Residence of Trusts & Estates--7701

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 301 and 602 [TD 8813] RIN 1545-
AU74

TITLE: Residence of Trusts and Estates--7701

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations providing guidance
regarding the definition of a trust as a United States person
(domestic trust) or a foreign trust. This document also provides
guidance regarding the election for certain trusts to remain
domestic trusts for taxable years beginning after December 31, 1996.
The regulations incorporate changes to the law made by the Small
Business Job Protection Act of 1996 and by the Taxpayer Relief Act
of 1997. The final regulations affect the determination of the
residency of trusts as foreign or domestic for federal tax purposes.

DATES: Effective Date: These regulations are effective February 2,
1999.

Dates of Applicability: See §301.7701-7(e).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, James
A. Quinn at (202) 622-3060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and
Budget for review in accordance with the Paperwork Reduction Act (44
U.S.C. 3507) under control number 1545-1600.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.

The collections of information in these final regulations are in
§301.7701-7(d)(2)(ii) and (f). This information is required by the
IRS to assure compliance with the provisions of the Small Business
Job Protection Act of 1996 and by the Taxpayer Relief Act of 1997
for trusts seeking to retain their residency as domestic or foreign
trusts in the event of an inadvertent change and for trusts electing
to remain domestic trusts. The likely respondents are trusts. The
estimated average annual burden per respondent is 0.5 hoU.S.

Comments concerning the accuracy of this burden estimate should be
sent to the Internal Revenue Service, Attn.: IRS Reports Clearance
Officer. OP:FS:FP, Washington, DC 20224, and to the Office of
Management and Budget, Attn.: Desk Officer for the Department of the
Treasury, Office of Information and Regulatory Affairs, Washington,
DC 20503.

Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Background

On June 5, 1997, the IRS published in the Federal Register a notice
of proposed rulemaking (62 FR 30796) to provide guidance on the
definition of a foreign trust and a domestic trust under section
7701(a)(30) and (31), as amended by section 1907 of the Small
Business Job Protection Act of 1996 (SBJP Act), Public Law 104-188,
110 Stat. 1755 (August 20, 1996).

Written comments responding to the notice of proposed rulemaking
were received, and a public hearing was held on September 16, 1997.
After consideration of the comments received, the proposed
regulations are adopted as revised by this Treasury decision.

Section 1161(a) of the Taxpayer Relief Act of 1997 (TRA 1997),
Public Law 105-34, 111 Stat. 788 (August 5, 1997), provides that, to
the extent prescribed in regulations by the Secretary of the
Treasury or his delegate, a trust that was in existence on August
20, 1996 (other than a trust treated as owned by the grantor under
subpart E of part I of subchapter J of chapter 1 of the Internal
Revenue Code of 1986 (Code)), and that was treated as a United
States person on August 19, 1996, may elect to continue to be
treated as a United States person notwithstanding the enactment of
section 7701(a)(30)(E). Notice 98-25 (1998-18 I.R.B. 11) provides
guidance regarding the election to remain a domestic trust. The IRS
and the Treasury Department are incorporating the guidance contained
in Notice 98-25 concerning the election to remain a domestic trust
in these final regulations. The final regulations also provide
guidance regarding the circumstances that cause a termination of the
election and guidance concerning revocation of the election to
remain a domestic trust.

In addition, section 1601(i)(3)(A) of TRA 1997 amended section
7701(a)(30)(E)(ii) by striking the word A fiduciaries @ and
inserting A persons @ in its place. The final regulations have been
drafted consistent with this change.

Explanation of Provisions

A. Court Test and Safe Harbor Issues

1. Foreign classification bias and safe harbor. Some commentators
point out generally that the Code and the proposed regulations are
biased in favor of trusts being treated as foreign trusts. The
commentators recommend that the regulations should reduce the bias
in favor of foreign treatment. The safe harbor in the proposed
regulations 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.

One commentator recommends that the safe harbor be made clearly
applicable in the case of any trust if a majority of the trustees
are United States persons and the other requirements are met.

The IRS and the Treasury Department agree with the commentator that
the safe harbor should not be limited to trusts with only United
States fiduciaries. Since the primary concern addressed by the safe
harbor is the difficulty in determining 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, the final regulations provide a safe harbor only for the
court test. A trust that satisfies the safe harbor, therefore, would
also need to meet the control test in order to be a domestic trust.
In addition, an example has been added to the control test
illustrating that the control test is satisfied if United States
persons control all substantial decisions by a majority vote.

Commentators note that many trust instruments do not direct where
the trust is to be administered. Therefore, they suggest that a
trust should satisfy the safe harbor if the trust is in fact
administered in the United States (regardless of whether this is
mandated by the trust document).

The IRS and the Treasury Department believe that, if a trust is
administered exclusively in the United States, it is not necessary
that the trust instrument actually direct that the trust be
administered in the United States. Accordingly, the final
regulations provide that a trust satisfies the safe harbor if the
trust instrument does not direct that the trust be administered in a
jurisdiction outside the United States, and the trust is in fact
administered in the United States.

These changes in the final regulations will allow more trusts to
fall within the safe harbor.

