Congress's end game of catching wealthy expatriators.

• Author: Madden, David

Through a series of 1996 amendments to Sec. 877 and a plethora of recently introduced bills aimed at sealing loopholes, Congress continues its battle to curtail millionaire Americans from leaving the U.S. tax free.

The idea of having a special "alternative tax regime" apply to individuals who relinquish their U.S. citizenship with a principal purpose of avoiding U.S. tax is nothing new. As early as the 1960s, legislators searched for ways to discourage individuals from relinquishing citizenship as a way to avert U.S. taxation. Congress passed the Foreign Investors Tax Act of 1966, subjecting individuals who relinquish their citizenship with a principal purpose of avoiding tax to a 10-year period of tax at the regular graduated rates on certain U.S.-source income. However, the Act proved fruitless because individuals still found ways to achieve these goals.

The ineffectiveness of the Foreign Investors Tax Act of 1966 led to numerous amendments, the most significant being the Health Insurance Portability and Accountability Act of 1996 (HIPAA). The HIPAA extended the alternative tax regime to long-term U.S. residents and provided both objective and subjective tests to determine whether an individual who had renounced his or her citizenship or residency did so with a principal purpose to avoid taxation. The objective test under Sec. 877(a)(2) provides that an individual is deemed to be doing that if his or her (1) average annual U.S. Federal income tax liability for the five tax years preceding citizenship relinquishment or residency termination exceeds $100,000; or (2) net worth on the date of citizenship relinquishment or residency termination is at least $500,000.

Individuals meeting the objective test are automatically subject to an alternative tax regime for 10 years after relinquishing citizenship or long-term resident status. Additionally, the HIPAA amendments expanded the types of income subject to taxation (e.g., foreign property acquired in nonrecognition transactions and amounts earned through controlled foreign corporations).

Although the amendments appeared foreboding, relief was provided in the form of a subjective test. Certain categories of individuals could request a ruling on whether their circumstances would deem them to have a principal purpose of tax avoidance. Congress and the IRS felt confident that the new amendments were sufficiently stringent to discourage individuals from relinquishing citizenship or residency to...