LOS ANGELES COUNTY BAR ASSOCIATION
FOREIGN TAX COMMITTEE1
PROPOSED GUIDANCE REGARDING
U.S. FEDERAL TAX TREATMENT OF
RESTITUTION OF PROPERTY TO U.S.
CITIZENS SEIZED BY THEIR FORMER
This proposal was prepared by Albert S. Golbert on behalf of the
Foreign Tax Committee of the Taxation Section of the Los Angeles County Bar
Association. The author wishes to thank Rufus v. Rhoades, Paul A. Sczudlo and
Lawrence H. Heller for their thoughtful review and critique of this paper, and
Robert E. Culbertson and Milton Cerny for their excellent Opinion and Analysis
of many of the issues herein discussed in the article published in Tax Notes
International on December 16, 1996 at 2021. The preparer is particularly
indebted to Mr. Cerny who afforded him the opportunity to discuss the issues in
depth and provided insight and suggestions which have been incorporated in this
Contact Person: Albert S. Golbert
Golbert & Associates
One Bunker Hill 8th Floor
601 West Fifth Street
Los Angeles, California 90071
The comments contained in this paper represent the individual views of the author who prepared them.
They do not represent the position of the State Bar of California or of the Los Angeles County Bar Association.
Although the author might have had clients affected by the rules applicable to the subject matter of
this paper and may have advised such clients on applicable law, the author has not been engaged by any client to
participate in this project nor is the tax status of any client of the author dependent upon the outcome, if any, of
Albert S. Golbert
Prior to the collapse of the Soviet Union and the communist states
within its hegemony, many thousands fled to the West including the United
States. The great majority of these refugees from Communism suffered
deprivations of property, real and personal, seized by these totalitarian regimes
without compensation or recourse whatsoever. The return of democracy, a
reaffirmation of the rule of law and the desire of these former Soviet bloc
republics to participate and eventually to integrate in the political and economic
organizations of the West, generally, and with those of the European
Community, in particular, have led to efforts to redress prior injustices by
returning nationalized properties or, by paying compensation in lieu of
restitution. These events have been producing tax complications for the
recipients of such restitution because recipients who have become U.S. citizens
or tax residents are subject to tax on their world-wide income.
When U.S. persons receive restitution of property which had
earlier been seized by Communist or totalitarian governments in their prior
homelands, it is not always clear whether current laws and regulations dealing
with deprivation of rights would apply to the issues of: (i) whether the receipt of
compensation in lieu of the property seized is a taxable event; (ii) whether the
recipient=s basis in the property seized is a carry-over basis derived from
original cost, or current fair market value; or (iii) imposition of U.S. estate and
gift tax on the value of the properties upon their disposition or upon death of the
2 Albert S. Golbert
If this approach is adopted, recipients of restituted properties
should take a fair market value (FMV) basis in the property at the time of its
receipt; precedents hold that FMV basis is appropriate where it is necessary to
preserve the intended effect of an income tax exemption. To do otherwise
would frustrate the restitution of the property or payment in lieu thereof as upon
disposition of the property or upon receipt of payment in excess of historical
basis, the United States would impose a tax on amounts of restitution which
should be exempt.
Just as the IRS has concluded that it is appropriate to assign an
FMV basis to property when necessary to preserve the intended effect of an
income tax exemption, the Service has also concluded that an exemption from
estate or gift taxation may be required in order to preserve the intended effect of
an exemption. Moreover, restitution payments should be exempt from estate or
gift taxation on the basis of international comity, as imposing U.S. taxation on
the payment of reparations or restitution for prior takings would become in large
measure a transfer to the U.S. Treasury, largely frustrating the purpose of such
Clearly, an estate and gift tax exclusion should not be open-ended,
but it should last long enough to provide an estate tax exemption of the
restitution to the party who receives the restitution even if such party is an heir
of the individual who suffered the original loss. For example, with respect to
income-producing properties, the exclusion should be long enough for the
income to cover the estate tax payments. Likewise, when the property is a
residence or non-income producing property, the exemption should be long
enough to permit the recipients to build up sufficient net income to cover the 55
percent U.S. transfer tax.
Finally, gifts made within a reasonable time, say, three years after
receipt of restitution, should be treated as contemporaneous gifts or gifts made
in contemplation of death, as many of the recipients are already near or past
retirement age. This suggestion is based upon the view that death should not be
1956 2 C.B. 25.
3 Albert S. Golbert
considered a tax-avoidance device and that gifts should be treated consistently
with a roughly contemporaneous bequest, as Section 2035 historically ensured.
Were the United States to intercept such restituted properties or
payments via its ability to tax their recipients (who were already victimized by
the predecessor regimes of the current payors), it would become, ironically, a
successor-in-interest to those totalitarian regimes the acts of which are the very
reason for which reparations and restitution have begun to flow. While this is
not meant to equate the right to tax with the power to expropriate, the first of
which is sanctioned by the rule of law while the second is not, U.S. taxation of
reparations and restitution payments would still be egregious in that the U.S.
does not have a persuasive claim to such taxes and because the Internal Revenue
Code does not require such result. Moreover, it is well within the authority of
the IRS and Treasury Department to limit U.S. taxation to amounts legitimately
and equitably within its taxing jurisdiction (See, Revenue Ruling 56-518).
