Proposed Tax Regs Provide Exceptions To Treating Transferors As Trust Owners

Published May 8, new proposed regs (REG-124850-08) provide guidance on information reporting of transactions with foreign trusts, receipt of large foreign gifts, loans from foreign trusts, and uses of foreign trust property. The regs also contain proposed amendments to the rules governing foreign trusts that have one or more U.S. beneficiaries. The proposed regs affect U.S. persons that own or transact with foreign trusts or that receive large gifts or bequests from foreign persons.

The proposed regs add or amend rules under sections:

• 643(i) (loans from foreign trusts);
• 679 (foreign trusts that have U.S. beneficiaries);
• 6039F (reporting large gifts received from foreign persons);
• 6048 (foreign trust information reporting); and
• 6677 (penalties for failure to report).

This article covers the proposed regs under section 679, which treat U.S. transferors as owners of foreign trusts that have U.S. beneficiaries, unless an exception applies.

Section 679Section 679 is in Part I of subchapter J, which generally covers estates, trusts, and beneficiaries. Part I is divided into subparts A-F, and section 679 is in subpart E (sections 671-679), which contains several rules that treat trust grantors and others as substantial trust owners. Section 679 applies to foreign trusts that have U.S. beneficiaries and generally treats U.S. transferors as foreign trust owners.

Section 679(a)-(e) provides:

1. the general rule that treats U.S. transferors as owners of foreign trusts that have U.S. beneficiaries;
2. rules for trusts that acquire U.S. beneficiaries;
3. rules that treat trusts as having U.S. beneficiaries;
4. a presumption that a trust has a U.S. beneficiary; and
5. a grant of authority to prescribe regs.

Transferor Treated as Owner

Section 679(a)(1)-(5) lays out the primary concept of section 679 — U.S. transferors are treated as owners of foreign trusts with U.S. beneficiaries. It provides:

1. a general rule;
2. exceptions;
3. a description of obligations that don’t satisfy the exceptions;
4. treatment of foreign grantors who become U.S. persons; and
5. treatment of outbound trust migrations.

General Rule. Under the general rule in paragraph (a)(1), a U.S. person who directly or indirectly transfers property to a foreign trust (other than a deferred compensation or charitable trust described in section 6048(a)(3)(B)(ii)) is treated as the owner of the portion of the trust attributable to the property if there is a U.S. beneficiary of any portion of the trust.

Exceptions. Subparagraphs (a)(2)(A)-(B) provide two exceptions to the general rule in paragraph (a)(1). It does not apply to any transfer because of the death of the transferor. It also does not apply to any transfer of property to a trust in exchange for consideration of at least the fair market value of the transferred property. Consideration other than cash is taken into account at its FMV.

Obligations Disregarded. Under paragraph (a)(3), some obligations are not taken into account in applying the FMV of the noncash consideration exception. Under subparagraph (a)(3)(A), in determining whether the exception in subparagraph (a)(2)(B) applies to any transfer by a person described in clause (a)(3)(C)(ii) or (iii), the following is not taken into account:

• any obligation of a person described in subparagraph (a)(3)(C); and
• any obligation guaranteed by a person described in subparagraph (C).

Subparagraph (a)(3)(B) provides special rules for the treatment of principal payments on a disregarded obligation referred to in subparagraph (A). Those payments are taken into account on and after the date of the payment in determining the portion of the trust attributable to the property transferred.

The persons described in subparagraph (a)(3)(C) are:

1. the trust;
2. any grantor, owner, or beneficiary of the trust; and
3. any person who is related (within the meaning of section 643(i)(2)(B)) to any grantor, owner, or beneficiary of the trust.

Becoming a U.S. Person. Paragraph (a)(4) provides special rules that apply to foreign grantors who later become U.S. persons. The general rule in subparagraph (a)(4)(A) applies if a nonresident alien has a U.S. residency starting date within five years after directly or indirectly transferring property to a foreign trust. In that case, sections 679 and 6048 are applied as if the NRA transferred to the trust on its U.S. residency starting date an amount equal to the portion of the trust attributable to the property transferred by the NRA to the trust.

