Bulletin No. 1997–25

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June 23, 1997

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be relied

upon as authoritative interpretations.

INCOME TAX

EXEMPT ORGANIZATIONS

REG–251703–96, page 5.

Proposed regulations under section 7701 of the Code

provide guidance relating to the definition of a trust as a

United States person (domestic trust) or foreign trust. A

public hearing will be held on September 16, 1997.

Announcement 97–62, page 34.

A list is given of organizations now classified as private

foundations.

REG–252487–96, page 9.

Proposed regulations under section 672 of the Code

relate to the application of the grantor trust rules to

certain trusts established by foreign persons. A public

hearing will be held on August 27, 1997.

Rev. Proc. 97–30, page 20.

Election of general asset accounts. An automatic

consent procedure is provided for electing general asset

accounts for depreciable property placed in service in

prior years. Rev. Proc. 97–27 modified.

EMPLOYEE PLANS

Notice 97–35, page 32.

Weighted average interest rate update. Guidelines are

set forth for determining for June 1997, the weighted

average interest rate and the resulting permissible range

of interest rates used to calculate current liability for

purposes of the full funding limitation of section

412(c)(7) of the Code as amended by the Omnibus

Budget Reconciliation Act of 1987 and by the Uruguay

Round Agreements Act (GATT).

Finding Lists begin on page 38.

Announcement of Disbarments and Suspensions begins on page 35.

ADMINISTRATIVE

Del. Order 232 (Rev. 3), page 21.

The authority to issue Taxpayer Assistance Orders (TAOs)

under IRC section 7811 is delegated to certain officials.

Del. Order 232 (Rev. 2) superseded.

Notice 97–34, page 22.

This notice provides guidance regarding the new foreign

trust and foreign gift reporting provisions contained in

the Small Business Job Protection Act of 1996.

Mission of the Service

The purpose of the Internal Revenue Service is to

collect the proper amount of tax revenue at the least

cost; serve the public by continually improving the

quality of our products and services; and perform in a

manner warranting the highest degree of public

confidence in our integrity, efficiency and fairness.

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying

and administering the law in a reasonable,

practical manner. Issues should only be raised by

examining of ficers when they have merit, never

arbitrarily or for trading purposes. At the same

time, the examining officer should never hesitate

to raise a meritorious issue. It is also important

that care be exercised not to raise an issue or to

ask a court to adopt a position inconsistent with

an established Service position.

The function of the Internal Revenue Service is to

administer the Internal Revenue Code. Tax policy

for raising revenue is determined by Congress.

With this in mind, it is the duty of the Service to

carry out that policy by correctly applying the laws

enacted by Congress; to determine the reasonable

meaning of various Code provisions in light of the

Congressional purpose in enacting them; and to

perform this work in a fair and impartial manner,

with neither a government nor a taxpayer point of view.

Administration should be both reasonable and

vigorous. It should be conducted with as little

delay as possible and with great cour tesy and

considerateness. It should never try to overreach,

and should be reasonable within the bounds of law

and sound administration. It should, however, be

vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax

devices and fraud.

At the heart of administration is interpretation of the

Code. It is the responsibility of each person in the

Service, charged with the duty of interpreting the

law, to try to find the true meaning of the statutory

provision and not to adopt a strained construction in

the belief that he or she is ‘‘protecting the revenue.’’

The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

Introduction

The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for

announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation,

court decisions, and other items of general interest. It is

published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin

contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold on a

single-copy basis.

court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are

cautioned against reaching the same conclusions in

other cases unless the facts and circumstances are

substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on

provisions of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all

substantive rulings necessary to promote a uniform

application of the tax laws, including all rulings that

supersede, revoke, modify, or amend any of those

previously published in the Bulletin. All published rulings

apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management

are not published; however, statements of internal

practices and procedures that affect the rights and

duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows:

Subpart A, Tax Conventions, and Subpart B, Legislation

and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and

Subparts. Also included in this part are Bank Secrecy

Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the

Treasury’s Office of the Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts

stated in the revenue ruling. In those based on positions

taken in rulings to taxpayers or technical advice to

Service field offices, identifying details and information

of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory

requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in

this part, none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not

have the force and effect of Treasury Department

Regulations, but they may be used as precedents.

Unpublished rulings will not be relied on, used, or cited

as precedents by Service personnel in the disposition of

other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,

The first Bulletin for each month includes an index for

the matters published during the preceding month.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin

of the succeeding quarterly and semi-annual period,

respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

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

Section 168.—Accelerated Cost

Recovery System

Section 446.—General Rule for

Methods of Accounting

May a taxpayer make a general asset account

election in the current taxable year for depreciable

property placed in service in a prior taxable year?

See Rev. Proc. 97–30, page 20.

If a taxpayer makes a general asset account

election in the current taxable year for depreciable

property placed in service in a prior taxable year,

is this election a change in method of accounting?

See Rev. Proc. 97–30, page 20.

26 CFR 1.168(i)–1: General asset accounts.

May a taxpayer make a general asset account

election in the current taxable year for depreciable

property placed in service in a prior taxable year?

See Rev. Proc. 97–30, page 20.

June 23, 1997

26 CFR 1.446–1: General rule for methods of

accounting.

If a taxpayer makes a general asset account

election in the current taxable year for depreciable

property placed in service in a prior taxable year,

is this election a change in method of accounting?

See Rev. Proc. 97–30, page 20.

Section 481.—Adjustments

Required by Changes in Method of

Accounting

If a taxpayer makes a general asset account

election in the current taxable year for depreciable

property placed in service in a prior taxable year,

does this change in method of accounting require

an adjustment under §§ 481(a)? See Rev. Proc.

97–30, page 20.

1997–25

I.R.B.

Part III. Administrative, Procedural, and Miscellaneous

Notice of Proposed Rulemaking

and Notice of Public Hearing

Residence of Trusts and

Estates—7701

REG–251703–96

AGENCY: Internal Revenue Service

(IRS), Treasury.

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

SUMMARY: This document contains

proposed regulations providing guidance

relating to the definition of a trust as a

United States person (domestic trust) or

foreign trust. The proposed regulations

reflect changes to the law made by the

Small Business Job Protection Act of

1996 and affect the determination of the

residency of trusts for federal tax purposes. This document also provides notice of a public hearing on these proposed regulations.

DATES: Written comments must be received by August 4, 1997. Requests to

speak (with outlines of oral comments

to be discussed) at the public hearing

scheduled for September 16, 1997, at 10

a.m. must be submitted by August 26,

1997.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–251703–96),

room 5226, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG–251703–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet

by selecting the ‘‘Tax Regs’’ option on

the IRS Home Page, or by submitting

comments directly to the IRS Internet

site at http://www.irs.ustreas.gov/prod/

tax_regs/comments.html. The public

hearing will be held in the Internal

Revenue Service Auditorium, Internal

Revenue Building, 1111 Constitution

Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION

CONTACT: Concerning the regulations,

James A. Quinn or Eliana Dolgoff,

(202) 622–3060; concerning submissions

and the hearing, Evangelista Lee, (202)

622–7190 (not toll-free numbers).

1997–25

I.R.B.

SUPPLEMENTARY INFORMATION:

Explanation of Provisions

Background

The proposed regulations provide that

a foreign trust is taxed in the same

manner as a nonresident alien. Thus,

once a trust is determined to be a

foreign trust, the residency of the fiduciary of the trust is not relevant in

determining the residence of the trust.

Additionally, section 7701(b) does not

apply to determine whether a trust is a

resident of the United States, and a

foreign trust is not present in the United

States for purposes of section 871(a)(2).

The proposed regulations require that

the terms of the trust instrument and

applicable law be applied to determine

whether the court test and the control

test are met. The residency of a trust

may change if the result of the court test

or control test changes.

Section 1907 of the Small Business

Job Protection Act of 1996 (the Act),

Public Law 104–188, 110 Stat. 1755

(August 20, 1996) amended sections

7701(a)(30) and (31) to provide a new

rule for determining whether a trust is

domestic or foreign (the new rule does

not apply to estates), effective for tax

years beginning after December 31,

1996, or at the election of the trustee of

a trust to tax years ending after August

20, 1996. Section 7701(a)(30)(E) provides that the term United States person

means any trust if (i) a court within the

United States is able to exercise primary

supervision over the administration of

the trust (court test), and (ii) one or

more United States fiduciaries have the

authority to control all substantial decisions of the trust (control test). Section

7701(a)(31)(B) provides that the term

foreign trust means any trust other than

trust

described

section

7701(a)(30)(E).

Prior to the Act, section 7701(a)(31)

provided that foreign estate and foreign

trust mean an estate or trust, as the case

may be, the income of which, from

sources without the United States, which

is not effectively connected with the

conduct of a trade or business within the

United States, is not includible in gross

income under subtitle A. Accordingly,

whether a trust was domestic or foreign

depended on whether the trust was more

comparable to a resident or nonresident

alien individual. Thus, it was necessary

to consider and weigh various factors

such as the location of the assets, the

country under whose laws the trust was

created, the residence of the fiduciary,

the nationality of the decedent or settlor,

the nationality of the beneficiaries, and

the location of the administration of the

trust. See Rev. Rul. 60–181 (1960–1

C.B. 257), citing B.W. Jones Trust v.

Commissioner, 46 B.T.A. 531 (1942),

aff’d, 132 F.2d 914 (4th Cir. 1943).

The Act made a number of procedural

and substantive changes to the tax treatment of foreign trusts that were designed to improve tax compliance and

administration. In making these overall

changes, Congress believed that it would

be appropriate to have an objective test

for determining whether a trust is foreign or domestic. Consequently, it enacted the two-part test set forth above.

The Safe Harbor

The IRS and Treasury Department

were concerned that the lack of authority construing trust law in many states

would make it difficult for taxpayers to

determine whether a trust is domestic or

foreign under the court and control tests.

Specifically, it may be difficult to determine whether the court of a particular

state would assert primary supervision

over the administration of a trust if that

trust had never appeared before a court.

Therefore, the proposed regulations provide a safe harbor based upon the

principle that when the administration of

a trust is conducted entirely within a

particular locality, the local courts will

exercise primary supervision over the

trust. Restatement (2d) of Conflicts of

Laws § 267. The safe harbor provides

that a trust is a domestic trust if,

pursuant to the terms of a trust instrument, the trust has only United States

fiduciaries, such fiduciaries are administering the trust exclusively in the United

States, and the trust is not subject to an

automatic migration provision. The IRS

and Treasury Department request comments on whether this special rule is

sufficient to address the lack of a welldeveloped body of local law.

The Court Test

The proposed regulations define the

relevant terms for purposes of the court

test. The term court includes any federal, state, or local court.

The term the United States includes

only the States and the District of

Columbia. Accordingly, a court within a

June 23, 1997

territory or possession of the United

States or within a foreign country is not

a court within the United States and a

trust subject to the primary supervision

of such a court fails to meet the court

test. The IRS and Treasury Department

request comments on the conclusion that

the term the United States is used in its

geographical sense and therefore excludes territories and possessions.

The term is able to exercise means

that if petitioned, a court has or would

have the authority under applicable law

to render orders or judgments resolving

issues concerning administration of the

trust.

The term primary supervision means

that a court has or would have the

authority to determine substantially all

issues regarding the administration of

the trust. Simply having jurisdiction

over the trustee, a beneficiary, or trust

property is not primary supervision.

The term administration of the trust

means the carrying out of the duties

imposed on a fiduciary by the terms of

the trust instrument and applicable law.

In order to provide certainty to taxpayers, the proposed regulations provide

some bright-line rules for satisfying the

court test. A trust meets the court test if

an authorized fiduciary registers the

trust in a court within the United States

under a state statute that has provisions

substantially similar to Article VII, Trust

Administration, of the Uniform Probate

Code.

In the case of a testamentary trust

established under a will probated within

the United States, if all fiduciaries of the

trust have been qualified as trustees of

the trust by a court within the United

States, the trust meets the court test.

In the case of an inter vivos trust, if

the fiduciaries or beneficiaries take steps

with a court within the United States

(such as the filing of a written request

with the court) that cause the administration of the trust to be subject to the

primary supervision of the court, the

trust meets the court test.

The proposed regulations clarify that

if both a United States court and a

foreign court are able to exercise primary supervision over the administration

of the trust, the trust will be considered

to meet the court test.

The proposed regulations contain

rules addressing automatic migration

clauses, also known as ‘‘flee clauses.’’

The proposed regulations provide that

the court test is not met if a United

States court’s attempt to assert jurisdiction or otherwise supervise the adminisJune 23, 1997

tration of the trust directly or indirectly

would cause the trust to migrate from

the United States.

The Control Test

The control test requires that one or

more United States fiduciaries have the

authority to control all substantial decisions of the trust. Under the proposed

regulations, the term fiduciary refers to

any person described in section

7701(a)(6) and § 301.7701–6(b). For

purposes of the control test, any other

person that has the power to control

substantial decisions of the trust, for

example a trust protector, will also be

treated as a fiduciary. The proposed

regulations treat such persons as fiduciaries because they are exercising powers

traditionally held by fiduciaries or because they can effectively exercise control over the fiduciaries.

Substantial decisions are those decisions that persons are authorized or

required to make under the terms of the

trust instrument and applicable law and

that are not ministerial. Included in the

proposed regulations is a nonexclusive

list of substantial decisions. Substantial

decisions do not include decisions exercisable by a grantor that is not a

fiduciary of the trust, or decisions exercisable by a beneficiary that affect only

the beneficiary’s interest in the trust.

In accordance with the legislative history, the proposed regulations provide

that United States fiduciaries have the

authority to control all substantial decisions of the trust when they have the

power by vote or otherwise to make all

of the substantial decisions of the trust

and no foreign fiduciary has the power

to veto the substantial decisions of the

United States fiduciaries.

The proposed regulations contain

rules addressing automatic migration

clauses, also known as ‘‘flee clauses.’’

The proposed regulations provide that

the control test is not met if an attempt

by any governmental agency or creditor

to collect information from or assert a

claim against the trust would cause one

or more substantial decisions of the trust

to no longer be controlled by United

States fiduciaries.

The proposed regulations are proposed to apply to trusts for taxable years

beginning after December 31, 1996, and

to a trust whose trustee has elected to

apply sections 7701(a)(30) and (31) to

the trust for taxable years ending after

August 20, 1996, under section

1907(a)(3)(B) of the Act. Notice 96–65

(1996–52 I.R.B. 28) grants trusts that

meet the conditions specified in that

notice additional time to comply with

the new domestic trust criteria contained

in the Act and allows such trusts to

continue to file as domestic trusts during

the period specified in that notice. Notice 96–65 also addresses the time and

manner for making the election provided

by the Act to apply the new domestic

trust criteria retroactively for taxable

years of the trust ending after August

20, 1996. Notice 96–65 remains in effect and should be consulted for these

purposes.

Special Analyses

It has been determined that this notice

of proposed rulemaking 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

regulation does not impose a collection

of information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue

Code, this notice of proposed rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small

Business Administration for comment on

its impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (preferably a signed original and

eight (8) copies) that are submitted

timely to the IRS. All comments will be

available for public inspection and copying.

A public hearing has been scheduled

for September 16, 1997, at 10 a.m. in

the Internal Revenue Service Auditorium, Internal Revenue Building, 1111

Constitution Avenue, NW, Washington

DC. Because of access restrictions, visitors will not be admitted beyond the

Internal Revenue Building lobby more

than 15 minutes before the hearing

starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral

comments at the hearing must submit

written comments by August 4, 1997,

and submit an outline of the topics to be

discussed and the time to be devoted to

1997–25

I.R.B.

each topic (preferably a signed original

and eight (8) copies) by August 26,

1997.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are James A. Quinn and Eliana

Dolgoff of the Office of Assistant Chief

Counsel (Passthroughs and Special Industries). However, other personnel from

the IRS and Treasury Department participated in their development.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 301 is

proposed to be amended as follows:

PART

301—PROCEDURE AND

ADMINISTRATION

Paragraph 1. The authority citation for

part 301 continues to read in part as

follows:

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

§ 301.7701–5 [Amended]

Par. 2. The last sentence of section

301.7701–5 is removed.