4 Albert S. Golbert
I. RESTITUTION AND REPARATION PAYMENTS SHOULD BE
EXEMPT FROM U.S. INCOME TAX
A. Payments in Reimbursement for Deprivation of Civil or
Personal Rights Enjoy a Broad Tax Exemption
It is a well-established principle that payments in reimbursement
for the deprivation of civil or personal rights do not constitute taxable income.4
The ruling which recognized this principle5 applied it to the various forms of
compensation paid by the German government to victims of Nazi persecution,
but the Service has also applied the same principle to compensation paid by the
Austrian government to Nazi victims,6 to payments by the Netherlands to
individuals disabled resisting Nazi occupation,7 and to compensation paid by the
U.S. government itself to Aleutian Indians for deprivation of their rights.8
Rev. Rul. 56-518, 1956-2 C.B. 25. See also Rev. Rul. 55-132, 1955-1 C.B. 213 (exclusion of
payments to prisoners of war under the War C1aims Act of 1948, cited in Rev. Rul. 56-518); Rev. Rul.57-505,
I957-2 C.B. 50 (clarification of Rev. Rul. 56-518); Rev. Rul. 58-500, 1958-2 C. B. 21 (Amplification of Rev.
Rul. 56-518; PLR 5810175430A (Oct 17, 1958) (applying Rev. Rul. 56-518); PLR 6808130960A (Aug 13,
1968) (similar); Private letter rulings, GCMs, and other unpublished IRS documents may not be used or cited as
precedent, but may provide useful analysis and an indication of the Service=s own views on an issue; they are
referenced here for those purposes.
Rev. Rul 58-370, 1958-2 C.B. 14. See also, Rev. Rul. 69-212 (extending Rev. Rul. 58-370 to
additional Austrian statute); and PLR 6911281440A (Nov. 28, 1969) applying Rev. Rul. 69-21222.
PLR 9223046 (Mar. 10, 1992) citing Rev. Rul. 56-518 and subsequent rulings. N.B. The principles
of Rev. Rul 56-518 were here applied to a non-German case and indicates its continuing validity.
PLR 9406011 (Nov. 9, 1998) citing with approval Rev. Rul. 56-518.
5 Albert S. Golbert
Currently, Eastern European nations eager for acceptance in
Western political institutions are granting restitution for the prior deprivation of
civil and personal rights frequently, but not exclusively, relating to property.
Though compensation for property loss is often the major component of such
restitution, the fact that the computation of the restitution is tied to the loss of
property and not directly to the loss of other civil and personal liberties, such as
life and liberty, should nor preclude tax exemption for the restitution. The
precedents permit exemption for payments based on the deprivation of property
rights, where the deprivation of such rights are pursuant to a political regime in
which property rights, and other fundamental civil and personal liberties, are
systematically compromised. Revenue Ruling 56-518 refers to persecution
resulting in Adamage to life, body, health, liberty, rights of property ownership,
or to professional or economic advancement@ (emphasis supplied). This ruling
specifically provided that where a right of property ownership is the subject of
restitution, payments measured by the value of the expropriated property would
first be applied to recover the persecuted taxpayer=s basis in the property and
that the question of whether any payments in excess of taxpayer=s basis
constitutes taxable income would be addressed on a facts-and-circumstances
basis.9 No subsequent ruling from the Service has amplified the treatment of
restitution payment for property rights. Thus, while it is clear that Revenue
Ruling 56-518 requires the exclusion from income of state compensation for the
wrongful acts of Communist governments resulting in deprivation of civil and
personal rights, its application to property rights is unclear. Because of this
uncertainty and the fact that the ruling addresses only the Nazi atrocities, it is
possible that IRS agents may take the mistaken view that such ruling applies
only to Germany (which has, historically, been the principle payor of such
compensation) or is meant to bolster and confirm that certain provision in the
1991 Income Tax Treaty Between Germany and the United States (the Treaty),
exempting, inter alia, payments for injuries or damages resulting from political
persecution thus giving rise to a negative inference elsewhere.10 Thus, to avoid
extended controversy over these issues, we urge the publication of official
guidance confirming the applicability of the principles of Revenue Ruling 56-
518 and its progeny to compensation paid by the governments of Eastern Europe
See, Rev. Rul. 56-518, Section II.C.
APensions, annuities and other amounts paid by one of the Contracting States [i.e., Germany] or by a
juridical person organized under the public laws of that State [the federal Treuhandgesellschaft] as
compensation for an injury or damage sustained as a result of hostilities or political persecution shall be exempt
from tax by the other State@ [i.e., the United States] (emphasis added). Article 19, paragraph 1(c).
