Effective date

The proposal to modify the treatment of a trust or estate as a U.S. person would apply to
taxable years beginning after December 31, 1996. In addition, if the trustee of a trust so elects,
the proposal would apply to taxable years ending after the date of enactment. The proposed
amendment to section 1491 would be effective on the date of enactment.

e. Information r ‘ing and penalties relating to foreign ts

The proposal would expand the reporting requirements with respect to foreign trusts if
there is a U.S. grantor of the foreign trust or a distribution from the foreign trust to a U.S. person.
The proposal would require the responsible parties to file the designated information reports with
the Treasury Department upon the occurrence of certain events. A failure to comply with the
reporting requirements would result in increased monetary penalties under the proposal.

Information reporting requirements

First, the proposal would require the grantor, transferor or executor (i.e., the "responsible
party") to notify the Treasury Department upon the occurrence of certain reportable events. The
reportable events include direct and indirect transfers of property to a foreign trust, other than a
nonexempt employees' trust described in section 402(b), and the death of a U.S. citizen or
resident if any portion of a foreign trust was included in the gross estate of the decedent. The
required notice would identify the money or other property transferred and report information
regarding the trustee and beneficiaries of the foreign trust.

Second, a U.S. person that is treated as the owner of any portion of a foreign trust would
be required to ensure that the trust files an annual report to provide full accounting of all the trust
activities for the taxable year, the name of the U.S. agent for the trust, and other information as
prescribed by the Secretary of the Treasury.‘ In addition, unless a U.S. person is authorized to
accept service of process as the trust's limited agent with respect to any request by the Treasury
Department to examine records or to take testimony and any summons for such records or
testimony in connection with the tax treatment of any items related to the trust, the Treasury
Secretary would be entitled to determine the amount to be taken into account under the grantor
trust rules (secs. 671 through 679). This limited agency relationship would not constitute an
agency relationship for any other purpose under Federal or State law.

Third, any U.S. person who receives (directly or indirectly) any distribution from a
foreign trust would be required to file a notice to report the name of the trust, the aggregate

* It is intended that the regulations would require the trust to furnish information to U.S.

grantors and beneficiaries concerning income reportable by such persons in a manner similar to
that used to report the items on schedule K-1 of Form 1041.

-12-



To avoid a double benefit, the proposal would deny the credit to taxpayers to the extent
the taxpayer may use otherwise qualified adoption expenses as the basis of another credit or
deduction. Similarly, the credit would not be allowed for any expenses for which a grant is
received under any Federal, State, or local program. This latter limit, however, would not apply
in the case of special needs adoptions.

The proposal would provide that individuals who are married at the end of the taxable
year must file a joint return to receive the credit unless they lived apart from each other for the
last six months of the taxable year and the individual claiming the credit (1) maintained as his or
her home a household for the child for more than one-half of the taxable year and (2) furnished
over one-half of the cost of maintaining that household in that taxable year. Further, the
proposal would provide that an individual legally separated from his spouse under a decree of
divorce or separate maintenance would not be considered married for purposes of this provision.

Exclusion income

The proposal would provide a maximum $5,000 exclusion from the gross income of an
employee for specified certain adoption expenses be paid by the employer. The $5,000 limit
would be a per child limit, not an annual limitation. In order for the exclusion to apply, the
expenses would have to be paid under an adoption assistance program in connection with an
adoption of an eligible child (as described above) by an employee. An adoption assistance
program would be a nondiscriminatory plan of an employer under which the employer provides
employees with adoption assistance. Also, not more than five percent of the benefits under the
program for any year could benefit a class of individuals consisting of more than five percent
owners of the employee or their spouses or dependents. An adoption assistance program would
not have to be funded. An adoption reimbursement program operated under section 1052 of title
10 of the U.S. Code (relating to the armed forces) or section 514 of title 14 of the U.S. Code
(relating to members of the Coast Guard) would be treated as an adoption assistance program for
these purposes. Adoption assistance would be a qualified benefit under a cafeteria plan. The
exclusion would be phased out ratably for taxpayers with modified AGI above $75,000 and
would be fully phased out at $115,000 of modified AGI. No credit would be allowed for
adoption expenses paid or reimbursed under an adoption assistance program.