2. Automatic migration or flee clauses. The proposed regulations
provide that a trust will not satisfy the court test if the trust
instrument contains an automatic migration clause that would cause
the trust to migrate from the United States if a United States court
attempts to assert jurisdiction or otherwise supervise the
administration of the trust. Commentators argue that the rule in the
proposed regulations concerning automatic migration clauses is too
broad. They argue that an automatic migration clause should not
cause a trust to be treated as a foreign trust if migration is
triggered only by events that are not particular to a given trust,
its trustees, beneficiaries, or grantors. For example, if a trust
will migrate because of foreign invasion of the United States, the
residency of the trust should not be affected.

The final regulations adopt the suggestion and provide that a trust
will not fail the court test if the trust instrument provides that
the trust will migrate from the United States only in the case of
foreign invasion of the United States or widespread confiscation or
nationalization of property in the United States.

3. Clarify that the list of specific situations for meeting the
court test is not an exclusive list. Commentators recommend that the
regulations be clarified to provide that the situations set forth in
§301.7701-7(d)(2) of the proposed regulations that meet the court
test are not the exclusive ways to meet the court test.

The purpose of setting forth specific situations that meet the court
test was to provide bright-line rules that would give taxpayers
certainty of treatment to the extent possible. These rules, however,
are not exclusive. The court test will also be satisfied by meeting
the requirements set forth in the final regulations in
§301.7701-7(c).

4. Disregard state law. A commentator recommends that the
regulations should establish bright-line rules for the court test
without reference to state law.

The IRS and the Treasury Department believe that the proper
interpretation of section 7701(a)(30)(E) requires that state law be
applied under the court test. In addition, the proposed regulations
provide bright-line rules for both the court test and the control
test to the extent permitted by the statute. For example, the
regulations provide a safe harbor and provide for specific cases
where the court test is satisfied. Therefore, the final regulations
remain unchanged in this regard.

5. Court test excessively broad. One commentator argues that the
court test is excessively broad because many trusts that are, in the
commentator's view, foreign trusts will potentially be deemed
domestic trusts. Specifically, the commentator is concerned about a
trust in which the only domestic aspect is a single United States
trustee who controls all substantial decisions of the trust. Another
commentator recommends that the regulations should make clear that
trustee meetings and other trustee activities in the United States
will not cause the court test to be met.

The IRS and the Treasury Department do not believe that there is
statutory authority for modifying the court test as suggested and,
therefore, the final regulations remain unchanged.

Furthermore, trustee meetings and activities in the United States
may be a relevant factor to be taken into account in determining
whether the court test has been met.

6. Petition of court by a single beneficiary. A commentator
recommends that §301.7701-7(d)(2)(iii) of the proposed regulations
should be clarified to provide that the court test is met only if
either (i) a court within the United States actually exercises
primary supervision over the trust, or (ii) a majority of
beneficiaries take steps to cause a United States court to exercise
primary supervision. The commentator expresses concern about a
possible situation where, under the commentator's interpretation of
the regulations, a single beneficiary of a foreign trust takes steps
with a United States court petitioning it to assume primary
supervision of the trust and, regardless of whether the court does
in fact exercise primary supervision of the trust, the foreign trust
becomes a domestic trust.

While §301.7701-7(d)(2)(iii) of the proposed regulations permits the
trustees and/or beneficiaries of a trust to take steps to ensure
that the court test is satisfied, taking preliminary steps with a
United States court without in fact causing the administration of
the trust to be subject to the primary supervision of the United
States court would not satisfy the court test. Thus, the concern
about a single beneficiary altering the residence of the trust by
merely taking preliminary steps is unwarranted.

B. Control Test Issues

1. Who counts for purposes of the control test. The proposed
regulations provide that substantial decisions do not include
decisions exercisable by a grantor or by a beneficiary of the trust
that affect solely the beneficiary's interest in the trust, unless
the grantor or beneficiary is acting in a fiduciary capacity. The
proposed regulations provide this rule because the statute prior to
amendment by TRA 1997 provided that United States fiduciaries must
control all substantial decisions of a domestic trust. Therefore,
the proposed regulations exclude decisions by those who are not
holding powers in a fiduciary capacity.

As noted, TRA 1997 substituted A persons @ for A fiduciaries @ in
the control test. In light of the change in the statute,
commentators point out that there is no statutory basis for ignoring
the powers held by grantors and beneficiaries for purposes of the
control test.

Therefore, the final regulations change the rule set forth in the
proposed regulations and, for purposes of the control test, count
all powers held by grantors and powers held by beneficiaries
including those that affect solely the portion of the trust in which
the beneficiary has an interest. Accordingly, all persons with any
power over substantial decisions of the trust, whether acting in a
fiduciary capacity or not, must be counted for purposes of the
control test.

Under the proposed regulations, excluding grantors (and
beneficiaries) from the control test would have allowed certain
individual retirement accounts (IRAs) and other tax-exempt trusts to
continue to be treated as domestic trusts and thus retain their tax-
exempt status even if the grantor/beneficiary of the trust is a
foreign person. The IRS and the Treasury Department believe that
Congress did not intend the TRA 1997 changes to affect the tax-
exempt status of IRAs and other tax-exempt trusts whose tax-exempt
status depends on their being domestic trusts.

