. benefi- ciary . (i) The facts are the same as in Example 1 . In 2008, B becomes a nonresident alien. On the date B becomes a nonresident alien, the stock transferred by A to FT in 2001 has a fair market value of $125,000 and an adjusted basis of $50,000.

(ii) Under paragraph (c)(2) of this section, beginning in 2009, FT is not treated as having a U.S. beneficiary, and A is not treated as the owner of the portion of the trust attributable to the prior transfer of stock. For rules regarding the recognition of gain on the termination of ownership status, see section 684.

§1.679–3 Transfers.

(a) In general . A transfer means a direct, indirect, or constructive transfer.

(b) Transfers by certain trusts —(1) In general . If any portion of a trust is treated as owned by a U.S. person, a transfer of property from that portion of the trust to a foreign trust is treated as a transfer from the owner of that portion to the foreign trust.

(2) Example . The following example illustrates this paragraph (b):

Example . In 2001, A, a U.S. citizen, creates and funds DT, a domestic trust. A has the power to revest absolutely in himself the title to the property in DT and is treated as the owner of DT pursuant to section 676. In 2004, DT transfers property to FT, a foreign trust. A is treated as having transferred the property to FT in 2004 for purposes of this section.

(c) Indirect transfers —(1) Principal purpose of tax avoidance . A transfer to a foreign trust by any person (intermediary) to whom a U.S. person transfers property is treated as an indirect transfer by a U.S. person to the foreign trust if such transfer

August 6, 2001 108 2001–32 I.R.B.

diary. The fair market value of the property transferred will be determined as of the date of the transfer by the U.S. person to the intermediary.

(iii) Effect on intermediary . If a transfer of property is treated as an indirect transfer under paragraph (c)(1) of this section, the intermediary is not treated as having transferred the property to the foreign trust.

(4) Related parties . For purposes of this paragraph (c), a U.S. transferor is treated as related to a U.S. beneficiary of a foreign trust if the U.S. transferor and the beneficiary are related for purposes of section 643(i)(2)(B), with the following modifications—

(i) 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

(ii) 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.

(5) Examples . The rules of this paragraph (c) are illustrated by the following examples:

Example 1. Principal purpose of tax avoidance . A, a U.S. citizen, creates and funds FT, a foreign trust, for the benefit of A ’s children, who are U.S. citizens. In 2004, A decides to transfer an additional 1000X to the foreign trust. Pursuant to a plan with a principal purpose of avoiding the application of section 679, A transfers 1000X to I, a foreign person. I subsequently transfers 1000X to FT . Under paragraph (c)(1) of this section, A is treated as having made a transfer of 1000X to FT .

Example 2. U.S. person unable to demonstrate that intermediary acted independently . A, a U.S. citizen, creates and funds FT, a foreign trust, for the benefit of A ’s children, who are U.S. citizens. On July 1, 2004, A transfers XYZ stock to D, A ’s uncle, who is a nonresident alien. D immediately sells the XYZ stock and uses the proceeds to purchase ABC stock. On January 1, 2007, D transfers the ABC stock to FT . A is unable to demonstrate to the satisfaction of the Commissioner, pursuant to paragraph (c)(2) of this section, that D acted independently of A in making the transfer to FT. Under paragraph (c)(1) of this section, A is treated as having transferred the ABC stock to FT . Under paragraph (c)(3) of this section, D is treated as an agent of A, and the transfer is deemed to have been made on January 1, 2007. Example 3. Indirect loan to foreign trust . A, a U.S. citizen, previously created and funded FT, a foreign trust, for the benefit of A ’s children, who are U.S. citizens. On July 1, 2004, A deposits 500X with FB, a foreign bank. On January 1, 2005, FB loans 450X to FT . A is unable to demonstrate to the satisfaction of the Commissioner, pursuant to para

graph (c)(2) of this section, that FB has a relationship with FT that establishes a reasonable basis for concluding that FB would make a loan to FT or that FB acted independently of A in making the loan. Under paragraph (c)(1) of this section, A is deemed to have transferred 450X directly to FT on January 1, 2005. Under paragraph (c)(3) of this section, FB is treated as an agent of A . For possible exceptions with respect to qualified obligations of the trust, and the treatment of principal repayments with respect to obligations of the trust that are not qualified obligations, see §1.679–4.

Example 4. Loan to foreign trust prior to deposit of funds in foreign bank . The facts are the same as in Example 3, except that A makes the 500X deposit with FB on January 2, 2005, the day after FB makes the loan to FT . The result is the same as in Example 3 . (d) Constructive transfers —(1) In gen- eral . For purposes of paragraph (a) of this section, a constructive transfer includes any assumption or satisfaction of a foreign trust’s obligation to a third party.

(2) Examples . The rules of this paragraph (d) are illustrated by the following examples. In each example, A is a U.S. citizen and FT is a foreign trust. The examples are as follows:

Example 1. Payment of debt of foreign trust . FT owes 1000X to Y, an unrelated foreign corporation, for the performance of services by Y for FT . In satisfaction of FT ’s liability to Y, A transfers to Y property with a fair market value of 1000X. Under paragraph (d)(1) of this section, A is treated as having made a constructive transfer of the property to FT .

Example 2. Assumption of liability of foreign trust . FT owes 1000X to Y, an unrelated foreign corporation, for the performance of services by Y for FT . A assumes FT ’s liability to pay Y . Under paragraph (d)(1) of this section, A is treated as having made a constructive transfer of property with a fair market value of 1000X to FT .

(e) Guarantee of trust obligations —(1) In general . If a foreign trust borrows money or other property from any person who is not a related person (within the meaning of §1.679–1(c)(5)) with respect to the trust (lender) and a U.S. person (U.S. guarantor) that is a related person with respect to the trust guarantees (within the meaning of paragraph (e)(4) of this section) the foreign trust’s obligation, the U.S. guarantor is treated for purposes of this section as a U.S. transferor that has made a transfer to the trust on the date of the guarantee in an amount determined under paragraph (e)(2) of this section. To the extent this paragraph causes the U.S. guarantor to be treated as having made a transfer to the trust, a lender that is a U.S. person shall not be treated as having transferred that amount to the foreign trust.

(2) Amount transferred . The amount deemed transferred by a U.S. guarantor

described in paragraph (e)(1) of this section is the guaranteed portion of the adjusted issue price of the obligation (within the meaning of §1.1275–1(b)) plus any accrued but unpaid qualified stated interest (within the meaning of §1.1273–1(c)).

(3) Principal repayments . If a U.S. person is treated under this paragraph (e) as having made a transfer by reason of the guarantee of an obligation, payments of principal to the lender by the foreign trust with respect to the obligation are taken into account on and after the date of the payment in determining the portion of the trust attributable to the property deemed transferred by the U.S. guarantor.

(4) Guarantee . For purposes of this section, the term guarantee—

(i) Includes any arrangement under which a person, directly or indirectly, assures, on a conditional or unconditional basis, the payment of another’s obligation;

(ii) Encompasses any form of credit support, and includes a commitment to make a capital contribution to the debtor or otherwise maintain its financial viability; and

(iii) Includes an arrangement reflected in a comfort letter, regardless of whether the arrangement gives rise to a legally enforceable obligation. If an arrangement is contingent upon the occurrence of an event, in determining whether the arrangement is a guarantee, it is assumed that the event has occurred.

(5) Examples . The rules of this paragraph (e) are illustrated by the following examples. In all of the examples, A is a U.S. resident and FT is a foreign trust. The examples are as follows:

Example 1 . Foreign lender . X, a foreign corporation, loans 1000X of cash to FT in exchange for FT ’s obligation to repay the loan. A guarantees the repayment of 600X of FT ’s obligation. Under paragraph (e)(2) of this section, A is treated as having transferred 600X to FT .

Example 2. Unrelated U.S. lender . The facts are the same as in Example 1, except X is a U.S. person that is not a related person within the meaning of §1.679–1(c)(5). The result is the same as in Exam- ple 1 .

(f) Transfers to entities owned by a for- eign trust —(1) General rule . If a U.S. person is a related person (as defined in §1.679–1(c)(5)) with respect to a foreign trust, any transfer of property by the U.S. person to an entity in which the foreign trust holds an ownership interest is treated as a transfer of such property by the U.S.