Effective Date

The proposal would be effective for taxable years beginning after December 3 1, 1996.

-3-



would not apply where the grantor is a controlled foreign corporation. Under the proposal, the
grantor trust rules would apply in determining whether a foreign corporation is characterized as a
passive foreign investment company ("PFIC"). Thus, a foreign corporation could not avoid
PFIC status by transferring its assets to a grantor trust.

Ifa U.S. beneficiary of an inbound grantor trust transfers property to the foreign grantor
by gift, such beneficary would be treated as a grantor of a portion of the trust to the extent of the
transfer. This rule would apply without regard to whether the foreign grantor would otherwise
be treated as the owner of any portion of such trust.

In a case where a foreign grantor, who would be treated as the owner of a trust but for the
above rule, actually pays tax on the income of the trust to a foreign country, it is anticipated that
Treasury regulations would provide that, for foreign tax credit purposes, U.S. beneficiaries who
are subject to U.S. income tax on the same income would be treated as having paid the foreign
taxes that were paid by the foreign grantor. Any resulting foreign tax credits would be subject to
applicable foreign tax credit limitations.

The proposal would provide a transition rule for any domestic trust that has a foreign
grantor who is treated as the owner of the trust under present law. If such a trust becomes a
foreign trust before January 1, 1997, or if the assets of such a trust are transferred to a foreign
trust before that date, such trust would be exempt from the excise tax on transfers to a foreign -
trust otherwise imposed by section 1491. However, the proposal's new reporting requirements
and penalties would be applicable.

Distributions by foreign trusts through nominees

The proposal would treat any amount paid to a U.S. person, where the amount was
derived (directly or indirectly) from a foreign trust of which the payor is not the grantor, as if
paid by the foreign trust directly to the U.S. person. This rule would disregard the role of an
intermediary or nominee that may be interposed between a foreign trust and a U.S. beneficiary.
Unlike present law, however, the rule would apply whether or not the trust was created byaUS.
person. The rule would not apply to a withdrawal from a foreign trust by its grantor, with a
subsequent gift or other payment to a U.S. person.

Effective date
The proposal would be effective on the date of enactment.
b. Foreign trusts that are not grantor trusts

Interest charge on accumulation distributions

The proposal would change the interest rate applicable to accumulation distributions
from foreign trusts from simple interest at a fixed rate of 6 percent to compound interest

-8-



2. Modify treatment of foreign trusts

Present Law
I id gran sts with forei. ntor:

Under the grantor trust rules (secs. 671-679), a grantor that retains certain rights or
powers generally is treated as the owner of the trust's assets without regard to whether the
grantor is a domestic or foreign person. Under these rules, U.S. trust beneficiaries can avoid U.S.
tax on distributions from a trust where a foreign grantor is treated as owner of the trust, even
though no tax may be imposed on the trust income by any jurisdiction. In addition, a special rule
treats a U.S. beneficiary of an inbound grantor trust who transferred property to the foreign
grantor by gift of a portion of the trust as a grantor of the trust to the extent of the transfer.

Foreign trusts that are not grantor trusts

Under the accumulation distribution rules (which generally apply to distributions from a
trust in excess of the trust's distributable net income for the taxable year), a distribution by a
foreign nongrantor trust of previously accumulated income generally is taxed at the U.S.
beneficiary's average marginal rate for the prior 5 years, plus interest (secs. 666, 667). Interest is
computed at a fixed annual rate of 6 percent, with no compounding (sec. 668). If adequate -
records of the trust are not available to determine the proper application of the rules relating to
accumulation distributions to any distribution from a trust, the distribution is treated as an
accumulation distribution out of income earned during the first year of the trust (sec. 666(d)).

If a foreign nongrantor trust makes a loan to one of its beneficiaries, the principal of such
a loan generally is not taxable as income to the beneficiary.

Outbound foreign grantor trusts with U.S. grantors

Under the grantor trust rules, a U.S. person who transfers property to a foreign trust
generally is treated as the owner of the portion of the trust comprising that property for any
taxable year in which there is a U.S. beneficiary of any portion of the trust (sec. 679(a)). This
treatment generally does not apply, however, to transfers by reason of death, to transfers made
before the transferor became a U.S. person, or to sales or exchanges of property at fair market
value where gain is recognized to the transferor.