6 Albert S. Golbert
today, and, one day, the communist governments still surviving in the Far East,
and extending the exemption in Revenue Ruling 56-518 clearly to payments for
B. The Exemption is Neither Dependent Upon or Affected by
Changes in Property Valuation
Revenue Ruling 56-518 is ambiguous when it comes to exempting
a property recovery in excess of basis, even suggesting that a recovery in excess
of basis may not benefit from the exemption if the facts-and-circumstances
analysis is unfavorable:
(W)here the right of property ownership is involved, payments which are
measured by the value of property taken from persecuted taxpayers do not in
any event constitute taxable income where the taxpayer has not recovered his
basis . . . In any case in which payments measured by the value of property
exceed the cost or other basis of the property, the question whether the excess
represents taxable income will be determined on the basis of the facts and
circumstances of each case.
Notwithstanding the foregoing, this provision in the ruling should
not alter the result in the case of property which is returned to the original
owner, because such compensation does not constitute payments measured by
the value of the property, but rather a return of the property itself. In such cases,
the restitution cannot meaningfully exceed the taxpayer=s original basis in the
property, when the restitution received is the very property which was originally
seized. Even in cases where the property has appreciated in value, there is no
realization of that increase in value when the property itself is simply returned.
Thus the ruling=s suggestion that the Service might seek to tax the receipt of a
cash payment exceeding the basis of seized property does not apply where the
seized property itself is restored to the taxpayer. The entire value of the
restitution should be viewed as a return of the taxpayer=s basis which does not
The existence of such provision in the German Treaty is not the negation of the general principle to
compensation received from other countries. Art. 19 was included in the 1991 treaty at the request of Germany
and is consistent with standard German treaty practice. Given its consistency with our own domestic rules, there
was no reason for the United States to object to its inclusion. See, Rev. Rul. 71-477, 1971-2 C.B. 479, which
confirmed that Rev. Rul. 58-500 (clarifying Rev. Rul. 56-518) continued to apply to German payments in
taxable years prior to the effective date of the 1991 Treaty. Thus, Rev. Rul. 71-477 can be said specifically to
acknowledge that the validity of the exemption principle is independent of the treaty provision and applicable
even when no treaty provision is in place.
7 Albert S. Golbert
generate any taxable income. This, of course, begs the issue of basis, i.e.,
whether it should be a carry-over or stepped up basis.
Where the loss of property is compensated by a cash payment (or
other property transfer), in lieu of a return of the expropriated property, the
facts-and-circumstances analysis suggested by Revenue Ruling 56-518 does not
appear to be appropriate. Such analysis will generally show that the deprivation
of property was inevitably in conjunction with a broader deprivation of the
individual=s other civil and personal rights by the expropriating regime. A flat
exemption of the property-based payments appears to be appropriate. This
analysis is bolstered by the opinion of IRS Chief Counsel who concluded that:
it is improbable under the principles set forth in Revenue Ruling 56-518 that
taxable income was expected to result in cases where compensation for
property damage exceeds taxpayer=s basis in the damaged property.12
It is not unreasonable to presume that this conclusion reflects the
fact that even where a cash payment exceeds basis, the whole amount is still
compensation for the deprivation of rights, and therefore excludable under the
general principle. Moreover, it is not at all clear what alternative principle could
be applied in the analysis of the facts and circumstances of each case
contemplated by the ruling as the ruling suggests no other principle which
would distinguish one recovery in excess of basis from another.
Were the ruling to be otherwise interpreted, it would lead to
curious and inexplicable results. For example, if a Prague apartment building
belonging to Czech Jews were confiscated in 1938 by the Nazis and sold in
1946 to, say, Westinghouse Corporation which promptly converted it into an
office building only to have it seized again, this time by the Czech Communist
regime in 1950, both Westinghouse and the original owners (or their heirs)
would have claims for restitution. Whether the property were recovered by the
descendants of the original owners or Westinghouse, with the other receiving
cash compensation in lieu of the property, neither would be subject to tax under
Czech law, even if the recipient of the property should promptly resell the
property before significant appreciation could be realized. Assuming the heirs
of the original owners are now U.S. taxpayers as is Westinghouse, it would
GCM 34560 (July 26, 1971).
8 Albert S. Golbert
appear contrary to the purposes of the ruling for these recipients of Czech
restitution to be treated differently for the purposes of U.S. taxation.
Following on what has been said, we urge that published guidance
clarify that the restitution of previously nationalized property does not in any
event produce taxable income, and that the same principle be consistently
applied to exempt cash recovery in excess of historical basis from taxation.
II. PROPERTY RECEIVED IN RESTITUTION TAKES AN FMV
BASIS FOR U.S. TAX PURPOSES
Recipients of restitution should receive an FMV basis in the property at
the time of its receipt. Such result would be consistent with precedents holding
the FMV basis is appropriate where it is necessary to preserve the intended
effect of an income tax exemption.
A. IRS Adopted FMV Basis Principle in Government
In implementing the German Treaty exemption,13 the Service
adopted, in Notice 95-31, an FMV basis approach as part of an agreement of the
competent authorities, which approach is consistent with the reasoning of other
authorities discussed below assigning FMV basis when necessary to preserve
the intended effect of an income tax exemption.14 The notice makes it quite
clear that the articles intent of exempting war reparation payments would be
frustrated if the recipients of property took an historical basis, since upon
disposition the United States would impose tax on amounts intended to be
exempt.15 Instead, under the rule adopted by the notice, on a subsequent
disposition of the property, the taxpayer will realize only gain attributable to
See, fn. 10, supra, and accompanying text.