2001–32 I.R.B. 109 August 6, 2001

person to the foreign trust followed by a transfer of the property from the foreign trust to the entity owned by the foreign trust, unless the U.S. person demonstrates to the satisfaction of the Commissioner that the transfer to the entity is properly attributable to the U.S. person’s ownership interest in the entity.

(2) Examples . The rules of this paragraph (f) are illustrated by the following examples. In all of the examples, A is a U.S. citizen, FT is a foreign trust, and FC is a foreign corporation. The examples are as follows:

Example 1. Transfer treated as transfer to trust . A creates and funds FT, which is treated as having a U.S. beneficiary under §1.679–2. FT owns all of the outstanding stock of FC . A transfers property directly to FC . Because FT is the sole shareholder of FC, A is unable to demonstrate to the satisfaction of the Commissioner that the transfer is properly attributable to A ’s ownership interest in FC . Accordingly, under this paragraph (f), A is treated as having transferred the property to FT, followed by a transfer of such property by FT to FC . Under §1.679–1(a), A is treated as the owner of the portion of FT attributable to the property treated as transferred directly to FT . Under §1.367(a)–1T(c)(4)(ii), the transfer of property by FT to FC is treated as a transfer of the property by A to FC .

Example 2. Transfer treated as transfer to trust . The facts are the same as in Example 1, except that FT is not treated as having a U.S. beneficiary under §1.679–2. Under this paragraph (f), A is treated as having transferred the property to FT, followed by a transfer of such property by FT to FC . A is not treated as the owner of FT for purposes of §1.679–1(a). For rules regarding the recognition of gain on the transfer, see section 684. Example 3. Transfer not treated as transfer to trust . A creates and funds FT . FC has outstanding solely 100 shares of common stock. FT owns 50 shares of FC stock, and A owns the remaining 50 shares. On July 1, 2001, FT and A each transfer 1000X to FC. A is able to demonstrate to the satisfaction of the Commissioner that A ’s transfer to FC is properly attributable to A ’s ownership interest in FC . Accordingly, under this paragraph (f), A ’s transfer to FC is not treated as a transfer to FT .

§1.679–4 Exceptions to general rule.

(a) In general . Section 1.679–1 does not apply to—

(1) Any transfer of property to a foreign trust by reason of the death of the transferor;

(2) Any transfer of property to a foreign trust described in sections 402(b), 404(a)(4), or 404A; (3) Any transfer of property to a foreign trust described in section 501(c)(3) (without regard to the requirements of section 508(a)); and

(4) Any transfer of property to a foreign trust to the extent the transfer is for fair market value.

(b) Transfers for fair market value —(1) In general . For purposes of this section, 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. For purposes of this section, a distribution to a trust with respect to an interest held by such trust in an entity other than a trust or an interest in certain investment trusts described in §301.7701–4(c) of this chapter, liquidating trusts described in §301.7701–4(d) of this chapter, or environmental remediation trusts described in §301.7701–4(e) of this chapter is considered to be a transfer for fair market value.

(2) Special rule—(i) Transfers for par- tial consideration . For purposes of this section, if a person transfers property to a foreign trust in exchange for property having a fair market value that is less than the fair market value of the property transferred, the exception in paragraph (a)(4) of this section applies only to the extent of the fair market value of the property received.

(ii) Example . This paragraph (b) is illustrated by the following example:

Example . A, a U.S. citizen, transfers property that has a fair market value of 1000X to FT, a foreign trust, in exchange for 600X of cash. Under this paragraph (b), §1.679–1 applies with respect to the transfer of 400X (1000X less 600X) to FT .

(c) Certain obligations not taken into account . Solely for purposes of this section, in determining whether a transfer by a U.S. transferor that is a related person (as defined in §1.679–1(c)(5)) with respect to the foreign trust is for fair market value, any obligation (as defined in §1.679–1(c)(6)) of the trust or a related person (as defined in §1.679–1(c)(5)) that is not a qualified obligation within the meaning of paragraph (d)(1) of this section shall not be taken into account.

(d) Qualified obligations —(1) In gen- eral . For purposes of this section, an

obligation is treated as a qualified obligation only if—

(i) The obligation is reduced to writing by an express written agreement;

(ii) The term of the obligation does not exceed five years (for purposes of determining the term of an obligation, the obligation’s maturity date is the last possible date that the obligation can be outstanding under the terms of the obligation);

(iii) All payments on the obligation are denominated in U.S. dollars;

(iv) The yield to maturity is not less than 100 percent of the applicable Federal rate and not greater that 130 percent of the applicable Federal rate (the applicable Federal rate for an obligation is the applicable Federal rate in effect under section 1274(d) for the day on which the obligation is issued, as published in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter));

(v) The U.S. transferor extends the period for assessment of any income or transfer tax attributable to the transfer and any consequential income tax changes for each year that the obligation is outstanding, to a date not earlier than three years after the maturity date of the obligation (this extension is not necessary if the maturity date of the obligation does not extend beyond the end of the U.S. transferor’s taxable year for the year of the transfer and is paid within such period); when properly executed and filed, such an agreement is deemed to be consented to for purposes of §301.6501(c)–1(d) of this chapter; and

(vi) The U.S. transferor reports the status of the loan, including principal and interest payments, on Form 3520 for every year that the loan is outstanding.

(2) Additional loans . If, while the original obligation is outstanding, the U.S. transferor or a person related to the trust (within the meaning of §1.679–1(c)(5)) directly or indirectly obtains another obligation issued by the trust, or if the U.S. transferor directly or indirectly obtains another obligation issued by a person related to the trust, the original obligation is deemed to have the maturity date of any such subsequent obligation in determining whether the term of the original obligation exceeds the specified 5-year term. In addition, a series of obligations issued and repaid by the trust (or a person

August 6, 2001 110 2001–32 I.R.B.

related to the trust) is treated as a single obligation if the transactions giving rise to the obligations are structured with a principal purpose to avoid the application of this provision.

(3) Obligations that cease to be quali- fied . If an obligation treated as a qualified obligation subsequently fails to be a qualified obligation ( e.g., renegotiation of the terms of the obligation causes the term of the obligation to exceed five years), the U.S. transferor is treated as making a transfer to the trust in an amount equal to the original obligation’s adjusted issue price (within the meaning of §1.1275–1(b)) plus any accrued but unpaid qualified stated interest (within the meaning of §1.1273–1(c)) as of the date of the subsequent event that causes the obligation to no longer be a qualified obligation. If the maturity date is extended beyond five years by reason of the issuance of a subsequent obligation by the trust (or person related to the trust), the amount of the transfer will not exceed the issue price of the subsequent obligation. The subsequent obligation is separately tested to determine if it is a qualified obligation.

(4) Transfers resulting from failed quali- fied obligations . In general, a transfer resulting from a failed qualified obligation is deemed to occur on the date of the subsequent event that causes the obligation to no longer be a qualified obligation. However, based on all of the facts and circumstances, the Commissioner may deem a transfer to have occurred on any date on or after the issue date of the original obligation. For example, if at the time the original obligation was issued, the transferor knew or had reason to know that the obligation would not be repaid, the Commissioner could deem the transfer to have occurred on the issue date of the original obligation.

(5) Renegotiated loans . Any loan that is renegotiated, extended, or revised is treated as a new loan, and any transfer of funds to a foreign trust after such renegotiation, extension, or revision under a preexisting loan agreement is treated as a transfer subject to this section.

(6) Principal repayments . The payment of principal with respect to any obligation that is not treated as a qualified obligation under this paragraph is taken into account on and after the date of the payment in determining the portion of the trust attributable to the property transferred.

(7) Examples . The rules of this paragraph (d) are illustrated by the following examples. In the examples, A and B are U.S. residents and FT is a foreign trust. The examples are as follows:

Example 1. Demand loan . A transfers 500X to FT in exchange for a demand note that permits A to require repayment by FT at any time. A is a related person (as defined in §1.679–1(c)(5)) with respect to FT . Because FT ’s obligation to A could remain outstanding for more than five years, the obligation is not a qualified obligation within the meaning of paragraph (d) of this section and, pursuant to paragraph (c) of this section, it is not taken into account for purposes of determining whether A ’s transfer is eligible for the fair market value exception of paragraph (a)(4) of this section. Accordingly, §1.679–1 applies with respect to the full 500X transfer to FT .