Because these trusts are required to be created or organized in the
United States, and are subject to other detailed requirements for
qualification under the Code, the final regulations provide that
these trusts satisfy the control test, provided that United States
fiduciaries control all of the substantial decisions of the trust
that are made by trust fiduciaries. This provision of the final
regulations generally reaches the same result as the provision in
the proposed regulations.

2. Time to correct inadvertent changes in fiduciaries. The proposed
regulations provide that 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 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.

Commentators recommend that trusts be given more time to take
corrective action to avoid a change in residency or, alternatively,
the regulations should give the IRS discretionary authority to
continue treating a trust that inadvertently fails the control test
as a domestic trust even if the control test is not met within six
months.

The final regulations extend the period of time to 12 months from
the date of the change to complete corrective action. The final
regulations also provide that the district director may grant an
extension of time to make the modification if the failure to make
the modification within the 12-month period was due to reasonable
cause. In addition, the final regulations define the term
inadvertent change to mean a change with respect to a person who has
a power to make a substantial decision of the trust, if such change
(if not corrected) would cause an unintended change to the foreign
or domestic residency of the trust.

3. Effect of power to veto decisions. The proposed regulations
define control to mean 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 any of the substantial decisions.

Thus, if United States fiduciaries have the power to make all the
substantial decisions of the trust, but a foreign person could veto
one of the decisions, the trust would fail the control test and
would be a foreign trust. A commentator disagrees with the
conclusion that the power to veto decisions may be determinative of
who has control.

The final regulations retain the definition of control set forth in
the proposed regulations. The effect of a veto power is specifically
noted in the legislative history. H.R. Rep. No.

542, Part 2, 104 Cong., 2d Sess. 31 (1996). Furthermore, th control
should be defined to mean full power over the trust consistent with
a trustee's traditional role in trust administration. Accordingly,
if a United States person only has the power to veto the decisions
of a foreign trustee, the control test is not satisfied. Likewise,
if a foreign person has the power to veto the decisions of a United
States trustee, the control test is not satisfied. Thus, in both
cases, the trust would be a foreign trust.

4. Power to remove, add, or replace a trustee. Some commentators
disagree with treating a decision to remove, add, or replace a
trustee as a substantial decision. Commentators also argue that the
proposed regulations are not consistent with the rules that apply
for determining the ownership of grantor trusts or with the rules
for determining whether property is included in a decedent's estate
for estate tax purposes. A commentator recommends that the final
regulations provide that a decision to appoint a trustee to succeed
a trustee who has died, resigned, or otherwise ceased to act as a
trustee, without the power to remove the trustee, is not a
substantial decision.

The IRS and the Treasury Department believe that the purpose of the
control test is to determine the residence of a trust and therefore
is different from the purpose of the rules for grantor trusts and
for estate taxes. The final regulations continue to treat the
decision to remove, add, or replace a trustee as a substantial
decision. In addition, the final regulations provide that the
decision to appoint a successor fiduciary to succeed a fiduciary who
has died, resigned, or otherwise ceased to act as a trustee, even if
it is not accompanied by an unrestricted power to remove a trustee,
is a substantial decision, unless this power is limited such that it
cannot be exercised in a manner that would change the trust's
residency from foreign to domestic, or vice versa.

5. Investment decisions. Commentators argue that investment
decisions should not be treated as substantial decisions.

The final regulations continue to treat investment decisions as
substantial decisions. However, the final regulations provide that
if a United States fiduciary contracts for the services of an
investment advisor, and the advisor's power to make investment
decisions can be terminated at the will of the United States
fiduciary, the United States fiduciary will be treated as retaining
control over the investment decisions made by the investment
advisor, whether the investment advisor is foreign or domestic.

C. Transition Rule and Grandfathering Issues

1. Pre-existing foreign trusts. Commentators recommend various
grandfathering rules for pre-existing foreign trusts that would
allow them to remain treated as foreign trusts. A commentator
recommends that a trust would be deemed to be a foreign trust prior
to the effective date of section 7701(a)(30) and (31), as amended by
the SBJP Act (new law), if the trust is treated as a foreign trust
under the new law. In particular, the commentator expresses concern
that some trusts believed to be foreign trusts under section 7701(a)
(30) and (31), prior to amendment by the SBJP Act (prior law), may
have in fact been domestic trusts under prior law. If such trusts
qualify as foreign trusts under the new law, they will be considered
to have changed their classification from domestic to foreign on
January 1, 1997.

Trusts that change from domestic to foreign may be subject to tax
for the deemed transfer to a foreign trust under section 1491 (as in
effect prior to its repeal by TRA 1997) and subject to penalties for
failure to report such transfer under section 6677 if they continue
to treat themselves as foreign trusts.

In addition, a commentator recommends that trusts that were formed
prior to August 20, 1996, as group trust arrangements exempt from
tax under sections 501(a) and 408(e) and described in Rev. Rul.
81-100 (1981-1 C.B. 326) not be subject to section 7701(a)(30) and
(31) as amended by the SBJP Act, but should be subject to section
7701(a)(30) and (31) as in effect prior to August 20, 1996.

The IRS and the Treasury Department do not believe that there is
statutory authority for adopting the requested grandfathering rules
for pre-existing foreign trusts or for applying prior law to group
trust arrangements described in Rev.

Rul. 81-100. The election provision included in TRA 1997 provides
specific transition relief only for trusts that treated themselves
as domestic trusts prior to August 20, 1996, not for trusts that
treated themselves as foreign trusts. Therefore, the final
regulations do not include the recommended transition rules.