Residence of estates and trusts

An estate or trust is treated as foreign if it is not subject to U.S. income taxation on its
income that is neither derived from U.S. sources nor effectively connected with the conduct of a
U.S. trade or business. Thus, if a trust is taxed in a manner similar to a nonresident alien
individual, it is considered to be a foreign trust. Any other estate or trust is treated as domestic.

5.



B. Revenue Offsets
(Title IV of the Bill)

1. Remove business exclusion for energy subsidies provided by public utilities

Present Law

Internal Revenue Code section 136, as added by the Energy Policy Act of 1992, provides
an exclusion from the gross income of a customer of a public utility for the value of any subsidy
provided by the utility for the purchase or installation of an energy conservation measure with
respect to a dwelling unit (as defined by sec. 280A(f)(1)). In addition, for subsidies received
after 1994, section 136 provides a partial exclusion from gross income for the value of any
subsidy provided by a utility for the purchase or installation of an energy conservation measure
with respect to property that is not a dwelling unit. The amount of the exclusion is 40 percent of
the value for subsidies received in 1995, 50 percent of the value for subsidies received in 1996,
and 65 percent of the value for subsidies received after 1996.

For this purpose, an energy conservation measure is any installation or modification
primarily designed to reduce consumption of electricity or natural gas or to improve the
management of energy demand with respect to property. With respect to property other than a
dwelling unit, an energy conservation measure includes “specially defined energy property"
(generally, property described in sec. 48(1)(5) of the Code as in effect on the day before the date
of enactment of the Revenue Reconciliation Act of 1990).

The exclusion does not apply to payments made to or from a qualified cogeneration
facility or a qualifying small power production facility pursuant to section 210 of the Public
Utility Regulatory Policy Act of 1978.

Section 136 denies a deduction or credit to a taxpayer (or in appropriate cases requires a
reduction in the adjusted basis of property of a taxpayer) for any expenditure to the extent that a
subsidy related to the expenditure was excluded from the gross income of the taxpayer.

Description of Proposal

The proposal would repeal the partial exclusion for any subsidy provided by a utility for
the purchase or installation of an energy conservation measure with respect to property that is
not a dwelling unit.

Effective Date
The proposal would be effective for subsidies received after December 31, 1996, unless

received pursuant to a binding written contract in effect on September 13, 1995, and all times
thereafter.

4.



c. A nonresident alien who transfers property to a foreign trust and then becomes a U.S.
resident within 5 years after the transfer would be treated as making a transfer to the foreign trust
on his residency starting date. In determining whether a foreign trust paid fair market value to
the transferor for property transferred to the trust, obligations issued by the trust, any person
related to any grantor or beneficiary generally would not be taken into account.

d. A two-part objective test would be established for determining whether a trust is
foreign or domestic for tax purposes.

e. The proposal would expand the reporting requirements with respect to foreign trusts if
there is a U.S. grantor of the foreign trust or a distribution from the foreign trust to a U.S. person.
The proposal would require the responsible parties to file the designated information reports with
the Treasury Department upon the occurrence of certain events. A failure to comply with the
reporting requirements would result in increased monetary penalties under the proposal. Unless a
U.S. owner of any portion of a foreign trust appoints a limited agent to accept service of process
with respect to requests and summons by the Treasury Department in connection with the tax
treatment of items relating to the trust, special sanctions would apply.

f. Any U.S. person (other than certain tax-exempt organizations) that receives purported
gifts or bequests from foreign sources totaling more than $10,000 during the year would be
required to report the gift to the Treasury Department. Monetary penalties and certain sanctions-~
would apply to a failure to comply with the reporting requirement.

The proposal is described in more detail below.

a. Inbound grantor tr ith foreign grantors

Foreign grantors not treated as owners

Under the proposal, the grantor trust rules generally would apply only to the extent that
they result, directly or indirectly, in amounts being currently taken into account in computing the
income of a U.S. citizen or resident or a domestic corporation. Thus, the grantor trust rules
generally would not apply to any portion of a trust where their effect would be to treat a foreign
person as owner of that portion. The proposal would provide certain exceptions to this general
tule, The grantor trust rules would continue to apply to any trust that is revocable by the grantor.
In addition, the grantor trust rules would continue to apply to any trust where the only amounts
distributable during the lifetime of the grantor are to the grantor or the grantor's spouse. These
exceptions would not apply to the extent of gifts made by a U.S. beneficiary of the trust to the
foreign grantor. The proposal also would not apply to trusts established to pay compensation,
and certain trusts in existence as of September 19, 1995.7 In addition, the proposal generally

? The exception would not apply to the portion of any such trust attributable to any
transfers made after September 19, 1995.