Under subparagraph (a)(4)(B), undistributed net income for periods before the NRA’s residency starting date are taken into account in determining the portion of the trust that is attributable to property transferred by the NRA to the trust but is not otherwise taken into account.

Under subparagraph (a)(4)(C), an NRA’s residency starting date is determined under the rules in section 7701(b)(2)(A) for determining the first and last year of U.S. residency.

Outbound Trust Migration. Paragraph (a)(5) applies if an individual who is a citizen or resident of the United States transfers property to a trust that is not a foreign trust, and the trust becomes a foreign trust while the individual is alive. In that case, sections 679 and 6048 are applied as if the individual transferred to the trust on the date the trust becomes a foreign trust an amount equal to the portion of the trust attributable to the property previously transferred by the individual. A rule similar to the rule in paragraph (a)(4)(B) for undistributed net income also applies for purposes of paragraph (a)(5).

Trust Acquires a U.S. Beneficiary

Section 679(b)(1)-(2) provides rules for trusts that acquire U.S. beneficiaries that apply if:

• subsection (a) applies to a trust for the transferor’s tax year; and
• subsection (a) would have applied to the trust in its immediately preceding tax year except that there was no U.S. beneficiary for any portion of the trust in that year.

In that case, the transferor is treated as having income (in addition to its other income) equal to the undistributed net income (at the close of the preceding year) attributable to the portion of the trust referred to in subsection (a).

Deemed U.S. Beneficiaries

Section 679(c) treats some trusts as having U.S. beneficiaries. Paragraphs (c)(1)-(6) provide rules:

1. that deem trusts to have U.S. beneficiaries;
2. for ownership attribution when entities are involved;
3. for disregarding U.S. beneficiaries;
4. for treatment of trusts that allow discretion to identify beneficiaries;
5. for treatment of agreements and understandings as terms of the trust; and
6. for treatment of loan repayments or compensation for use of trust property.

Deemed U.S. Beneficiary. Under the general rules in subparagraphs (c)(1)(A)-(B), a trust is treated as having a U.S. beneficiary for the tax year unless:

• under the terms of the trust, no part of the income or corpus may be paid or accumulated to or for the benefit of a U.S. person; and
• if the trust were terminated at any time during the year, no part of the income or corpus could be paid to or for the benefit of a U.S. person.

To apply subparagraph (c)(1)(A), an amount is treated as accumulated for the benefit of a U.S. person even if the U.S. person’s interest in the trust is contingent on a future event.

Ownership Attribution. Under ownership attribution rules in subparagraphs (c)(2)(A)-(C), an amount is treated as paid or accumulated to or for the benefit of a U.S. person if the amount is paid to or accumulated for a foreign corporation, foreign partnership, or foreign trust or estate, and:

• the corporation is a controlled foreign corporation (as defined in section 957(a));
• the foreign partnership has a partner that is a U.S. person; or
• the foreign trust or estate has a U.S. beneficiary (within the meaning of paragraph (c)(1)).

Disregarding U.S. Beneficiaries. Under paragraph (c)(3), a beneficiary is not treated as a U.S. person in applying section 679 to any transfer of property to a foreign trust if the beneficiary first became a U.S. person more than five years after the date of the transfer.

Discretion. Under paragraph (c)(4), in applying subparagraph (c)(1)(A), if any person has the discretion (by authority given in the trust agreement, power of appointment, or otherwise) of making a distribution from the trust to, or for the benefit of, any person, the trust is treated as having a beneficiary who is a U.S. person unless:

• the terms of the trust specifically identify the class of persons to whom distributions may be made; and
• none of those persons are U.S. persons during the tax year.

Agreements or Understandings. Under paragraph (c)(5), to apply subparagraph (c)(1)(A), if any U.S. person who directly or indirectly transfers property to the trust is directly or indirectly involved in any agreement or understanding (written, oral, or otherwise) that may cause the income or corpus of the trust to be paid or accumulated to or for the benefit of a U.S. person, the agreement or understanding is treated as a term of the trust.