2. Foreign trust safe harbor. A commentator recommends that newly-
created trusts established under foreign law should benefit from a
foreign trust safe harbor. The commentator suggests a safe harbor
that would provide that a trust established under foreign law, which
does not by its terms provide for administration in the United
States, and which does not file United States federal income tax
returns as a United States trust will fail the court test and will
be treated as a foreign trust unless the trust is described in
§301.7701-7(d)(2)(i) or (ii) of the proposed regulations (situations
that meet the court test).

Given the statutory bias towards foreign trust classification, the
IRS and Treasury Department do not agree that a safe harbor for
foreign trusts is necessary because sufficient guidance is given as
to the circumstances that will cause a trust to be foreign.
Therefore, the final regulations do not include the recommended
rules.

D. Puerto Rico Trusts

The statute uses the term the United States in a geographical sense
and 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 is not a court within the United States and all trusts
subject to the supervision of such a court are thereby foreign. That
rule was stated explicitly in the proposed regulations.

Some commentators argue that adverse tax consequences result from
this rule. Therefore, they recommend that the final regulations
provide, contrary to what the statute implies, that Puerto Rico
courts are A courts within the United States @ for purposes of
section 7701(a)(30)(E)(i) and, therefore, that Puerto Rico trusts
will meet the court test.

The final regulations do not adopt the suggestion. Rather, the final
regulations continue to provide that a trust that is subject to the
primary supervision of the Puerto Rico courts will be treated as a
foreign trust for federal tax purposes.

E. Effective date

The proposed regulations provide that the regulations would be
applicable to trusts for taxable years beginning after December 31,
1996, and to trusts whose trustees have elected to apply sections
7701(a)(30) and (31) to the trusts for taxable years ending after
August 20, 1996, under section 1907(a)(3)(B) of the SBJP Act.

The final regulations modify the effective date in the proposed
regulations. Except for §301.7701-7(f) of the final regulations,
which applies beginning February 2, 1999, the final regulations are
applicable to trusts for taxable years ending after February 2,
1999. In addition, trusts may rely on the final regulations (i) for
taxable years of the trusts beginning after December 31, 1996, and
(ii) for taxable years ending after August 20, 1996, in the case of
trusts electing under section 1907(a)(3)(B) of the SBJP Act.

If a trust is created after August 19, 1996, and before April 3,
1999, and the trust satisfies the control test set.18 forth in the
proposed regulations published under section 7701(a)(30) and (31)
(62 FR 30796, June 5, 1997), but does not satisfy the control test
set forth in the final regulations, the trust may be modified to
satisfy the control test of the final regulations by December 31,
1999. If the modification is completed by December 31, 1999, the
trust will be treated as satisfying the control test of the final
regulations for taxable years beginning after December 31, 1996 (and
for taxable years ending after August 20, 1996, if the election
under section 1907(a)(3)(B) of the SBJP Act has been made for the
trust).

Effect on Other Documents

Notice 98-25 (1998-18 I.R.B. 11) is obsolete as of February 2, 1999.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It is hereby certified that
the collections of information in these regulations will not have a
significant economic impact on a substantial number of small
entities. This certification is based upon the fact that the
estimated average burden per trust in complying with the collection
of information in §301.7701-7(d)(2)(ii) and (f) is 0.5 hours. In
addition, each trust will only have to file the election statement
to remain a domestic trust once. Therefore, a Regulatory Flexibility
Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6)
is not required. Pursuant to section 7805(f) of the Code, the notice
of proposed rulemaking preceding these regulations was submitted to
the Small Business Administration for comment on its impact on small
business.

Drafting Information

The principal author of these regulations is James A. Quinn of the
Office of Assistant Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the IRS and Treasury
Department participated in their development..20 List of Subjects

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations Accordingly, 26 CFR parts
301 and 602 are 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 §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 persons 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 (Code) on any day 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 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
individual who is not present in the United States at any time.
Section 641(b). Section 7701(b) is not applicable to trusts because
it only applies to individuals. In addition, a foreign trust is not
considered to be present in the United States at any time for
purposes of section 871(a)(2), which deals with capital gains of
nonresident aliens present in the United States for 183 days or
more.

(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.

(c) The court test--(1) Safe harbor. A trust satisfies the court
test if B

(i) The trust instrument does not direct that the trust be
administered outside of the United States;

(ii) The trust in fact is administered exclusively in the United
States; and

(iii) The trust is not subject to an automatic migration provision
described in paragraph (c)(4)(ii) of this section.

(2) Example. The following example illustrates the rule of paragraph
(c)(1) of this section:

Example. A creates a trust for the equal benefit of A's two
children, B and C. The trust instrument provides that DC, a State Y
corporation, is the trustee of the trust. State Y is a state within
the United States. DC administers the trust exclusively in State Y
and the trust instrument is silent as to where the trust is to be
administered. The trust is not subject to an automatic migration
provision described in paragraph (c)(4)(ii) of this section. The
trust satisfies the safe harbor of paragraph (c)(1) of this section
and the court test.

