Transcript Getting Started Tax Compliance Seminar January 31, 2012

Getting Started Tax
Compliance Seminar
January 31, 2012
Grand Cayman Islands
Shawn P. Wolf, Esq.
Packman, Neuwahl & Rosenberg
E-mail: [email protected]
1500 San Remo Ave. Suite 125
Coral Gables, Florida 33146
Telephone: (305) 665-3311
Facsimile: (305) 665-1244
750 South Dixie Highway
Boca Raton, Florida 33432
Telephone: (561) 393-8700
Facsimile: (305) 665-1244
Copyright © 2012 by Packman, Neuwahl & Rosenberg
General U.S. Tax Rules
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U.S. Income Tax
Residence Rules
 U.S. citizens.
 U.S. Green Card (possible treaty exception, where
applicable).
 183 days or more in a calendar year (possible treaty
exception).
 30 days or less in a calendar year ―not a U.S. tax resident.
 Substantial Presence Test—3 year rule (add total days in
current year, 1/3 of days in prior year, and 1/6 of days in
second prior year)—if 183 days or more unless either a
“closer connection” to a foreign country (Form 8840) or
deemed to be a resident of a treaty country under a
“tiebreaker” rule (Form 8833), 121 days per year
maximum avoids this.
 Special rules for students, diplomats, certain other
individuals, and limited medical condition situations
arising in the U.S. that prevent the individual from leaving
the U.S.
 U.S. income tax treaties provide additional potential
flexibility.
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Worldwide Income
Taxation
 U.S. citizens, resident aliens (“RA”) and domestic
corporations (“U.S. Persons”) are taxed in the U.S.
on a world wide basis.
 This rule applies regardless of being taxed in a
foreign jurisdiction.
 Section 911 exclusion minimizes U.S. income tax for
certain eligible individuals.
 U.S. Foreign Tax Credit rules help minimize double
taxation. Direct and Indirect Foreign Tax Credits
may be available.
 Income Tax Treaties must be considered with respect
to which jurisdiction has the right to tax income and
and applicable withholding tax rates.
 NOTE: 15% U.S. dividend rate only applicable for
dividends from Qualified Foreign Corporations. See
Notice 2011-64, 2011-37 IRB 8/18/2001 (updating
the prior Notices on this issue).
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U.S. Estate Tax and
Gift Tax Rules
 Not the same as U.S. income tax rules.
 U.S. citizens.
 U.S. domiciliary (possible treaty exception where
applicable).
 Domicile determination is based upon the intent of the
person as manifested by the facts showing permanent
abode.
 Nonresident alien domicilaires only have a $60,000 estate
tax exclusion and no gift tax exclusion other than the
annual exclusion.
 Annual exclusion gifts ($13,000 for 2012) and to noncitizen spouses ($139,000 for 2012).
 It is possible to be an income tax resident and a
nondomiciliary for U.S. estate and gift tax purposes.
 Medical conditions that don’t avoid income tax residence
may avoid U.S. domiciliary status.
 Worldwide asset taxation for citizens and U.S. domiciled
persons.
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Section 911 Exclusion
 Qualified individuals may elect to exclude both their
foreign earned income and a housing cost amount
from gross income, subject to certain limitations.
 The sum of the amounts that a qualified individual
excludes as foreign earned income and as foreign
housing costs may not exceed the individual’s
foreign earned income for the taxable year.
 The maximum amount of foreign earned income that
an individual may exclude is currently limited to
$95,100 annually (subject to an annual inflation
adjustment, with this amount being for 201).
 Be aware of new limitations (floor and ceiling)
applicable to the housing exclusion and Notice 200687 relating to increased amounts for particular
countries / cities.
 Consider Forms 2555 and 2555EZ.
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Section 911 Exclusion
(Cont.)
 The term “qualified individual” means an
individual whose tax home is in a foreign
country and who is:
 a citizen of the United States and
establishes that he or she has been a
“bona fide resident” of a foreign country
or countries for an uninterrupted period
which includes an entire taxable year
(the bona fide residence test), or
 a citizen or resident of the United States
who, during any period of twelve
consecutive months, is present in a
foreign country or countries during at
least 330 full days in such period (the
physical presence test).