Par. 3. Section 301.7701–7 is added

to read as follows:

§ 301.7701–7 Trusts—domestic and foreign.

(a) In general. (1) A trust is a United

States person if—

(i) A court within the United States is

able to exercise primary supervision

over the administration of the trust

(court test); and

(ii) One or more United States fiduciaries have the authority to control all

substantial decisions of the trust (control

test).

(2) A trust is a United States person

for purposes of the Internal Revenue

Code at any time that the trust meets

both the court test and the control test.

For purposes of the regulations in this

chapter, the term domestic trust means a

trust that is a United States person. The

1997–25

I.R.B.

term foreign trust means any trust other

than a domestic trust.

(3) Except as otherwise provided in

part I, subchapter J, chapter 1 of the

Code, the taxable income of a foreign

trust is computed in the same manner as

the taxable income of a nonresident

alien. Thus, section 7701(b) does not

apply to determine whether a foreign

trust is a resident alien. In addition, a

foreign trust is not considered to be

present in the United States for purposes

of section 871(a)(2).

(b) Applicable law. The terms of the

trust instrument and applicable law must

be applied to determine whether the

court test and the control test are met.

trust is a domestic trust if the trust has

only United States fiduciaries, as defined in paragraph (e) of this section,

the trust is administered exclusively in

the United States pursuant to the terms

of a trust instrument, and the trust is not

subject to an automatic migration provision described in paragraph (d)(2)(v) or

(e)(3) of this section.

(2) Example. The following example

illustrates the rule of paragraph (c)(1) of

this section:

Example. A executes a trust instrument for the

equal benefit of A’s two children, B and C. The

trust instrument provides that DC, a State Y

corporation, is the only trustee of the trust.

Pursuant to the terms of the trust instrument, the

trust is administered in State Y, a state within the

United States. The trust is not subject to an

automatic migration provision described in paragraph (d)(2)(v) or (e)(3) of this section. No person

other than DC has any power over the trust. The

trust satisfies the safe harbor of paragraph (c)(1)

and is a domestic trust.

(d) The court test—(1) Definitions.

The following definitions apply for purposes of the court test:

(i) Court. The term court includes

any federal, state, or local court.

(ii) The United States. The term the

United States is used in this section in a

geographical sense. Thus, for purposes

of the court test, the United States

includes only the States and the District

of Columbia. See section 7701(a)(9).

Accordingly, a court within a territory or

possession of the United States or

within a foreign country is not a court

within the United States.

(iii) Is able to exercise. The term is

able to exercise means that a court has

or would have the authority under applicable law to render orders or judgments

resolving issues concerning administration of the trust.

(iv) Primary supervision. The term

primary supervision means that a court

has or would have the authority to

determine substantially all issues regarding the administration of the entire trust.

A court may have primary supervision

even if another court has jurisdiction

over a trustee, a beneficiary, or trust

property.

(v) Administration. The term administration of the trust means the carrying

out of the duties imposed on a fiduciary

by the terms of the trust instrument and

applicable law, including maintaining

the books and records of the trust, filing

tax returns, defending the trust from

suits by creditors, and determining the

amount and timing of distributions.

(2) Situations that meet the court

test—(i) Uniform Probate Code. A trust

meets the court test if a trust is registered by an authorized fiduciary in a

court within the United States under a

state statute that has provisions substantially similar to Article VII, Trust Administration, of the Uniform Probate

Code, 8 Uniform Laws Annotated 1

(West Supp. 1997), available from the

National Conference of Commissioners

on Uniform State Laws, 676 North St.

Clair Street, Suite 1700, Chicago, Illinois 60611.

(ii) Testamentary trust. In the case of

a trust created pursuant to the terms of a

will probated within the United States

(other than an ancillary probate), if all

fiduciaries of the trust have been qualified as trustees of the trust by a court

within the United States, the trust meets

the court test.

(iii) Inter vivos trust. In the case of a

trust other than a testamentary trust, if

the fiduciaries and/or beneficiaries take

steps with a court within the United

States that cause the administration of

the trust to be subject to the primary

supervision of the court, the trust meets

the court test.

(iv) A United States and a foreign

court are able to exercise primary supervision over the administration of the

trust. If both a United States court and a

foreign court are able to exercise primary supervision over the administration

of the trust, the trust meets the court

test.

(v) Automatic migration provisions.

Notwithstanding any other provision in

this section, a court within the United

States is not considered to have primary

supervision over the administration of

the trust if the trust instrument provides

that a United States court’s attempt to

assert jurisdiction or otherwise supervise

June 23, 1997

the administration of the trust directly or

indirectly would cause the trust to migrate from the United States.

(3) Examples. The following examples illustrate the rules of this paragraph (d):

Example 1. A, a United States citizen, executes

a trust instrument for the equal benefit of A’s two

United States children. The trust instrument provides that DC, a domestic corporation, is to act as

trustee of the trust and that the trust is to be

administered in Country X, a foreign country. The

trust instrument provides that the law of State Y, a

state within the United States, is to govern the

trust. Under the law of Country X, a court within

Country X is able to exercise primary supervision

over the administration of the trust but, as required

by the trust instrument, applies the law of State Y

to the trust. No court within the United States is

able to exercise primary supervision over the

administration of the trust. The trust fails to satisfy

the court test and therefore is a foreign trust.

Example 2. Trust T owns a single asset, an

interest in land located in State Y, a state within

the United States. Under the law of State Y, a trust

owning solely real property within the state is

subject to the primary supervision over the administration of the trust by a court within State Y. The

trust satisfies the court test.

Example 3. A, a United States citizen, executes

a trust instrument for his own benefit and the

benefit of B, his United States spouse. The trust

instrument provides that the trust is to be administered in State Y, a state within the United States,

by DC, a State Y corporation. The trust instrument

further provides that in the event that a creditor

sues the trustee in a United States court, the trust

will migrate from State Y to Country Z, a foreign

jurisdiction, so that no United States court will

have jurisdiction over the trust. A court within the

United States is not able to exercise primary

supervision over the administration of the trust

because the United States court’s jurisdiction over

the administration of the trust is automatically

terminated in the event the court attempts to assert

jurisdiction. Therefore, the trust fails to satisfy the

court test from the time of its creation and is a

foreign trust.

(e) Control test—(1) Definitions—(i)

United States fiduciary. The term fiduciary includes any person described in

section 7701(a)(6) and § 301.7701–6(b).

In addition, for purposes of this section,

any other person who has the power to

control one or more substantial decisions of the trust (and therefore has a

power ordinarily held by a fiduciary)

will be treated as a fiduciary. A person

may be treated as a fiduciary even if the

trust instrument provides for the person

to be relieved of personal liability for

violation of duties. A United States

fiduciary is a fiduciary that is a United

States person within the meaning of

section 7701(a)(30). For example, a fiduciary which is a United States corporation owned by a nonresident alien is a

United States fiduciary.

(ii) Substantial decisions. (A) The

term substantial decisions means those

decisions (other than those described in

June 23, 1997

paragraph (e)(1)(ii)(B) of this section)

that persons are authorized or required

to make under the terms of the trust

instrument and applicable law and that

are not ministerial. Substantial decisions

include, but are not limited to—

(1) Whether and when to distribute

income or corpus;

(2) The amount of any distributions;

(3) The selection of a beneficiary;

(4) The power to make investment

decisions;

(5) Whether a receipt is allocable to

income or principal;

(6) Whether to terminate the trust;

(7) Whether to compromise, arbitrate,

or abandon claims of the trust;

(8) Whether to sue on behalf of the

trust or to defend suits against the trust;

and

(9) Whether to remove, add, or replace a trustee.

(B) Substantial decisions do not include decisions exercisable by a grantor,

unless the grantor is acting as a fiduciary under section 7701(a)(6) and

§ 301.7701–6(b). In addition, substantial decisions do not include decisions

exercisable by a beneficiary, unless the

beneficiary is acting as a fiduciary under

section 7701(a)(6) and § 301.7701–6(b),

that affect solely the portion of the trust

in which the beneficiary has an interest.

Decisions that are ministerial include

decisions regarding details such as the

bookkeeping, the collection of rents, and

the execution of investment decisions

made by the fiduciaries.

(iii) Control. Control means having

the power, by vote or otherwise, to

make all of the substantial decisions of

the trust, with no other person having

the power to veto the substantial decisions. However, the ability of a grantor

(other than a grantor acting as a fiduciary under section 7701(a)(6) and

§ 301.7701–6(b)) to veto another person’s substantial decision does not cause

such person to fail to control that substantial decision. In addition, the ability

of a beneficiary (other than a beneficiary acting as a fiduciary under section

7701(a)(6) and § 301.7701–6(b)) to veto

another person’s substantial decision that

affects solely the portion of the trust in

which the beneficiary has an interest

does not cause such person to fail to

control that substantial decision.

(2) Replacement of a fiduciary. In the

event of an inadvertent change in the

fiduciaries that would cause a change in

the residency of a trust, the trust is

allowed six months from the date of the

change in the fiduciaries to adjust either

the fiduciaries or the residence of the

fiduciaries so as to avoid a change in

the residence of the trust. Inadvertent

changes in the fiduciaries include the

death of a fiduciary or the abrupt resignation of a fiduciary. If the adjustment

is made within six months, the trust is

treated as retaining its pre-change residence during the six-month period. If

the adjustment is not made within six

months, the trust residence changes as

of the date of the inadvertent change.

(3) Automatic migration provisions.

Notwithstanding any other provision in

this section, United States fiduciaries are

not considered to control all substantial

decisions of the trust if an attempt by

any governmental agency or creditor to

collect information from or assert a

claim against the trust would cause one

or more substantial decisions of the trust

to no longer be controlled by United

States fiduciaries.

(4) Examples. The following examples illustrate the rules of this paragraph (e):

Example 1. A is a nonresident alien individual.

A is the grantor and beneficiary of an individual

retirement account (IRA) and has the exclusive

power to make decisions regarding withdrawals

from the IRA and to direct its investments. A is

not a fiduciary as defined in paragraph (e)(1)(i) of

this section. The IRA has a single United States

trustee and no foreign trustees. The United States

trustee has the power to control all decisions of

the trust other than withdrawal and investment

decisions. In this case, decisions regarding withdrawals and the trust’s investments are not substantial decisions because these decisions are

solely exercisable by the grantor. Therefore, the

control test is satisfied because the United States

fiduciary controls all substantial decisions.

Example 2. A is a nonresident alien individual.

A is the grantor of a trust and has the power to

revoke the trust, in whole or in part and revest

assets in A. A is the owner of the trust under

section 676. A is not a fiduciary as defined in

paragraph (e)(1)(i) of this section. The trust has

two trustees, B, a United States person and C, a

nonresident alien. C’s only power is the power to

make distributions from the trust and C can

exercise this power without authorization from B.

In this case, decisions exercisable by A to have

trust assets distributed to A are not substantial

decisions because these decisions are exercisable

by the grantor. However, distribution decisions

exercisable by C are substantial decisions. Therefore, the trust is a foreign trust because B does not

control all substantial decisions of the trust.

Example 3. Trust has three fiduciaries, A, B, and

C. A and B are United States citizens and C is a

nonresident alien. The trust instrument directs that

C is to make all of the trust’s investment decisions, but that A and B may veto C’s investment

decisions. A and B cannot act to make the

investment decisions on their own. The control test

is not satisfied because the United States fiduciaries, A and B, do not have the power to make all

of the substantial decisions of the trust.

Example 4. Trust has two fiduciaries, A and B,

both of whom are United States citizens. The trust

instrument provides that C, a foreign corporation,

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I.R.B.

will serve as an advisor and recommend investments to A and B. A and B may accept or reject

C’s recommendations and can make investments

that C has not recommended. A and B control all

other decisions of the trust. A and B delegate to C

the authority to execute the investment decisions

approved by A and B. The control test is satisfied

because the United States fiduciaries control all

substantial decisions of the trust.

Example 5. Trust has three fiduciaries, A, B, and

C. A and B are United States citizens and C is a

nonresident alien. The trust instrument provides

that no substantial decisions of the trust can be

made unless there is unanimity among the fiduciaries. The control test is not satisfied because the

United States fiduciaries do not control all the

substantial decisions of the trust. No substantial

decisions can be made without C’s agreement.

Example 6. (i) A trust that satisfies the court test

has three fiduciaries, A, B, and C. A and B are

United States citizens and C is a nonresident alien.

Decisions are made by majority vote of the

fiduciaries. The trust instrument provides that

upon the death or resignation of any of the

fiduciaries, D, a nonresident alien, is the successor

fiduciary. A dies and D becomes a fiduciary of the

trust. Two months after A dies, E, a United States

person, replaces D as a fiduciary of the trust.

During the period after A’s death and before E

begins to serve, the trust satisfies the control test

and remains a domestic trust.

(ii) Assume the same facts as in paragraph (i) of

this Example 6 except that at the end of the

six-month period after A’s death, D has not been

replaced and remains a fiduciary of the trust. The

trust became a foreign trust on the date A died.

Example 7. Trust has three beneficiaries, A, B

and C, all of whom are nonresident aliens. Each

beneficiary has the right to receive all of the

income from his or her share of the trust for life.

Each beneficiary also has a limited power of

appointment over his or her respective share of the

trust. The trust has only one fiduciary, D, a United

States citizen. The trust meets the control test

because the United States fiduciary controls all

substantial decisions of the trust notwithstanding

the beneficiaries’ powers of appointment over their

respective interests.

(f) Effective date. This section is applicable to trusts for taxable years beginning after December 31, 1996, and to

trusts whose trustee has elected to apply

sections 7701(a)(30) and (31) to the

trust for taxable years ending after August 20, 1996, under section

1907(a)(3)(B) of the Small Business Job

Protection Act of 1996, Public Law

104–188, 110 Stat. 1755 (26 U.S.C.

7701 note).

Michael P. Dolan,

Acting Commissioner of Internal

Revenue.

(Filed by the Office of the Federal Register on

June 4, 1997, 8:45 a.m., and published in the issue

of the Federal Register for June 5, 1997, 62 F.R.

30796)

1997–25

I.R.B.

Notice of Proposed Rulemaking

and Notice of Public Hearing

SUPPLEMENTARY INFORMATION

Background

Inbound Grantor Trusts With

Foreign Grantors

REG–252487–96

AGENCY: Internal Revenue Service

(IRS), Treasury.

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

SUMMARY: This document contains

proposed regulations implementing section 672(f) of the Internal Revenue

Code, as amended by the Small Business Job Protection Act of 1996, which

relates to the application of the grantor

trust rules to certain trusts established

by foreign persons. The proposed regulations affect primarily United States

persons who are beneficiaries of trusts

established by foreign persons. This

document also provides notice of a

public hearing on these proposed regulations.

DATES: Written comments must be received by August 4, 1997. Requests to

speak (with outlines of oral comments)

to be discussed at the public hearing

scheduled for August 27, 1997, at 10

a.m. must be submitted by August 6,

1997.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–252487–96),

room 5226, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG–252487–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet

by selecting the ‘‘Tax Regs’’ option on

the IRS Home Page, or by submitting

comments directly to the IRS Internet

site at http://www.irs.ustreas.gov/prod/

tax_regs/comments.html. The public

hearing will be held in room 3313,

Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION

CONTACT: Concerning § 1.671–2(e),

James Quinn (202) 622–3060; concerning the remainder of these regulations,

M. Grace Fleeman (202) 622–3850;

concerning submissions and the hearing,

Michael Slaughter (202) 622–7190 (not

toll-free numbers).

Section 1904 of the Small Business

Job Protection Act of 1996 (the Act),

Public Law 104–188, 110 Stat. 1755

(August 20, 1996), amended section

672(f) and certain other sections of the

Internal Revenue Code (Code). The

amendments affect the application of

sections 671 through 679 of the Code

(the grantor trust rules) to certain trusts

created by foreign persons.

1. Prior law

Under prior law, a grantor of a trust

generally was treated as the owner of

any portion of the trust over which he

retained any of the powers or interests

described in sections 673 through 677

without regard to whether he was a

domestic or foreign person. A special

rule contained in prior section 672(f)

generally provided that, if a U.S. beneficiary of a trust created by a foreign

person transferred property to the foreign person by gift, the U.S. beneficiary

was treated as the grantor of the trust to

the extent of the transfer.