(3) Definitions. The following definitions apply for purposes of
this section:

(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 under this paragraph (c)(3)(iv)
notwithstanding the fact that 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 by the terms of the trust
instrument and applicable law, including maintaining the books and
records of the trust, filing tax returns, managing and investing the
assets of the trust, defending the trust from suits by creditors,
and determining the amount and timing of distributions.

(4) Situations that cause a trust to satisfy or fail to satisfy the
court test. (i) Except as provided in paragraph (c)(4)(ii) of this
section, paragraphs (c)(4)(i)(A) through (D) of this section set
forth some specific situations in which a trust satisfies the court
test. The four situations described are not intended to be an
exclusive list.

(A) Uniform Probate Code. A trust meets the court test if the trust
is registered by an authorized fiduciary or fiduciaries of the trust
in a court within the United States pursuant to 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. 1998), available from the National
Conference of Commissioners on Uniform State Laws, 676 North St.
Clair Street, Suite 1700, Chicago, Illinois 60611.

(B) 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.

(C) 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.

(D) A United States court 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.

(ii) 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 the
administration of the trust directly or indirectly would cause the
trust to migrate from the United States. However, this paragraph (c)
(4)(ii) will not apply if the trust instrument provides that the
trust will migrate from the United States only in the case of
foreign invasion of the United States or widespread confiscation or
nationalization of property in the United States.

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

Example 1. A, a United States citizen, creates a trust for the equal
benefit of A's two children, both of whom are United States
citizens. 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.

DC maintains a branch office in Country X with personnel authorized
to act as trustees in Country X. The trust instrument provides that
the law of State Y, a state within the United States, is to govern
the interpretation of 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.

Pursuant to the trust instrument, the Country X court applies the
law of State Y to the trust. Under the terms of the trust instrument
the trust is administered in Country X. 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. A, a United States citizen, creates a trust for A's own
benefit and the benefit of A's spouse, B, a United States citizen.
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 automatically migrate from State Y to Country Z, a foreign
country, 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.

(d) Control test--(1) Definitions--(i) United States person.

The term United States person means a United States person within
the meaning of section 7701(a)(30). For example, a domestic
corporation is a United States person, regardless of whether its
shareholders are United States persons.

(ii) Substantial decisions. The term substantial decisions means
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. Decisions that are ministerial include
decisions regarding details such as the bookkeeping, the collection
of rents, and the execution of investment decisions.

Substantial decisions include, but are not limited to, decisions
concerning B

(A) Whether and when to distribute income or corpus;

(B) The amount of any distributions;

(C) The selection of a beneficiary;

(D) Whether a receipt is allocable to income or principal;

(E) Whether to terminate the trust;

(F) Whether to compromise, arbitrate, or abandon claims of the
trust;

(G) Whether to sue on behalf of the trust or to defend suits against
the trust;

(H) Whether to remove, add, or replace a trustee;

(I) Whether to appoint a successor trustee to succeed a trustee who
has died, resigned, or otherwise ceased to act as a trustee, even if
the power to make such a decision is not accompanied by an
unrestricted power to remove a trustee, unless the power to make
such a decision is limited such that it cannot be exercised in a
manner that would change the trust's residency from foreign to
domestic, or vice versa; and

(J) Investment decisions; however, if a United States person under
section 7701(a)(30) hires an investment advisor for the trust,
investment decisions made by the investment advisor will be
considered substantial decisions controlled by the United States
person if the United States person can terminate the investment
advisor's power to make investment decisions at will.

(iii) Control. The term 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 any of the substantial
decisions. To determine whether United States persons have control,
it is necessary to consider all persons who have authority to make a
substantial decision of the trust, not only the trust fiduciaries.

(iv) Treatment of certain employee benefit trusts. Provided that
United States fiduciaries control all of the substantial decisions
made by the trustees or fiduciaries, the following types of trusts
are deemed to satisfy the control test set forth in paragraph (a)(1)
(ii) of this section B

(A) A qualified trust described in section 401(a);

(B) A trust described in section 457(g);

(C) A trust that is an individual retirement account described in
section 408(a);

(D) A trust that is an individual retirement account described in
section 408(k) or 408(p);

(E) A trust that is a Roth IRA described in section 408A;

(F) A trust that is an education individual retirement account
described in section 530;

(G) A trust that is a voluntary employees' beneficiary association
described in section 501(c)(9);

(H) Such additional categories of trusts as the Commissioner may
designate in revenue procedures, notices, or other guidance
published in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)
(b)).

(v) Examples. The following examples illustrate the rules of
paragraph (d)(1) of this section:

Example 1. Trust has three fiduciaries, A, B, and C. A and B are
United States citizens and C is a nonresident alien. No persons
except the fiduciaries have authority to make any decisions of the
trust. 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 United States
persons do not control all the substantial decisions of the trust.
No substantial decisions can be made without C's agreement.

Example 2. Assume the same facts as in Example 1, except that the
trust instrument provides that all substantial decisions of the
trust are to be decided by a majority vote among the fiduciaries.
The control test is satisfied because a majority of the fiduciaries
are United States persons and therefore United States persons
control all the substantial decisions of the trust.

Example 3. Assume the same facts as in Example 2, except that 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.29 because the United
States persons, A and B, do not have the power to make all of the
substantial decisions of the trust.