Repayment or Compensation. Under paragraph (c)(6), in applying subsection (c), a loan of cash or marketable securities (or the use of any other trust property) directly or indirectly to or by any U.S. person (regardless of whether a beneficiary under the terms of the trust) is treated as paid or accumulated for the benefit of a U.S. person. The preceding sentence does not apply to the extent the U.S. person repays the loan at a market rate of interest (or pays the FMV of the use of the property) within a reasonable period of time.

U.S. Beneficiary Presumption

Under section 679(d), if a U.S. person directly or indirectly transfers property to a foreign trust (other than a trust described in section 6048(a)(3)(B)(ii)), the secretary may treat the trust as having a U.S. beneficiary for purposes of applying section 679 to the transfer unless the person:

• submits required information about the transfer to the secretary; and
• demonstrates to the satisfaction of the secretary that the trust satisfies the requirements of subparagraphs (c)(1)(A)-(B).

Grant of Authority

Section 679(e) provides a grant of authority to prescribe regs necessary or appropriate to carry out the purposes of section 679.

Section 679 Regs

Section 679 regs are provided in sections 1.679-0 to -7 and contain an outline and rules that:

1. treat U.S. transferors as owners of foreign trusts;
2. describe trusts that have U.S. beneficiaries;
3. provide guidance on transfers to trusts;
4. provide exceptions to the general rule;
5. address pre-immigration trusts;
6. address outbound migrations of domestic trusts; and
7. establish a series of applicability dates.

The new proposed regs revise or add to reg. sections 1.679-1, -2, -4, and -7. A previous article covered the revisions to reg. sections 1.679-1 and -2 (Tax Notes Int’l, July 29, 2024, p. 665). This article covers the revisions to reg. sections 1.679-4 and -7, both originally issued in T.D. 8955 on July 20, 2001.

Reg. Sections 1.679-1 and -2

Reg. section 1.679-1(a) treats a U.S. transferor who transfers property to a foreign trust as the owner of the portion of the trust attributable to the property transferred if there is a U.S. beneficiary of any portion of the trust, unless an exception in reg. section 1.679-4 applies.

Reg. section 1.679-2 treats a foreign trust as having a U.S. beneficiary unless, during the tax year of the U.S. transferor:

• no part of the trust income or corpus may be paid or accumulated to or for the benefit of, directly or indirectly, a U.S. person; and
• if the trust is terminated at any time during the tax year, no part of its income or corpus could be paid to or for the benefit of, directly or indirectly, a U.S. person.

Reg. Section 1.679-4Exceptions to the general rule in reg. section 1.679-1 are described in reg. section 1.679-4(a)-(d), which provides:

• a list of the exceptions;
• guidance on the exception in subparagraph (d)(4) for transfers of property in exchange for FMV;
• a rule that disregards obligations other than qualified obligations in determining whether FMV was transferred;
• a definition of qualified obligations.

Exceptions

Reg. section 1.679-4(a)(1)-(4) lists the exceptions to treatment of U.S. transferors as owners of foreign trusts. Reg. section 1.679-1 does not apply to any transfer of property to a foreign trust:

(1) because of the death of the transferor;

(2) described as an employees’ trust, foreign stock bonus, pension, or profit-sharing trust, or deferred compensation trust in sections 402(b), 404(a)(4), or 404A;

(3) described as a tax-exempt organization in section 501(c)(3) (without regard to the notice and application requirements in section 508(a)); and

(4) to the extent the transfer is for FMV.

Transfers for FMV

Reg. section 1.679-4(b) provides guidance on the exception in subparagraph (a)(4) for transfers of property to a foreign trust in exchange for FMV. Under subparagraph (b)(1), a transfer is for FMV only to the extent of the value of property received from the trust, services rendered by the trust, or the right to use trust property. For example, rents, royalties, interest, and compensation paid to a trust are transfers for FMV only to the extent that the payments reflect an arm’s-length price for the use of the trust property or for the trust services.