Under the prior rules, if a foreign

person created a trust with one or more

U.S. beneficiaries that was treated as a

grantor trust with the foreign person as

the grantor, a distribution of income

from the trust to a U.S. beneficiary was

treated as a gift and was not subject to

U.S. income tax in the hands of the

beneficiary. See Rev. Rul. 69–70

(1969–1 C.B. 182). If the income of the

trust was not taxable to the foreign

grantor under section 871 and also not

taxable to either the grantor or the trust

by either the grantor’s country of residence or another foreign country, the

income of the trust was, thus, not subject to tax by any jurisdiction.

A special rule contained in section

665(c) provided generally that intermediaries or nominees interposed between

certain foreign trusts and their U.S.

beneficiaries could be disregarded. However, that rule applied only to trusts

created by U.S. persons.

2. Overview of changes

The changes made by section 1904 of

the Act are designed to ensure that U.S.

persons who benefit from offshore trusts

created by foreign persons (inbound

trusts) pay an appropriate amount of

U.S. tax. Generally, the grantor trust

rules now cause a person to be treated

as the owner of a trust only to the

June 23, 1997

extent such application results, directly

or indirectly, in an amount being currently taken into account in computing

the income of a U.S. citizen or resident

or a domestic corporation. Exceptions

are provided for certain revocable trusts,

for trusts from which the only amounts

distributable during the lifetime of the

grantor are to the grantor or the grantor’s spouse, and for certain compensatory trusts. There also are grandfather

rules for certain trusts that were in

existence on September 19, 1995.

As a result of the changes, many

inbound trusts that were grantor trusts

under prior law are now nongrantor

trusts. Distributions of trust income to

the U.S. beneficiaries of such trusts are

now taxable to U.S. beneficiaries and

may be subject to an interest charge on

accumulation distributions.

Section 1904 of the Act also includes

some special rules. Section 643(h),

which replaces former section 665(c),

treats any amount paid to a U.S. person

that is derived directly or indirectly

from a foreign trust of which the payor

is not the grantor as if the amount is

paid by the foreign trust directly to the

U.S. person. Section 672(f)(4) allows

the IRS to recharacterize a purported

gift or bequest from a partnership or

foreign corporation when necessary to

prevent the avoidance of the purpose of

section 672(f). Section 672(f)(5), which

is an expansion of prior section 672(f),

generally provides that if a U.S. beneficiary of a trust created by a foreign

person transfers property to the foreign

person, the U.S. beneficiary is treated as

the grantor of the trust to the extent of

the transfer.

Explanation of Provisions

1. § 1.643(h)–1: Distributions by certain foreign trusts through intermediaries

The proposed regulations describe the

circumstances under which an amount

of property that is derived, directly or

indirectly, by a U.S. person from a

foreign trust through an intermediary

will be deemed to have been paid

directly by the foreign trust to the U.S.

person. This rule does not apply if the

intermediary is the grantor of the portion of the trust from which the amount

is distributed. The amount will be

deemed to have been paid directly by

the foreign trust if any one of the

following conditions is satisfied: (1) the

intermediary is related (as defined in the

regulations) to either the U.S. person or

June 23, 1997

the foreign trust and the intermediary

transfers to the U.S. person either property that the intermediary received from

the trust or proceeds from the property

that the intermediary received from the

trust; (2) the intermediary would not

have transferred the property to the U.S.

person (or would not have transferred

the property on substantially the same

terms) but for the fact the intermediary

received property from the foreign trust;

or (3) the intermediary received the

property from the foreign trust pursuant

to a plan one of the principal purposes

of which was the avoidance of U.S. tax.

The proposed regulations describe the

effect of disregarding the intermediary.

If the intermediary is an agent of either

the foreign trust or the U.S. person

under generally applicable agency principles (under the standards set forth in

Commissioner v. Bollinger, 485 U.S.

340 (1988)), the amount is treated as

paid by the foreign trust to the U.S.

person in the year it would be so treated

under the general principles. Thus, if the

intermediary is an agent of the foreign

trust, the amount is treated as paid to

the U.S. person in the year it is paid by

the intermediary to the U.S. person. If,

however, the intermediary is an agent of

the U.S. person, the amount is treated as

paid to the U.S. person in the year it is

paid by the foreign trust to the intermediary.

If the intermediary is not an agent of

either the foreign trust or the U.S.

person under generally applicable

agency principles, the intermediary generally will be treated as an agent of the

foreign trust, and the amount will be

treated as paid by the foreign trust to

the U.S. person in the year the amount

is paid by the intermediary to the U.S.

person. However, the district director

may determine, based on all the relevant

facts and circumstances, that the intermediary should be treated as the agent

of the U.S. person.

The regulations provide a de minimis

rule for distributions that do not exceed

in the aggregate $10,000.

2. § 1.671–2(e): Definition of grantor

The proposed regulations provide a

definition of grantor that applies for

purposes of the grantor trust rules generally. A grantor is any individual, corporation, or other person to the extent such

person (i) creates a trust or (ii) directly

or indirectly makes a gratuitous transfer

to a trust. For purposes of the proposed

regulations, a gratuitous transfer is any

transfer other than a transfer for fair

market value, or a corporate or partnership distribution. Treasury and the IRS

request comments regarding the appropriate scope of gratuitous transfers.

A grantor includes a person who

acquires an interest in a trust in a

nongratuitous transfer from a person

who is a grantor of the trust. A grantor

also includes an investor who acquires

an interest in a fixed investment trust

from a person who had acquired his

interest through a direct investment in

the trust. Treasury and the IRS request

comments on the appropriate scope of

these rules as they affect fixed investment trusts.

If a person creates or funds any

portion of a trust primarily as an accommodation for another person, the other

person will be treated as a grantor with

respect to such portion of the trust. See,

e.g., Stern v. Commissioner, 77 T.C. 614

(1981), rev’d on other grounds, 747 F.2d

555 (9th Cir. 1984).

These regulations are not intended to

change the result of existing law with

respect to trusts used for business purposes. See § 301.7701–4(e) (environmental remediation trusts); Rev. Rul.

87–127, 1987–2 C.B. 156 (pre-need funeral trusts); Rev. Proc. 92–64, 1992–2

C.B. 422 (rabbi trusts). Treasury and the

IRS request comments on the application of these new rules to trusts used for

business purposes.

A grantor of a trust may or may not

be treated as an owner of the trust under

sections 671 through 677 and 679. A

person other than a grantor of a trust

may be treated as an owner of the trust

under section 678.

3. § 1.672(f)–1: Foreign persons not

treated as owners

The proposed regulations prescribe a

two-step analysis for implementing the

general rule of section 672(f). First, the

grantor trust rules other than section

672(f) (the basic grantor trust rules) are

applied to determine the worldwide

amount and the U.S. amount. Then, the

trust is treated as partially or wholly

owned by a foreign person based on an

annual year-end comparison of the

worldwide amount and the U.S. amount.

The worldwide amount is defined as

the net amount of income, gains, deductions, and losses that would be taken

into account for the current year under

the basic grantor trust rules in computing the worldwide taxable income of

any person, whether or not such person

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I.R.B.

is a U.S. taxpayer (as defined in the

regulation). The worldwide amount is

determined in accordance with U.S.

principles of income taxation, and includes amounts that would be attributable to foreign persons, without regard

to whether such amounts are subject to

U.S. income taxation.

The U.S. amount is defined as the net

amount of income, gains, deductions,

and losses that would be taken into

account for the current year under the

basic grantor trust rules (directly or

through one or more entities) in computing the taxable income of a U.S. taxpayer. The U.S. amount includes

amounts such as interest on state or

local bonds that are not includible in

gross income.

A U.S. taxpayer is defined as any

person who is a U.S. citizen, a resident

alien individual, a domestic corporation,

a U.S. person who is treated as the

owner of a trust under section 679, or a

domestic trust to the extent such trust

actually pays U.S. tax with respect to

the income, gains, deductions, and

losses.

If the worldwide amount and the U.S.

amount are the same, the basic grantor

trust rules continue to apply without the

limitation of section 672(f). If the

worldwide amount is greater than the

U.S. amount, section 672(f) prevents the

basic grantor trust rules from treating a

person as the owner of that portion of

the trust attributable to the excess of the

worldwide amount over the U.S.

amount.

4. § 1.672(f)–2: Trusts created by certain foreign corporations

Section 672(f)(3) provides in part

that, except as otherwise provided in

regulations, a controlled foreign corporation (CFC) shall be treated as a domestic corporation for purposes of section

672(f)(1). Under the proposed regulations, a CFC that creates and funds a

trust will be treated as a domestic

corporation to the extent that, if the

basic grantor trust rules were applied,

income earned by the trust for the

taxable year would be subpart F income

to the CFC that would be currently

taken into account in computing the

gross income of a U.S. citizen or resident or a domestic corporation. However, the CFC will not be treated as a

domestic corporation to the extent the

income of the trust would not be subpart

F income or to the extent it would be

subpart F income but would not be

1997–25

I.R.B.

taken into account in computing the

gross income of a U.S. citizen or resident or a domestic corporation (e.g., the

CFC had no overall earnings and profits).

The proposed regulations include

similar rules for trusts created by passive foreign investment companies

(PFICs) or foreign personal holding

companies.

Section 672(f)(3) also provides that

the general rule of section 672(f)(1)

shall not apply for purposes of section

1296. The proposed regulations implement this rule by providing that, for

purposes of determining whether a foreign corporation is a PFIC, the grantor

trust rules shall be applied as if section

672(f) had not come into effect. Consequently, a foreign corporation cannot

avoid PFIC status by transferring passive assets to a trust that would be

treated as a nongrantor trust if section

672(f) were applied.

5. § 1.672(f)–3: Exceptions to general

rule

A. Certain revocable trusts

The proposed regulations provide that

the general rule of § 1.672(f)–1 does

not apply to any portion of a trust if the

power to revest in the grantor title to

such portion is exercisable solely by the

grantor without the approval or consent

of any other person. If the grantor can

exercise the power only with the approval of a related or subordinate party

who is subservient to the grantor, such

power will be treated as exercisable

solely by the grantor.

The exception will not apply unless

the power to revest is exercisable for a

period or periods aggregating 183 days

or more during the taxable year of the

trust. This rule is intended to provide a

bright line rule for the benefit of both

taxpayers and IRS examiners that addresses potentially abusive situations in

which a power to revest is so limited

that it is not likely to be exercised. The

183 days need not be consecutive; thus,

a power to revest that is exercisable

each year from January 1 through May

31 and again from September 1 through

December 31 would be eligible for the

exception.

Consistent with the statute, the proposed regulations provide a grandfather

rule for a trust that was treated as

owned by the grantor under section 676

on September 19, 1995. As long as such

a trust would continue to be so treated

under the basic grantor trust rules, the

trust will be exempt from the general

rule of section 672(f), except with respect to any portion of the trust attributable to transfers to the trust after September 19, 1995. Under the proposed

regulations, separate accounting is required for amounts transferred to the

trust after September 19, 1995, together

with all income and gains thereof, as

well as losses and distributions therefrom.

B. Certain other trusts

The proposed regulations provide that

the general rule does not apply to any

trust (or portion of a trust) if the only

amounts distributable (whether income

or corpus) from such trust (or portion of

a trust) during the lifetime of the grantor

are amounts distributable to the grantor

or the grantor’s spouse. For this purpose,

payments

reasonable

nongratuitous amounts, such as reasonable administrative expenses, are not

considered to be amounts distributable

from the trust.

The proposed regulations clarify that

amounts distributable in discharge of a

legal obligation of the grantor or the

grantor’s spouse will generally be

treated as amounts distributable to the

grantor or the grantor’s spouse. Thus, it

is expected that a reinsurance trust that

would have been a grantor trust under

prior law generally will continue to be a

grantor trust. (No inference is intended

as to whether a reinsurance trust constitutes a trust under regulation

§ 301.7701–4.) However, a legal obligation will not include an obligation to a

person who is related (as defined in the

regulations) to the grantor or the grantor’s spouse, unless the obligation was

entered into for adequate and full consideration in money or money’s worth.

Trusts from which distributions are taxable as compensation for services rendered generally will be covered by the

exception for compensatory trusts, described below.

Amounts distributable to support a

family member will be treated as

amounts distributable to the grantor or

the grantor’s spouse only if certain

requirements are satisfied. Although different jurisdictions have different requirements for support obligations, administrative simplicity is served by

providing one uniform rule on this

point. Under the proposed regulations,

the family member must be an individual who would be treated as a dependent of the grantor or the grantor’s

June 23, 1997

spouse under sections 152(a)(1) through

(8), without regard to the requirement

that half of the individual’s support be

received from the grantor or the grantor’s spouse. In addition, the family

member must be either permanently and

totally disabled (within the meaning of

section 22(e)(3)) or, in the case of a son,

daughter, stepson, or stepdaughter, less

than 24 years old.

Consistent with the statute, the proposed regulations provide a grandfather

rule for a trust that was treated as

owned by the grantor under section 677

(other than subsection (a)(3) thereof) on

September 19, 1995. As long as such a

trust would continue to be so treated

under the basic grantor trust rules, the

trust will be exempt from the general

rule, except with respect to any portion

of the trust attributable to transfers to

the trust after September 19, 1995. Under the proposed regulations, separate

accounting is required for amounts

transferred to the trust after September

19, 1995, together with all income and

gains thereof, as well as losses and

distributions therefrom.

C. Compensatory trusts

The proposed regulations implement

section 672(f)(2)(B), which provides

that, except as provided in regulations,

the general rule shall not apply to any

portion of a trust from which distributions are taxable as compensation for

services rendered. Tracking the language

of the statute, the proposed regulations

list categories of trusts that constitute

compensatory trusts, without regard to

whether they could be treated as grantor

trusts under the basic grantor trust rules.

This list is intended to be an exclusive

list. However, the proposed regulations

also provide that additional categories of

compensatory trusts may be designated

later in guidance published in the Internal Revenue Bulletin.

The following categories of trusts are

classified as compensatory trusts: (i)

qualified trusts described in section

401(a), (ii) trusts described in section

457(g), (iii) nonexempt employees’

trusts described in section 402(b), (iv)

individual retirement account (IRA)

trusts that are either simplified employee

pensions described in section 408(k) or

simple retirement accounts described in

section 408(p), (v) IRA trusts to which

the only contributions are rollover contributions listed in section 408(a)(1), (vi)

certain so–called rabbi trusts (see Rev.

Proc. 92–64 (1992–2 C.B. 422)), and

June 23, 1997

(vii) trusts that are welfare benefit funds

described in section 419(e) (without regard to whether they provide taxable

benefits).

The IRS and Treasury contemplate

that the nonexempt employees’ trusts

listed in category (iii) above will be

treated as grantor trusts only to the

extent provided in proposed regulations

§ 1.671–1(g) and § 1.671–1(h), which

were published in the Federal Register

(61 FR 50778) on September 27, 1996.

IRAs that are excluded from the list

of compensatory trusts because they are

funded by individuals, rather than employers, are expected to be covered by

one or both of the exceptions for revocable trusts or for trusts from which the

only amounts distributable during the

lifetime of the grantor are to the grantor

or the grantor’s spouse.

6. § 1.672(f)–4: Recharacterization of

purported gifts

The proposed regulations implement

the purported gift rule of section

672(f)(4), which was enacted as a

backstop to section 672(f). See Staff of

the Joint Committee on Taxation, 104th

Cong., 2nd Sess., General Explanation

of the Tax Legislation Enacted in the

104th Congress, at 271 (1996). The

purported gift rule prevents taxpayers

from avoiding the general rule of section 672(f) by using a partnership or a

foreign corporation as a substitute for a

trust.