Example 2. Private annuity . A transfers 4000X to FT in exchange for an annuity from the foreign trust that will pay A 100X per year for the rest of A ’s life. A is a related person (as defined in §1.679–1(c)(5)) with respect to FT . Because FT ’s obligation to A could remain outstanding for more than five years, the obligation is not a qualified obligation within the meaning of paragraph (d)(1) of this section and, pursuant to paragraph (c) of this section, it is not taken into account for purposes of determining whether A ’s transfer is eligible for the fair market value exception of paragraph (a)(4) of this section. Accordingly, §1.679–1 applies with respect to the full 4000X transfer to FT .

Example 3. Loan to unrelated foreign trust . B transfers 1000X to FT in exchange for an obligation of the trust. The term of the obligation is fifteen years. B is not a related person (as defined in §1.679–1(c)(5)) with respect to FT . Because B is not a related person, the fair market value of the obligation received by B is taken into account for purposes of determining whether B ’s transfer is eligible for the fair market value exception of paragraph (a)(4) of this section, even though the obligation is not a qualified obligation within the meaning of paragraph (d)(1) of this section.

Example 4. Transfer for an obligation with term in excess of 5 years . A transfers property that has a fair market value of 5000X to FT in exchange for an obligation of the trust. The term of the obligation is ten years. A is a related person (as defined in §1.679–1(c)(5)) with respect to FT . Because the term of the obligation is greater than five years, the obligation is not a qualified obligation within the meaning of paragraph (d)(1) of this section and, pursuant to paragraph (c) of this section, it is not taken into account for purposes of determining whether A ’s transfer is eligible for the fair market value exception of paragraph (a)(4) of this section. Accordingly, §1.679–1 applies with respect to the full 5000X transfer to FT . Example 5. Transfer for a qualified obligation . The facts are the same as in Example 4, except that the term of the obligation is 3 years. Assuming the other requirements of paragraph (d)(1) of this section are satisfied, the obligation is a qualified obligation and its adjusted issue price is taken into account for purposes of determining whether A ’s transfer is eligible for the fair market value exception of paragraph (a)(4) of this section.

Example 6. Effect of subsequent obligation on original obligation . A transfers property that has a fair market value of 1000X to FT in exchange for an obligation that satisfies the requirements of paragraph (d)(1) of this section. A is a related person (as defined in §1.679–1(c)(5)) with respect to FT . Two years later, A transfers an additional 2000X to FT and receives another obligation from FT that has a maturity date four years from the date that the second obligation was issued. Under paragraph (d)(2) of this section, the original obligation is deemed to have the maturity date of the second obligation. Under paragraph (a) of this section, A is treated as having made a transfer in an amount equal to the original obligation’s adjusted issue price (within the meaning of §1.1275–1(b)) plus any accrued but unpaid qualified stated interest (within the meaning of §1.1273–1(c)) as of the date of issuance of the second obligation. The second obligation is tested separately to determine whether it is a qualified obligation for purposes of applying paragraph (a) of this section to the second transfer.

§1.679–5 Pre-immigration trusts.

(a) In general . If a nonresident alien individual becomes a U.S. person and the individual has a residency starting date (as determined under section 7701(b) (2)(A)) within 5 years after directly or indirectly transferring property to a foreign trust (the original transfer), the individual is treated as having transferred to the trust on the residency starting date an amount equal to the portion of the trust attributable to the property transferred by the individual in the original transfer.

(b) Special rules —(1) Change in grantor trust status . For purposes of paragraph (a) of this section, if a nonresident alien individual who is treated as owning any portion of a trust under the provisions of subpart E of part I of subchapter J, chapter 1 of the Internal Revenue Code, subsequently ceases to be so treated, the individual is treated as having made the original transfer to the foreign trust immediately before the trust ceases to be treated as owned by the individual.

(2) Treatment of undistributed income . For purposes of paragraph (a) of this section, the property deemed transferred to the foreign trust on the residency starting date includes undistributed net income, as defined in section 665(a), attributable to the property deemed transferred. Undistributed net income for periods before the individual’s residency starting date is taken into account only for purposes of determining the amount of the property deemed transferred.

2001–32 I.R.B. 111 August 6, 2001

(c) Examples . The rules of this section are illustrated by the following examples:

Example 1. Nonresident alien becomes resident alien . On January 1, 2002, A, a nonresident alien individual, transfers property to a foreign trust, FT . On January 1, 2006, A becomes a resident of the United States within the meaning of section 7701(b)(1)(A) and has a residency starting date of January 1, 2006, within the meaning of section 7701(b)(2)(A). Under paragraph (a) of this section, A is treated as a U.S. transferor and is deemed to transfer the property to FT on January 1, 2006. Under paragraph (b)(2) of this section, the property deemed transferred to FT on January 1, 2006, includes the undistributed net income of the trust, as defined in section 665(a), attributable to the property originally transferred.

Example 2. Nonresident alien loses power to revest property . On January 1, 2002, A, a nonresident alien individual, transfers property to a foreign trust, FT . A has the power to revest absolutely in himself the title to such property transferred and is treated as the owner of the trust pursuant to sections 676 and 672(f). On January 1, 2008, the terms of FT are amended to remove A ’s power to revest in himself title to the property transferred, and A ceases to be treated as the owner of FT . On January 1, 2010, A becomes a resident of the United States. Under paragraph (b)(1) of this section, for purposes of paragraph (a) of this section A is treated as having originally transferred the property to FT on January 1, 2008. Because this date is within five years of A ’s residency starting date, A is deemed to have made a transfer to the foreign trust on January 1, 2010, his residency starting date. Under paragraph (b)(2) of this section, the property deemed transferred to the foreign trust on January 1, 2010, includes the undistributed net income of the trust, as defined in section 665(a), attributable to the property deemed transferred.

§1.679–6 Outbound migrations of do- mestic trusts.

(a) In general . Subject to the provisions of paragraph (b) of this section, if an individual who is a U.S. person transfers property to a trust that is not a foreign trust, and such trust becomes a foreign trust while the U.S. person is alive, the U.S. individual is treated as a U.S. transferor and is deemed to transfer the property to a foreign trust on the date the domestic trust becomes a foreign trust.

(b) Amount deemed transferred . For purposes of paragraph (a) of this section, the property deemed transferred to the trust when it becomes a foreign trust includes undistributed net income, as defined in section 665(a), attributable to the property previously transferred. Undistributed net income for periods prior to the migration is taken into account only for purposes of determining the portion of the trust that is attributable to the property transferred by the U.S. person.

(c) Example . The following example illustrates the rules of this section. For purposes of the example, A is a resident alien, B is A ’s son, who is a resident alien, and DT is a domestic trust. The example is as follows:

Example. Outbound migration of domestic trust . On January 1, 2002, A transfers property to DT, for the benefit of B . On January 1, 2003, DT acquires a foreign trustee who has the power to determine whether and when distributions will be made to B . Under section 7701(a)(30)(E) and §301.7701– 7(d)(ii)(A) of this chapter, DT becomes a foreign trust on January 1, 2003. Under paragraph (a) of this section, A is treated as transferring property to a foreign trust on January 1, 2003. Under paragraph (b) of this section, the property deemed transferred to the trust when it becomes a foreign trust includes undistributed net income, as defined in section 665(a), attributable to the property deemed transferred.

§1.679–7 Effective dates.

(a) In general . Except as provided in paragraph (b) of this section, the rules of §§1.679–1, 1.679–2, 1.679–3, and 1.679–4 apply with respect to transfers after August 7, 2000.

(b) Special rules . (1) The rules of §1.679–4(c) and (d) apply to an obligation issued after February 6, 1995, whether or not in accordance with a preexisting arrangement or understanding. For purposes of the rules of §1.679–4(c) and (d), if an obligation issued on or before February 6, 1995, is modified after that date, and the modification is a significant modification within the meaning of §1.1001–3, the obligation is treated as if it were issued on the date of the modification. However, the penalty provided in section 6677 applies only to a failure to report transfers in exchange for obligations issued after August 20, 1996.