In making the FMV determination, an interest in the trust is not considered to be property received from the trust. A distribution to a trust because of its ownership interest in an entity is considered to be a transfer for FMV, unless the entity is another trust, an investment trust described in reg. section 301.7701-4(c), a liquidating trust described in reg. section 301.7701-4(d), or an environmental remediation trust described in reg. section 301.7701-4(e).

Subparagraph (b)(2) has a special rule for partial consideration transfers. If a person transfers property to a foreign trust in exchange for property having a FMV that is less than that of the property transferred, the exception in subparagraph (a)(4) applies only to the extent of the FMV of the property received.

Subdivision (b)(2)(ii) provides an example that illustrates paragraph (b). U.S. citizen A transfers property that has a $1,000 FMV to foreign trust FT in exchange for $600 cash. Under paragraph (b), reg. section 1.679-1 applies to a transfer of $400 to FT ($400 = $1,000 FMV property transferred – $600 cash received).

Obligations Disregarded

Reg. section 1.679-4(c) disregards obligations that are not qualified obligations in determining whether a transfer by a U.S. transferor that is related to the foreign trust is in exchange for FMV. In other words, any obligation of the trust or a related person that is not a qualified obligation is not taken into account. Related person is defined in reg. section 1.679-1(c)(5); obligation is defined in reg. section 1.679-1(c)(6); and qualified obligation is defined in subparagraph (d)(1).

Qualified Obligations

Reg. section 1.679-4(d)(1)-(7) provides guidance on qualified obligations. It provides:

• requirements for qualified obligation status;
• treatment of additional loans;
• treatment of obligations that cease to be qualified;
• treatment of obligations that fail to qualify;
• treatment of renegotiated loans;
• treatment of principal payments on obligations that are not qualified; and
• six examples.

Requirements. Subparagraph (d)(1) defines qualified obligations as those meeting the requirements in subdivisions (d)(1)(i)-(vi). An obligation is treated as a qualified obligation only if:

1. It is reduced to writing by an express written agreement.
2. Its term does not exceed five years (in determining an obligation’s term, its maturity date is the last possible date that the obligation can be outstanding).
3. All payments are denominated in U.S. dollars.
4. Its yield to maturity 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 is the rate in effect under section 1274(d) on the day the obligation is issued as published in the Internal Revenue Bulletin (see reg. section 601.601(d)(2)).
5. The U.S. transferor extends the period for assessment of any tax attributable to the transfer and any resulting income tax changes for each year the obligation is outstanding to a date not earlier than three years after the maturity date. This extension is not necessary if the maturity date does not extend beyond the end of the U.S. transferor’s tax year in the year of the transfer and is paid within that period. When properly executed and filed, the agreement is deemed consented to under reg. section 301.6501(c)-1(d).
6. The U.S. transferor reports the status of the loan, including principal and interest payments, on Form 3520 for every year that the loan is outstanding.

Additional Loans. Subparagraph (d)(2) addresses additional loans and applies 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. In that case, the original obligation is deemed to have the maturity date of any subsequent obligation in determining whether the term of the original obligation exceeds five years.

Also, a series of obligations issued and repaid by the trust (or a person related to the trust) is treated as a single obligation if the transactions giving rise to the obligations are structured with a principal purpose to avoid the application of this provision.

Qualification Ceases. Subparagraph (d)(3) addresses obligations that cease to be qualified. It applies if an obligation treated as a qualified obligation subsequently fails to be a qualified obligation (for example, renegotiation causes its term to exceed five years). In that case, the U.S. transferor is treated as making a transfer to the trust in an amount equal to the original obligation’s adjusted issue price plus any accrued but unpaid qualified stated interest as of the date of the event that causes the obligation to no longer be a qualified obligation. Adjusted issue price is defined in reg. section 1.1275-1(b), and qualified stated interest is defined in reg. section 1.1273-1(c).