As a general rule, if a U.S. donee

receives a purported gift or bequest

directly or indirectly from a partnership,

the purported gift or bequest must be

included in the U.S. donee’s income as

ordinary income. If a U.S. donee receives a purported gift or bequest directly or indirectly from a foreign corporation, the purported gift or bequest

generally must be included in the U.S.

donee’s gross income as a distribution

from the foreign corporation. In the

latter case, the U.S. donee will not be

treated as having basis in the foreign

corporation, and the U.S. donee will be

treated as having a holding period in the

foreign corporation equal to the average

holding period (using a weighted average) of the actual interest holders.

However, the gift or bequest will not

be recharacterized if the donee can

establish that a U.S. citizen or resident

alien who directly or indirectly holds an

interest in the partnership or foreign

corporation treated the purported gift as

a distribution from the partnership or

foreign corporation and a subsequent

gift to the donee. There also is an

exception for charitable contributions to

donees described in section 170(c).

The proposed regulations provide

rules for gratuitous transfers to U.S.

donees from trusts created by partnerships or foreign corporations. As a result, a partnership or foreign corporation

cannot avoid the purported gift rule by

creating a nongrantor trust that makes

an immediate nontaxable distribution of

trust corpus to a U.S. donee. Under the

proposed regulations, if the partnership

or foreign corporation is not treated

under the grantor trust rules as the

owner of the portion of the trust from

which property is distributed to a U.S.

donee in a gratuitous transfer, the distribution will be characterized as a distribution from the partnership or foreign

corporation if such characterization results in a higher U.S. tax liability.

Notwithstanding any other provision,

the proposed regulations provide that the

district director may recharacterize a

transfer that is subject to the rules of

section 672(f)(4) to prevent the avoidance of U.S. tax or clearly to reflect

income. For example, the district director may determine, based upon the facts

and circumstances, that a distribution

from a partnership or foreign corporation is more properly treated as a distribution from a trust.

The proposed regulations provide a de

minimis rule for purported gifts or bequests that do not exceed in the aggregate $10,000.

7. § 1.672(f)–5: Special rules

A. Transfers by certain beneficiaries to

foreign settlor

The proposed regulations provide that

if, but for section 672(f)(5), a foreign

person would be treated as the owner of

any portion of a trust, any U.S. beneficiary of the trust will be treated as the

owner of a portion of the trust to the

extent the U.S. beneficiary directly or

indirectly made transfers of property to

such foreign person in excess of transfers to the U.S. beneficiary from the

foreign person. (Such a transfer may

also constitute an indirect transfer from

a U.S. person to a foreign trust for

purposes of section 679.) The U.S. beneficiary need not have been a U.S.

person at the time of the transfer.

The proposed regulations do not

specify a time period within which a

transfer must have been made to trigger

this rule. However, they do provide that

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I.R.B.

the rule will not apply to the extent the

U.S. beneficiary can demonstrate that

the transfer was wholly unrelated to any

transaction involving the trust. In addition, consistent with the statute, the

proposed regulations provide that a

transfer of property does not include

either a nongratuitous transfer or a gift

that would be excluded from taxable

gifts under section 2503(b).

B. Different taxable years

The proposed regulations provide that

if a person has a different taxable year

from the taxable year of the trust, an

amount is currently taken into account

in computing the income of such person

for purposes of the general rule if the

amount is taken into account for the

taxable year of such person that includes

the last day of the taxable year of the

trust.

C. Entity characterization

The proposed regulations provide that

entities generally will be characterized

under U.S. income tax principles. See

regulations §§ 301.7701–1 through

301.7701–4. However, an entity having

a single owner could avoid the purported gift rule if it could elect to be

disregarded as a separate entity, because

the purported gift or bequest would then

be received from the owner of the

entity, rather than from the entity itself.

Therefore, the proposed regulations provide that, for purposes of section

672(f)(4), a wholly owned business entity must be treated as a corporation,

separate from its single owner.

8. § 301.7701–2(c)(2)(iii): Special rule

for business entities that make purported

gifts

As explained above, an entity having

a single owner could avoid the purported gift rule if it elected to be

disregarded as a separate entity under

the existing entity classification regulations. Therefore, the proposed regulations add a new sentence to the existing

regulations to provide that, for purposes

of section 672(f)(4), a wholly owned

business entity must be treated as a

corporation, separate from its owner.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been

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I.R.B.

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these

regulations, and, because the regulations

do not impose a collection of information on small entities, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does

not apply. Pursuant to section 7805(f) of

the Code, these regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on

small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (preferably a signed original and

eight (8) copies) that are submitted

timely to the IRS. All comments will be

available for public inspection and copying.

A public hearing has been scheduled

for August 27, 1997, at 10 a.m., in room

3313, Internal Revenue Building, 1111

Constitution Avenue, NW, Washington

DC. Because of access restrictions, visitors will not be admitted beyond the

Internal Revenue Building lobby more

than 15 minutes before the hearing

starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral

comments at the hearing must submit

written comments by August 4, 1997,

and submit an outline of the topics to be

discussed and the time to be devoted to

each topic (preferably a signed original

and eight (8) copies) by August 6, 1997.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal author of these regulations is M. Grace Fleeman of the Office

of Associate Chief Counsel (International). However, other personnel from

the IRS and Treasury Department participated in their development.

Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301

are proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding entries in

numerical order to read as follows:

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

Section 1.643(h)–1 also issued under

26 U.S.C. 643(a)(7).

Section 1.671–2(e) also issued under

26 U.S.C. 643(a)(7) and 672(f)(6).

Section 1.672(f)–1 also issued under

26 U.S.C. 643(a)(7) and 672(f)(6).

Section 1.672(f)–2 also issued under

26 U.S.C. 643(a)(7), 672(f)(3) and (6).

Section 1.672(f)–3 also issued under

26 U.S.C. 643(a)(7), 672(f)(2) and (6).

Section 1.672(f)–4 also issued under

26 U.S.C. 643(a)(7), 672(f)(4) and (6).

Section 1.672(f)–5 also issued under

26 U.S.C. 643(a)(7) and 672(f)(6). * * *

Par. 2. Section 1.643(h)–1 is added to

read as follows: § 1.643(h)–1 Distributions by certain foreign trusts through

intermediaries.

(a) In general. For purposes of sections 641 through 683, any amount of

property that is derived, directly or

indirectly, by a United States person

from a foreign trust through another

person (an intermediary) shall be

deemed to have been paid directly by

the foreign trust to the United States

person if any one of the following

conditions is satisfied—

(1) The intermediary is related

(within the meaning of paragraph (e) of

this section) to either the United States

person or the foreign trust and the

intermediary transfers to the United

States person either property that the

intermediary received from the foreign

trust or proceeds from the property that

the intermediary received from the foreign trust;

(2) The intermediary would not have

transferred the property to the United

States person (or would not have transferred the property to the United States

person on substantially the same terms)

but for the fact that the intermediary

received property from the foreign trust;

(3) The intermediary received the

property from the foreign trust pursuant

to a plan one of the principal purposes

of which was the avoidance of U.S. tax.

(b) Exception for grantor as intermediary. Paragraph (a) of this section shall

not apply if the intermediary is the

grantor of the portion of the trust from

which the amount is derived. For the

definition of grantor, see § 1.671–2(e).

June 23, 1997

directly by the foreign trust to a United

States person pursuant to this section,

one of the following rules shall apply:

(1) Intermediary is agent under general principles. If the intermediary is an

agent of the foreign trust or the United

States person under generally applicable

agency principles, the payment shall be

treated as paid by the foreign trust to

the United States person in the year it

would be so treated under such principles. Thus, if the intermediary is an

agent of the foreign trust, the payment

shall be treated as paid to the United

States person in the year the amount is

paid by the intermediary to the United

States person. If, however, the intermediary is an agent of the United States

person, the payment shall be treated as

paid to the United States person in the

year the amount is paid by the foreign

trust to the intermediary.

(2) Intermediary is not agent under

general principles—(i) Agent of foreign

trust. Except as provided in paragraph

(c)(2)(ii) of this section, if the intermediary is not an agent of the foreign trust

or the United States person under generally applicable agency principles—

(A) The intermediary shall be treated

as an agent of the foreign trust; and

(B) The payment shall be treated as

paid by the foreign trust to the United

States person in the year the amount is

paid by the intermediary to the United

States person.

(ii) Agent of United States person.

The district director may determine,

based on all the relevant facts and

circumstances, that the intermediary

should be treated as the agent of the

United States person. If the intermediary

is treated as the agent of the United

States person pursuant to this paragraph

(c)(2)(ii), the payment shall be treated as

paid to the United States person in the

year the intermediary receives the payment from the foreign trust.

(d) De minimis exception. This section shall not apply if, during the taxable year of the United States person,

the aggregate amount that is transferred

to such person from all foreign trusts

through one or more intermediaries does

not exceed $10,000.

(e) Related parties. For purposes of

this section, an intermediary shall be

treated as related to a United States

person or foreign trust if the intermediary and the United States person or

foreign trust are related within the

meaning of section 643(i)(2)(B), with

the following modifications:

June 23, 1997

(1) For purposes of applying section

267 (other than section 267(f)) and

section 707(b)(1), ‘‘at least 10 percent’’

shall be substituted for ‘‘more than 50

percent’’ each place it appears;

(2) The principles of section

267(b)(10), substituting ‘‘at least 10 percent’’ for ‘‘more than 50 percent,’’ shall

apply to determine whether two corporations are related; and

(3) The principles applicable to trusts

shall apply to determine whether an

estate is related to another person.

(f) Examples. The following examples illustrate the rules of this section. In each example, FT is an irrevocable foreign trust that is not treated as

owned by any other person. The examples follow:

Example 1. Related intermediary. I, a nonresident alien who is not the grantor of FT, receives a

distribution of stock from FT in the year 2001. In

the year 2002, I sells the stock to an unrelated

party for its fair market value of 100X and gives

the 100X to his daughter, B, who is a U.S.

resident. I is not an agent of either FT or B under

generally applicable agency principles. Under

paragraphs (a)(1) and (c)(2)(i) of this section, FT

is deemed to have distributed 100X directly to B

in the year 2002.

Example 2. ‘‘But for’’ condition. I, a foreign

bank that is unrelated to any of the parties in these

transactions, received a deposit of 500X from FT

in the year 2001. In the year 2002, I transfers

400X to B, a United States person, in a transfer

that it would not have made but for the fact that I

had received 500X from FT. I is not an agent of

either FT or B under generally applicable agency

principles. Under paragraphs (a)(2) and (c)(2)(i) of

this section, FT is deemed to have distributed

400X directly to B in the year 2002.

Example 3. Tax avoidance purpose. FT was

created in 1980 by A, a nonresident alien. In the

year 2001, FT’s trustee, T, determines that 1000X

of accumulated income should be distributed to

A’s U.S. granddaughter, B. Pursuant to a plan with

a principal purpose of avoiding the interest charge

that would be imposed by section 668, T causes

FT to distribute 1000X to I, an unrelated foreign

person. I subsequently transfers 1000X to B in the

year 2001. Under paragraph (a)(3) of this section,

B is deemed to have received an accumulation

distribution from FT in the year 2001.

Example 4. Amount not derived from foreign

trust. W and her husband, H, are both nonresident

aliens. W’s son, S, is a U.S. resident. W receives

annual income of 5000X from her own investments. Several years ago, H created and funded

FT using his separate property. At the beginning of

the year 2001, W receives a distribution of 100X

from FT. There is no plan with a principal purpose

of avoiding U.S. tax. At the end of the year 2001,

W gives 100X of her investment income to S.

None of the conditions in paragraph (a) of this

section is satisfied. The transfer to S is treated as a

nontaxable gift from W and not as an amount

derived directly or indirectly from FT.

(g) Effective date. The rules of this

section are applicable for transfers made

by foreign trusts on or after August 20,

1996.

Par. 3. In § 1.671–2, paragraph (e) is

revised to read as follows:

§ 1.671–2 Applicable principles.

(e)(1) For purposes of subchapter J of

the Internal Revenue Code, a grantor

includes any person to the extent such

person either creates a trust, or directly

or indirectly makes a gratuitous transfer

(within the meaning of paragraph

(e)(4)(i) of this section) of property to a

trust.

(2) A grantor includes a person who

acquires an interest in a trust from a

grantor of the trust if either—

(i) The transfer is nongratuitous

(within the meaning of paragraph

(e)(4)(ii) of this section); or

(ii) The transfer is of an interest in a

fixed investment trust.

(3) If one person creates or funds a

trust (or portion of a trust) primarily as

an accommodation for another person,

the other person shall be treated as a

grantor of the trust (or portion of the

trust).

(4)(i) A gratuitous transfer is any

transfer other than a transfer for fair

market value, or a corporate or partnership distribution. A transfer of property

to a trust may be considered a gratuitous

transfer without regard to whether the

transfer is a gift for gift tax purposes

(see chapter 12 of subtitle B of the

Internal Revenue Code).

(A) For purposes of this paragraph

(e), a transfer for fair market value

includes only transfers in consideration

for property received from the trust,

services rendered by the trust, or the

right to use property of the trust. A

transfer is for fair market value only to

the extent that the value of the property

received, services rendered, or the right

to use property is equal to at least the

fair market value of the property transferred. For example, rents, royalties, and

compensation paid to a trust are transfers for fair market value only if the

payments reflect an arm’s length price

for the use of the property of, or

services rendered by, the trust. For purposes of this determination, if a person

contributes property to a trust (or to

another entity that subsequently transfers

the property (or proceeds therefrom) to

a trust) in exchange for any type of

interest in the trust (or other entity),

such interest in the trust (or other entity)

shall be disregarded in determining

whether fair market value has been

received. In addition, a person shall not

be treated as making a transfer for fair

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I.R.B.

market value merely because the

transferor recognizes gain on the transaction. For example, if a taxpayer elects

to treat a transfer of appreciated property to a foreign trust as a deemed sale

under section 1057, such a transfer will

not be treated as a transfer for fair

market value because the transferor did

not receive actual fair market value

consideration pursuant to the deemed

sale.

(B) For purposes of this paragraph

(e), a transfer to a trust is a corporate

distribution, and therefore not a gratuitous transfer, only if it is a distribution

described in section 301, 302, 305, 355

or 356. Similarly, for purposes of this

paragraph (e), a transfer to a trust is a

partnership distribution, and therefore

not a gratuitous transfer, only if it is

described in section 731. A distribution

from one trust to another trust that is a

beneficiary of the first trust is a gratuitous transfer.

director may determine, based upon the

facts and circumstances, that a direct or

indirect transfer to a trust is more

properly characterized as a gratuitous

transfer if the transfer was structured

with a principal purpose of avoiding

U.S. tax. See, e.g., sections 643(a)(7)

and 679(d).

(ii) For purposes of this paragraph

(e), any transfer other than a gratuitous

transfer is a nongratuitous transfer.

(5) The following examples illustrate

the rules of this paragraph (e):

Example 1. A creates and funds a trust, T, for

the benefit of her children. Under paragraph (e)(1)

of the section, A is a grantor of T.

Example 2. A makes an investment in a fixed

investment trust, T, that is classified as a trust

under § 301.7701-4(c)(1) of this chapter. B subsequently acquires A’s entire interest in T for fair

market value. Under paragraph (e)(2) of this

section, B is a grantor of T with respect to such

interest.

Example 3. A, an attorney, creates a trust, T, for

the benefit of his client, B, and B’s children. The

trust instrument names A as the grantor. A funds T

with a nominal contribution out of his own funds.

A views the contribution as an investment in the

generation of fees for future legal services. Under

paragraph (e)(3) of this section, B is a grantor of

Example 4. A, a U.S. citizen, creates and funds

a trust, T, for the benefit of B. B holds an

unrestricted power to withdraw any amount contributed to the trust for a period of 60 days after

the contribution is made. B is treated as an owner

of T under section 678 as a result of the

withdrawal power. However, B is not a grantor of

T under paragraph (e)(1) of this section as a result

of the withdrawal power, because B neither created T nor made a gratuitous transfer to T.

Example 5. A contributes cash to a trust, T,

through a broker, in exchange for units in T. The

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I.R.B.

value of the units in T is disregarded in determining whether A has received fair market value

under paragraph (e)(4)(i)(A) of this section. Therefore, A has made a gratuitous transfer to T, and,

under paragraph (e)(1) of this section, A is a

grantor of T.