(2) The rules of §1.679–5 apply to persons whose residency starting date is after August 7, 2000.

(3) The rules of §1.679–6 apply to trusts that become foreign trusts after August 7, 2000.

Par. 3. In §1.958–1, the first sentence of paragraph (b) is revised to read as follows:

§1.958–1 Direct and indirect ownership of stock.

• ---

(b) * * * For purposes of paragraph (a)(2) of this section, stock owned, directly or indirectly, by or for a foreign

corporation, foreign partnership, foreign trust (within the meaning of section 7701(a)(31)) described in sections 671 through 679, or other foreign trust or foreign estate (within the meaning of section 7701(a)(31)) shall be considered as being owned proportionately by its shareholders, partners, grantors or other persons treated as owners under sections 671 through 679 of any portion of the trust that includes the stock, or beneficiaries, respectively. * * *

• ---

§1.958–2 [Amended]

Par. 4. In §1.958–2, paragraph (c)(1)(ii)( b ) is amended by removing the language “678” and adding “679” in its place.

Robert E. Wenzel, Deputy Commissioner

of Internal Revenue.

Approved July 9, 2001.

Mark Weinberger, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on July 19, 2001, 8:45 a.m., and published in the issue of the Federal Register for July 20, 2001, 66 F.R. 37886)

Section 684.—Recognition of Gain on Certain Transfers to Certain Foreign Trusts and Es- tates

26 CFR 1.684–1: Recognition of gain on transfers to certain foreign trusts and estates.

T.D. 8956

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Recognition of Gain on Certain Transfers to Certain Foreign Trusts and Estates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations under section 684 of the Internal Revenue Code relating to recog

August 6, 2001 112 2001–32 I.R.B.

nition of gain on certain transfers to certain foreign trusts and estates. The regulations affect United States persons who transfer property to foreign trusts and estates.

DATES: Effective Date : These regulations are effective July 20, 2001.

Applicability Date : These regulations are applicable to transfers of property to foreign trusts and foreign estates after August 7, 2000.

FOR FURTHER INFORMATION CONTACT: Karen A. Rennie-Quarrie, (202) 622-3880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains final regulations relating to the Income Tax Regulations (CFR part 1) under section 684 of the Internal Revenue Code (Code). On August 7, 2000, Treasury and the IRS published a notice of proposed rulemaking (REG–108522–00, 2000–34 I.R.B. 187) in the Federal Register (65 FR 48198) under section 684 of the Code relating to gain recognition on transfers of property by U.S. persons to foreign trusts and estates. Comments responding to the notice of proposed rulemaking were received and a public hearing was held on November 8, 2000. After consideration of all comments, the proposed regulations are adopted as final regulations as revised by this Treasury decision.

Explanation of Provisions

I. Comments and Changes to §1.684–1: Recognition of Gain on Transfers to Cer- tain Foreign Trusts and Estates

Under the proposed regulations, a U.S. person who transfers property to a foreign trust or estate generally must recognize gain immediately even if deferral might otherwise be permitted under another provision of the Code.

One commenter questioned the authority for the conclusion in §1.684–1(d) Ex- ample 4 that a U.S. person must recognize gain immediately upon the transfer of appreciated property to a foreign trust in exchange for a private annuity. The general rule in section 684(a) provides, in part, that the transfer to the foreign trust is treated as a sale or exchange for an

amount equal to the fair market value of the property transferred and the transferor must recognize the gain in the property, except as provided in regulations. The language of section 684(a) does not provide for any deferral of this gain. Moreover, the legislative history of former section 1491 (the predecessor of section 684 regarding transfers of property by U.S. persons to foreign trusts) makes it clear that Congress did not look favorably upon deferral in the context of transfers to foreign trusts in exchange for private annuities: “The committee believes that any policy in favor of permitting deferral of tax in private annuity transactions should not apply to a private annuity transaction with a foreign trust.” S. Rep. No. 94–938, at 217, n.5 (1976). Therefore, Treasury and the IRS do not believe it would be appropriate to adopt regulations that would permit deferral in such a case. The final regulations retain Example 4 without modification.

II. Comments and Changes to §1.684–2: Transfers

The proposed regulations define the term transfer broadly to mean any direct, indirect, or constructive transfer. Section 1.684–2(e) of the proposed regulations provides that if any portion of a foreign trust is treated as owned by a U.S. person and such portion ceases to be treated as owned by such U.S. person, the U.S. person is treated as having transferred the assets of such portion to a foreign trust immediately before the trust is no longer treated as owned by the U.S. person. Section 1.684–2(e)(2) Example 2 illustrates this rule in the case of the death of the grantor.

One commenter questioned the authority for the position that death is a transfer to which section 684 applies. Section 684(a) expressly applies to “ any transfer of property by a United States person to a foreign estate or trust” (emphasis added). Section 679 also generally applies to transfers of property by U.S. persons to foreign trusts. In the case of section 679, however, section 679(a)(2)(A) specifically excepts transfers by reason of death from the application of the general rule of section 679. This exception implies that Congress believed that, unless otherwise excepted, a transfer by reason of death would be a transfer to which section 679

applied. Because Congress provided no exception in section 684 for transfers by reason of death, it follows that section 684 applies to such transfers. Additional support for this conclusion is found in the information reporting rules in section 6048(a)(3)(A)(ii), which provides that a “reportable event” includes “the transfer of any money or property (directly or indirectly) to a foreign trust by a United States person, including a transfer by rea- son of death ” (emphasis added). Although section 684 generally applies to transfers by reason of death, §1.684–3(c) provides an exception to the general rule of gain recognition in the case of certain transfers at death.

One commenter requested guidance concerning a transfer of property by a domestic trust (that is not treated as owned by another person) to a foreign trust as a result of the testamentary exercise of a limited power of appointment with respect to the domestic trust. Treasury and the IRS believe that, under general principles regarding limited powers of appointment, the domestic trust, and not the holder of the limited power of appointment, is the transferor of the property. Accordingly, the domestic trust must recognize gain under the general rule of §1.684–1(a) unless an exception applies. The final regulations do not include any special rules for such transfers.

One commenter asked about the interaction of §1.684–2(d) and §1.684–2(e) in the context of an actual transfer of property from a foreign trust that is treated as owned by a U.S. person to either a foreign charitable organization or a U.S. charity. Under §1.684–2(d) of the proposed regulations, if any portion of a trust is treated as owned by a U.S. person, a transfer of property from that portion of the trust to a foreign trust is treated as a transfer from the owner. Under §1.684–2(e) of the proposed regulations, if a portion of a foreign trust that is treated as owned by a U.S. person ceases to be treated as owned by the U.S. person, the U.S. person is treated as having transferred the assets of that portion of the trust to a foreign trust immediately before such portion is no longer treated as owned by the U.S. person.

The commenter noted that §1.684–2(e) of the proposed regulation could be read to apply in situations where a portion of a

2001–32 I.R.B. 113 August 6, 2001

foreign corporation to a foreign trust if the corporation was not required to recognize gain on the transfer under section 1032. See Notice 97–18 (1997–1 C.B. 389, Sec. II.A.1). In response to this comment, §1.684–3(e) of the final regulations provides a new exception for transfers of stock (including treasury stock) by a domestic corporation to a foreign trust if the domestic corporation is not required to recognize gain on the transfer under section 1032.

Commenters also suggested that contributions by U.S. persons to foreign compensatory trusts described in sections 402(b), 404(a)(4), or 404A should be exempt from gain recognition under section 684. Treasury and the IRS have considered the proposed exception but do not believe it is consistent with the intended purpose of section 684. Accordingly, the final regulations do not include an exception for transfers to foreign compensatory trusts. However, the exception for transfers of stock to which section 1032 would apply may be available in appropriate cases for transfers of stock of a domestic parent company to a foreign compensatory trust set up by a foreign subsidiary.

