Code-Treaty Conflicts Where Congress Is Silent: The Anti-Expatriation “Inheritance Tax” Under §2801

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Thomas S.  Bissell, CPA

By Thomas S. Bissell, CPA Celebration, Florida

This author's most recent commentary discussed the question of how to resolve a conflict between a tax treaty and a later-enacted statute, where the statute and its legislative history are silent on the existence of the conflict. Based on the legislative history of §7852(d)(1) (enacted in 1988) — which provides that “neither the treaty nor the law shall have preferential status by reason of its being a treaty or law” — it was concluded that while there may be a slight presumption under a “later in time” rule that the statute overrides (i.e., abrogates) the treaty, it is also important to consult a number of other sources that may provide guidance as to what the legislative drafters would have said about the issue if they had actually discussed it in any of the legislative history. It is clear that a later-enacted statute may override a pre-existing treaty, and that if the legislative history (even if obliquely stated) indicates that an override was intended, then an override will have occurred. The difficulty is in attempting to “psych out” what Congress would have said about the issue, given the fact that in most cases of “silence” the existence of the Code-treaty conflict was probably not even considered during the legislative process.

This commentary briefly examines the “inheritance” tax that is imposed under §2801. Because of space limitations, one or more future commentaries will consider additional examples of Code-treaty conflicts where a newly enacted statute conflicts with one or more pre-existing tax treaties, and where both the Code and the legislative history are silent about the conflict.

Section 2801 was enacted in 2008 as part of the “anti-expatriation” rules that impose an “exit tax” on certain U.S. citizens and long-term green card holders who renounce their U.S. citizenship or immigration status and become nonresident aliens. Section 2801 imposes a tax in a manner similar to the U.S. estate and gift tax rules on U.S. citizens and residents who receive gifts or bequests from a “covered expatriate” at any time after the expatriation of the covered expatriate who makes the inter vivos or testamentary transfer. As discussed in detail in a comment letter by Michael Karlin, it is likely that an exemption from the §2801 tax is available to the U.S. recipient if the covered expatriate is resident in a foreign country that is a party to one of the post-1970 U.S. estate and gift tax treaties (usually referred to as “domicile” treaties), and possibly also in a country that is a party to one of the pre-1971 “situs” treaties.

Unfortunately, both the statute and the legislative history are silent on the conflict between §2801 and tax treaties, and thus whether the enactment of §2801 had the effect of overriding all inconsistent treaties. The proposed regulations published on September 28, 2015 (REG-112997-10) are also silent on both questions. However, based on the history of the Code's anti-expatriation rules since they were first enacted in 1966, a strong argument can be made that no treaty override occurred when §2801 was enacted. When the first anti-expatriation rules were enacted in 1966, the enacting language specifically stated that no treaty overrides were intended. When those rules were tightened by Congress in 1996, the Conference Committee stated that all inconsistent treaty rules were being overridden, but only for a period of 10 years; after that, all inconsistent treaty rules would once again prevail over the Code. Thus, Congress has been especially deferential in this particular area with respect to any tax treaties that conflict with any newly enacted anti-expatriation rules.

Although Congress was silent in 2008 on the conflict between §2801 and treaties, some additional insight into Congress's likely intent can be gleaned from three rules that were included in the new anti-expatriation income tax provisions, and which specifically recognized and addressed the Code-treaty conflict. Where a “covered expatriate” elects to defer the payment of the tax that is imposed on a “mark to market” basis on his/her appreciated property, the individual may elect under§877A(b) to postpone the imposition of tax on certain specified items by posting adequate security to ensure payment of the tax when the particular asset is ultimately sold. However, §877A(b)(5) provides that in order to make the election, the individual must also make an “irrevocable waiver of any right under any treaty … which would preclude assessment or collection of any tax imposed” under §877A. Congress could just as easily have provided instead that the deferred tax under §877A(b) would be imposed notwithstanding the provisions of any tax treaties — thus in effect overriding all tax treaties to that extent without the need for the individual to waive his/her treaty benefits. Instead, Congress indirectly recognized that any pre-existing and inconsistent tax treaties would continue to prevail over §877A(b), and that in effect the Code would prevail only if the individual affirmatively waived the benefits of all tax treaties.