Example 6. A borrows cash from T, an unrelated trust. Arm’s-length interest payments by A to

T will not be treated as gratuitous transfers under

paragraph (e)(4)(i)(A) of this section. Therefore,

under paragraph (e)(1) of this section, A is not a

grantor of T with respect to the interest payments.

Example 7. A creates and funds a domestic

trust, DT. After A’s death, DT distributes cash to a

foreign trust, FT, that is a beneficiary of DT.

Under paragraph (e)(4)(i)(B) of this section, the

trust distribution by DT is a gratuitous transfer.

Therefore, under paragraph (e)(1) of this section,

DT is a grantor of FT with respect to such

transfer.

Example 8. A creates and funds a trust, T. T

owns stock of C, a publicly traded company, that

pays a dividend to its shareholders, including T.

The dividend paid by C is a nongratuitous transfer

under paragraph (e)(4)(i)(B) of this section. Therefore, C is not a grantor under paragraph (e)(1) of

this section with respect to the dividend.

Example 9. A, a nonresident alien, creates a

trust, T, for the benefit of her spouse, B, who is a

U.S. citizen. T is not treated as owned by any

other person. A sells property worth $1,000,000 to

T in exchange for $100,000 in cash. Under

paragraph (e)(4)(i)(A) of this section, the $900,000

excess is a gratuitous transfer by A. Therefore, A

is a grantor of T under paragraph (e)(1) of this

section with respect to such transfer.

(6) The rules of this paragraph (e) are

applicable as of August 20, 1996.

Par.

4. Sections

1.672(f)–1,

1.672(f)–2, 1.672(f)–3, 1.672(f)–4, and

1.672(f)–5 are added to read as follows:

§ 1.672(f)–1 Foreign

treated as owners.

persons

not

(a) General rule. Section 672(f)(1)

provides that sections 671 through 679

(the grantor trust rules) shall cause a

person to be treated as the owner of any

portion of a trust only to the extent such

application results in an amount (if any)

being currently taken into account (directly or through one or more entities)

in computing the income of a citizen or

resident of the United States or a domestic corporation. Section 672(f)(1)

may apply only to a trust that would be

treated as owned, in whole or in part, by

a foreign person under the grantor trust

rules without regard to section 672(f).

For rules describing the application of

this section, see paragraph (b) of this

section. For definitions regarding the

rules of this section, see paragraph (c)

of this section. For examples illustrating

the application of this section, see paragraph (d) of this section. For the effective date of the rules of this section, see

paragraph (e) of this section.

(b) Application of general rule—(1)

Initial determination. To determine

whether a trust is treated as owned by a

foreign person, the taxpayer should first

apply the grantor trust rules without

regard to section 672(f) (the basic

grantor trust rules) to determine the

worldwide amount (as defined in paragraph (c)(1) of this section) and the U.S.

amount (as defined in paragraph (c)(2)

of this section).

(2) Result. The trust is treated as

owned by a foreign person based on an

annual comparison at the end of the

trust’s taxable year of the worldwide

amount and the U.S. amount. If there is

a worldwide amount and such amount is

greater than the U.S. amount, under

section 672(f) the foreign person shall

not be treated as the owner of the

portion of the trust attributable to the

excess of the worldwide amount over

the U.S. amount. Otherwise, the basic

grantor trust rules shall apply without

the limitation of section 672(f). For

examples, see paragraph (d) of this

section.

Worldwide

amount. The worldwide amount is the

net amount of income, gains, deductions, and losses that would be taken

into account for the current year under

the basic grantor trust rules in computing the worldwide taxable income of

any person, whether or not such person

is a U.S. taxpayer (as defined in paragraph (c)(3) of this section). The worldwide amount is computed in accordance

with U.S. principles of income taxation

and includes amounts that would be

attributable to foreign persons, without

regard to whether such amounts are

subject to U.S. income tax.

(2) U.S. amount. The U.S. amount is

the net amount of income, gains, deductions, and losses that would be taken

into account for the current year under

the basic grantor trust rules (directly or

through one or more entities) in computing the taxable income of a U.S. taxpayer (as defined in paragraph (c)(3)of

this section). The U.S. amount includes

amounts that would be attributable to

the U.S. taxpayer even if the amount

would not be includible in gross income

(e.g., tax-exempt interest described in

section 103(a)).

(3) U.S. taxpayer. A U.S. taxpayer is

any person who is a U.S. citizen, a

resident alien individual, a domestic corporation, a U.S. person who is treated as

the owner of a trust under section 679,

or a domestic trust to the extent such

trust actually pays U.S. tax with respect

to its income, gains, deductions, and

losses.

June 23, 1997

(d) Examples. The following examples illustrate the rules of this section:

Example 1. U.S. amount equals worldwide

amount. A, a citizen of the United States, creates

and funds an irrevocable foreign trust, FT, for the

benefit of his U.S. son, B. Under the basic grantor

trust rules (see section 679), A would be treated as

the owner of FT. For the taxable year ending

December 31, 1999, FT has ordinary income of

100X, long-term capital gain of 200X, deductions

of 20X, and short-term capital losses of 15X.

Under paragraph (c)(1) of this section, the worldwide amount is 265X (100X + 200X – 20X 15X). Under paragraph (c)(2) of this section, the

U.S. amount also is 265X. Consequently, under

paragraph (b)(2) of this section, because the

worldwide amount is equal to the U.S. amount,

the basic grantor trust rules apply without the

limitation of section 672(f) to treat A as the owner

of FT.

Example 2. No U.S. amount. A, a nonresident

alien, funds an irrevocable domestic trust, DT, for

the benefit of his U.S. son, B. A has a reversionary interest within the meaning of section 673. If

the basic grantor trust rules were applied, A would

be treated as the owner of DT, and any distributions to B would be considered nontaxable gifts

from A to B. Under paragraph (c)(2) of this

section, there is no U.S. amount, because no

amount is taken into account for the current year

under the basic grantor trust rules in computing

the taxable income of a U.S. taxpayer. Under

paragraph (c)(1) of this section, the worldwide

amount is equal to DT’s net income. Under

paragraph (b)(2) of this section, A is not treated as

the owner of any portion of DT. Consequently, DT

is a separate taxable entity, and distributions from

DT to B must be taken into account in computing

B’s income.

Example 3. U.S. amount less than worldwide

amount. FP is a foreign partnership for U.S.

income tax purposes. FP has two partners: C, a

nonresident alien, and D, a U.S. citizen. The

partnership agreement provides that all income,

gains, losses, deductions, and credits are allocated

50 percent to each partner. FP contributed cash to

an irrevocable foreign trust, FT, primarily for the

benefit of E, D’s U.S. brother. FP can control the

beneficial enjoyment of the trust assets within the

meaning of section 674. If the basic grantor trust

rules were applied, FT would be treated as the

owner of FP. Because D’s 50 percent distributive

share of FP’s income would be currently taken

into account in computing the income of a U.S.

citizen, the U.S. amount computed under paragraph (c)(2) of this section is equal to one half of

the worldwide amount computed under paragraph

(c)(1) of this section. Therefore, under paragraph

(b)(2) of this section, FP is not treated as the

owner of the portion of FT attributable to C’s

interest in FP. Such portion of FT will be treated

as a separate taxable entity, and distributions by

FT to E with respect to that portion of the trust

will be considered distributions to E under section

662 and may be subject to the section 668 interest

charge on accumulation distributions. (In addition,

distributions from FP to E may be subject to

recharacterization as purported gifts under

§ 1.672(f)–4.)

Example 4. No worldwide amount. USC is a

U.S. corporation with a wholly owned foreign

subsidiary, FC. USC funds an irrevocable foreign

trust, FT, that cannot benefit any U.S. person.

USC retains no power or interest that would cause

it to be treated as the owner of FT under the basic

grantor trust rules. However, FC is given a power

June 23, 1997

of appointment such that FC would be treated as

the owner of FT under section 678. FT acquires a

note issued by FC. FT has no items of income,

deduction, losses, or credit other than income from

the note. Under U.S. income tax principles, if the

basic grantor trust rules were applied, FC would

be treated as the owner of FT. Thus, FC would be

treated as both the debtor and the creditor with

respect to the note, and the note would be

disregarded. Under paragraph (c)(1) of this section, there is no worldwide amount. Under paragraph (c)(2) of this section, there is no U.S.

amount. Consequently, under paragraph (b)(2) of

this section, the basic grantor trust rules apply

without the limitation of section 672(f) to treat FC

as the owner of FT.

Example 5. Deemed contribution on effective

date. Assume the same facts as in Example 2. DT

was created in 1990. On August 20, 1996, DT

held accumulated income. Prior to August 20,

1996, A was treated as the owner of DT. A is

deemed to have contributed the assets that were

held in DT on August 20, 1996 to a new trust on

that date.

(e) Effective date. The rules of this

section are applicable as of August 20,

1996.

§ 1.672(f)–2 Trusts created by certain

foreign corporations.

(a) Controlled foreign corporations. A

controlled foreign corporation (as defined in section 957) that creates and

funds a trust shall be treated as a

domestic corporation for purposes of

§§ 1.672(f)–1 through 1.672(f)–5 to the

extent that, if the grantor trust rules

without regard to section 672(f) (the

basic grantor trust rules) were applied,

income earned by the trust for the

taxable year would be currently taken

into account pursuant to section 951 in

computing the gross income of a citizen

or resident of the United States or a

domestic corporation.

(b) Passive foreign investment companies—(1) In general. A passive foreign investment company (as defined in

section 1296) that creates and funds a

trust shall be treated as a domestic

corporation

for

purposes

§§ 1.672(f)–1 through 1.672(f)–5 to the

extent that, if the basic grantor trust

rules were applied, income earned by

the trust for the taxable year would be

currently taken into account pursuant to

section 1293 in computing the gross

income of a citizen or resident of the

United States or a domestic corporation.

(2) Application of section 1296. For

purposes of determining whether a foreign corporation is a passive foreign

investment company as defined in section 1296, the grantor trust rules shall be

applied as if section 672(f) had not

come into effect.

pany (as defined in section 552) that

creates and funds a trust shall be treated

as a domestic corporation for purposes

of §§ 1.672(f)–1 through 1.672(f)–5 to

the extent that, if the basic grantor trust

rules were applied, income earned by

the trust for the taxable year would be

currently taken into account pursuant to

section 551 in computing the gross

income of a citizen or resident of the

United States or a domestic corporation.

(d) Examples. The following examples illustrate the rules of this section. In each example, FT is an irrevocable foreign trust, and CFC is a

controlled foreign corporation. The examples follow:

Example 1. Controlled foreign corporation

without ultimate U.S. ownership. Two nonresident

aliens, A and B, create a domestic partnership, DP.

DP’s only asset is all the stock of CFC. CFC

creates and funds FT to benefit A’s U.S. daughter,

C. CFC retains an administrative power over the

trust as described in section 675. Thus, if the basic

grantor trust rules were applied, CFC would be

treated as the owner of FT, and distributions from

FT to C would not be taxed as distributions under

section 662. However, under paragraph (a) of this

section, CFC is not treated as a domestic corporation for purposes of § 1.672(f)–1. Although CFC

is a controlled foreign corporation (because CFC

is owned by DP, a domestic person), no income

earned by CFC will be included in the income of

a U.S. taxpayer. Consequently, there is no U.S.

amount under § 1.672(f)–1(c)(2). Under

§ 1.672(f)–1(b)(2), the basic grantor trust rules do

not apply to treat CFC as the owner of FT.

Transfers from FT to C are considered to be

distributions to C under section 662 and may be

subject to the section 668 interest charge on

accumulation distributions. (In addition, distributions to C from DP, CFC, or FT may be subject to

recharacterization as purported gifts under

§ 1.672(f)–4.)

Example 2. Trust income is all subpart F

income. CFC is wholly owned by USC, a domestic corporation. CFC creates and funds FT for the

benefit of USC. CFC can control the beneficial

enjoyment of the trust assets within the meaning

of section 674. All of FT’s income is of the type

that is subpart F income (as defined in section

952). FT does not distribute any income. Without

regard to income earned by FT, CFC has a

significant amount of earnings and profits. If the

basic grantor trust rules were applied, CFC would

be treated as the owner of FT, and all items of

income of FT would be currently taken into

account in computing the income of USC, a

domestic corporation. Consequently, under paragraph (a) of this section, CFC is treated as a

domestic corporation for purposes of § 1.672(f)–1.

Under § 1.672(f)–1(b)(2), the basic grantor trust

rules apply without the limitation of section 672(f)

to treat CFC as the owner of FT. Distributions

from FT to USC are treated as distributions from

CFC to USC.

Example 3. Portion of trust income is subpart F

income. Assume the same facts as in Example 2,

except that FT also owns all of the stock of S, a

corporation that is incorporated in the same country as CFC and that uses a substantial part of its

assets in a trade or business in such country. Thus,

dividends from S are not subpart F income. In the

taxable year ending December 31, 1999, FT’s only

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income is subpart F income of 200X and dividends from S of 50X. FT has no deductions or

losses for 199X. Under paragraph (a) of this

section, CFC is treated as a domestic corporation

for purposes of computing the U.S. amount under

§ 1.672(f)–1(c)(2) only to the extent FT’s income

is of the type that is subpart F income. Consequently, the U.S. amount is 200X. Under

§ 1.672(f)–1(c)(1), the worldwide amount is

250X. Under § 1.672(f)–1(b)(2), CFC is not

treated as the owner of the portion of FT attributable to the excess of the worldwide amount over

the U.S. amount. Such portion of FT will be

treated as a separate taxable entity. Distributions to

USP with respect to such portion of FT will be

included in USP’s income under section 662 and

may be subject to the section 668 interest charge

on accumulation distributions.

Example 4. Reduction in portion of trust treated

as nongrantor trust. Assume the same facts as in

Example 3. For each of the years 2001 through

2010, FT receives dividend income of 2X from S,

none of which is distributed. In the year 2011, at a

time when FT’s basis in the stock of S is 80X, S

sells its business and invests the proceeds in assets

that generate subpart F income. CFC will now be

treated as the owner of the portion of FT that had

previously been treated as a separate taxable

entity. FT will be deemed to have distributed 80X

(the stock of S) to CFC. CFC will be required to

include 20X of undistributed net income (2X a

year for 10 years) in its income.

(d) Effective date. The rules of this

section are applicable as of August 20,

1996.

§ 1.672(f)–3 Exceptions to general rule.

(a) Certain revocable trusts—(1) In

general. The general rule of § 1.672(f)–

1(a) shall not apply to any portion of a

trust if the power to revest absolutely in

the grantor title to such portion is

exercisable solely by the grantor without

the approval or consent of any other

person. If the grantor can exercise such

power only with the approval of a

related or subordinate party who is

subservient to the grantor, such power

will be treated as exercisable solely by

the grantor. The grantor will be treated

as having a power to revest only if the

grantor has such power for a period or

periods aggregating 183 days or more

during the taxable year of the trust. See

section 643(a)(7). For the definition of

grantor, see § 1.671–2(e). For the definition of related or subordinate party,

see § 1.672(c)–1. For purposes of this

paragraph (a), a related or subordinate

party is subservient to the grantor unless

the presumption in the last sentence of

§ 1.672(c)–1 is rebutted by a preponderance of the evidence.

(2) Grandfather rule—(i) In general.

The general rule of § 1.672(f)–1 shall

not apply to a trust that was treated as

owned by the grantor under section 676

on September 19, 1995, as long as the

trust would continue to be so treated

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under the basic grantor trust rules. However, such a trust will be subject to the

general rule of § 1.672(f)–1 with respect to any portion of the trust attributable to transfers to the trust after September 19, 1995.

(ii) Separate accounting for transfers

after September 19, 1995. In the case of

a revocable trust that contains both

amounts held in the trust on September

19, 1995, and amounts that were transferred to the trust after September 19,

1995, paragraph (a)(2)(i) of this section

shall apply only if the amounts that

were held in the trust on September 19,

1995, together with all income, gains,

and losses derived therefrom (less all

post-September 19, 1995, distributions

therefrom) are separately accounted for

from the amounts that were transferred

to the trust after September 19, 1995,

together with all income, gains, and

losses derived therefrom (less all distributions therefrom). If there is no separate accounting, the general rule of

§ 1.672(f)–1 shall apply to the trust. If

there is separate accounting, the general

rule of § 1.672(f)–1 shall not apply to

the portion of the trust that is attributable to amounts that were held in the

trust on September 19, 1995.