Another commenter requested an exception for transfers of life insurance contracts to foreign trusts. The commenter noted that the proceeds of life insurance contracts do not generally give rise to any taxable gain if held by a U.S. individual or trust. Congress has recognized that life insurance contracts might be used to effectuate inappropriate outbound transfers of property. As part of the repeal of section 1491 in 1997, Congress enacted section 1035(c), which provides regulatory authority to deny the nonrecognition treatment given to exchanges of life insurance contracts under section 1035(a) where the exchange has the effect of transferring property to any person other than a U.S. person. Public Law 105–34, §1131(b)(c). Because of the potential for abuse and the lack of a compelling reason for creating an exception for offshore transfers of life insurance contracts, Treasury and the IRS have concluded that such an exception is not warranted.

IV. Comments and Changes to §1.684–4: Outbound Migration of Domestic Trusts

Section 1.684–4 of the proposed regulation provides that if a U.S. person trans

foreign trust ceases to be treated as owned by a U.S. person because of an actual transfer of property from the trust. The final regulations clarify that §1.684–2(e) does not apply (and that §1.684–2(d) may apply) when any portion of a trust ceases to be owned by a U.S. person by reason of an actual transfer of property from the trust. As a result, the general rule of gain recognition under §1.684–1(a) would not apply to an actual transfer by a foreign trust that is treated as owned by a U.S. person to a foreign charitable trust that meets the requirements of §1.684–3(b), or to a U.S. charity, even if the transfer causes the portion of the trust to cease to be owned by the U.S. person.

III. Comments and Changes to §1.684–3: Exceptions to the General Rule of Gain Recognition

Section 1.684–3(a) of the proposed regulations provides that a U.S. person who transfers property to a foreign trust is not required to recognize gain on the transfer to the extent that any person is treated as the owner of the trust under section 671. One commenter questioned whether the term any person includes foreign persons. Although not specifically addressed in the final regulations, it is understood that the term any person includes foreign as well as U.S. persons.

Section 1.684–3(b) of the proposed regulations provides an exception for transfers to a foreign trust that has already received a ruling or determination letter from the IRS recognizing the trust’s tax exempt status under section 501(c)(3), provided that the letter has been neither revoked nor modified. Commenters questioned the requirement that a foreign trust obtain a ruling or determination letter from the IRS recognizing the trust’s tax exempt status under section 501(c)(3). They assert that the requirement may interfere with a U.S. person’s ability to make contributions to a foreign charitable entity that may not be familiar with U.S. tax laws and may not have any reason to obtain a determination letter from the IRS. They suggest that the final regulations require only that the U.S. transferor disclose to the IRS, at such time and in such manner as the IRS may provide, that the transfer has been made and that the U.S. transferor believes the transferee is an organization described in section 501(c)(3).

In response to commenters’ concerns, the final regulations eliminate the requirement that the foreign trust receive a ruling or determination letter from the IRS recognizing the trust’s tax exempt status under section 501(c)(3). The final regulations provide, instead, that the general rule of gain recognition does not apply to any transfer of property to a foreign trust that is described in section 501(c)(3) (without regard to the requirements of section 508(a)). However, taxpayers should be aware that, under Notice 97–34 (1997–1 C.B. 422), the U.S. transferor has a reporting obligation on Form 3520 with respect to such a transfer, unless the foreign trust has received a ruling or determination letter from the IRS recognizing the trust’s tax exempt status under section 501(c)(3). Moreover, if the IRS subsequently determines that the foreign trust is not described in section 501(c)(3), the exception will not apply and the U.S. transferor will be required to recognize gain as of the time of the original transfer, and may be subject to interest and penalties, if applicable.

Section 1.684–3(c) of the proposed regulations provides an exception for transfers of property by reason of the death of the U.S. transferor if both of the following requirements are satisfied: (1) the property is included in the U.S. transferor’s gross estate for Federal estate tax purposes, and (2) the basis of the property in the hands of the foreign trust is determined under section 1014(a). One commenter questioned whether section 684 would apply in the case of an individual who is a U.S. person for income tax purposes, but a non-domiciliary for estate tax purposes, with the result that the property of the individual would be entitled to a step-up in basis, but would not be included in the individual’s gross estate. The final regulations eliminate the requirement that the property be included in the U.S. transferor’s gross estate and allow the exception to apply as long as the basis of the property in the hands of the foreign trust is determined under section 1014(a).

Another commenter requested that the final regulations confirm that section 1032 applies to provide for nonrecognition of gain on issuer stock transferred to a foreign trust. The commenter noted that under former section 1491, no excise tax was imposed on a transfer of stock by a

August 6, 2001 114 2001–32 I.R.B.

fers property to a domestic trust and, for any reason, the domestic trust becomes a foreign trust, the domestic trust will be deemed to have transferred all of its assets to a foreign trust and the domestic trust must immediately recognize gain. The proposed regulations do, however, incorporate the relief for inadvertent migrations that is set forth in §301.7701– 7(d)(2). One commenter suggested that the final regulations should extend the inadvertent migration rules of §301.7701–7(d)(2) to apply to §301.7701–7(f), which deals with the election by certain trusts to remain domestic trusts. Under §301.7701– 7(d)(2), in the event of an inadvertent change in any person that has the power to make a substantial decision of the trust that would cause the domestic or foreign residency of the trust to change ( e.g., an inadvertent change from a U.S. trustee to a foreign trustee by reason of the U.S. trustee’s death), the trust is allowed 12 months to make necessary changes to avoid a change in the trust’s residency ( e.g., the replacement of the foreign successor trustee with a U.S. successor trustee). The commenter suggests that a trust with an election in force under §301.7701–7(d)(2) should be allowed a similar amount of time to make necessary changes if a U.S. trustee is inadvertently replaced by a foreign trustee.

The final regulations do not include such a rule. Under §301.7701–7(f), a trust generally can elect to remain a domestic trust if it was in existence on August 20, 1996, and it was treated as a domestic trust on August 19, 1996. Section 301.7701–7(f)(4)(ii) provides that such an election terminates if subsequent changes are made to the trust that result in the trust no longer having any reasonable basis for being treated as a domestic trust under section 7701(a)(30) prior to its amendment by the Small Business Job Protection Act of 1996 (SBJP Act), Pub. L. 104–188, 110 Stat. 1755. Whereas the “control test” of section 7701(a)(30) (E)(ii), as enacted by the SBJP Act, contains a relatively bright-line test for purposes of determining a trust’s status, thereby necessitating the inadvertent migration rule of §301.7701–7(d)(2), the determination of domestic or foreign status prior to the SBJP Act was governed by less objective criteria.

Under pre-SBJP Act law, an inadvertent short-term replacement of a domestic trustee by a foreign trustee would not necessarily cause a change in the trust’s status. Accordingly, a specific inadvertent migration rule for §301.7701–7(f) is not appropriate. Instead, as set forth in §301.7701–7(f)(4)(ii), an election under §301.7701–7(f) will not be terminated unless the trust has no reasonable basis for being treated as a domestic trust under pre-SBJP Act law.

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. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Drafting Information

The principal author of these regulations is Karen A. Rennie-Quarrie of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in their development.

• ---

Adoption of Amendments to the Regu- lations

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 1.684–1 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684–2 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684–3 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684–4 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684–5 also issued under 26 U.S.C. 643(a)(7) and 684(a). * * *

Par. 2. Sections 1.684–1, 1.684–2, 1.684–3, 1.684–4 and 1.684–5 are added under the undesignated centerheading “Miscellaneous” to read as follows:

§1.684–1 Recognition of gain on trans- fers to certain foreign trusts and estates.

(a) Immediate recognition of gain —(1) In general . Any U.S. person who transfers property to a foreign trust or foreign estate shall be required to recognize gain at the time of the transfer equal to the excess of the fair market value of the property transferred over the adjusted basis (for purposes of determining gain) of such property in the hands of the U.S. transferor unless an exception applies under the provisions of §1.684–3. The amount of gain recognized is determined on an asset-by-asset basis.

(2) No recognition of loss . Under this section a U.S. person may not recognize loss on the transfer of an asset to a foreign trust or foreign estate. A U.S. person may not offset gain realized on the transfer of an appreciated asset to a foreign trust or foreign estate by a loss realized on the transfer of a depreciated asset to the foreign trust or foreign estate.