Notice 95-31, 1995-1 C.B. 307.
The treaty provision was Aintended to provide U.S. exemption for German war reparation payments@
and states: AAlthough Article 19(1)(c) of the Treaty does not specifically address the question, the competent
authorities have agreed that a fair market value basis is within the intent of Article 19(1)(c). The linkage
between the intended exemption and the adoption of FMV basis is drawn even more clearly in the IRS
information release which accompanied publication of the notice (IR-95-39): >. . . under the treaty, the tax basis
of any property received will be its fair market value at the time of receipt by the taxpayer.= Notice 95-31
points out that the Treasury Department Technical Explanation to the Treaty states that Article 19(1)(c) of the
Treaty >is intended to provide U.S. exemption for German war reparation payments.= @
9 Albert S. Golbert
appreciation of the property occurring after the time of its receipt by the
Just as the intent of German treaty article 19 was simply
confirmation of an exemption which already existed under U.S. law,17 if an
FMV basis is required to preserve that intent in the treaty context, it is equally
required when applying the underlying principles of U.S. law in a non-treaty
setting. In short, the same step-up in basis of the property to its FMV on the
date of restitution should apply whether or not a treaty rule applies.
B. Case Law and Rulings Adopt an FMV Basis When Necessary
to Preserve an Exemption
Notice 95-31 was not the first time the Service recognized the
principle that failure to assign an FMV basis to property which is received in an
exempt transaction could as a practical matter deny the benefit of the intended
exemption as it would impose full income tax upon the disposition of such
1. Preservation of Indian Tax Exemptions
Notice 95-31 and IR-95-39.
Under the prior treaty between West Germany (the Deutsche Bundes Republik (DBR), or the German
Federal Republic) and the United States, the IRS ruled that any amount paid by West Germany for injury or
damage sustained as a result of hostilities or political persecution was exempt from U.S. tax. This included
compensation for property even if the compensation exceeded the basis in the property. See, Rev. Rul. 71-477,
1971-2 C.B. 479 and GCM 34560 [July 26, 1971] interpreting Art. XI, Section (1)(c), of the Convention
between the United States of America and the Federal Republic of Germany for the Avoidance of Double
Taxation with respect to Taxes on Income and to certain other Taxes  (the Convention).
10 Albert S. Golbert
Federal tax exemptions, some extending back as far as the
19 Century, confer federal tax exemption to certain amounts paid to members
of Indian tribes. The connection between tax exemption and FMV basis was
first recognized in this context, specifically in Shepard v. United States and in
the Services subsequent acquiescence.18 Shepard was allotted 80 acres of land
in 1905 to be held in trust by the federal government. In 1952, he was granted
ownership in fee simple for purpose of selling it. The court found that the
receipt of property under the relevant legislation was intended to be exempt
from tax,19 and determined that to preserve the exemption it was necessary to
give Shepard an FMV basis in the property at the time of its transfer in fee
The Service acquiesced in the correctness of the court=s
judgment in Revenue Ruling 62-48 and noted therein that the court in Squire
found that allotments under the General Allotment Act were exempt from
taxation while held in trust and continued to hold that the purposes of the Act
required that during that period not only the trust corpus but also the income
derived directly therefrom should be preserved free from taxation.
The Service then extended this analysis to the issue of basis:
Since imposition of a capital gains tax upon the appreciation during the trust
period of such an allotment would also appear to be at variance with the tax
exemption and the purposes of the Act. . . the Internal Revenue Service will
follow the holding of the Shepard case in determining an Indian=s basis in
his fee simple allotment.
The same analysis would hold that imposition of a capital
gains tax on any appreciation during the period of Communist seizure would be
at variance with the intent Revenue Ruling 56-518.
2. Preservation of Exemption Through FMV Basis in Other
162 F.Supp. 313 (E.D.Wis. 1958); Rev. Rul 62-48, 1962-1 C.B. 131.
Citing Squire v. Capoeman,351 U.S. 1 (1956) in which the Supreme Court held that the statute
conferred an exemption.
11 Albert S. Golbert
The Service has applied the principle established in Shepard
and Revenue Ruling 62-48 in several other contexts. In Revenue Ruling 74-
205,20 the Service held that recipients of certain federal housing subsidies could
include the subsidized amounts in the basis of their property. This holding was
based on the recognition that inclusion of the subsidized amounts in basis was
necessary to preserve an intended tax exemption of the subsidies.21
Another GCM held that a deduction should be permitted for
penalties for premature withdrawal of funds from a time savings account to
preserve the intended effect of excluding interest and dividends from gross
income under Section 116.22
[T]he intent of the tax exemption found in the 1970 Act would be defeated if
the taxpayer was (sic) not allowed to include the relocation payment in the
basis of the replacement property. Without the basis adjustment, the
relocation payment would indirectly be taxed when the taxpayer ultimately
sells the newly acquired property. Similarly, disallowances of part of the
forfeiture deduction would have the practical effect of reducing the amount of
dividends and interest which a taxpayer can receive without incurring any tax
liability, below the amounts expressly set forth in Section 116.