Similarly, where a covered expatriate has rights to deferred compensation (as specially defined), in certain cases he/she may take steps to postpone the imposition of the mark-to-market tax until the item is actually paid at a later date in cash. If all of those steps are taken, the item of deferred compensation will be treated as “eligible deferred compensation” under §877A(d)(3). One of the requirements for making the election is that the individual must “make an irrevocable waiver” of any tax treaty rights with respect to withholding thereon. Commentators generally believe that this waiver only applies to withholding on such items, and not to the individual's substantive tax liability as a nonresident alien under §871 and under the relevant tax treaty.

These rules are relevant in considering the treaty override issue for two reasons. First, if Congress intended the §877A rules to override any inconsistent tax treaties, one assumes that it would not have required the individual to waive the benefits of all tax treaties, and instead would have provided simply that (provided the individual took the other steps necessary to postpone the tax) any inconsistent treaty provisions would be overridden. Second (and if commentators on this issue are correct), because Congress limited the treaty waiver rules to withholding tax but apparently did not tamper with the treaty rules on substantive tax liability, Congress must have intended not to override those substantive tax rules.

Even more telling is a slightly different rule that applies where a covered expatriate has an interest in a nongrantor trust. Under §877A(f), the general mark-to-market rule is not applied, and U.S. taxation is deferred until distributions are actually made from the trust, unless the individual makes an up-front election to pay tax on the net present value of his/her interest in the trust. If no such election is made, §877A(f)(4)(B) provides that when distributions are made, the individual “shall be treated as having waived any right to claim any reduction under any treaty” with respect to withholding on such distributions. Thus, this “deemed waiver” is different from the waiver with respect to “eligible deferred compensation,” because it is not dependent on the making of an election on the part of the individual; instead, the deemed waiver will occur automatically. As such, the “deemed waiver” appears on its face to be tantamount to an override of any relevant treaty. As is true of the “eligible deferred compensation” rules, however, commentators also believe that§877A(f) did not change the substantive tax rules that apply under a tax treaty. If so, the continued existence of tax treaty benefits in this situation is a further indication that any treaty override with respect to an interest in a nongrantor trust is intended to be extremely limited in scope. Of much more importance for this discussion, however, is the fact that where a treaty override was clearly intended — i.e., by requiring withholding tax to be imposed notwithstanding the contrary provisions in all pre-existing tax treaties — the override was explicitly included in the language of the statute itself.

These examples from the 2008 legislation, which enacted §2801, and from the prior history of the anti-expatriation rules, indicate that Congress has been extremely deferential towards the existence of pre-existing tax treaties in this particular area, and indeed has been extremely reluctant to override any treaties without explicitly stating so either in the statute itself or in the Committee reports. Indeed, the basic structure of §877A itself — which imposes a mark-to-market income tax as of the day prior to the day on which the individual expatriates (i.e., on a day on which the individual would not be resident in a tax treaty country, and thus could not claim any treaty benefits) — clearly reflects Congress's reluctance to override any pre-existing tax treaties, which is what would have occurred if Congress had provided that the taxing date would be later in time.

It may also be relevant to mention two landmark court decisions in the 1980s. When Congress replaced the lifetime estate tax exemption in 1976 with the present unified credit, the courts subsequently held that the pre-1971 “situs” treaties (which allowed a pro rata lifetime exemption to be claimed by the estate of a treaty-country domiciliary in calculating U.S. estate tax on U.S.-situs assets) should be interpreted so as to allow a pro rata unified credit to be claimed instead, even though both the Code and the legislative history were silent on the question. The holding in those cases is arguably much more treaty-favorable than an argument that the currently existing treaties prevail over §2801, because the language of the treaties in those cases clearly did not mesh at all with the Code language on the unified credit. Although these two court decisions were reached before §7852(d)(1) was enacted in 1988, it is believed that that provision merely clarified pre-1988 existing law on the issue of Code-treaty conflicts. As a result, those cases can perhaps be cited as evidence that, at least in the field of estate tax treaties, a newly enacted statute should be broadly construed in favor of a pre-existing treaty, where the legislative history of the statute is silent on the Code-treaty conflict.

For more information, in the Tax Management Portfolios, see Heimos, 837 T.M., Non-Citizens — Estate, Gift and Generation-Skipping Taxation , Klasing and Francis, 6080 T.M., Section 911 and Other International Tax Rules Relating to U.S. Citizens and Residents, and in Tax Practice Series, see ¶6310, The Nonresident Alien's Estate.

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