(3) Examples. The following examples illustrate the rules of this paragraph (a):

Example 1. Owner is grantor. After September

19, 1995, FP1, a foreign person, creates and funds

a revocable trust, T, for the benefit of FP1’s

children, who are U.S. residents. The trustee is a

foreign bank, FB, that is owned and controlled by

FP1 and FP2, who is FP1’s brother. The power to

revoke T and revest absolutely in FP1 title to the

trust property is exercisable by FP1, but only with

the approval or consent of FB. There are no facts

that would suggest that FB is not subservient to

FP1. Therefore, under paragraph (a)(1) of this

section, T is not subject to the general rule of

§ 1.672(f)–1. FP1 is treated as the owner of T.

Example 2. Owner not grantor. Assume the

same facts as in Example 1, except that FP1 dies.

After FP1’s death, FP2 has the power to withdraw

the assets of T, but only with the approval of FB.

There are no facts that would suggest that FB is

not subservient to FP2. However, under paragraph

(a)(1) of this section, T is now subject to the

general rule of § 1.672(f)–1, because FP2 is not a

grantor of T. FP2 is not treated as the owner of T.

Example 3. Trustee not related or subordinate

party. Assume the same facts as in Example 1,

except that neither FP1 nor any member of his

family has any substantial ownership interest or

other connection with FB. FP1 can remove and

replace FB at any time for any reason. Although

FP1 can replace FB if FB refuses to approve or

consent to FP1’s decision to revest the trust

property in himself, FB is not a related or

subordinate party. Therefore, under paragraph

(a)(1) of this section, T is subject to the general

rule of § 1.672(f)–1. FP1 will not be treated as

the owner of T.

Example 4. Unrelated trustee will consent to

revocation. FP, a foreign person, creates and funds

an irrevocable trust, T. The trustee is a foreign

bank, FB, that is not a related or subordinate party

within the meaning of § 1.672(c)–1. FB has the

discretion to distribute trust income or corpus to

any person, including FP. Even if FB would in

fact distribute all the trust property to FP if

requested to do so by FP, under paragraph (a)(1)

of this section, T is subject to the general rule of

§ 1.672(f)–1, because FP does not have the power

to revoke T. FP will not be treated as the owner of

Example 5. Husband treated as holding power

held by wife. H and his wife, W, both nonresident

aliens, create and fund a trust, T, using community

property. The power to revoke T and revest

absolutely in H and W title to the trust property is

exercisable either by W acting alone or by H with

the consent of W. W has advised H that she will

not consent to any decision by H to revoke T.

Although W is a related or subordinate party to H

within the meaning of § 1.672(c)–1, the presumption that W is subservient to H is rebutted by a

preponderance of the evidence. However, pursuant

to section 672(e), H is treated as holding the

power to revest that is held by W. Therefore,

under paragraph (a)(1) of this section, T is not

subject to the general rule of § 1.672(f)–1. H and

W are treated as the owners of T.

Example 6. U.S. grantor of trust revocable by

foreign person. A, a nonresident alien, creates a

revocable foreign trust, FT, and funds FT with

$5,000 cash. The only possible beneficiary of FT

is a foreign person. B, a U.S. citizen, contributes

$1,000,000 of appreciated property to FT. B

retains no powers that would cause B to be treated

as an owner of any portion of FT under the

grantor trust rules. Although A has the power to

revest absolutely in itself title to the appreciated

property, A is not a grantor of FT with respect to

the appreciated property. See § 1.671–2(e). Therefore, under paragraph (a)(1) of this section, the

portion of FT that is attributable to the appreciated

property is subject to the general rule of

§ 1.672(f)–1. A is not treated as the owner of such

portion.

(b) Certain other trusts—(1) In general. The general rule of § 1.672(f)–1(a)

shall not apply to any trust (or portion

of a trust) during the lifetime of the

grantor if the only amounts distributable

(whether income or corpus) from such

trust (or portion of a trust) during the

lifetime of the grantor are amounts

distributable to the grantor or the spouse

of the grantor. This paragraph (b) shall

not apply to that portion of a trust from

which, at any time after October 20,

1996, any amounts are distributable to

any person other than the grantor or the

spouse of the grantor. For purposes of

this paragraph (b), payments of

nongratuitous amounts (within the

meaning of § 1.671–2(e)(4)(ii)) will not

be considered amounts distributable. For

the definition of grantor, see § 1.671–

2(e).

(2) Amounts distributable in discharge of legal obligation—(i) In general. Subject to the provisions of paragraph (b)(2)(ii) of this section, amounts

June 23, 1997

that are distributable from a portion of a

trust in discharge of a legal obligation

of the grantor or the spouse of the

grantor shall be treated as amounts

distributable to the grantor or the spouse

of the grantor for purposes of paragraph

(b)(1) of this section. For this purpose,

an obligation is considered a legal obligation if it is enforceable under the local

law of the jurisdiction in which the

grantor (or the spouse of the grantor)

resides.

(ii) Legal obligation to related person. For purposes of paragraph (b)(2)(i)

of this section, the term legal obligation

does not include an obligation to a

related person except to the extent the

obligation was contracted bona fide and

for adequate and full consideration in

money or money’s worth (see

§ 20.2043–1 of this chapter). For this

purpose, a related person is a person

described in § 1.643(h)–1(e).

(3) Amounts distributable in discharge of support obligation. Amounts

that are distributable from a portion of a

trust in discharge of the grantor’s or the

grantor’s spouse’s obligation to support

a family member shall be treated as

amounts distributable to the grantor or

the spouse of the grantor only if the

family member is an individual who

would be treated as a dependent of the

grantor or the grantor’s spouse under

sections 152(a)(1) through (8), without

regard to the requirement that half of

the individual’s support be received

from the grantor or the grantor’s spouse,

and the family member is either—

(i) Permanently and totally disabled

(within the meaning of section 22(e)(3));

(ii) In the case of a son, daughter,

stepson, or stepdaughter, less than 24

years old.

(4) Grandfather rule—(i) In general.

The general rule of § 1.672(f)–1 shall

not apply to a trust that was treated as

owned by the grantor under section 677

(other than section 677(a)(3)) on September 19, 1995, as long as the trust

would continue to be so treated under

the basic grantor trust rules. However,

such a trust will be subject to the

general rule of § 1.672(f)–1 with respect to any portion of the trust attributable to transfers to the trust after September 19, 1995.

(ii) Separate accounting for transfers

after September 19, 1995. In the case of

a trust that contains both amounts held

in the trust on September 19, 1995, and

amounts that were transferred to the

trust after September 19, 1995, paraJune 23, 1997

graph (b)(4)(i) of this section shall apply

only if the amounts that were held in

the trust on September 19, 1995, together with all income, gains, and losses

derived therefrom (less all postSeptember 19, 1995, distributions therefrom) are separately accounted for from

the amounts that were transferred to the

trust after September 19, 1995, together

with all income, gains, and losses derived therefrom (less all distributions

therefrom). If there is no separate accounting, the general rule of

§ 1.672(f)–1 shall apply to the trust. If

there is separate accounting, the general

rule of § 1.672(f)–1 shall not apply to

the portion of the trust that is attributable to amounts that were held in the

trust on September 19, 1995.

(5) Examples. The following examples illustrate the rules of this paragraph (b):

Example 1. Amounts distributable only to

grantor or grantor’s spouse. H and his wife, W,

are both nonresident aliens. H and W have a child,

C, who is a U.S. resident. H creates and funds an

irrevocable trust, FT, using only his separate

property. The only amounts distributable (whether

income or corpus) from FT as long as either H or

W are alive are amounts distributable to H or W.

Upon the death of both H and W, C may receive

distributions from FT. Under paragraph (b)(1) of

this section, FT is not subject to the general rule

of § 1.672(f)–1 during H’s lifetime. H is treated

as the owner of FT.

Example 2. Amounts temporarily distributable

to person other than grantor or grantor’s spouse.

Assume the same facts as in Example 1, except

that C is a 30-year old law student at the time FT

is created, FT is created after October 20, 1996,

and the trust instrument provides that as long as C

is in law school amounts may be distributed from

FT to pay C’s expenses. Thereafter, the only

amounts distributable from FT as long as either H

or W are alive will be amounts distributable to H

or W. C’s expenses are not treated as legal

obligations of H or W under paragraph (b)(2)(ii)

of this section or as support obligations under

paragraph (b)(3) of this section. Therefore, under

paragraph (b)(1) of this section, FT is subject to

the general rule of § 1.672(f)–1(a). H is not

treated as the owner of FT. After C graduates from

law school, the general rule of § 1.672(f)–1 still

will be applicable, and H still will not be treated

as the owner of FT.

Example 3. Grantor predeceases spouse. Assume the same facts as in Example 1. H predeceases W. Under paragraph (b)(1) of this section,

FT will become subject to the general rule of

§ 1.672(f)–1 upon H’s death, because W is not a

grantor. Accordingly, FT will be treated as a

separate taxable entity upon H’s death.

Example 4. Effect of divorce. H creates and

funds a trust, FT, from which the only amounts

distributable are amounts distributable to himself

and A. At the time FT is created, A is H’s wife.

However, the trust document refers to A only by

her name. H and A divorce. Under paragraph

(b)(1) of this section, FT will be subject to the

general rule of § 1.672(f)–1 after the divorce,

because amounts will still be distributable to A,

and A will no longer be the spouse of the grantor.

After the divorce, FT will be treated as a separate

taxable entity.

Example 5. Fixed investment trust. FC, a foreign corporation, invests in a domestic fixed

investment trust, DT, that is classified as a trust

under § 301.7701–4(c)(1) of this chapter. The

only amounts that are distributable from the

portion of DT that is owned by FC are amounts

distributable to FC. Under paragraph (b)(1) of this

section, such portion of DT is exempt from the

general rule of § 1.672(f)–1. FC is treated as the

owner of its portion of DT.

Example 6. Reinsurance trust. A domestic insurance company, DI, reinsures a portion of its

business with a foreign insurance company, FI. FI

creates and funds an irrevocable domestic trust,

DT, in the United States as security for its

obligations under the reinsurance agreement. The

trust funds are held by a U.S. bank and may be

used only to pay claims arising out of the

reinsurance policies. On the termination of DT,

any assets remaining will revert to FI. The only

amounts that are distributable from DT are distributable in discharge of FI’s legal obligation. Therefore, under paragraph (b)(1) of this section, DT is

exempt from the general rule of § 1.672(f)–1. FI

is treated as the owner of DT.

Example 7. Asset securitization trust. A foreign

corporation, FC, borrows money from a bank, B,

to finance the purchase of an airplane. FC creates

a foreign trust, FT, to hold the airplane as security

for the loan from B. The only amounts that are

distributable from FT are amounts distributable to

B in the event that FC defaults on its loan from B.

Thus, the only amounts distributable from FT are

in discharge of FC’s legal obligation to B. When

FC repays the loan, the trust assets will revert to

FC. Under paragraph (b)(1) of this section, FT is

exempt from the general rule of § 1.672(f)–1. FC

is treated as the owner of FT.

(c)(4) of this section, § 1.672(f)–1 does

not apply to any portion of a trust

distributions from which are taxable as

compensation for services rendered. A

trust described in this paragraph (c)(1) is

referred to in this section as a compensatory trust.

(2) Trusts classified as compensatory

trusts. The following types of trusts are

the only types of trusts that shall be

classified as compensatory trusts within

the meaning of paragraph (c)(1) of this

section—

(i) A qualified trust described in section 401(a) (but see § 1.641(a)–0(a));

(ii) A trust described in section

457(g);

(iii) A nonexempt employees’ trust

described in section 402(b) (see

§ 1.671–1(g) and (h));

(iv) A trust that is an individual retirement account described in section

408(k) or 408(p);

(v) A trust that is an individual retirement account the only contributions to

which are rollover contributions listed in

section 408(a)(1);

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(vi) A trust that would be a

nonexempt employees’ trust described in

section 402(b) but for the fact that the

trust’s assets are not set aside from the

claims of creditors of the actual or

deemed transferor within the meaning of

§ 1.83–3(e); and

(vii) A trust that is a welfare benefit

fund described in section 419(e).

(3) Other individual retirement accounts. For rules that apply to individual

retirement accounts (within the meaning

of section 408(a)) that are not compensatory trusts within the meaning of

paragraph (c)(1) of this section, see

paragraphs (a) and (b) of this section.

(4) Exceptions. The Commissioner

may, in revenue rulings, notices, or

other guidance published in the Internal

Revenue Bulletin (see § 601.601(d)(2)(ii)(b)), designate categories of compensatory trusts to which the general rule of

paragraph (c)(1) of this section does not

apply.

(d) Effective date. Except as provided

in paragraph (b)(1) of this section, the

rules of this section are applicable as of

August 20, 1996.

§ 1.672(f)–4 Recharacterization of purported gifts.

(a) In general—(1) Purported gifts

from partnerships. Except as provided in

paragraphs (b) and (f) of this section,

and without regard to the existence of

any trust, if a United States person (U.S.

donee) directly or indirectly receives a

purported gift or bequest (as defined in

paragraph (d) of this section) from a

partnership, the purported gift or bequest

must be included in the U.S. donee’s

gross income as ordinary income.

(2) Purported gifts from foreign corporations. Except as provided in paragraphs (b) and (f) of this section, and

without regard to the existence of any

trust, if a U.S. donee directly or indirectly receives a purported gift or bequest (as defined in paragraph (d) of

this section) from a foreign corporation,

the purported gift or bequest must be

included in the U.S. donee’s gross income as if it were a distribution from

the foreign corporation. For purposes of

section 1012, the U.S. donee will not be

treated as having basis in the foreign

corporation. However, for purposes of

section 1223, the U.S. donee will be

treated as having a holding period in the

foreign corporation on the date of the

deemed distribution equal to the

weighted average of the holding periods

of the actual interest holders.

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(b) Exceptions—(1) U.S. partner or

shareholder treats transfer as distribution and gift. Paragraph (a) of this

section shall not apply if the U.S. donee

can establish that a U.S. citizen or

resident alien who directly or indirectly

holds an interest in the partnership or

foreign corporation treated the purported

gift as a distribution to the U.S. partner

or shareholder and a subsequent gift to

the U.S. donee.

(2) Charitable contributions. Paragraph (a) of this section shall not apply

to U.S. donees that are described in

section 170(c).

created by partnerships or foreign corporations. If a partnership or foreign

corporation is treated as the owner,

under sections 671 through 679, of a

portion of a trust from which property is

distributed to a U.S. donee in a gratuitous transfer, the U.S. donee must treat

the amount as a distribution from the

partnership or foreign corporation. If a

partnership or foreign corporation is not

treated as the owner, under sections 671

through 679, of the portion of a trust

from which property is distributed to a

U.S. donee in a gratuitous transfer, the

U.S. donee shall be taxable in the

manner provided in paragraph (a) of this

section only if the U.S. tax computed

under that section exceeds the U.S. tax

that would be due if the U.S. donee

treats the amount as a distribution from

the trust.

(d) Definition of purported gift or

bequest. For purposes of this section, a

purported gift or bequest is any transfer

by a partnership or foreign corporation

(other than a transfer for fair market

value) to a person who is not a partner

in the partnership or shareholder of the

foreign corporation.

(e) Effect on U.S. partner or shareholder. This section applies only to

computations of the U.S. donee’s gross

income. This section does not affect the

U.S. tax treatment of a U.S. partner in

the partnership or a U.S. shareholder of

the foreign corporation.

(f) Recharacterization by district director. Notwithstanding any other provision in this section, if a U.S. donee

receives a transfer that is subject to the

rules of this section, the district director

may recharacterize such transfer to prevent the avoidance of U.S. tax or clearly

to reflect income. For example, the

district director may determine, based

upon the facts and circumstances, that a

distribution from a partnership or for-

eign corporation is more properly characterized as a distribution from a trust.