That receipt of properties in restitution is exempt from U.S.
income tax was established in Section I, above. It is also manifestly clear that
such exemption would be rendered nugatory upon a subsequent disposition of
such property absent FMV basis at the time of receipt. Were a carryover basis
to attach to such property (much of which was acquired prior to World War II),
the intervening appreciation would be subject to full U.S. income taxation
having the practical effect of denying the benefits intended by the restitution.
Thus, it is appropriate that the Service has adopted an FMV basis analysis in the
reparations context under the German tax treaty, and the same analysis should
1974-1 C.B. 20.
AWhile the taxpayer would not be taxed on the amount of the replacement housing payment when
received, reduction of basis in that amount would, in effect, mean that he would be taxed on that amount at a
later date upon sale of the house.@ GCM 34957 (July 20, 1972). The Service, in recognizing this potential
anomaly were basis not to include the subsidized amounts, noted: A. . . the effect would be to change the
exemption of income into a deferment of income, thereby reducing substantially the basic tax benefit intended to
be accorded . . .@ In support of its conclusion, the GCM cited Revenue Ruling 62-48 as Aanother instance
where the Service determined basis by reliance on overall statutory intent . . .@
GCM 38658 (May 24, 1982).
12 Albert S. Golbert
be extended, malgré the absence of similar treaties, to restitutions in Eastern
Europe and beyond.
C. Adoption of FMV Basis Serves Appropriate Legal and
Even in the absence of the precedents discussed above, adoption of
FMV basis for property restitutions in Eastern Europe provides appropriate legal
and practical benefits. In this regard, it is essential to recognize that such
nationalizations were legal under the domestic laws pursuant to which they were
carried out.23 Throughout the Communist era (varying by country from 40 years
to 70 years), the former owners had no right, title or interest in and to their
properties following expropriation, and the eventual restoration of such
properties to their original owners or heirs does not rewrite history. The fact
remains that the original owners were shorn of legal title. The restituted title
was granted B not as a matter of legal right B but as a matter of fundamental
justice, and is clearly new title to the properties. Thus, to treat a recipient of
restituted property as if ownership rights had never been interrupted by
requiring the recipient to carry over an historical basis amount, would be
inconsistent with both the law and reality. Further, it would be an
administrative nightmare to reconstruct historical tax attributes and currency
exchange rates given the fact that such properties would not normally have
obtained an historical basis for U.S. tax purposes. Moreover, locating records,
either municipal or personal, after all of the years and the ravages of wars and
insurrections, not to mention the flight of refugees with little more than the
clothing on one=s back, would be both impossible to establish or to challenge.
The act of state doctrine generally prohibits the courts of one country to sit in judgment on the acts of
another done within its own territory pursuant to its own laws. Nevertheless, the United States has consistently
maintained, since Elihu Root served as Secretary of State, that: Each country is bound to give to the nationals of
another country in its territory the benefit of the same . . . protection and redress for injury which the country
gives to its own citizens . . . provided the protection which the country gives to its own citizens conforms to the
established standard of civilization. 4 Proceedings, American Society of International Law 16, 20-22 (1910).
The fact that the seizure of foreign-owned property was accompanied by the seizure of the property of its own
nationals, will not immunize the expropriating state from the view that all takings must be accompanied by the
payment of prompt and adequate compensation to the victims of the seizure in order to comply with minimum
international law standards of justice. See, the Hickenlooper Amendment, 22 U.S.C. ' 2370(e), Foreign
Assistance Act of 1962, as amended, which codified the U.S. view of international law on the subject.
However, international law can be extended only to non-nationals of the expropriating state, not to its own
citizens. Thus, the reversal by a successor government of the expropriations, does not go to the issue of the
legality of the original takings. The essence of sovereignty is that Athe decree of the sovereign makes law@
(within, of course, its own territorial limits and as applied to its own nationals). American Banana Co. v. United
Fruit Co., 213 U.S. 347, 358 (1909).
13 Albert S. Golbert
Finally, a U.S. basis computation would require a fictional determination of
allowable depreciation, and a prohibitively complex analysis of applicable U.S.
depreciation rules over the past half century. Tax compliance resources should
be better spent elsewhere.
Accordingly, we urge that published guidelines apply the principles
of Notice 95-31, Revenue Ruling 62-46, and Shepard to hold that basis in
restituted properties for U.S. income tax purposes equals their fair market value
at the time of restitution.
III. ROUGHLY CONTEMPORANEOUS TRANSFERS OF
RESTITUTED PROPERTIES SHOULD NOT BE SUBJECT TO
U.S. ESTATE OR GIFT TAXATION
There are at least two excellent reasons B but little substantive authority B
upon which to support the conclusion that a gift or bequest of property at a point
roughly contemporaneous with its restitution should not be subject to U.S. gift,
estate or GST tax.24 The first is a technical reason which is based on precedents
implementing other tax exemptions, and the second is a broader policy concern
relating to international comity.
A. Taxing a Contemporaneous Gift or Bequest Would Vitiate the
Just as the IRS has found it appropriate to assign an FMV to
property to preserve the intended effect of an income tax exemption, the Service
has similarly held that an exemption from estate or gift tax may also be required
to preserve the intended effect of an exemption. This is particularly noteworthy
in the implementation of treaties and statutes exempting Indians from tax.