(b) Definitions . The following definitions apply for purposes of this section:

(1) U.S. person . The term U.S. person means a United States person as defined in section 7701(a)(30), and includes a nonresident alien individual who elects under section 6013(g) to be treated as a resident of the United States.

(2) U.S. transferor . The term U.S. transferor means any U.S. person who makes a transfer (as defined in §1.684–2) of property to a foreign trust or foreign estate.

(3) Foreign trust . Section 7701(a) (31)(B) defines foreign trust. See also §301.7701–7 of this chapter.

(4) Foreign estate . Section 7701(a) (31)(A) defines foreign estate.

(c) Reporting requirements . A U.S. person who transfers property to a foreign

2001–32 I.R.B. 115 August 6, 2001

trust or foreign estate must comply with the reporting requirements under section 6048. (d) Examples . The following examples illustrate the rules of this section. In all examples, A is a U.S. person and FT is a foreign trust. The examples are as follows:

Example 1. Transfer to foreign trust . A transfers property that has a fair market value of 1000X to FT . A ’s adjusted basis in the property is 400X. FT has no U.S. beneficiary within the meaning of §1.679–2, and no person is treated as owning any portion of FT . Under paragraph (a)(1) of this section, A recognizes gain at the time of the transfer equal to 600X.

Example 2. Transfer of multiple properties . A transfers property Q, with a fair market value of 1000X, and property R, with a fair market value of 2000X, to FT . At the time of the transfer, A ’s adjusted basis in property Q is 700X, and A ’s adjusted basis in property R is 2200X. FT has no U.S. beneficiary within the meaning of §1.679–2, and no person is treated as owning any portion of FT . Under paragraph (a)(1) of this section, A recognizes the 300X of gain attributable to property Q. Under paragraph (a)(2) of this section, A does not recognize the 200X of loss attributable to property R, and may not offset that loss against the gain attributable to property Q.

Example 3. Transfer for less than fair market value . A transfers property that has a fair market value of 1000X to FT in exchange for 400X of cash. A ’s adjusted basis in the property is 200X. FT has no U.S. beneficiary within the meaning of §1.679–2, and no person is treated as owning any portion of FT . Under paragraph (a)(1) of this section, A recognizes gain at the time of the transfer equal to 800X.

Example 4. Exchange of property for private an- nuity . A transfers property that has a fair market value of 1000X to FT in exchange for FT ’s obligation to pay A 50X per year for the rest of A ’s life. A ’s adjusted basis in the property is 100X. FT has no U.S. beneficiary within the meaning of §1.679–2, and no person is treated as owning any portion of FT . A is required to recognize gain equal to 900X immediately upon transfer of the property to the trust. This result applies even though A might otherwise have been allowed to defer recognition of gain under another provision of the Internal Revenue Code.

Example 5. Transfer of property to related for- eign trust in exchange for qualified obligation . A transfers property that has a fair market value of 1000X to FT in exchange for FT ’s obligation to make payments to A during the next four years. FT is related to A as defined in §1.679–1(c)(5). The obligation is treated as a qualified obligation within the meaning of §1.679–4(d), and no person is treated as owning any portion of FT . A ’s adjusted basis in the property is 100X. A is required to recognize gain equal to 900X immediately upon transfer of the property to the trust. This result applies even though A might otherwise have been allowed to defer recognition of gain under another provision of the Internal Revenue Code. Section 1.684–3(d) provides rules relating to transfers for fair market value to unrelated foreign trusts.

§1.684–2 Transfers.

(a) In general . A transfer means a direct, indirect, or constructive transfer.

(b) Indirect transfers —(1) In general . Section 1.679–3(c) shall apply to determine if a transfer to a foreign trust or foreign estate, by any person, is treated as an indirect transfer by a U.S. person to the foreign trust or foreign estate.

(2) Examples . The following examples illustrate the rules of this paragraph (b). In all examples, A is a U.S. citizen, FT is a foreign trust, and I is A ’s uncle, who is a nonresident alien. The examples are as follows:

Example 1. Principal purpose of tax avoidance . A creates and funds FT for the benefit of A ’s cousin, who is a nonresident alien. FT has no U.S. beneficiary within the meaning of §1.679–2, and no person is treated as owning any portion of FT . In 2004, A decides to transfer additional property with a fair market value of 1000X and an adjusted basis of 600X to FT . Pursuant to a plan with a principal purpose of avoiding the application of section 684, A transfers the property to I . I subsequently transfers the property to FT . Under paragraph (b) of this section and §1.679–3(c), A is treated as having transferred the property to FT .

Example 2. U.S. person unable to demonstrate that intermediary acted independently . A creates and funds FT for the benefit of A ’s cousin, who is a nonresident alien. FT has no U.S. beneficiary within the meaning of §1.679–2, and no person is treated as owning any portion of FT . On July 1, 2004, A transfers property with a fair market value of 1000X and an adjusted basis of 300X to I, a foreign person. On January 1, 2007, at a time when the fair market value of the property is 1100X, I transfers the property to FT . A is unable to demonstrate to the satisfaction of the Commissioner, under §1.679–3 (c)(2)(ii), that I acted independently of A in making the transfer to FT . Under paragraph (b) of this section and §1.679–3(c), A is treated as having transferred the property to FT . Under paragraph (b) of this section and §1.679–3(c)(3), I is treated as an agent of A, and the transfer is deemed to have been made on January 1, 2007. Under §1.684–1(a), A recognizes gain equal to 800X on that date.

(c) Constructive transfers. Section 1.679–3(d) shall apply to determine if a transfer to a foreign trust or foreign estate is treated as a constructive transfer by a U.S. person to the foreign trust or foreign estate.

(d) Transfers by certain trusts —(1) In general . If any portion of a trust is treated as owned by a U.S. person, a transfer of property from that portion of the trust to a foreign trust is treated as a transfer from the owner of that portion to the foreign trust.

(2) Examples. The following examples illustrate the rules of this paragraph

(d). In all examples, A is a U.S. person, DT is a domestic trust, and FT is a foreign trust. The examples are as follows:

Example 1. Transfer by a domestic trust . On January 1, 2001, A transfers property which has a fair market value of 1000X and an adjusted basis of 200X to DT . A retains the power to revoke DT . On January 1, 2003, DT transfers property which has a fair market value of 500X and an adjusted basis of 100X to FT . At the time of the transfer, FT has no U.S. beneficiary as defined in §1.679–2 and no person is treated as owning any portion of FT . A is treated as having transferred the property to FT and is required to recognize gain of 400X, under §1.684–1, at the time of the transfer by DT to FT .

Example 2. Transfer by a foreign trust . On January 1, 2001, A transfers property which has a fair market value of 1000X and an adjusted basis of 200X to FT1 . At the time of the transfer, FT1 has a U.S. beneficiary as defined in §1.679–2 and A is treated as the owner of FT1 under section 679. On January 1, 2003, FT1 transfers property which has a fair market value of 500X and an adjusted basis of 100X to FT2 . At the time of the transfer, FT2 has no U.S. beneficiary as defined in §1.679–2 and no person is treated as owning any portion of FT2 . A is treated as having transferred the property to FT2 and is required to recognize gain of 400X, under §1.684–1, at the time of the transfer by FT1 to FT2 .

(e) Deemed transfers when foreign trust no longer treated as owned by a U.S. person —(1) In general . If any portion of a foreign trust is treated as owned by a U.S. person under subpart E of part I of subchapter J, chapter 1 of the Internal Revenue Code, and such portion ceases to be treated as owned by that person under such subpart (other than by reason of an actual transfer of property from the trust to which §1.684–2(d) applies), the U.S. person shall be treated as having transferred, immediately before (but on the same date that) the trust is no longer treated as owned by that U.S. person, the assets of such portion to a foreign trust.

(2) Examples . The following examples illustrate the rules of this paragraph (e). In all examples, A is a U.S. citizen and FT is a foreign trust. The examples are as follows:

Example 1. Loss of U.S. beneficiary. (i) On January 1, 2001, A transfers property, which has a fair market value of 1000X and an adjusted basis of 400X, to FT . At the time of the transfer, FT has a U.S. beneficiary within the meaning of §1.679–2, and A is treated as owning FT under section 679. Under §1.684–3(a), §1.684–1 does not cause A to recognize gain at the time of the transfer.