(g) De minimis exception. This section shall not apply if, during the taxable year of a U.S. donee, the aggregate

amount of purported gifts or bequests

that is transferred to such U.S. donee

directly or indirectly from a partnership

or foreign corporation does not exceed

$10,000. The aggregate amount must

include gifts or bequests from persons

that the U.S. donee knows or has reason

to know are related to the partnership or

foreign corporation (within the meaning

of section 643(i)).

(h) Examples. The following examples illustrate the rules of this section:

Example 1. FC is a foreign corporation that is

wholly owned by A, a nonresident alien. FC

distributes property directly to A’s U.S. daughter,

B, purportedly as a gift. Under paragraph (a)(2) of

this section, B must treat the distribution as a

dividend from FC. (However, if B can establish

that the distribution exceeded FC’s earnings and

profits, B must treat such excess as an amount

received in excess of basis under section

301(c)(3).) If FC is a passive foreign investment

company, B must treat the amount as a distribution under section 1291. B will be treated as

having the same holding period as A.

Example 2. FC is a foreign corporation that is

wholly owned by A, a nonresident alien. FC

creates and funds a revocable foreign trust, FT,

from which a gratuitous transfer is made immediately to A’s U.S. daughter, B. Thus, the transfer is

out of trust corpus. FC is not treated as the owner

of FT under sections 671 through 679. Under

paragraph (c) of this section, B must treat the

transfer as a dividend from FC, rather than a

distribution from FT, if such treatment results in a

higher U.S. tax liability.

(i) Effective date. The rules of this

section are applicable for any transfer

by a partnership or foreign corporation

on or after August 20, 1996.

§ 1.672(f)–5 Special rules.

(a) Transfers by certain beneficiaries

to foreign settlor—(1) In general. If, but

for section 672(f)(5), a foreign person

would be treated as the owner of any

portion of a trust, any U.S. beneficiary

of such trust shall be treated as the

owner of a portion of the trust to the

extent the U.S. beneficiary directly or

indirectly made transfers of property to

such foreign person (without regard to

whether the U.S. beneficiary was a U.S.

beneficiary at the time of any transfer)

in excess of transfers to the U.S. beneficiary from the foreign person. The rule

of this paragraph will not apply to the

extent the U.S. beneficiary can demonstrate to the satisfaction of the district

director that the transfer by the U.S.

beneficiary to the foreign person was

wholly unrelated to any transaction inJune 23, 1997

volving the trust. For purposes of this

paragraph, a transfer of property does

not include a nongratuitous transfer. See

§ 671–2(e)(4)(ii). In addition, a gift

shall not be taken into account to the

extent such gift would not be characterized as a taxable gift under section

2503(b). For a definition of U.S. beneficiary, see section 679.

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

Example 1. A, a nonresident alien, contributes

property to FC, a foreign corporation that is

wholly owned by A. FC creates a foreign trust,

FT, for the benefit of A and his children. FT is

revocable by FC without the approval or consent

of any other person. FC funds FT with the

property received from A. A and his family move

to the United States. Under paragraph (a)(1) of

this section, A is treated as the owner of FT.

Example 2. B, a U.S. citizen, makes a gratuitous transfer of $1 million to his uncle, C, a

nonresident alien. C creates a foreign trust, FT, for

the benefit of B and his children. FT is revocable

by C without the approval or consent of any other

person. C funds FT with the property received

from B. Under paragraph (a)(1) of this section, B

is treated as the owner of FT. (B also would be

treated as the owner of FT as a result of section

679.)

(b) Different taxable years. If a person has a different taxable year (as

defined in section 7701(a)(23)) from the

taxable year of the trust, an amount is

currently taken into account in computing the income of such person for

purposes of § 1.672(f)–1 if the amount

is taken into account for the taxable

year of such person that includes the

last day of the taxable year of the trust.

generally shall be characterized under

U.S. income tax principles. See

§§ 301.7701–1 through 301.7701–4 of

this chapter. However, for purposes of

§ 1.672(f)–4, a transferor that is a

wholly owned business entity shall be

treated as a corporation, separate from

its single owner. See § 301.7701–

2(c)(2)(iii) of this chapter.

(d) Effective date. The rules of this

section are generally applicable as of

August 20, 1996. However, the rules in

paragraph (c) of this section shall not be

applicable until [date of publication as a

final regulation in the Federal Register].

PART 301—PROCEDURE AND

ADMINISTRATION

Par. 5. The authority citation for part

301 is amended by adding an entry in

numerical order to read as follows:

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

June 23, 1997

Section 301.7701–2(c)(2)(iii) also issued under 26 U.S.C. 643(a)(7),

672(f)(4) and (6).

Par. 6. Section 301.7701–2 is

amended by adding paragraph (c)(2)(iii)

to read as follows:

§ 301.7701–2 Business entities; definitions.

(2) * * *

(iii) Special rule for foreign business

entities that make purported gifts. For

the purposes of applying the rules of

section 672(f)(4), a wholly owned business entity shall be treated as a corporation, separate from its single owner.

Michael P. Dolan,

Acting Commissioner of Internal

Revenue.

(Filed by the Office of the Federal Register on

June 4, 1997, 8:45 a.m., and published in the issue

of the Federal Register for June 5, 1997, 62 F.R.

30785)

26 CFR 601.204: Changes in accounting periods

and in methods of accounting.

(Also Part I, §§ 168, 446, 481; 1.168(i)–1, 1.446–

1.)

Rev. Proc. 97–30

SECTION 1. PURPOSE

This revenue procedure allows a taxpayer to make a general asset account

election under § 168(i)(4) of the Internal Revenue Code for certain property

that was placed in service in taxable

years ending before October 11, 1994.

The election set forth in this revenue

procedure is available only for a taxable

year ending in 1996 or 1997 (the year

of change).

SECTION 2. BACKGROUND

.01 Section 168(i)(4) provides that,

under regulations, a taxpayer may maintain one or more general asset accounts

for any property to which § 168 applies.

The rules for general asset accounts are

provided in § 1.168(i)–1 of the Income

Tax Regulations, which allows a taxpayer to make an election to group

assets into one or more general asset

accounts. The assets in any particular

account are depreciated as a single asset.

Each general asset account generally

includes only assets that are placed in

service by the taxpayer in the same

taxable year and that have the same

depreciation method, recovery period,

convention, and asset class.

Section 1.168(i)–1 applies to property

subject to § 168 that is placed in service in taxable years ending on or after

October 11, 1994. For property subject

to § 168 that was placed in service after

December 31, 1986, in taxable years

ending before October 11, 1994,

§ 1.168(i)–1(l) provides that the Internal

Revenue Service will allow any reasonable method that is consistently applied

to the taxpayer’s general asset accounts.

.02 Except as otherwise expressly

provided, a taxpayer must obtain the

consent of the Commissioner of Internal

Revenue to change a method of accounting for federal income tax purposes. Section 446(e) and § 1.446–

1(e)(2)(i). To obtain this consent, the

taxpayer must file a Form 3115, Application for Change in Accounting

Method, during the taxable year in

which the taxpayer desires to make the

proposed change. Section 1.446–

1T(e)(3)(i).

.03 The Commissioner is authorized

to prescribe administrative procedures

setting forth the limitations, terms, and

conditions necessary to obtain consent

for effecting a change in method of

accounting and to prevent amounts from

being duplicated or omitted, including

the taxable year or years in which the

§ 481(a) adjustment is to be taken into

account. Section 1.446–1(e)(3)(ii).

SECTION 3. GENERAL ASSET

ACCOUNT ELECTION

.01 Subject to section 3.02 of this

revenue procedure, a taxpayer may elect

to apply the general asset account rules

in § 1.168(i)–1 for any item of property: (1) depreciated by the taxpayer

under § 168; (2) placed in service by

the taxpayer after December 31, 1986,

in any taxable year ending before October 11, 1994; (3) for which the taxpayer

has not previously made a general asset

account election; and (4) held by the

taxpayer as of the beginning of the year

of change.

.02 This election may be made only if

the taxpayer has records that establish:

(1) the taxable year in which the property was placed in service by the taxpayer; (2) the applicable depreciation

method, recovery period, and convention

under § 168 for the property; (3) the

unadjusted depreciable basis (as defined

in § 1.168(i)–1(b)(1)) of the property as

of the beginning of the year of change;

and (4) the depreciation allowed or

1997–25

I.R.B.

allowable, whichever is greater, for the

property as of the end of the taxable

year immediately preceding the year of

change.

SECTION 4. EFFECT OF ELECTION

.01 In general. If a taxpayer makes a

general asset account election under this

revenue procedure, the taxpayer consents to, and agrees to apply, all of the

provisions of § 1.168(i)–1 to the property subject to the election, beginning

with the year of change. Thus, pursuant

to § 1.168(i)–1(k)(1), the election generally is irrevocable and will be binding

on the taxpayer for computing taxable

income for the year of change and for

all subsequent taxable years. The election has no effect on the depreciation

method, recovery period, and convention

of the property.

.02 Establishment of general asset

accounts. Any property subject to a

general asset account election under this

revenue procedure must be grouped into

one or more general asset accounts in

accordance with the rules in § 1.168(i)–

1(c) and separate from any account

formed in any taxable year prior to the

year of change. In addition, each general

asset account must include a beginning

balance for both the unadjusted depreciable basis and the depreciation reserve

of the general asset account. The beginning balance for the unadjusted depreciable basis of the general asset account

is equal to the sum of the unadjusted

depreciable bases as of the beginning of

the year of change for all property

included in the general asset account.

The beginning balance of the depreciation reserve of the general asset account

is equal to the sum of the depreciation

allowed or allowable, whichever is

greater, as of the end of the taxable year

immediately preceding the year of

change for all property included in the

general asset account.

SECTION 5. CHANGE IN METHOD

OF ACCOUNTING

.01 Consent. A general asset account

election for any item of property that is

made pursuant to this revenue procedure

is a change in method of accounting.

Under § 1.446–1(e)(2)(i), the consent of

the Commissioner is hereby granted to

make this method change by any tax1997–25

I.R.B.

payer for any item of property for which

a general asset account election is made

pursuant to this revenue procedure. This

consent is granted for the taxpayer’s

year of change. The consent is conditioned, however, on the taxpayer’s complying with this revenue procedure. If

the taxpayer does not comply with this

revenue procedure, the taxpayer will be

deemed to have initiated a change in

method of accounting without obtaining

the consent of the Commissioner required under § 446(e).

.02 No § 481(a) adjustment. Because

the adjusted basis of the property is not

changed by the general asset account

election, the method change is made on

a cut-off basis and, thus, no adjustment

under § 481(a) is required or permitted.

.03 Manner of making method

change.

(1) Complete and file a current

Form 3115. The general asset account

election under this revenue procedure is

made on the taxpayer’s timely filed

original federal income tax return (including extensions) for the year of

change or on an amended return for the

year of change filed no later than December 20, 1997. The election is made

by attaching a completed, current Form

3115 to the taxpayer’s original or

amended return for the year of change.

The requirement to file a Form 3115

during the taxable year in which the

taxpayer desires to make the proposed

change is waived in accordance with

§ 1.446–1(e)(3)(ii).

(2) No user fee. No user fee is

required for a Form 3115 filed under

this revenue procedure. Any user fee

that is submitted with any Form 3115

requesting permission to make a general

asset account election under this revenue

procedure will be returned to the taxpayer.

.04 No protection from examination

changes. A general asset account election under this revenue procedure does

not change the taxpayer’s present

method of computing depreciation allowances for the property subject to the

election and, consequently, examination

protection is not provided. Therefore,

for any taxable year before the year of

change, a taxpayer that receives consent

to make a general asset account election

under this revenue procedure does not

thereby obtain protection from examination changes for the property included in

the general asset account.

SECTION 6. EFFECTIVE DATE

An election may be made pursuant to

this revenue procedure for a taxpayer’s

taxable year ending in 1996 or 1997.

SECTION 7. EFFECT ON OTHER

DOCUMENTS

Rev. Proc. 97–27, 1997–21 I.R.B. 10,

is modified.

DRAFTING INFORMATION

The principal author of this revenue

procedure is Kathleen Reed of the Office of Assistant Chief Counsel

(Passthroughs and Special Industries).

For further information regarding this

revenue procedure, contact Mark Pitzer

at (202) 622–3110 (not a toll-free call).

Issuance of Taxpayer Assistance

Orders (TAOs)

Delegation Order 232 (Rev. 3)

Effective: April 16, 1997.

Authority: To issue Taxpayer Assistance Orders (TAOs), other than TAOs

involving a principal residence, under

IRC § 7811, as amended by § 102 of

Public Law 104–168 (Taxpayer Bill of

Rights 2).

Delegated to: Assistant Commissioner

(International); Regional Commissioners; District Directors and Assistant Directors; Service Center Directors and

Assistant Directors; Regional, Service

Center, District, and International Taxpayer Advocates.

Redelegation: This authority may be

redelegated to an Associate Taxpayer

Advocate.

Authority: To issue Taxpayer Assistance Orders (TAOs), under IRC

§ 7811, to release a principal residence

of a taxpayer levied upon or to cease

any action regarding a principal residence.

Delegated to: Regional Commissioners, Assistant Commissioner (International), and the Regional and International Taxpayer Advocates.

Redelegation: This authority may not

be redelegated.

The authority to modify or rescind a

TAO is limited by IRC § 7811(c), as

amended by § 102(b) of Public Law

104–168, to only the Commissioner,

Deputy Commissioner, and Taxpayer

Advocate.

June 23, 1997

Source of Authority: Treasury Order

150–10.

This order supersedes Del. Order 232

(Rev. 2).

Dated April 16, 1997.

Lee R. Monks

Taxpayer Advocate.

Information Reporting on

Transactions With Foreign Trusts

and on Large Foreign Gifts

Notice 97–34

This notice provides guidance regarding the new foreign trust and foreign

gift reporting provisions contained in the

Small Business Job Protection Act of

1996 (the ‘‘Act’’). The Act expands

information reporting requirements under section 6048 of the Internal Revenue

Code (the ‘‘Code’’) for U.S. persons

who make transfers to foreign trusts and

for U.S. owners of foreign trusts. In

addition, the Act adds new reporting

requirements for U.S. beneficiaries of

foreign trusts, extensively revises the

civil penalties for failure to file information with respect to foreign trusts, and

adds civil penalties for failure to report

certain transfers to foreign entities. See

sections 6048(c), 6677, and 1494(c).

The Act also adds section 6039F to the

Code, creating reporting requirements

for U.S. persons who receive large gifts

from foreign persons.

Notice 96–60, 1996–49 I.R.B. 7, provided that taxpayers would not be required to file information statements

under section 6048(a) or be subject to

associated penalties under section 6677

until further guidance was issued. Section VIII of this notice sets forth this

further guidance.

This notice has eight sections. Section

I explains the expected revisions to

Forms 3520 and 3520–A. Section II

provides certain definitions of terms

used in this notice. Section III provides

guidance on reporting of transfers to

foreign trusts. Section IV explains the

reporting responsibilities of U.S. owners

of foreign trusts, including the information returns to be filed by these foreign

There are currently two provisions of the Internal

Revenue Code designated as section 6039F. The

second provision was added by the Health Insurance Portability and Accountability Act of 1996

(HIPAA). Treasury intends to seek a technical

correction to HIPAA to redesignate section 6039F

as added by HIPAA as section 6039G. All subsequent references to section 6039F in this Notice

relate to section 6039F as contained in the Small

Business Job Protection Act of 1996.

June 23, 1997

trusts and the procedures for foreign

trusts to appoint U.S. agents. Section V

provides guidance regarding the new

reporting requirements for U.S. beneficiaries of foreign trusts. Section VI

explains the new reporting rules for U.S.

persons who receive large gifts from

foreign persons. Section VII provides

guidance on the new penalties for failure to comply with these reporting requirements. Finally, Section VIII provides special transition rules.

Treasury and the Service expect to

issue regulations incorporating the guidance set forth in this notice. Until such

regulations are issued, taxpayers must

comply with the guidance set forth in

this notice.