-7-



DESCRIPTION OF
REVENUE PROVISIONS OF H.R. 3286
RELATING TO
TAX CREDIT FOR ADOPTION EXPENSES AND
CERTAIN REVENUE OFFSETS

Scheduled for Markup
Before the
HOUSE COMMITTEE ON WAYS AND MEANS

on May 1, 1996

Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
April 26, 1996

JCX-14-96



Sale or exchange at market value

Present law contains an exception from grantor trust treatment for property transferred by
a U.S. person to a foreign trust in the form of a sale or exchange at fair market value where gain
is recognized to the transferor. In determining whether the trust paid fair market value to the
transferor, the proposal generally would not, except as provided by regulations, take into account
obligations issued by the trust, by any grantor or beneficiary of the trust, or by any person related
to a grantor or beneficiary. In addition, to the extent provided by regulations, obligations
guaranteed by the trust, by any grantor or beneficiary of the trust, or by any person related to a
grantor or beneficiary also would not be taken into account.

Other transfers

Under the proposal, a transfer of property to certain charitable trusts would be exempt
from the application of the rules treating foreign trusts with U.S. grantors and U.S. beneficiaries
as grantor trusts.

Transferors or beneficiaries who become U.S. persons

The proposal would apply the rules of section 679 to certain foreign persons who transfer
property to a foreign trust and subsequently become U.S. persons. A nonresident alien individual
who transfers property, directly or indirectly, to a foreign trust and then becomes a resident of
the United States within 5 years after the transfer generally would be treated as making a transfer
to the foreign trust at the time the individual becomes a U.S. resident. The amount of the deemed
transfer would be the portion of the trust (including undistributed earnings) attributable to the
property previously transferred. Consequently, the individual generally would be treated under
the rules of section 679 as the owner of that portion of the trust in any taxable year in which the
trust has U.S. beneficiaries. The proposal's new reporting requirements and penalties (discussed
below) also would be applicable.

Under the proposal, a beneficiary would not be treated as a U.S. person for purposes of
determining whether the transferor of property to a foreign trust would be taxed as a grantor with
respect to any portion of a foreign trust if such beneficiary first became a U.S. resident more than
5 years after the transfer.

Out t igration:

The proposal would apply the rules of section 679 to a U.S. person that transferred
property to a domestic trust if the trust subsequently became a foreign trust while the transferor
was still alive. Such a person would be deemed to make a transfer to the foreign trust on the date
of the migration. The amount of the deemed transfer would be the portion of the trust (including
undistributed earnings) attributable to the property previously transferred. Consequently, the
individual generally would be treated under the rules of section 679 as the owner of that portion
of the trust in any taxable year in which the trust has U.S. beneficiaries. The proposa!'s reporting

-10-



determined in the manner of the interest imposed on underpayments of tax under section
6621(a)(2). Simple interest would be accrued at the rate of 6 percent through 1995. Beginning on
January 1, 1996, however, compound interest based on the underpayment rate would be imposed
not only on tax amounts determined under the accumulation distribution rules but also on the
total simple interest for pre-1996 periods, if any. For purposes of computing the interest charge,
the accumulation distribution would be allocated proportionately to prior trust years in which the
trust had undistributed net income (and the beneficiary receiving the distribution was a U.S.
citizen or resident), rather than to the earliest of such years. An accumulation distribution would
be treated as reducing proportionately the undistributed net income from prior years.

Anti- e tions orit

The proposal would include an anti-abuse rule which authorizes the Secretary of the
Treasury to issue regulations, on or after the date of enactment, that may be necessary or
appropriate to carry out the purposes of the rules applicable to estates, trusts and beneficiaries,
including regulations to prevent the avoidance of those purposes.