Example 4. Assume the same facts as in Example 3, except A and B may
accept or veto C's investment decisions and can make investments
that C has not recommended. The control test is satisfied because
the United States persons control all substantial decisions of the
trust.

(2) Replacement of any person who had authority to make a
substantial decision of the trust--(i) Replacement within 12 months.
In the event of an inadvertent change in any person that has the
power to make a substantial decision of the trust that would cause
the domestic or foreign residency of the trust to change, the trust
is allowed 12 months from the date of the change to make necessary
changes either with respect to the persons who control the
substantial decisions or with respect to the residence of such
persons to avoid a change in the trust's residency. For purposes of
this section, an inadvertent change means the death, incapacity,
resignation, change in residency or other change with respect to a
person that has a power to make a substantial decision of the trust
that would cause a change to the residency of the trust but that was
not intended to change the residency of the trust. If the necessary
change is made within 12 months, the trust is treated as retaining
its pre-change residency during the 12-month period. If the
necessary change is not made within 12 months, the trust's residency
changes as of the date of the inadvertent change.

(ii) Request for extension of time. If reasonable actions have been
taken to make the necessary change to prevent a change in trust
residency, but due to circumstances beyond the trust's control the
trust is unable to make the modification within 12 months, the trust
may provide a written statement to the district director having
jurisdiction over the trust's return setting forth the reasons for
failing to make the necessary change within the required time
period. If the district director determines that the failure was due
to reasonable cause, the district director may grant the trust an
extension of time to make the necessary change. Whether an extension
of time is granted is in the sole discretion of the district
director and, if granted, may contain such terms with respect to
assessment as may be necessary to ensure that the correct amount of
tax will be collected from the trust, its owners, and its
beneficiaries. If the district director does not grant an extension,
the trust's residency changes as of the date of the inadvertent
change.

(iii) Examples. The following examples illustrate the rules of
paragraphs (d)(2)(i) and (ii) of this section:

Example 1. 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. All decisions of the trust are made by
majority vote of the fiduciaries. The trust instrument provides that
upon the death or resignation of any of the fiduciaries, D, is the
successor fiduciary. A dies and D automatically becomes a fiduciary
of the trust. When D becomes a fiduciary of the trust, D is a
nonresident alien. Two months after A dies, B replaces D with E, a
United States person. Because D was replaced with E within 12 months
after the date of A's death, during the period after A's death and
before E begins to serve, the trust satisfies the control test and
remains a domestic trust.

Example 2. Assume the same facts as in Example 1 except that at the
end of the 12-month period after A's death, D has not been replaced
and remains a fiduciary of the trust. The trust becomes a foreign
trust on the date A died unless the district director grants an
extension of the time period to make the necessary change.

(3) Automatic migration provisions. Notwithstanding any other
provision in this section, United States persons 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
persons.

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

Example 1. A, a nonresident alien individual, is the grantor and,
during A's lifetime, the sole beneficiary of a trust that qualifies
as an individual retirement account (IRA). A has the exclusive power
to make decisions regarding withdrawals from the IRA and to direct
its investments. The IRA's sole trustee is a United States person
within the meaning of section 7701(a)(30).

The control test is satisfied with respect to this trust because the
special rule of paragraph (d)(1)(iv) of this section applies.

Example 2. A, a nonresident alien individual, 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 treated as the owner of the trust under
sections 672(f) and 676. A is not a fiduciary of the trust. The
trust has one trustee, B, a United States person, and the trust has
one beneficiary, C. B has the discretion to distribute corpus or
income to C. In this case, decisions exercisable by A to have trust
assets distributed to A are substantial decisions. Therefore, the
trust is a foreign trust because B does not control all substantial
decisions of the trust.

Example 3. A trust, Trust T, has two fiduciaries, A and B.

Both A and B are United States persons. A and B hire C, an
investment advisor who is a foreign person, and may terminate C's
employment at will. The investment advisor makes the investment
decisions for the trust. A and B control all other decisions of the
trust. Although C has the power to make investment.32 decisions, A
and B are treated as controlling these decisions.

Therefore, the control test is satisfied.

Example 4. G, a United States citizen, creates a trust.

The trust provides for income to A and B for life, remainder to A's
and B's descendants. A is a nonresident alien and B is a United
States person. The trustee of the trust is a United States person.
The trust instrument authorizes A to replace the trustee. The power
to replace the trustee is a substantial decision. Because A, a
nonresident alien, controls a substantial decision, the control test
is not satisfied.

(e) Effective date--(1) General rule. Except for the election to
remain a domestic trust provided in paragraph (f) of this section,
this section is applicable to trusts for taxable years ending after
February 2, 1999. This section may be relied on by trusts for
taxable years beginning after December 31, 1996, and also may be
relied on by trusts whose trustees have elected to apply sections
7701(a)(30) and (31) to the trusts for taxable years ending after
August 20, 1996, under section 1907(a)(3)(B) of the Small Business
Job Protection Act of 1996, (the SBJP Act) Public Law 104-188, 110
Stat. 1755 (26 U.S.C. 7701 note).