As the rationale for estate tax is essentially the same as for gift and GST taxes, we will address only
the former with the understanding that all three taxes operate together to impose tax on wealth transfers and are
generally construed in pari materia, See, e.g., Harris v. Commissioner, 340 U.S. 106 (1950.
14 Albert S. Golbert
In Squire v. Capoeman,25 the Supreme Court held that the General
Allotment Act exempted certain income from federal tax. Subsequently, a
federal district court held that, inter alia, lands allotted under that act were not
includable in a deceased Indian=s gross estate.26 The Service effectively
acquiesced to that decision in a Revenue Ruling which stated:
The Capoeman case is considered by the Internal Revenue Service to support
an exemption from an estate tax because imposing a Federal estate tax is as
likely to deplete the property that the United States has undertaken to convey
undiluted and undiminished as imposing an income tax.27
The Ninth Circuit Court of Appeals has gone on to hold that:
AUnder the rationale in Capoeman, we find that allotted lands and allotment
proceeds are exempt from gift tax.@28 While not dispositive (because the Indian
cases have turned on the precise scope of the tax exemption), these cases
suggest that an estate or gift tax exemption need not be expressly provided for in
order to be applicable, if necessary, to preserve a tax exemption.
Revenue Ruling 79-35 addressed the U.S. estate tax treatment of a
survivor annuity paid by Germany as compensation for the Nazi regime=s
wrongful treatment of the decedent.29 The ruling held that the value of the
annuity is not includable in the gross estate of the decedent, but did not
articulate the rationale for its conclusion. Nevertheless, it is a clear example of
property received as a compensatory payment from a foreign sovereign being
exempted from U.S. estate tax and it sheds additional light on the extent and
scope of the exemption from tax articulated in Revenue Ruling 56-518 by
suggesting that the latter Ruling should be extended broadly to cover an
exemption from estate and gift taxation.
Moreover, the holding of Revenue Ruling 79-35 is justified by the
fact that a contrary conclusion would have the practical effect of vitiating the
intended U.S. income tax exemption by subjecting a compensatory property
See f.n. 18, supra, and accompanying text.
Asenap v. U.S., 283 F. Supp. 566 (W.D. Okla. 1968).
Rev. Rul. 69-164, 1969-1 C.B. 220.
Kirschling v. U.S., 746 F. 2d 512 (9th Cir. 1984).
1979-1 C.B. 294.
15 Albert S. Golbert
right (the annuity) to more burdensome U.S. estate taxation. Here, an estate tax
exclusion not only preserves the income tax exemption under Revenue Ruling
58-518, it is also consistent with that ruling=s implicit principle that
compensation for the prior deprivation of rights is neither an accretion to wealth
nor part of the wealth that should be subject to U.S. taxation. In other words,
effective preservation of the U.S. income tax exemption under Revenue Ruling
56-518 requires a parallel exclusion from U.S. estate and gift taxes.
B. Broader Principles of International Comity Support an Estate
Tax Exclusion of Restituted Properties
1. The Rulings Exempting Foreign Reparations Are
Supported by Principles of International Comity
The broader principles underlying the authorities above
discussed provide further support for excluding restituted properties from U.S.
estate and gift taxes as Revenue Ruling 58-518 and its progeny appear to be
founded on principles of international comity, principles which are applicable
here. The Supreme Court provided the seminal definition of comity over 100
Comity, in the legal sense, is neither a matter of absolute obligation, on the
one hand, nor of mere courtesy and good will, upon the other. But it is the
recognition which one nation allow within its territory to the legislative,
executive or judicial acts of another nation, having due regard both to
international duty and convenience, and to the rights of its own citizens or of
other persons who are under the protection of its law.30
Hilton v. Guyot, 159 U.S. 113, 163-4 (1895). The principle was more recently confirmed in Laker
Airways Ltd. v. Sabena Belgian World Airlines, 731 F.2d 909 (D.C. Cir. 1984), where the court stated that
comity Asummarizes in a brief word a complex and elusive concept B the degree of deference that a domestic
forum must pay to the act of a foreign government not otherwise binding on the forum.@ Id. at p. 937.
16 Albert S. Golbert
Because courts often balance competing interests of the two
sovereigns when considering comity,31 the doctrine of comity has been closely
circumscribed in the area of taxation given the strength of the interest of this
country in the collection of its taxes.32 This doctrine is, nevertheless, reflected
in a number of code and treaty provisions exempting foreign government
employee salaries from U.S. tax.33
In the situations addressed by Revenue Rulings 56-518 and
79-35, it is clear that imposing U.S. taxation on the payment of reparations and
restitution would impede the government functions of the country making the
payment. Instead of compensating the individual for injuries sustained, the
payment would become in large measure a transfer to the U.S. Treasury,
frustrating its purpose to the extent of the U.S. tax liability. Avoiding such
interference with a foreign government program of compensation, restitution or
reparation is thus justified as a matter of international comity. These
considerations, while not expressly referred to in Revenue Ruling 56-518 and
79-35, definitely support the technical positions adopted in these Rulings. The
same consideration support an equivalent restriction on U.S. estate and gift tax
jurisdiction over property returned by a foreign sovereign as compensation for a
The argument could be made that U.S. tax laws continue to
apply even where a foreign jurisdiction applies different, potentially more
favorable rules (e.g., specific exemptions, lower tax rates, etc.) and that the
integrity of the U.S. tax rules should be respected and do not fall merely because
a U.S. taxpayer has U.S.-taxable transactions in a foreign jurisdiction. While
U.S. Tax rules generally do govern the calculation of the tax liability of U.S.