Loans to grantors or beneficiaries

In the case of a loan of cash or marketable securities by the foreign trust to a U.S. grantor
or a U.S. beneficiary (or a U.S. person related to such grantor or beneficiary’), except to the
extent provided by Treasury regulations, the proposal would treat the full amount of the loan as
distributed to the grantor or beneficiary. It is expected that the regulations would provide an
exception from this treatment for loans with arm's-length terms. It is further expected that
whether there is a reasonable expectation that a loan will be repaid would be taken into account
in applying the exception from this treatment to such loan. In addition, any subsequent
transaction between the trust and the original borrower regarding the principal of the loan (e.g.,
repayment) would be disregarded for all purposes of the Code.

Effective date

The proposal to modify the interest charge on accumulation distributions would apply to
distributions after the date of enactment. The proposal with respect to loans to U.S. grantors or
U.S. beneficiaries would apply to loans made after September 19, 1995.

c. Outbound foreign grantor trusts with U.S. grantors

The proposal would make several modifications to the rules of section 679 under which
foreign trusts with U.S. grantors and U.S. beneficiaries are treated as grantor trusts.

> For this purpose, a person generally would be treated as related to the grantor or

beneficiary if the relationship between such person and the grantor or beneficiary would result in
a disallowance of losses under section 267 or 707(b).

-9-



Section 1491 generally imposes a 35-percent excise tax on a U.S. person that transfers
appreciated property to certain foreign entities, including a foreign trust. In the case of a
domestic trust that changes its situs and becomes a foreign trust, it is unclear whether property
has been transferred from a U.S. person to a foreign entity, and, thus, whether the transfer is
subject to the excise tax.

Information reporting and penalties related to foreign trusts

Any U.S. person who creates a foreign trust or transfers money or property to a foreign
trust is required to report that event to the Treasury Department without regard to whether the
trust is a grantor or a nongrantor trust. Similarly, any U.S. person who transfers property to a
foreign trust that has one or more U.S. beneficiaries is required to report annually to the Treasury
Department. In addition, if the transfer of any appreciated property by a U.S. person is subject to
section 1491, the transferor is required to report the transfer to the Treasury Department.

Any person who fails to file a required report with respect to the creation of, or a transfer
to, a foreign trust may be subjected to a penalty of 5 percent of the amount transferred to the
foreign trust. Similarly, any person who fails to file a required annual report with respect to a
foreign trust with U.S. beneficiaries may be subjected to a penalty of 5 percent of the value of
the corpus of the trust at the close of the taxable year. The maximum amount of the penalty
imposed under either case may not exceed $1,000. A reasonable cause exception is available.

Reporting of foreign gifts

There is no requirement to report gifts or bequests from foreign sources.

Description of Proposal
Overview

The proposal would modify certain aspects of the tax treatment of foreign trusts with
U.S. beneficiaries as follows:

a. The grantor trust rules generally would apply only to the extent that they result,
directly or indirectly, in amounts being currently taken into account in computing the income of
aU.S. person. Certain exceptions would apply.

b. Beginning on January 1, 1996, the interest rate applicable to accumulation
distributions from foreign nongrantor trusts would be the rate imposed on underpayment of tax
under section 6621{a)(2), with compounding. The accumulation distribution generally would be
allocated proportionately to prior trust years in which the trust had undistributed net income.
The full amount of a loan of cash or marketable securities by a foreign nongrantor trust to a U.S.
grantor or a U.S. beneficiary (or a U.S. person related to such a grantor or beneficiary) generally
would be treated as a distribution to the grantor or beneficiary.

6-



DESCRIPTION OF REVENUE PROVISIONS OF H.R. 3286

A. Tax Credit for Adoption Expenses; Exclusion for Certain Adoption Expenses
(Title I of the Bill)

Present Law

Present law does not provide a tax credit for adoption expenses. Also, present law does
not provide an exclusion from gross income for employer-provided adoption assistance. The
Federal Adoption Assistance program (a Federal outlay program) provides financial assistance
for the adoption of certain special needs children. In general, a special needs child is defined as a
child who (1) according to a State determination, could not or should not be returned to the home
of the natural parents and (2) on account of a specific factor or condition (such as ethnic
background, age, membership in a minority or sibling group, medical condition, or physical,
mental or emotional handicap), could not reasonably be expected to be adopted unless adoption
assistance is provided. Specifically, the program provides assistance for adoption expenses for
those special needs children receiving Federally assisted adoption assistance payments as well as
special needs children in private and State-funded programs. The maximum Federal
reimbursement is $1,000 per special needs child. Reimbursable expenses include those
nonrecurring costs directly associated with the adoption process such as legal costs, social
service review, and transportation costs.