If the maturity date is extended beyond five years because the trust (or a person related to the trust) issues a subsequent obligation, the amount of the transfer will not exceed the issue price of the subsequent obligation. The subsequent obligation is separately tested to determine if it is a qualified obligation.

Failed Qualification. Subparagraph (d)(4) addresses transfers caused by failed qualified obligations. A transfer caused by a failed qualified obligation is deemed to occur on the date of the subsequent event that causes the obligation to no longer be a qualified obligation.

However, based on all facts and circumstances, the IRS may deem a transfer to have occurred on any date on or after the issue date of the original obligation. For example, if at the time the original obligation was issued the transferor knew or had reason to know that the obligation would not be repaid, the IRS could deem the transfer to have occurred on the issue date of the original obligation.

Renegotiated Loans. Subparagraph (d)(5) addresses renegotiated loans. Any loan that is renegotiated, extended, or revised is treated as a new loan; and any transfer of funds to a foreign trust after the renegotiation, extension, or revision under a preexisting loan agreement is treated as a transfer.

Principal Payments. Subparagraph (d)(6) addresses principal repayments. A principal payment on any obligation that is not a qualified obligation under paragraph (d) is taken into account on and after the date of the payment in determining the portion of the trust attributable to the property transferred.

Examples. Subparagraph (d)(7) provides six examples that illustrate paragraph (d). In the examples, A and B are U.S. residents and FT is a foreign trust.

Example 1 illustrates a demand loan. A transfers $500 to FT in exchange for a demand note that permits A to require repayment by FT at any time. A is a related person (as defined in reg. section 1.679-1(c)(5)) to FT.

Because FT’s obligation to A could remain outstanding for more than five years, the obligation is not a qualified obligation within the meaning of paragraph (d). Under paragraph (c), the obligation is not taken into account in determining whether A’s transfer is eligible for the FMV exception in subparagraph (a)(4). Therefore, reg. section 1.679-1 applies to the full $500 transfer to FT.

Example 2 illustrates a private annuity. A transfers $4,000 to FT in exchange for an annuity from the foreign trust that will pay $100 per year to A for the rest of A’s life. A is a related person to FT (as defined in reg. section 1.679-1(c)(5)).

Because FT’s obligation to A could remain outstanding for more than five years, the obligation is not a qualified obligation under subparagraph (d)(1). Under paragraph (c), it is not taken into account to determine whether A’s transfer is eligible for the FMV exception of subparagraph (a)(4). Therefore, reg. section 1.679-1 applies to the full $4,000 transfer to FT.

Example 3 illustrates a loan to an unrelated foreign trust. B transfers $1,000 to FT in exchange for an obligation of the trust. The term of the obligation is 15 years. B is not a related person to FT (as defined in reg. section 1.679-1(c)(5)).

Because B is not a related person, the FMV of the obligation received by B is taken into account in determining whether B’s transfer is eligible for the FMV exception in subparagraph (a)(4) as described in paragraph (c), even though the obligation is not a qualified obligation within the meaning of subparagraph (d)(1).

Example 4 illustrates a transfer for an obligation with a term greater than five years. A transfers property that has a FMV of $5,000 to FT in exchange for an obligation of the trust. The term of the obligation is 10 years. A is a related person to FT (as defined in reg. section 1.679-1(c)(5)).

Because the term of the obligation is greater than five years, it is not a qualified obligation within the meaning of subparagraph (d)(1). Under paragraph (c), it is not taken into account in determining whether A’s transfer is eligible for the FMV exception in subparagraph (a)(4). Therefore, reg. section 1.679-1 applies to the full $5,000 transfer to FT.

Example 5 illustrates a transfer for a qualified obligation. The facts are the same as in Example 4, except that the term of the obligation is three years. Assuming the other requirements in subparagraph (d)(1) are satisfied, the obligation is a qualified obligation, and its adjusted issue price is taken into account to determine whether A’s transfer is eligible for the FMV exception in subparagraph (a)(4).