taxpayers (and such taxpayers rely on targeted U.S. tax relief such as the foreign
tax credit and the Section 911 exclusion), the blind application of U.S. rules to
See, Restatement of the Foreign Relations Law of the United States (Second), ' 40 which lists five
factors to be balanced, including the Avital interests of each state,@ and Restatement of the Foreign Relations
Law of the United States (Third) ' 403(3): Aa state should defer to another whose interest is clearly greater.@
See, e.g., Overseas Inns S.A.P.A. v. U.S., 685 F. Supp. 968 (N.D. Tex. 1988), aff=d, 911 F.@d 1146
(5 Cir. 1990) stating: A[T]here is, in the United States, an inexpungeable public policy that favors payment of
lawfully owed federal income taxes.@
A[The exemption] reflects the accepted principle of international comity that one sovereign should
not, by taxation, impede the government functions of another. The same principle is reflected in the provisions
of sections 892, 893 and 895 of the Code.@ GCM 39311 (Dec. 6, 1984) (emphasis supplied).
17 Albert S. Golbert
tax payments of reparations and restitutions would be inappropriate in this
context because they were intended by the paying governments to be net
payments, free from governmental tribute. For the U.S. to step into the breach
by taxing payments intended to be free from tax, would not only defeat the
purpose of the restitution payments, but would well constitute an unwelcome
intrusion into the domestic affairs of another sovereign.
2. Imposition of U.S. Estate Tax Would Seriously Impede
Imposing U.S. income or estate tax on the restitution of
property by a foreign sovereign would have the effect of transferring the greater
part of the restituted property to the U.S. government, not to the recipient that
the foreign government intended. It is hardly in the interests of the U.S. to do
fiscal harm to newly democratic governments nor to deprive victims of prior
regimes of the attempt by such new democracies to make them whole. Thus, the
U.S. tax rules applicable to U.S. citizens and residents should yield to the
objectives of the foreign government to provide tax free reparation for past
infringement of their fundamental civil and personal rights.
International comity supports a policy restricting U.S. estate
taxation of restituted properties B given the applicable tax rate of 55% B which
would constitute an even greater interference with the foreign sovereign=s
actions than the imposition of income tax would have been. It would clearly
have the effect of compromising the foreign government=s restitution program
if the efforts to correct prior wrongful acts were to result in the United States
taking more than half of the entire compensation to the intended recipients.34
Neither would a foreign tax credit, where available, be meaningful unless the foreign transfer tax rate
approaches that of the U.S. (and few do). Private residences are often exempt from capital gains tax and from
death duties and in some states, e.g., the Czech Republic, only 5%.
18 Albert S. Golbert
3. The U.S. Claim of Jurisdiction to Tax Restituted
Properties is Relatively Weak
Amongst the bases of jurisdiction in international law, the
two which would here be called into play are the territorial basis and the
nationality basis. The United States, because of its unique policy of taxing its
citizens on their world-wide income whatever their residence, has only the
nationality principle upon which to justify its taxing jurisdiction here. The
foreign sovereign is often compensating persons who are dual nationals, i.e.,
nationals of the compensating country as well as of the United States.
Moreover, the property is within the jurisdiction of the foreign sovereign, the
recipient often returns to his or her homeland to reside in the restituted property
and it is, after all, the foreign sovereign who is paying the restitution and who
would undoubtedly view an attempt by the United States to extend its taxing
jurisdiction to such cases as untoward interference in a matter principally within
the domestic concern of the foreign restitution authority.
Thus, even though the United States may be technically
justified in asserting its taxing jurisdiction over its own citizens and resident
aliens, comity nevertheless would suggest the United States cede its own claim
of taxing jurisdiction to the superior claim of the foreign sovereign in the
interest of preserving the effectiveness of the efforts of such sovereign to
remedy past injustices. It is clear that in balancing the competing interests, that
of the foreign sovereign carries far more weight.