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Section 911 Exclusion
(Cont.)
 The term “tax home” is defined for
this purpose as an individual’s home
for purposes of §162(a)(2).
 The regulations provide further
guidance by stating “an individual’s
tax home is considered to be located
at his regular or principal (if more
than one regular) place of business or,
if the individual has no regular or
principal place of business because of
the nature of the business, then at his
regular place of abode in a real and
substantial sense.”
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Section 911 Exclusion
(Cont.)
 The following principles have
emerged, however, and are well
established
with
respect
to
§162(a)(2):
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a taxpayer’s home is the vicinity of his principal place
of employment and not the location of his principal
residence if such residence is located in a different
place from his principal place of employment;
a taxpayer who maintains a residence near his
principal place of employment is considered “away
from home” when he is required to travel to a different
location for temporary work;
a taxpayer is considered to have moved his tax home
to the new location if he accepts permanent or
indefinite employment in a new location;
employment is considered indefinite or permanent if it
appears the duration of such employment will extend
beyond a short period of time.
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Section 911 Exclusion
(Cont.)
 Bona Fide Resident Test
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Whether a citizen of the United States is a bona fide resident of a
foreign country or countries requires an analysis of all relevant facts
and circumstances.
In Sochurek v. Comr., 300 F.2d 34 (7th Cir. 1962) the Court of
Appeals set forth a number of factors to be weighed in determining
whether a taxpayer is a bona fide resident of a foreign country,
including:
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the taxpayer’s intention;
establishment of a home temporarily in the foreign country for an indefinite
period;
participation in the activities of the community on social and cultural levels,
identification with the daily lives of the people, and, in general, assimilation
into the foreign environment;
physical presence in the foreign country consistent with the taxpayer's
employment;
the nature, extent, and reasons for temporary absences from the foreign
home;
assumption of economic burdens and payment of taxes to the foreign
country;
status of a resident of the foreign country as contrasted to that of a transient
or sojourner;
the treatment of the taxpayer's income tax status by his employer;
marital status and residence of the taxpayer's family;
nature and duration of employment (i.e., whether assignment abroad can be
promptly accomplished within a definite or specified time); and
good faith in making the trip abroad (i.e., whether or not for purposes of tax
evasion).
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Section 911 Exclusion
(Cont.)
 Physical Presence Test
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The physical presence test requires that a taxpayer
must be physically present in a foreign country or
countries during at least 330 full days during any
consecutive twelve month period.
The twelve month period may begin with any day; it
ends on the day before the corresponding day in the
twelfth succeeding month. The twelve month period
may begin before or after the taxpayer arrives in a
foreign country and may end before or after the
taxpayer departs the foreign country. Therefore, the
qualifying period may include days of presence in the
United States.
The 330 full days need not be consecutive; they may
be interrupted by periods of presence in the United
States. In computing the 330 full days of presence in a
foreign country or countries, all separate periods of
presence during the period of twelve consecutive
months are aggregated in determining the number of
days present in a foreign country or countries.
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Foreign Tax Credit: In
General
 U.S. citizens, income tax residents
and domestic corporations are taxed
on their worldwide income. In order
to prevent the double taxation that
could result on income derived from
foreign sources, the United States
allows a credit for foreign taxes paid
or accrued.
 Consider Form 1116.
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U.S. Trade or Business
 Non-U.S. taxpayers engaged in a U.S. trade
or business must also pay tax in the United
States!
 Watch out for using an FC to engage in a
U.S. trade or business.
 Potential for three levels of U.S. income
tax!
 Corporate tax.
 Branch Profits Tax.
 Tax
on Dividend to U.S. Person
shareholders (possibly at capital gains
rates if a Qualified Foreign Corporation).
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Anti-Deferral Regimes
in General
 Over the years, Congress has successfully closed
various “loopholes.” For instance, where a U.S.
Person (i.e., U.S. citizen or RA) shareholder would
attempt to utilize an FC to defer, avoid, or evade U.S.
taxes.