Description of Proposal
Tax credit

The proposal would provide taxpayers with a maximum nonrefundable credit against
income tax liability of $5,000 per child for qualified adoption expenses paid or incurred by the
taxpayer. Any unused adoption credit could be carried forward by the taxpayer for up to five
years. Qualified adoption expenses would be reasonable and necessary adoption fees, court
costs, attorneys’ fees and other expenses that are directly related to the legal adoption of an
eligible child. In the case of an international adoption, the credit would not be available unless
the adoption is finalized. An eligible child would be an individual (1) who has not attained age
18 as of the time of the adoption, or (2) who is physically or mentally incapable of caring for
himself or herself. No credit would be allowed for expenses incurred (1) in violation of State or
Federal law, (2) in carrying out any surrogate parenting arrangement, or (3) in connection with
the adoption of a child of the taxpayer's spouse. The credit would be phased out ratably for
taxpayers with modified adjusted gross income (AGI) above $75,000, and would be fully phased
out at $115,000 of modified AGI.

The $5,000 limit would be a per child limit, not an annual limitation. For example, ifa
taxpayer incurs $3,000 of qualified adoption expenses in year one and $3,000 of qualified
adoption expenses in year two, then the taxpayer would receive a $3,000 credit in year one and a
$2,000 credit in year two.

-2-


amount of the distributions received, and other information that the Secretary of the Treasury
may prescribe. In cases where adequate records are not provided to the Secretary of Treasury to
determine that proper treatment of any distributions from a foreign trust, the distribution
includible in the gross income of the U.S. distributee would be treated as an accumulation
distribution from the mid year of a foreign trust (i.e., the number of years that the trust has been
in existence divided by 2) for purposes of computing the interest charge applicable to such
distribution.

Monetary penalties for failure to report

Under the proposal, a person who fails to provide the required notice in cases involving
the transfer of property to a new or existing foreign trust, or a distribution by a foreign trust to a
U.S. person, would be subject to an initial penalty equal to 35 percent of the gross reportable
amount. A failure to provide an annual reporting of trust activities would result in an initial
penalty equal to 5 percent of the gross reportable amount. In cases involving a transfer of
property to a foreign trust, the gross reportable amount would be the gross value of the property
transferred. In cases involving the death of a U.S. citizen or resident whose estate includes any
portion of a foreign trust, the gross amount would be the greater of: (a) the amount the decedent
is treated as owning under the grantor trust rules or (b) the value of the property includible in the
gross estate of the decedent. In cases where annual reporting of trust activities is required, the
gross reportable amount would be the gross value of the portion of the foreign trust's assets
treated as owned by the U.S. grantor at the close of the year, and in cases involving a distribution
toa U.S. beneficiary of a foreign trust, the gross reportable amount would be the amount of the
distribution to the beneficiary. An additional $10,000 penalty would be imposed for continued
failure for each 30-day period (or fraction thereof) beginning 90 days after the Treasury
Department notifies the responsible party of such failure. Such penalties would be subject to a
reasonable cause exception. In no event would the total amount of penalties exceed the gross
reportable amount.

Effective date

The reporting requirements and applicable penalties generally would apply to reportable
events occurring or distributions received after the date of enactment. The annual reporting
requirement and penalties applicable to U.S. grantors would apply to taxable years of such
persons beginning after the date of enactment.

f. Reporting of foreign gifts

The proposal generally would require any U.S. person (other than certain tax-exempt
organizations) that receives purported gifts or bequests from foreign sources totaling more than
$10,000 during the taxable year to report them to the Treasury Department. The threshold for
this reporting requirement would be indexed for inflation. The definition of a gift toa U.S.
person for this purpose would exclude amounts that are qualified tuition or medical payments
made on behalf of the U.S. person, as defined for gift tax purposes (sec. 2503(e)(2)). If the U.S.