C. Equitable Considerations Affecting Imposition of Estate Tax
First, if the original beneficiary of the restitution program dies just
before receipt either of the property or compensation in lieu thereof and the
same goes directly to his/her heirs, the successors will likely receive the
property directly from the foreign government and face no likely prospect of
estate tax for many years. Were the original beneficiary to be alive at the time
of restitution, albeit in his or her dotage, but dies shortly thereafter, the United
States could seek payment of its 55% estate tax. Such difference in treatment is
arbitrary in the extreme given that the two cases cannot sensibly be
Second, given the differences amongst recipients and the manner in
which they might be expected to react to a harsh and inequitable rule, it is not
19 Albert S. Golbert
difficult to anticipate a good deal of non-compliance with the payment of estate
tax upon the passing of an aged recipient, especially when the property is
outside of the United States, the recipient has returned to his or her homeland to
enjoy the fruits of the same and may well consider that he/she is beyond the
reach of the IRS. It is not unlikely, then, that compliance will be low and
imposition of tax on only the compliant recipients would create serious
Third, notwithstanding recent changes to U.S. expatriation rules
which now include long term resident aliens as well as citizens,35 the imposition
of U.S. estate tax would treat more harshly those refugees who became citizens
than those who sought to plan around U.S. estate tax by avoiding U.S.
citizenship and the elusive concept of domicile, which continues to have the
subjective element of intent to remain indefinitely,36 rather than the objective
tests of Section 7701(b). If it becomes the case that full U.S. estate tax is
imposed upon those who became citizens while those who did not can claim an
open-ended intent to return abroad to support the argument that a U.S. domicile
never obtained, gross inequities will be inevitable.
D. Appropriate Scope of Estate Tax Exclusion
While imposition of estate or gift taxation roughly
contemporaneous with the restitution of property would vitiate the income tax
exemption provided in Revenue Ruling 56-518, the efficacy of the income tax
exemption would not be so clearly vitiated by the imposition of estate tax after a
certain number of years of receiving income from or enjoyment and beneficial
use of the restituted property. Hence, timing would seem to be the key to
establishing a U.S. tax base for the restituted property or equivalent.
Clearly, if the property or compensation were held long enough
that the income therefrom would be sufficient to pay the 55% estate tax, the tax
The 10 year expatriation tax regime of IRC '' 2107, 2501(a)(3) and 877 was amended in 1996 by
the Health Insurance Portability and Accountability Act, Pub. L. No. 104-191, ' 511.
See, The Venus, Rae, Master, 12 U.S. 253, 3 L.Ed. 553, 8 Cranch 253 (1814). AThe British doctrine
on this subject is well known. >Once a British subject, always a British subject,= is an established rule in the
English law. Great Britain respects the naturalization laws of the United States only for commercial purposes.
If one of her subjects be naturalized in this country, and afterwards return to a British territory, she considers
him as still, to all intents and purposes, a British subject. She does not even require him to abjure his adopted
allegiance.@ Id. at 256.
20 Albert S. Golbert
free receipt of the restituted property would have been preserved. A calibrated
test, based upon the number of years of enjoyment or income, might achieve
such a result, but it is likely to be complex and devilish both from the standpoint
of compliance and of enforcement. Further, it is questionable whether a
statutory basis exists if the IRS were to adopt such an approach administratively.
A bright-line test would have the advantage of ease of compliance and
enforcement, provided it were of sufficient duration to comport with the
inherent equities in the restitution act itself. Thus, a period of, say, ten years
from date of restitution ought to be sufficient to build up sufficient equity to pay
a 55% estate tax upon devise or transfer. Again, however, there is a question
whether legislation would be required to adopt such a 10-year bright-line test
A gift tax exclusion of the same magnitude could result in efforts
of avoidance which would be demeaning both to the act of restitution and to the
effort to preserve its efficacy by limiting taxation of the restituted property.
Hence, limiting the gift exemption to a period of, say, three years from the date
of death of the restitution recipient would be both equitable and would also
avoid any inference of tax avoidance based on the view that death is not
typically viewed as a tax avoidance device and that gifts should be treated
consistently with a roughly contemporaneous bequest (as section 2035
historically ensured). Thus, gifts in contemplation of death would be treated
consistently for this purpose.
IV. THE IRS AND TREASURY HAVE THE AUTHORITY TO LIMIT
THE SCOPE OF U.S. TAXING JURISDICTION AND SHOULD
EXERCISE IT HERE
The history of tax administration is replete with cases in which the IRS
and Treasury have exercised their inherent authority to calibrate the scope of
federal taxation. Thus, for example, the IRS has consistently held that
disbursements made under social benefit programs for the promotion of general
welfare are not includable in a recipient=s gross income, notwithstanding the
breadth of section 71's definition of income and the absence of any applicable
statutory exception.37 In this regard, IRS counsel once cited many such
precedents before concluding:
See, e.g., IT 3230, 1932-2 C.B. 136 federal and state unemployment compensation); IT 3447, 19441-
1 C.B. 191(certain social security benefits), superceded by Rev. Rul. 70-217, 1970-1 C.B. 12; Rev. Rul. 55-652,
1955-2 C.B. 2 (certain unemployment benefits); Rev Rul. 57-102, 1957-1 C.B. 26 (state payments to blind
21 Albert S. Golbert
It is proper, we believe to conclude that section 61 is subject to limitation
in its broad sweep, i.e., the Commissioner is entitle to find a policy of social
welfare legislation in relation to the tax law, as the reason for excluding benefits
thereunder from taxation.38
persons); Rev. Rul 63-136, 1963-2 C.B. 19 (payments under the Manpower Development and Training Act);
Rev. Rul. 68-38, 1968-1 C.B. 446 (payments under Economic Opportunity Act of 1964).
22 Albert S. Golbert