Example 6 illustrates the effect of a subsequent obligation on an original obligation. A transfers property that has a FMV of $1,000 to FT in exchange for an obligation that satisfies the requirements of subparagraph (d)(1). A is a related person to FT (as defined in reg. section 1.679-1(c)(5)). Two years later, A transfers an additional $2,000 to FT and receives another obligation from FT that has a maturity date four years from the date that the second obligation was issued.

Under subparagraph (d)(2), the original obligation is deemed to have the maturity date of the second obligation. Under paragraph (a), A is treated as having made a transfer in an amount equal to the original obligation’s adjusted issue price plus any accrued but unpaid qualified stated interest as of the date of issuance of the second obligation. The second obligation is tested separately to determine whether it is a qualified obligation in applying paragraph (a) to the second transfer.

Prop. Reg. Section 1.679-4(d)

The new proposed regs revise the definition of qualified obligation in subparagraphs (d)(1)-(6) and provide:

• requirements for qualified obligation status;
• treatment of loan modifications;
• treatment of additional loans;
• an antiabuse rule;
• treatment of obligations that cease to qualify; and
• seven examples.

Requirements. The general requirements for qualified obligation status in subdivisions (d)(1)(i)-(vi) are redesignated, revised, and supplemented in proposed subdivisions (d)(1)(i)(A)-(F) and (d)(1)(ii)(A)-(B).

The requirements in subdivision (d)(1)(i) generally relate to the terms of the obligation. An obligation is treated as a qualified obligation only if the obligation at all times satisfies all of the following requirements:

1. The obligation is reduced to writing in an express written agreement.
2. 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).
3. All payments on the obligation must be made in cash in U.S. dollars.
4. The obligation is issued at par and provides for stated interest at a fixed rate or a qualified floating rate within the meaning of reg. section 1.1275-5(b).
5. 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 that in effect under section 1274(d) for the day the obligation is issued, as published in the Internal Revenue Bulletin (see reg. section 601.601(d)(2)). The yield to maturity and the applicable federal rate must be based on the same compounding period. If an obligation is a variable rate debt instrument that provides for stated interest at a qualified floating rate, the equivalent fixed rate debt instrument rules in reg. section 1.1274-2(f)(1) or 1.1275-5(e) apply to determine the obligation’s yield to maturity.
6. All stated interest is qualified stated interest within the meaning of reg. section 1.1273-1(c).

Proposed subdivision (d)(1)(ii) provides additional requirements to remain a qualified obligation that generally relate to taxpayer actions. An obligation will remain a qualified obligation only if, for the first year and each year that the obligation remains outstanding, the trust makes timely payments of all principal and interest on the obligation according to the terms of the obligation (which may include a reasonable grace period of no more than 30 days for a late payment) and the U.S. transferor fulfills the requirements of subdivision (d)(1)(ii)(A)-(B).

Subdivision (d)(1)(ii)(A)-(B) requires the U.S. transferor to extend the period for assessment of any income tax attributable to the obligation and any consequent income tax changes for each year that the obligation is outstanding to a date not earlier than three years after the maturity date of the obligation.

This extension is not necessary for the tax year of the U.S. transferor in which the maturity date of the obligation falls, provided that the obligation is paid in cash in U.S. dollars within that year.

The assessment period is extended by completing and filing Part I of Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts,” for every year that the obligation is outstanding. Part I of Form 3520 also may contain other terms with respect to assessment as may be considered necessary by the IRS to ensure the assessment and collection of the correct tax liability for each year for which the extension of the period of assessment is required. When Part I of Form 3520 is properly executed and filed, the consent to extend the period for assessment of tax will be deemed to be agreed upon and executed by the IRS under reg. section 301.6501(c)-1(d).

Subdivision (d)(1)(ii)(B) requires the U.S. transferor to timely report the status of the obligation, including principal and interest payments, on Part I of Form 3520 for each year that the obligation is outstanding.