(2) Trusts created after August 19, 1996. If a trust is created
after August 19, 1996, and before April 3, 1999, and the trust
satisfies the control test set forth in the regulations project
REG-251703-96 published under section 7701(a)(30) and (31) (1997-1
C.B. 795) (See §601.601(d)(2) of this chapter), but does not satisfy
the control test set forth in paragraph (d) of this section, the
trust may be modified to satisfy the control test of paragraph (d)
by December 31, 1999. If the modification is completed by December
31, 1999, the trust will be treated as satisfying the control test
of paragraph (d) for taxable years beginning after December 31,
1996, (and for taxable years ending after August 20, 1996, if the
election under section 1907(a)(3)(B) of the SBJP Act has been made
for the trust).

(f) Election to remain a domestic trust--(1) Trusts eligible to make
the election to remain domestic. A trust that was in existence on
August 20, 1996, and that was treated as a domestic trust on August
19, 1996, as provided in paragraph (f)(2) of this section, may elect
to continue treatment as a domestic trust notwithstanding section
7701(a)(30)(E). This election is not available to a trust that was
wholly-owned by its grantor under subpart E, part I, subchapter J,
chapter 1, of the Code on August 20, 1996. The election is available
to a trust if only a portion of the trust was treated as owned by
the grantor under subpart E on August 20, 1996. If a partially-owned
grantor trust makes the election, the election is effective for the
entire trust. Also, a trust may not make the election if the trust
has made an election pursuant to section 1907(a)(3)(B) of the SBJP
Act to apply the new trust criteria to the first taxable year of the
trust ending after August 20, 1996, because that election, once
made, is irrevocable.

(2) Determining whether a trust was treated as a domestic trust on
August 19, 1996--(i) Trusts filing Form 1041 for the taxable year
that includes August 19, 1996. For purposes of the election, a trust
is considered to have been treated as a domestic trust on August 19,
1996, if: the trustee filed a Form 1041, A U.S. Income Tax Return
for Estates and Trusts, @ for the trust for the period that includes
August 19, 1996 (and did not file a Form 1040NR, A U.S. Nonresident
Alien Income Tax Return, @ for that year); and the trust had a
reasonable basis (within the meaning of section 6662) under section
7701(a)(30) prior to amendment by the SBJP Act (prior law) for
reporting as a domestic trust for that period.

(ii) Trusts not filing a Form 1041. Some domestic trusts are not
required to file Form 1041. For example, certain group trusts
described in Rev. Rul. 81-100 (1981-1 C.B. 326) (See §601.601(d)(2)
of this chapter) consisting of trusts that are parts of qualified
retirement plans and individual retirement accounts are not required
to file Form 1041. Also, a domestic trust whose gross income for the
taxable year is less than the amount required for filing an income
tax return and that has no taxable income is not required to file a
Form 1041. Section 6012(a)(4). For purposes of the election, a trust
that filed neither a Form 1041 nor a Form 1040NR for the period that
includes August 19, 1996, will be considered to have been treated as
a domestic trust on August 19, 1996, if the trust had a reasonable
basis (within the meaning of section 6662) under prior law for being
treated as a domestic trust for that period and for filing neither a
Form 1041 nor a Form 1040NR for that period.

(3) Procedure for making the election to remain domestic--

(i) Required Statement. To make the election, a statement must be
filed with the Internal Revenue Service in the manner and time
described in this section. The statement must be entitled "Election
to Remain a Domestic Trust under Section 1161 of the Taxpayer Relief
Act of 1997," be signed under penalties of perjury by at least one
trustee of the trust, and contain the following information--

(A) A statement that the trust is electing to continue to be treated
as a domestic trust under section 1161 of the Taxpayer Relief Act of
1997;

(B) A statement that the trustee had a reasonable basis (within the
meaning of section 6662) under prior law for treating the trust as a
domestic trust on August 19, 1996. (The trustee need not explain the
reasonable basis on the election statement.);

(C) A statement either that the trust filed a Form 1041 treating the
trust as a domestic trust for the period that includes August 19,
1996, (and that the trust did not file a Form 1040NR for that
period), or that the trust was not required to file a Form 1041 or a
Form 1040NR for the period that includes August 19, 1996, with an
accompanying brief explanation as to why a Form 1041 was not
required to be filed; and

(D) The name, address, and employer identification number of the
trust.

(ii) Filing the required statement with the Internal Revenue
Service. (A) Except as provided in paragraphs (f)(3)(ii)(E) through
(G) of this section, the trust must attach the statement to a Form
1041. The statement may be attached to either the Form 1041 that is
filed for the first taxable year of the trust beginning after
December 31, 1996 (1997 taxable year), or to the Form 1041 filed for
the first taxable year of the trust beginning after December 31,
1997 (1998 taxable year). The statement, however, must be filed no
later than the due date for filing a Form 1041 for the 1998 taxable
year, plus extensions. The election will be effective for the 1997
taxable year, and thereafter, until revoked or terminated. If the
trust filed a Form 1041 for the 1997 taxable year without the
statement attached, the statement should be attached to the Form
1041 filed for the 1998 taxable year.

(B) If the trust has insufficient gross income and no taxable income
for its 1997 or 1998 taxable year, or both, and therefore is not
required to file a Form 1041 for either or both years, the trust
must make the election by filing a Form 1041 for either the 1997 or
1998 taxable year with the statement attached (even though not
otherwise required to file a Form 1041 for that year). The trust
should only provide on the Form 1041 the trust's name, name and
title of fiduciary, address, employer identification number, date
created, and type of entity. The statement must be attached to a
Form 1041 that is filed no later than October 15, 1999.