Section I. Revisions to Forms 3520

and 3520–A

Prior to the Act, a U.S. person who

transferred property to a foreign trust

was required to report the transfer on

Form 3520, ‘‘Creation of or Transfers to

Certain Foreign Trusts,’’ within 90 days

of the transfer. In addition, U.S. owners

of foreign trusts were required to file

annually Form 3520–A, ‘‘Annual Return

of Foreign Trust with U.S. Beneficiaries.’’ No reporting was required of U.S.

beneficiaries of foreign trusts or of U.S.

persons who received gifts from foreign

persons.

In order to facilitate taxpayer compliance and reduce duplicative reporting

requirements, the Service is developing

a revised Form 3520 (‘‘Annual Return

to Report Transactions With Foreign

Trusts and Receipt of Certain Foreign

Gifts’’) that generally will allow U.S.

persons to use a single form to comply

with all of the new reporting requirements of the Act pertaining to transactions with foreign trusts and the receipt

of foreign gifts. In addition, Form

3520–A will be revised so that foreign

trusts will be able to use that form to

meet the new information reporting requirements of section 6048(b). U.S.

owners of foreign trusts will no longer

be required to file Form 3520–A.

Section II. Definitions

For purposes of this notice, the terms

‘‘grantor,’’ ‘‘beneficiary,’’ and ‘‘obligation’’ are defined as follows.

A ‘‘grantor’’ includes any person who

creates a trust as well as any person

who directly or indirectly makes a gratuitous transfer of money or other property to a trust. A grantor includes a

person who acquires an interest in a

trust in a nongratuitous transfer from a

person who is a grantor of the trust. A

grantor also includes an investor who

acquires an interest in a fixed investment trust from a grantor of the trust. If

one person creates or funds any portion

of a trust primarily as an accommodation for another person, the other person

will be treated as the grantor with

respect to such portion of the trust.

Gratuitous transfers are described below

in Section III.

A ‘‘beneficiary’’ includes any person

that could possibly benefit (directly or

indirectly) from the trust at any time

(including any person who could benefit

if the trust were amended), whether or

not the person is named in the trust

instrument as a beneficiary and whether

or not the person can receive a distribution from the trust in the current year.

Sections 679(c), 643(a)(7). See also

H.R. Rep. No. 658, 94th Cong., 1st

Sess. 210 (1975), 1976–3 (vol. 2) C.B.

902. However, for purposes of sections

643(i), 679(a)(3)(C) and 1494, a person

will not be considered a beneficiary if,

based on all relevant facts and circumstances, it could not be reasonably anticipated that the person could possibly

benefit from the trust. For example, for

this purpose a publicly-traded corporation would generally not be treated as a

beneficiary of a family’s trust even if

the trustee is given complete discretion

to distribute trust income to anyone.

However, friends and business associates of the family would be considered

beneficiaries of such a trust because it

could be reasonably anticipated that the

trust could possibly benefit such persons.

An ‘‘obligation’’ includes 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.

Section III. Transfers to Foreign

Trusts

This section of the notice provides

guidance for the reporting of transfers to

foreign trusts. As more fully described

below, gratuitous transfers are reportable

under section 6048(a). For this purpose,

a gratuitous transfer is any transfer other

than: (a) a transfer for fair market value,

or (b) a corporate or partnership distribution. In addition, as more fully described below, nongratuitous transfers

(all transfers other than gratuitous transfers) to a foreign trust are reportable

1997–25

I.R.B.

under section 1494 if: (a) the U.S.

transferor does not immediately recognize all of the gain on the transfer (or

recognizes gain solely by reason of an

election under section 1057), or (b) the

U.S. transferor is related to the trust. If

a transfer is gratuitous in part and

nongratuitous in part, the gratuitous portion of the transfer must be reported

under

section

6048

and

the

nongratuitous portion of the transfer

must be reported under section 1494.

A. Background

Section 6048(a) generally provides

that any U.S. person who directly or

indirectly transfers money or other property to a foreign trust (including a

transfer by reason of death) must report

such transfer at the time and in the

manner prescribed by the Secretary. Section 6048(a)(2). Transfers to foreign

trusts described in sections 402(b),

404(a)(4), or 404A, or trusts determined

by the Secretary to be described in

section 501(c)(3) are not reportable under these requirements. Section

6048(a)(3)(B)(ii). Transfers involving

fair market value sales are also not

reportable. Section 6048(a)(3)(B)(i). The

Secretary may exempt other types of

transfers from being reported if the

United States does not have a significant

interest in obtaining the required information. Section 6048(d)(4). A person

who fails to comply with the reporting

requirements of section 6048(a) with

respect to a transfer occurring after

August 20, 1996, will be subject to a 35

percent penalty on the gross value of the

property transferred. Section 6677(a).

One of the purposes of the reporting

requirements in section 6048(a) is to

ensure that U.S. transferors comply with

section 679. Section 679 generally treats

a U.S. person as the owner of a foreign

trust if the U.S. person transfers property to the foreign trust and the trust

could benefit a U.S. person. However, a

U.S. person will not be treated as the

owner of the trust under section 679 if,

in exchange for the property transferred

to the trust, the U.S. person receives

property whose value is at least equal to

the fair market value of the property

transferred. Section 679(a)(2)(B).

Certain transfers of property by U.S.

persons to foreign trusts may be de2

As explained in Notice 97–18, Treasury and the

Service are studying whether distributions by

domestic corporations and partnerships should be

reportable under section 1494. This notice does

not affect the reporting of such corporate or

partnership distributions.

1997–25

I.R.B.

scribed in section 1491 as well as

section 6048(a). Section 1491 generally

provides that a U.S. person who transfers property to a foreign trust is subject

to a 35 percent excise tax on any

unrecognized gain in the transferred

property. Section 1494 generally provides that transfers described in section

1491 to certain foreign entities (including foreign trusts) must be reported.

Notice 97–18, 1997–10 I.R.B. 35, provided that in the case of transfers to

foreign trusts, reporting obligations under section 1494 may be satisfied if the

U.S. transferor complies with its reporting obligations under section 6048(a)

and the U.S. transferor does not owe

excise tax under section 1491.

B. Section 6048(a) Information Reporting

Except as otherwise provided in Section III.E., a U.S. person must report

under section 6048(a) any gratuitous

transfer to a foreign trust. Although

nongratuitous transfers generally are not

reportable under section 6048(a), any

transfer in exchange for an obligation

that is treated as a qualified obligation

(as defined in section III.C.2) must also

be reported under section 6048(a). In the

event of a reportable transfer occurring

by reason of death, the executor, as

defined in section 2203, is responsible

for reporting the transfer.

A gratuitous transfer is any transfer

other than (i) a transfer for fair market

value, or (ii) a corporate or partnership

distribution. A transfer of property to a

trust may be considered a gratuitous

transfer without regard to whether the

transfer is a gift for gift tax purposes

(see Chapter 12 of Subtitle B of the

Code). A gratuitous transfer to a foreign

trust must be reported on Form 3520.

For purposes of this notice, a transfer

for fair market value includes only

transfers in consideration for property

received from the trust, services rendered by the trust, or the right to use

property of the trust. A transfer is for

fair market value only to the extent that

the value of the property received, services rendered, or the right to use the

property is equal to the fair market

value of the property transferred. For

example, rents, royalties, and compensation paid to a trust are transfers for fair

market value only if the payments reflect an arm’s length price for the use of

the property of, or services rendered by,

the trust.

For purposes of this determination, if

a U.S. person contributes property to a

trust in exchange for any type of interest

in the trust, such interest in the trust will

be disregarded in determining whether

fair market value has been received. In

addition, a U.S. person will not be

treated as making a transfer for fair

market value merely because the

transferor recognizes gain on the transaction. For example, if a taxpayer elects

to treat a transfer of appreciated property to a foreign trust as a deemed sale

under section 1057, such a transfer will

not be treated as a transfer for fair

market value because the transferor did

not receive actual fair market value

consideration pursuant to the deemed

sale. For special rules regarding obligations issued by related foreign trusts, see

Section III.C. below.

For purposes of this notice, a transfer

to a foreign trust is a corporate distribution, and therefore not a gratuitous

transfer, only if it is a distribution

described in sections 301, 302, 305,

355, or 356. Similarly, for purposes of

this notice, a transfer to a foreign trust

is a partnership distribution, and therefore not a gratuitous transfer, only if it

is described in section 731. A distribution from one trust to another trust that

is a beneficiary of the first trust is a

gratuitous transfer. Moreover, a domestic

trust that becomes a foreign trust is

deemed to have made a gratuitous transfer of all its assets immediately before

becoming a foreign trust. See section

1491.

Notwithstanding any other guidance

provided by this notice, a gratuitous

transfer also includes any direct or indirect transfer that is structured with a

principal purpose of avoiding the application of sections 679 or 6048. See

sections 643(a)(7), 679(d), and 6048(a).

C. Trust Obligations

1. Background

Congress was concerned that certain

taxpayers may have attempted to avoid

the application of sections 679 and

6048(a) by transferring property to a

foreign trust in exchange for obligations

issued by the trust. H.R. Rep. No. 542,

104th Cong., 2d Sess., pt. 2 at 25

(1996). Thus, the Act provides that if a

U.S. person transfers money or other

property to a related foreign trust, any

obligation issued by the trust (or any

obligation of a person related to the

trust) will not be taken into account in

determining if the U.S. person received

fair market value, except to the extent

provided by regulations. Sections

679(a)(3)(A)(i), 6048(a)(3)(B)(i). For

June 23, 1997

purposes of determining whether an obligation is disregarded, a person is related to a trust if, without regard to the

transfer, the person is a grantor of the

trust, a beneficiary of the trust, or a

person who is related (within the meaning of section 643(i)(2)(B)) to any

grantor or beneficiary of the trust. Section 679(a)(3)(C).

Congress nevertheless intended that

Treasury and the Service would exercise

regulatory authority to allow certain

trust obligations to be taken into account

in determining whether such a transferor

has received fair market value. In exercising this regulatory authority, Congress

expected that Treasury and the Service

would give consideration to whether

there is a reasonable expectation that an

obligation of the trust would be repaid.

H.R. Conf. Rep. No. 737, 104th Cong.,

2d Sess. 335 (1996).

2. Qualified Obligations

Where a U.S. person transfers money

or other property to a related foreign

trust in exchange for an obligation from

that trust (or an obligation of a person

related to such trust), regulations will

provide that the obligation will be taken

into account for purposes of section 679

in determining whether the U.S.

transferor received fair market value

from the foreign trust only if the obligation is a ‘‘qualified obligation.’’

An obligation is 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 of the

obligation is not less than 100 percent

of the applicable Federal rate and not

greater than 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);

(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

June 23, 1997

obligation (this extension is not necessary if the maturity date of the obligation does not extend beyond the end of

the U.S. person’s taxable year and is

paid within such period); when properly

executed and filed, such an agreement

will be deemed to be consented to by

the Service Center Director or the Assistant Commissioner (International) for

purposes of § 301.6501(c)–1(d); and

(vi) The U.S. transferor reports the

status of the obligation, including principal and interest payments, on Form

3520 for each year that the obligation is

outstanding.

If, while the original obligation is

outstanding, the U.S. transferor or a

person related to the trust 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 will be 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 related to the trust)

will be 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.

If an obligation treated as a qualified

obligation subsequently fails to be a

qualified obligation (e.g., a renegotiation

of the terms of the obligation causes the

term of the obligation to exceed five

years), the U.S. transferor will be treated

as making a gratuitous 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 gratuitous transfer will not exceed

the issue price of the subsequent obligation. The subsequent obligation will be

separately tested to determine if it is a

qualified obligation.

Generally, as discussed above, a gratuitous transfer resulting from a failed

qualified obligation will be 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 facts and circumstances, the district director may deem a

gratuitous 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 district director could

deem the transfer to have occurred on

the issue date of the original obligation.

A demand loan does not have a specified term and, therefore, cannot be a

‘‘qualified obligation.’’ In addition, an

annuity contract cannot be a ‘‘qualified

obligation.’’

The rules for qualified obligations

apply to an obligation of a related

foreign trust (or of a person related to

the trust) issued after February 6, 1995,

whether or not in accordance with a

preexisting arrangement or understanding. For purposes of these rules, 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 contained in revised section 6677 will only apply to

the failure to report transfers in exchange for obligations issued after August 20, 1996.

D. Section 1494 Information Reporting

Notwithstanding that nongratuitous

transfers of property generally are not

reportable under section 6048(a), fair

market value transfers must nevertheless

be reported on Form 3520 pursuant to

section 1494 if:

(i) The U.S. transferor (other than a

person described in Part II.A.1.i.

through iii. of Notice 97–18, 1997–10

I.R.B. 35) makes a nongratuitous transfer of appreciated property to a foreign

trust and does not immediately recognize all of the gain on the property

transferred (or recognizes gain only by

reason of an election described in section 1057); or

(ii) The U.S. transferor is related to

the trust. A transferor is considered

related to the trust if the transferor is the

grantor of the trust, a beneficiary of the

trust, or a person related to a grantor or

beneficiary (applying the principles of

section 643(i)(2)(B), as modified by

Section II.A.2. of Notice 97–18,

1997–10 I.R.B. 35).

1997–25

I.R.B.

If such a nongratuitous transfer to a

foreign trust is reportable under section

1494, the transfer must be reported on

Form 3520 in a manner comparable to

the manner for reporting transactions

with other foreign entities on Form 926

(‘‘Return by a U.S. Transferor of Property to a Foreign Corporation, Foreign

Estate or Trust, or Foreign Partnership’’). See Notice 97–18, Section III.C.

Thus, if a U.S. person transfers appreciated property to a foreign trust and does

not immediately recognize the entire

amount of gain on the transfer (or

recognizes gain only by reason of an

election described in section 1057), the

transferor must separately identify the

property transferred. However, if the

transferor recognizes the gain (if any)

on the property transferred, but the

transferor is related to the foreign trust,

the transferor may aggregate the

amounts transferred to the trust during

the year, using the categories set forth in

Section III.C. of Notice 97–18.

The transferor will not be required to

file a separate Form 926 in addition to

Form 3520 unless the transferor owes

excise tax under section 1491 with respect to a transfer. Elections under section 1057 to avoid the section 1491

excise tax can be made on Form 3520.

E. Deferred Compensation and

Charitable Trusts

Without regard to whether a transfer

to a foreign trust is gratuitous or

nongratuitous, transfers to foreign trusts

described in sections 402(b), 404(a)(4),

404A, or 501(c)(3) are exempt from

reporting under section 6048(a). Section

6048(a)(3)(B)(ii). For purposes of this

provision, a trust will be considered

described in section 501(c)(3) only if it

has a determination letter from the Service that has not been revoked recognizing its status as exempt from income

taxation under section 501(a).

Section 6048(d)(4) authorizes the Secretary to suspend requirements of section 6048 as appropriate. Based on this

authority, no reporting will be required

under section 6048(a) on transfers to

Canadian Registered Retirement Savings

Plans (RRSPs) if the trust would qualify

for treaty benefits at the time of the

transfer under the Convention Between

the United States of America and

Canada with Respect to Taxes on Income and on Capital. Any U.S. person

relying on a tax treaty with Canada to

avoid information reporting must, however, disclose this position under section

6114.

1997–25

I.R.B.

Furthermore, the Secretary has determined that, if a foreign trust is described

in sections 402(b), 404(a)(4), 404A or

501(c)(3), or is an RRSP, and a transfer

to such trust would be exempt from

reporting under section 6048(a) pursuant

to this notice, no reporting is required

with respect to any transfer to that trust

under section 1494. Thus, no penalty

will apply under sections 6677 or

1494(c) with respect to the failure to

report any transfer to such a trust.

Comments are solicited concerning

whether other categories of transfers to

foreign trusts should be exempt from

reporting under sections 6048(a) and

1494.

F. Examples

The following examples illustrate the

rules in this Section II. In these examples, A is a U.S. citizen, DC is a

domestic corporation, DT is a domestic

trust that is not treated as owned by any

other person, and FT is a foreign trust.

Example 1. Contribution to FT. A contributes

cash to FT, through a broker, in exchange for

units in FT. The value of the units in FT is

disregarded in determining whether A h

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