(ii) On July 1, 2003, FT ceases to have a U.S. beneficiary as defined in §1.679–2(c) and as of that date neither A nor any other person is treated as owning any portion of FT . Pursuant to §1.679–2(c)(2), if FT ceases to be treated as having a U.S. beneficiary, A will cease to be treated as

August 6, 2001 116 2001–32 I.R.B.

Example 3. Transfer of property at death: Basis not determined under section 1014(a). (i) The initial facts are the same as Example 1 .

(ii) A dies on July 1, 2004. The fair market value at A ’s death of all property transferred to FT by A is 1500X. The basis in the property is 400X. A retains no power over FT, and FT ’s basis in the property transferred is not determined under section 1014(a). Under §1.684–2(e)(1), A is treated as having transferred the property to FT immediately before his death, and must recognize 1100X of gain at that time under §1.684–1.

Example 4. Transfer of property for fair market value to an unrelated foreign trust . A sells a house with a fair market value of 1000X to FT in exchange for a 30-year note issued by FT . A is not related to FT as defined in §1.679–1(c)(5). FT is not treated as owned by any person. Pursuant to paragraph (d) of this section, A is not required to recognize gain under §1.684–1.

§1.684–4 Outbound migrations of do- mestic trusts.

(a) In general . If a U.S. person transfers property to a domestic trust, and such trust becomes a foreign trust, and neither trust is treated as owned by any person under subpart E of part I of subchapter J, chapter 1 of the Internal Revenue Code, the trust shall be treated for purposes of this section as having transferred all of its assets to a foreign trust and the trust is required to recognize gain on the transfer under §1.684–1(a). The trust must also comply with the rules of section 6048.

(b) Date of transfer . The transfer described in this section shall be deemed to occur immediately before, but on the same date that, the trust meets the definition of a foreign trust set forth in section 7701(a)(31)(B). (c) Inadvertent migrations . In the event of an inadvertent migration, as defined in §301.7701–7(d)(2) of this chapter, a trust may avoid the application of this section by complying with the procedures set forth in §301.7701–7(d)(2) of this chapter.

(d) Examples . The following examples illustrate the rules of this section. In all examples, A is a U.S. citizen, B is a U.S. citizen, C is a nonresident alien, and T is a trust. The examples are as follows:

Example 1 . Migration of domestic trust with U.S. beneficiaries . A transfers property which has a fair market value of 1000X and an adjusted basis equal to 400X to T, a domestic trust, for the benefit of A ’s children who are also U.S. citizens. B is the trustee of T . On January 1, 2001, while A is still alive, B resigns as trustee and C becomes successor trustee under the terms of the trust. Pursuant to §301.7701–7(d) of this chapter, T becomes a foreign trust. T has U.S. beneficiaries within the meaning of

owner of FT beginning on the first day of the first taxable year following the last taxable year in which there was a U.S. beneficiary. Thus, on January 1, 2004, A ceases to be treated as owner of FT . On that date, the fair market value of the property is 1200X and the adjusted basis is 350X. Under paragraph (e)(1) of this section, A is treated as having transferred the property to FT on January 1, 2004, and must recognize 850X of gain at that time under §1.684–1.

Example 2. Death of grantor. (i) The initial facts are the same as in paragraph (i) of Example 1 .

(ii) On July 1, 2003, A dies, and as of that date no other person is treated as the owner of FT . On that date, the fair market value of the property is 1200X, and its adjusted basis equals 350X. Under paragraph (e)(1) of this section, A is treated as having transferred the property to FT immediately before his death, and generally is required to recognize 850X of gain at that time under §1.684–1. However, an exception may apply under §1.684–3(c).

Example 3. Release of a power . (i) On January 1, 2001, A transfers property that has a fair market value of 500X and an adjusted basis of 200X to FT . At the time of the transfer, FT does not have a U.S. beneficiary within the meaning of §1.679–2. However, A retains the power to revoke the trust. A is treated as the owner of the trust under section 676 and, therefore, under §1.684–3(a), A is not required to recognize gain under §1.684–1 at the time of the transfer.

(ii) On January 1, 2007, A releases the power to revoke the trust and, as of that date, neither A nor any other person is treated as owning any portion of FT. On that date, the fair market value of the property is 900X, and its adjusted basis is 200X. Under paragraph (e)(1) of this section, A is treated as having transferred the property to FT on January 1, 2007, and must recognize 700X of gain at that time. (f) Transfers to entities owned by a for- eign trust . Section 1.679–3(f) provides rules that apply with respect to transfers of property by a U.S. person to an entity in which a foreign trust holds an ownership interest.

§1.684–3 Exceptions to general rule of gain recognition.

(a) Transfers to grantor trusts . The general rule of gain recognition under §1.684–1 shall not apply to any transfer of property by a U.S. person to a foreign trust to the extent that any person is treated as the owner of the trust under section 671. Section 1.684–2(e) provides rules regarding a subsequent change in the status of the trust.

(b) Transfers to charitable trusts . The general rule of gain recognition under §1.684–1 shall not apply to any transfer of property to a foreign trust that is described in section 501(c)(3) (without regard to the requirements of section 508(a)).

(c) Certain transfers at death . The general rule of gain recognition under §1.684–1 shall not apply to any transfer of property by reason of death of the U.S. transferor if the basis of the property in the hands of the foreign trust is determined under section 1014(a).

(d) Transfers for fair market value to unrelated trusts . The general rule of gain recognition under §1.684–1 shall not apply to any transfer of property for fair market value to a foreign trust that is not a related foreign trust as defined in §1.679–1(c)(5). Section 1.671–2(e)(2)(ii) defines fair market value.

(e) Transfers to which section 1032 ap- plies . The general rule of gain recognition under §1.684–1 shall not apply to any transfer of stock (including treasury stock) by a domestic corporation to a foreign trust if the domestic corporation is not required to recognize gain on the transfer under section 1032.

(f) Certain distributions to trusts . For purposes of this section, a transfer does not include a distribution to a trust with respect to an interest held by such trust in an entity other than a trust or an interest in certain investment trusts described in §301.7701–4(c) of this chapter, liquidating trusts described in §301.7701–4(d) of this chapter, or environmental remediation trusts described in §301.7701–4(e) of this chapter.

(g) Examples . The following examples illustrate the rules of this section. In all examples, A is a U.S. citizen and FT is a foreign trust. The examples are as follows:

Example 1. Transfer to owner trust . In 2001, A transfers property which has a fair market value of 1000X and an adjusted basis equal to 400X to FT . At the time of the transfer, FT has a U.S. beneficiary within the meaning of §1.679–2, and A is treated as owning FT under section 679. Under paragraph (a) of this section, §1.684–1 does not cause A to recognize gain at the time of the transfer. See §1.684–2(e) for rules that may require A to recognize gain if the trust is no longer owned by A .

Example 2. Transfer of property at death: Basis determined under section 1014(a). (i) The initial facts are the same as Example 1 .

(ii) A dies on July 1, 2004. The fair market value at A ’s death of all property transferred to FT by A is 1500X. The basis in the property is 400X. A retained the power to revoke FT, thus, the value of all property owned by FT at A ’s death is includible in A ’s gross estate for U.S. estate tax purposes. Pursuant to paragraph (c) of this section, A is not required to recognize gain under §1.684–1 because the basis of the property in the hands of the foreign trust is determined under section 1014(a).

2001–32 I.R.B. 117 August 6, 2001

differential earnings amount” for any taxable year is an amount calculated in the same manner as the differential earnings amount for that taxable year, except that the average mutual earnings rate for the calendar year in which the taxable year begins is substituted for the average mutual earnings rate for the second calendar year preceding the calendar year in which the taxable year begins.