 A classic example of this would be an FC owned
100% by a single U.S. Person shareholder who
contributes $1,000,000 to the FC that in turn invests
the $1,000,000 in a passive interest-bearing account.
Assuming a 5% yield, this passive investment would
give rise to $50,000 of interest income per year.
 Because: (a) the FC could be located in a no or low
tax jurisdiction; and (b) specific investments made by
the FC can possibly avoid U.S. income taxation at
the FC’s level, Congress decided that the earnings of
certain FC’s owned by U.S. Persons should be taxed
currently, regardless of whether or not such earnings
are distributed.
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Controlled Foreign
Corporations
 The primary objectives of
Congress when enacting the
CFC provisions were to
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prevent unintended tax deferral
through the use of an FC; and
attack avoidance transactions such
as shifting income by or among
related parties to a low or no tax
jurisdiction
through
an
intermediary FC.
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Foreign Personal
Holding Company
 Prior to repeal by the Jobs Act, an FC constituted an
FPHC if it met an income test and an ownership test.
 The income test required that, in its first year as an
FPHC, 60% or more of its gross income had to
constitute FPHCI. Once an FC became an FPHC,
the minimum FPHCI percentage to remain an FPHC
in subsequent years was reduced to 50% or more.
 The stock ownership test was met when, at any time
during the taxable year, 5 or fewer U.S. Persons
owned, directly or indirectly (i.e., through
corporations, partnerships, trusts, spouses, siblings,
ancestors, or lineal descendants) more than 50% of
either the combined voting power of all classes of
stock of the FC entitled to vote, or the total value of
the stock of the FC.
 The Jobs Act repeal is effective for taxable years of
foreign corporations beginning after December 31,
2004, and taxable years of U.S. shareholders with or
within which such taxable years of foreign
corporations end.
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Passive Foreign
Investment Company
 Because certain of the provisions
discussed above did not always apply
to FCs with a broader ownership base
(e.g., a public FC), Congress enacted
the PFIC provisions.
 The PFIC rules ensure that U.S.
Persons with smaller ownership
interests are taxed, as these rules do
not rely on a specific ownership
percentage test for the provision to
apply to a U.S. Person shareholder.
 See §§1291-1298.
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Watch Out!
 U.S. Persons that inherit the
stock of a CFC / PFIC could be
in for a “big surprise.”
 PFIC stock does not receive a
date of
death basis step-up
under §1014 or §1022.
 Furthermore, the assets held by
the FC do not receive a step-up
in basis and liquidation of the FC
can result in adverse U.S.
income tax consequences!
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U.S. Compliance
Considerations
Summary of Filing
Considerations
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Form 926 applies to certain transfers to FCs.
Form 5471 applies to U.S. Persons that own interests in certain
FCs, and has 4 Categories of people to which it can apply.
Form 8621 is for PFICs and QEFs.
Form 5472 is used to report certain information about: (i) a
domestic corporation that is 25% foreign owned (as defined
below); and (ii) a foreign corporation that is 25% foreign owned
(as defined below) and is doing business in the United States.
Form 8865 applies to U.S. Persons that own interests in certain
foreign partnership, and has 4 Categories of people to which it can
apply.
TD F 90-22.1 is required to be filed by each U.S. Person who has
a “financial interest in or signature authority or other authority
over a bank, securities, or other financial account in a foreign
country, which exceeded $10,000 in aggregate value at any time
during the calendar year.” See the IRS FAQ for good overview of
the issues relating to this form. Also be prepared for a revised TD
F 90-22.1 to be released.
Consider the specific questions on Form 1040, Schedule B, Part
III.
Form 8858 is required to be filed with respect to certain
disregarded entities.
NEW FORM 8938 must be considered for offshore assets.
IMPORTANT: Civil and Criminal penalties may be imposed for
the failure to file the above mentioned forms!
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Penalties for Non-Compliance
and (Hopefully) How to They
Can be Avoided (Cont.).
 Reasonable Cause.