-13-



INTRODUCTION

The House Committee on Ways and Means has scheduled a markup on H.R. 3286
("Adoption Promotion and Stability Act of 1996") on May 1, 1996. H.R. 3286 was introduced
on April 23, 1996, by Ms. Molinari, Messrs. Archer and Bunning, Ms. Pryce, and Messrs.
Solomon, Tiahrt, and Shaw.

The bill was referred to the Committee on Ways and Means, and in addition, to the
Committee on Resources and Economic and Educational Opportunities, for a period to be
subsequently determined by the Speaker, in each case for consideration of such provisions as fall
within the jurisdiction of the committee concerned. Title I of the bill would provide a tax credit
for certain adoption expenses and an exclusion for certain adoption expenses. Title II of the bill
would remove certain barriers to interethnic adoptions. Title IH of the bill would modify child
custody proceedings affected by the Indian Child Welfare Act of 1978. Title IV of the bill
would provide certain revenue offsets: (1) remove business exclusion for energy subsidies
provided by public utilities; and (2) modify treatment of foreign trusts.

This document,’ prepared by the staff of the Joint Committee on Taxation, provides a
description of the revenue provisions of the bill (Titles I and IV).

' This document may be cited as follows: Joint Committee on Taxation, Description of
Revenue Provisions of H.R. 3286 Relating to Tax Credit for Adoption Expenses and Certai
Revenue Offsets (JCX-14-96), April 26, 1996.

-l-



CONTENTS

A. Tax Credit for Adoption Expenses; Exclusion for Certain Adoption
Expenses (Title I of the Bill) ....... 00.0.0... eee ec eee

B. Revenue Offsets (Title IV of the Bill) ........0.0.00.000..00.000000,

1. Remove business exclusion for energy subsidies provided by
public utilities 20 c cee ee

2. Modify treatment of foreign trusts ...................0.0004

Gi)


requirements and penalties (discussed below) also would be applicable.

Effective date

The rules described in this part would apply to transfers of property after February 6,
1995.

d. Residence of estates and
Tr ent . person

The proposal would establish a two-part objective test for determining for tax purposes
whether a trust is foreign or domestic. If both parts of the test are satisfied, the trust would be
treated as domestic. Only the first part of the test would apply to estates.

Under the first part of the proposed test, in order for an estate or trust to be treated as
domestic, a U.S. court (i.e., Federal, State, or local) must be able to exercise primary supervision
over the administration of the estate or trust. It is expected that this test would be satisfied by any
trust instrument that specifies that it is to be governed by the laws of any State.

Under the second part of the proposed test, in order for a trust to be treated as domestic,
one or more U.S. fiduciaries must have the authority to control all substantial decisions of the
trust. It is expected that this test would be satisfied in any case where fiduciaries who are U.S.
persons hold a majority of the fiduciary power (whether by vote or otherwise), and where no
foreign fiduciary, such as a "trust protector" or other trust advisor, has the power to veto
important decisions of the U.S. fiduciaries. It is further expected that, in applying this test, a
reasonable period of time would be allowed for a trust to replace a U.S. fiduciary who resigns or
dies before the trust would be treated as foreign.

Under the proposal, a foreign estate would be defined as an estate other than an estate
that is determined to be domestic under the court-supervision test. A foreign trust would be
defined as a trust other than a trust that is determined to be domestic under both the court-
supervision test and the U.S. fiduciary test.

Outbound migration of domestic trusts

Under the proposal, if a domestic trust changes its situs and becomes a foreign trust, the
trust would be treated as having made a transfer of its assets to the foreign trust and would be
subject to the 35-percent excise tax imposed by present-law section 1491 unless one of the
exceptions to this excise tax were applicable. The U.S. grantor also would be required to report
the transfer under the reporting requirements described below. Failure to report such a transfer
would result in penalties (discussed below).

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person fails, without reasonable cause, to report foreign gifts as required, the Treasury Secretary
would be authorized to determine, in its sole discretion, the tax treatment of the unreported gifts.
In addition, the U.S. person would be subject to a penalty equal to 5 percent of the amount of the
gift for each month that the failure continues, with the total penalty not to exceed 25 percent of
such amount.

Effective date

The proposal would apply to amounts received after the date of enactment.

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