The stock earnings rates and mutual earnings rates taken into account under § 809 generally are determined by dividing statement gain from operations by the average equity base. For this purpose, the term “statement gain from operations” means “the net gain or loss from operations required to be set forth in the annual statement, determined without regard to federal income taxes, and ... properly adjusted for realized capital gains and losses....” See § 809(g)(1). The term “equity base” is defined as an amount determined in the manner prescribed by regulations equal to surplus and capital increased by the amount of nonadmitted financial assets, the excess of the amount of statutory reserves over the amount of tax reserves, the sum of certain other reserves, and 50 percent of any policyholder dividends (or other similar liability) payable in the following taxable year. See § 809(b)(2), (3), (4), (5), and (6). Section 1.809–10 of the Income Tax Regulations provides that the equity base includes both the asset valuation reserve and the interest maintenance reserve for taxable years ending after December 31, 1991.

Section 1.809–9(a) of the regulations provides that neither the differential earnings rate under § 809(c) nor the recomputed differential earnings rate that is used in computing the recomputed differential earnings amount under § 809(f)(3) may be less than zero.

Rev. Rul. 99–3, 1999–1 C.B. 313, provides that a life insurance subsidiary of a mutual holding company is not a mutual life insurance company for which the deduction for policyholder dividends is reduced pursuant to §§ 808(c)(2) and 809.

For purposes of § 809, the differential earnings rate for 2000 and the rate used to calculate the recomputed differential earnings amount for 1999 (the recomputed differential earnings rate for 1999), and the figures on which these two rates are based are set forth in Table 1.

§1.679–2 and A is, therefore, treated as owning FT under section 679. Pursuant to §1.684–3(a), neither A nor T is required to recognize gain at the time of the migration. Section 1.684–2(e) provides rules that may require A to recognize gain upon a subsequent change in the status of the trust.

Example 2. Migration of domestic trust with no U.S. beneficiaries . A transfers property which has a fair market value of 1000X and an adjusted basis equal to 400X to T, a domestic trust for the benefit of A ’s mother who is not a citizen or resident of the United States. T is not treated as owned by another person. B is the trustee of T . On January 1, 2001, while A is still alive, B resigns as trustee and C becomes successor trustee under the terms of the trust. Pursuant to §301.7701–7(d) of this chapter, T becomes a foreign trust, FT . FT has no U.S. beneficiaries within the meaning of §1.679–2 and no person is treated as owning any portion of FT . T is required to recognize gain of 600X on January 1, 2001. Paragraph (c) of this section provides rules with respect to an inadvertent migration of a domestic trust.

§1.684–5 Effective date

Sections 1.684–1 through 1.684–4 apply to transfers of property to foreign trusts and foreign estates after August 7, 2000.

Robert E. Wenzel, Deputy Commissioner

of Internal Revenue.

Approved July 9, 2001.

Mark Weinberger, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on July 19, 2001, 8:45 a.m., and published in the issue of the Federal Register for July 20, 2001, 66 F.R. 37897)

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 809.—Reduction in Certain Deductions of Mutual Life Insurance Companies

26 CFR 1.809–9: Computation of the differential earnings rate and the recomputed differential earnings rate.

Mutual life insurance companies; differential earnings rate. The differential earnings rate for 2000 and the recomputed differential earnings rate for 1999 are set forth for use by mutual life insur

ance companies to compute their income tax liabilities for 2000.

Rev. Rul. 2001–33

This revenue ruling contains the differential earnings rate for 2000 and the recomputed differential earnings rate for 1999. Under § 809 of the Internal Revenue Code, mutual life insurance companies use these rates in computing their federal income tax liability for taxable years beginning in 2000. This revenue ruling also contains the figures on which the determinations of these rates are based. Notice 2001–24, 2001–12 I.R.B. 912, contained tentative determinations of these rates.

Section 809(a) provides that, in the case of any mutual life insurance company, the amount of the deduction allowable under § 808 for policyholder dividends is reduced (but not below zero) by the “differential earnings amount.” Any excess of the differential earnings amount over the amount of the deduction allowable under § 808 is taken into account as a reduction in the closing balance of reserves under subsections (a) and (b) of § 807. The “differential earnings amount” for any taxable year is the amount equal to the product of (a) the life insurance company’s average equity base for the taxable year multiplied by (b) the “differential earnings rate” for that taxable year. The “differential earnings rate” for the taxable year is the excess of (a) the “imputed earnings rate” for the taxable year over (b) the “average mutual earnings rate” for the second calendar year preceding the calendar year in which the taxable year begins. The “imputed earnings rate” for any taxable year is the amount that bears the same ratio to 16.5 percent as the “current stock earnings rate” for the taxable year bears to the “base period stock earnings rate.”

Section 809(f) provides that, in the case of any mutual life insurance company, if the “recomputed differential earnings amount” for any taxable year exceeds the differential earnings amount for that taxable year, the excess is included in life insurance gross income for the succeeding taxable year. If the differential earnings amount for any taxable year exceeds the recomputed differential earnings amount for that taxable year, the excess is allowed as a life insurance deduction for the succeeding taxable year. The “recomputed

August 6, 2001 118 2001–32 I.R.B.

Rev. Rul. 2001–33 Table 1

Determination of Rates To Be Used For Taxable Years

Beginning in 2000

Differential earnings rate for 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

Recomputed differential earnings rate for 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0

Imputed earnings rate for 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.815

Imputed earnings rate for 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.358

Base period stock earnings rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18.221

Current stock earnings rate for 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16.960

Stock earnings rate for 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19.321

Stock earnings rate for 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.836

Stock earnings rate for 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.724

Average mutual earnings rate for 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16.011

Average mutual earnings rate for 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16.164

DRAFTING INFORMATION

The principal author of this revenue ruling is Katherine A. Hossofsky of the Office of the Associate Chief Counsel (Financial Institutions and Products). For further information regarding this revenue ruling, contact Ms. Hossofsky at (202) 622-3477 (not a toll-free number).

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 1274.—Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property

(Also sections 42, 280G, 382, 412, 467, 468, 482, 483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes of sections 382, 1274, 1288, and other sections of the Code, tables set forth the rates for August 2001.

Rev. Rul. 2001–36

This revenue ruling provides various prescribed rates for federal income tax purposes for August 2001 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes

of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(2) for buildings placed in service during the current month. Finally, Table 5 contains the federal rate for determining the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520.

2001–32 I.R.B. 119 August 6, 2001

REV. RUL. 2001–36 TABLE 1

Applicable Federal Rates (AFR) for August 2001

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-Term

AFR 3.94% 3.90% 3.88% 3.87% 110% AFR 4.34% 4.29% 4.27% 4.25% 120% AFR 4.73% 4.68% 4.65% 4.64% 130% AFR 5.13% 5.07% 5.04% 5.02%

Mid-Term

AFR 4.99% 4.93% 4.90% 4.88% 110% AFR 5.49% 5.42% 5.38% 5.36% 120% AFR 6.01% 5.92% 5.88% 5.85% 130% AFR 6.51% 6.41% 6.36% 6.33% 150% AFR 7.54% 7.40% 7.33% 7.29% 175% AFR 8.82% 8.63% 8.54% 8.48%

Long-Term

AFR 5.72% 5.64% 5.60% 5.57% 110% AFR 6.30% 6.20% 6.15% 6.12% 120% AFR 6.88% 6.77% 6.71% 6.68% 130% AFR 7.46% 7.33% 7.26% 7.22%

REV. RUL. 2001–36 TABLE 2

Adjusted AFR for August 2001

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted AFR 3.01% 2.99% 2.98% 2.97%

Mid-term adjusted AFR 3.83% 3.79% 3.77% 3.76%

Long-term adjusted AFR 4.94% 4.88% 4.85% 4.83%

REV. RUL. 2001–36 TABLE 3

Rates Under Section 382 for August 2001

Adjusted federal long-term rate for the current month 4.94%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.) 5.01%

REV. RUL. 2001–36 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for August 2001

Appropriate percentage for the 70% present value low-income housing credit 8.25%

Appropriate percentage for the 30% present value low-income housing credit 3.54%

August 6, 2001 120 2001–32 I.R.B.

REV. RUL. 2001–36 TABLE 5

Rate Under Section 7520 for August 2001

Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest 6.0%

Section 1288.—Treatment of Original Issue Discounts on Tax- Exempt Obligations

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

Section 7872.—Treatment of Loans with Below-Market Interest Rates

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2001. See Rev. Rul. 2001–36, page 119.

2001–32 I.R.B. 121 August 6, 2001