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In general, the penalties stated above for noncompliance may
be abated if the taxpayer in question can demonstrate that the
failure to comply was due to reasonable cause and not willful
neglect. The fact that a foreign country would impose
penalties for disclosing the required information is not
reasonable cause. Similarly, reluctance on the part of a
foreign fiduciary or provisions in the trust instrument that
prevent the disclosure of required information is not
considered to be reasonable cause.
The key object in replying to the imposition of penalties is a
swift and detailed response to the IRS. In each case, develop
a strategy for seeking the abatement of penalties by providing
an explanation for the delay or failure to report. In many
cases, legal complexities deciphered through the taxpayer’s
recent engagement of qualified professionals and foreignrelated administrative and delayed response issues may (but
not necessarily will) provide a plausible and acceptable
opportunity for the IRS to reconsider its position in this type
of situation.
See FS-2011-13, December 2011.
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Penalties for Non-Compliance
and (Hopefully) How to They
Can be Avoided (Cont.).
 Offshore Voluntary Disclosure Program.
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Third IRS OVDP announced on January 9, 2012.
See IR-2012-5, Jan. 9, 2012.
Available only if not already under a civil or
criminal examination for any reason
NO “reasonable cause” arguments were
permitted, but “can opt out.”
Applicable to any unreported domestic or foreign
income, deductions or credits involving foreign
accounts, assets or holding entities, but generally
NOT if all income was reported, and only nonincome producing assets, holding entities or
offshore accounts weren’t reported.
Why do it? To stay out of jail!
Applies to individuals and entities.
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Penalties for Non-Compliance
and (Hopefully) How to They
Can be Avoided (Cont.).

Most important aspects of this OVDP:
 No deadline set at this time.
 Look to the 2011 OVDP FAQ for
guidance,
with
the
following
important changes (and subject to
change):
 The penalty for unreported accounts /
assets is now 27.5% (as opposed to 25%).
 Copies of original and “complete and
accurate” amended federal income tax
returns for 8 years, and accuracy and other
penalties will apply and interest will be
due.
 Watch IRS.gov for udates to the FAQ.
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Penalties for Non-Compliance
and (Hopefully) How to They
Can be Avoided (Cont.).
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Important issues in an OVDP:
 If the taxpayer was an estate, or an
individual who participated in the
failure to report the foreign account or
foreign entity in a required gift or
estate tax return, either as executor or
advisor, a complete and accurate
estate or gift tax return was required
to correct the underreporting of assets
held in or transferred through
undisclosed foreign accounts or
foreign entities.
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Penalties for Non-Compliance
and (Hopefully) How to They
Can be Avoided (Cont.).
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Reduced penalties on accounts / assets
may apply where:
 No unreported income.
 Certain “smaller” unreported accounts;
 Certain persons comply with local tax
filing requirements (this includes the
Cayman Islands!).
Compare potential civil/criminal
penalty results under the OVDP to
“Reasonable Cause”.
 You can opt out of the OVDP and go
through the standard examination
process if you don’t like the OVDP
penalty results.
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Penalties for Non-Compliance
and (Hopefully) How to They
Can be Avoided (Cont.).
You can request a payment plan (but
it may be difficult to obtain).
 Penalties under the OVDP should not
exceed the otherwise maximum
applicable civil penalties.
 The most difficult part of the process
is
obtaining
offshore
account
information, but many foreign
financial institutions are now (slowly
and expensively) producing U.S. style
statements with the necessary detailed
tax and income-related information
 Liberal PFIC calculations policy is
now in place through a “mark to
market” election.
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Attorney-Client Privilege.
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Accountants and CPAs have “duty of
confidentiality” but do not have “privilege”.
Attorneys have “privilege”, which makes it very
difficult for anyone to find out what is discussed
between a client and that lawyer. This is difficult
even for the IRS.
Speaking to a CPA or non-lawyer third party
about your situation may result in a loss of
privilege.
To best protect the attorney-client privilege, you
should consider hiring a lawyer, who can then:
(1) review your facts; (2) consider if “reasonable
cause” exists; (3) consider the terms of the
OVDP in light of your facts; (4) discuss with you
alternatives relating to your filing; and (5) in
turn, hire a CPA to analyze your facts
numerically (and prepare a report in the form of
draft tax returns).
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