Modifications. Subparagraph (d)(2) addresses modification of a qualified obligation. If the terms of a qualified obligation are modified and the modification is treated as an exchange under reg. section 1.1001-3, the new obligation that is deemed issued in the exchange under reg. section 1.1001-3 must satisfy all the requirements in paragraph (d)(1) to be a qualified obligation using the original obligation’s issue date. If the modification is not treated as an exchange under reg. section 1.1001-3, then the obligation must be retested as of the date of the modification to determine whether the obligation, as modified, continues to satisfy the requirements in paragraph (d)(1) to be a qualified obligation.

Additional Loans. Subparagraph (d)(3) addresses additional loans and applies if a qualified obligation is outstanding and the U.S. transferor directly or indirectly obtains an additional obligation issued by the foreign trust in exchange for cash or if the U.S. transferor directly or indirectly obtains an additional obligation issued by a person related to the trust. In that case, the outstanding obligation is deemed to have the maturity date of the additional obligation in determining whether the outstanding obligation exceeds the specified five-year term.

The outstanding obligation must be retested as of the issue date of the additional obligation to determine whether it would have satisfied, as of the outstanding obligation’s issue date, all the requirements in subparagraph (d)(1) to be a qualified obligation. If there is more than one qualified obligation outstanding, the determination is made based on the one with the earliest issue date. The additional obligation also must be separately tested to see if it satisfies the requirements of subparagraph (d)(1).

Antiabuse Rule. Subparagraph (d)(4) provides an antiabuse rule. Notwithstanding subparagraphs (d)(2) and (3), if the IRS determines, based on facts and circumstances, that two or more obligations issued by a foreign trust or a person related to the trust are structured with a principal purpose to avoid section 679, the IRS may treat the obligations as a single obligation that is not a qualified obligation.

Cease Qualification. Subparagraph (d)(5) governs obligations that cease to be qualified. Under subdivision (d)(5)(i), if an obligation ceases to be a qualified obligation (for example, because it is modified so that the term exceeds five years), the U.S. transferor is treated as making a transfer to the foreign trust.

Subdivision (d)(5)(ii) describes the amount deemed transferred to the trust. The amount that the U.S. transferor is treated as having transferred to the trust will be equal to the obligation’s outstanding stated principal amount plus any accrued but unpaid qualified stated interest (within the meaning of reg. section 1.1273-1(c)) as of the date of the event that causes the obligation to no longer be a qualified obligation.

If an obligation ceases to be a qualified obligation because the IRS treats two or more obligations as a single obligation under subparagraph (d)(4), the U.S. transferor is treated as making a transfer to the trust not greater than the outstanding stated principal amount plus accrued but unpaid qualified stated interest for each obligation as of the date determined by the IRS under subdivision (d)(5)(iii).

Subdivision (d)(5)(iii) describes the timing of transfers caused by failed qualified obligations. In general, a U.S. transferor is treated as making a transfer to the foreign trust on the date of the event that causes an obligation to no longer be a qualified obligation. However, based on all facts and circumstances, if an obligation is structured with a principal purpose of avoiding section 679, the IRS may deem a transfer to have occurred on any date on or after the issue date.

Examples. Subparagraph (d)(6) provides seven examples that illustrate paragraph (d). The first five examples in prop. reg. section 1.679-4(d)(6) mirror those in reg. section 1.679-4(d)(7) with minor revisions (like transfer amounts). Proposed Example 6 has relatively significant revisions, and Example 7 is new. In all examples, A and B are U.S. residents and FT is a foreign trust.

As in the current regs, proposed Example 1 illustrates a demand loan; Example 2 illustrates a private annuity; Example 3 illustrates a transfer to an unrelated foreign trust in exchange for an obligation; Example 4 illustrates a transfer for an obligation with a term greater than five years; and Example 5 illustrates a transfer for a qualified obligation.

Proposed Example 6 illustrates the effect of a modification treated as an exchange. A is a related person to FT (as defined in reg. section 1.679-1(c)(5)). A transfers property that has a FMV of $10,000 to FT in exchange for an obligation with a term of four years that satisfies the requirements of subparagraph (d)(1). Two years later, a significant modification of the obligation within the meaning of reg. section 1.1001-3 occurs, including an extension of the term by an additional three years. The modification is treated as an exchange under reg. section 1.1001-3.