(C) If the trust files a Form 1040NR for the 1997 taxable year based
on application of new section 7701(a)(30)(E) to the trust, and
satisfies paragraph (f)(1) of this section, in order for the trust
to make the election the trust must file an amended Form 1040NR
return for the 1997 taxable year. The trust must note on the amended
Form 1040NR that it is making an election under section 1161 of the
Taxpayer Relief Act of 1997. The trust must attach to the amended
Form 1040NR the statement required by paragraph (f)(3)(i) of this
section and a completed Form 1041 for the 1997 taxable year. The
items of income, deduction and credit of the trust must be excluded
from the amended Form 1040NR and reported on the Form 1041. The
amended Form 1040NR for the 1997 taxable year, with the statement
and the Form 1041 attached, must be filed with the Philadelphia
Service Center no later than the due date, plus extensions, for
filing a Form 1041 for the 1998 taxable year.

(D) If a trust has made estimated tax payments as a foreign trust
based on application of section 7701(a)(30)(E) to the trust, but has
not yet filed a Form 1040NR for the 1997 taxable year, when the
trust files its Form 1041 for the 1997 taxable year it must note on
its Form 1041 that it made estimated tax payments based on treatment
as a foreign trust. The Form 1041 must be filed with the
Philadelphia Service Center (and not with the service center where
the trust ordinarily would file its Form 1041).

(E) If a trust forms part of a qualified stock bonus, pension, or
profit sharing plan, the election provided by this paragraph (f)
must be made by attaching the statement to the plan's annual return
required under section 6058 (information return) for the first plan
year beginning after December 31, 1996, or to the plan's information
return for the first plan year beginning after December 31, 1997.
The statement must be attached to the plan's information return that
is filed no later than the due date for filing the plan's
information return for the first plan year beginning after December
31, 1997, plus extensions. The election will be effective for the
first plan year beginning after December 31, 1996, and thereafter,
until revoked or terminated.

(F) Any other type of trust that is not required to file a Form 1041
for the taxable year, but that is required to file an information
return (for example, Form 5227) for the 1997 or 1998 taxable year
must attach the statement to the trust's information return for the
1997 or 1998 taxable year. However, the statement must be attached
to an information return that is filed no later than the due date
for filing the trust's information return for the 1998 taxable year,
plus extensions. The election will be effective for the 1997 taxable
year, and thereafter, until revoked or terminated.

(G) A group trust described in Rev. Rul. 81-100 consisting of trusts
that are parts of qualified retirement plans and individual
retirement accounts (and any other trust that is not described above
and that is not required to file a Form 1041 or an information
return) need not attach the statement to any return and should file
the statement with the Philadelphia Service Center. The trust must
make the election provided by this paragraph (f) by filing the
statement by October 15, 1999.

The election will be effective for the 1997 taxable year, and
thereafter, until revoked or terminated.

(iii) Failure to file the statement in the required manner and time.
If a trust fails to file the statement in the manner or time
provided in paragraphs (f)(3)(i) and (ii) of this section, the
trustee may provide a written statement to the district director
having jurisdiction over the trust setting forth the reasons for
failing to file the statement in the required manner or time. If the
district director determines that the failure to file the statement
in the required manner or time was due to reasonable cause, the
district director may grant the trust an extension of time to file
the statement. Whether an extension of time is granted shall be in
the sole discretion of the district director. However, the relief
provided by this paragraph (f)(3)(iii) is not ordinarily available
if the statute of limitations for the trust's 1997 taxable year has
expired.

Additionally, if the district director grants an extension of time,
it may contain terms with respect to assessment as may be necessary
to ensure that the correct amount of tax will be collected from the
trust, its owners, and its beneficiaries.

(4) Revocation or termination of the election--(i) Revocation of
election. The election provided by this paragraph (f) to be treated
as a domestic trust may only be revoked with the consent of the
Commissioner. See sections 684, 6048, and 6677 for the federal tax
consequences and reporting requirements related to the change in
trust residence.

(ii) Termination of the election. An election under this paragraph
(f) to remain a domestic trust terminates if changes are made to the
trust subsequent to the effective date of the election that result
in the trust no longer having any reasonable basis (within the
meaning of section 6662) for being treated as a domestic trust under
section 7701(a)(30) prior to its amendment by the SBJP Act. The
termination of the election will result in the trust changing its
residency from a domestic trust to a foreign trust on the effective
date of the termination of the election. See sections 684, 6048, and
6677 for the federal tax consequences and reporting requirements
related to the change in trust residence.

(5) Effective date. This paragraph (f) is applicable beginning on
February 2, 1999.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for part 602 continues to read as
follows:

Authority: 26 U.S.C. 7805..Par. 5. In §602.101, paragraph (c) is
amended by adding an entry in numerical order to the table to read
as follows:

§602.101 OMB Control numbers.

* * * * *

(c) * * *

CFR part of section where Current OMB identified and described
control No.

* * * * *

301.7701-7 . . . . . . . . . . . . . . . . . . . . . 1545-1600

* * * * *

Robert E. Wenzel
Deputy Commissioner of Internal Revenue
Approved: January 13, 1999
Donald C. Lubick
Assistant Secretary of the Treasury

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