The new obligation that is deemed issued in the exchange under reg. section 1.1001-3 must satisfy the requirements of subparagraph (d)(1) to be a qualified obligation as of the original obligation’s issue date. Because the new obligation would not satisfy the five-year requirement of subparagraph (d)(1), the obligation ceases to be treated as a qualified obligation.

Example 7 illustrates the effect of a subsequent obligation on the original obligation. A is a related person to FT (as defined in reg. section 1.679-1(c)(5)). On January 1, year 1, A transfers $100,000 to FT in exchange for obligation 1 from FT. Obligation 1 has a maturity date of January 1, year 6, that satisfies the requirements of subparagraph (d)(1).

On June 30, year 1, A transfers an additional $50,000 to FT in exchange for obligation 2. Obligation 2 has a maturity date of June 30, year 6, that independently satisfies the requirements of subparagraph (d)(1).

Under subparagraph (d)(3), obligation 1 will be deemed to have a maturity date of June 30, year 6 (a greater than five-year term) and will cease to be a qualified obligation under subparagraph (d)(1). Under paragraph (c), because obligation 1 is not a qualified obligation, it is not taken into account in determining whether A’s transfer of $100,000 is eligible for the FMV exception in subparagraph (a)(4). Therefore, reg. section 1.679-1 applies to treat A as the owner of the portion of FT attributable to the $100,000 transferred to FT.

Obligation 2 is separately tested to determine whether it satisfies the qualified obligation rules in subparagraph (d)(1). To the extent it does, A is treated as eligible for the FMV exception in subparagraph (a)(4) and is not treated as the owner of the portion of FT attributable to the $50,000 transferred to FT.

Reg. Section 1.679-7

Reg. section 1.679-7 provides effective dates. The general date in paragraph (a) is that the rules of reg. sections 1.679-1, -2, -3, and -4 apply to transfers after August 7, 2000.

Subparagraphs (b)(1)-(3) provide exceptions to paragraph (a). Under subparagraph (b)(1), reg. section 1.679-4(c)-(d) applies to obligations issued after February 6, 1995, whether or not in accordance with a preexisting arrangement or understanding.

To apply reg. section 1.679-4(c)-(d), if an obligation issued on or before February 6, 1995, is modified after that date, and the modification is significant within the meaning of reg. section 1.1001-3, the obligation is treated as if it were issued on the date of the modification. However, the penalty in section 6677 applies only to a failure to report transfers in exchange for obligations that are issued after August 20, 1996.

Under subparagraph (b)(2), reg. section 1.679-5 applies to persons whose residency starting date is after August 7, 2000.

Under subparagraph (b)(3), reg. section 1.679-6 applies to trusts that become foreign trusts after August 7, 2000.

Prop. Reg. Section 1.679-7Prop. reg. section 1.679-7 adds exceptions to the general rule in subparagraphs (b)(4)-(7). Under subparagraph (b)(4), the amendments to reg. sections 1.679-1(c)(2) and (6) apply for tax years beginning after the date final regs are published in the Federal Register.

Under subparagraph (b)(5), reg. section 1.679-2(a)(5) applies to loans and the use of trust property after the date final regs are published in the Federal Register.

Under subparagraph (b)(6), reg. section 1.679-2(d) applies to transfers of property after the date final regs are published in the Federal Register.

Under subparagraph (b)(7), reg. section 1.679-4(d) applies to obligations issued or modified after the date final regs are published in the Federal Register.

If an obligation issued on or before the date final regs are published in the Federal Register is modified after that date, and the modification is significant under reg. section 1.1001-3, the new obligation deemed issued in the exchange is treated as issued after the date final regs are published in the Federal Register.

If the modification is not significant under reg. section 1.1001-3, then the original obligation must be retested as of the date of the modification to determine whether the obligation satisfies the requirements in subparagraph (d)(1) to be a qualified obligation.