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Tax Court Denies Government Summary Judgement in Foreign Income Case

Kunal Patel

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Tax Court Denies Government a Quick Win in Foreign Income Case

In Zuhovitzky v. CIR, T.C. Memo 2015-158, the government filed a motion for partial summary judgment on the issue wither the petitioner is subject to U.S. tax on worldwide income in the absence of a section 6013(g) election.

What is a 6013 election?

A 6013(g) election allows a nonresident who is married to a U.S. citizen or resident at the end of the year to be treated as a resident for income tax purposes. A couple who makes the election must file a joint return in the election year but a joint or separate return may be filed for subsequent years.

A 6013(h) election allows a dual status resident (i.e., who is a resident at the end of the year but not the beginning) that is married to an individual who is either a U.S. citizen or resident at the end of the year to be treated as a full year resident for income tax purposes.

Such an election must be made by attaching a signed statement to the joint return for the first year in which it applies.

Facts

During the years at issue, petitioner Jonathan Zuhovitzky was a citizen of both Israel and the United States; petitioner Esther Zuhovitzky was a citizen of both Israel and Austria. Esther has never resided in the United States. [The Zuhovizkys] filed joint tax returns for 1992 through 2008 but never filed an election under section 6013(g) to treat Esther as a resident of the United States during these years.

[The IRS] issued a notice of deficiency for the years at issue, in which [the IRS] determined the following:

Fraud penalty
Year Deficiency sec. 6663
2000 $276,596.00 $207,447.00
2001 265,143.00 198,857.25
2002 244,427.00 183,320.25
2003 337,244.00 252,933.00
2004 299,062.00 224,296.50
2005 174,870.00 131,152.50
2006 308,746.00 231,559.50
2007 124,137.00 93,102.75
2008 137,467.00 103,100.25

These deficiencies and penalties stem from determined unreported interest and dividend income from a UBS account in Esther’s name.

Issue

A nonresident alien has no requirement to report foreign income and assets, unless they’ve made an election to be treated as a resident, such as in this case, under IRC 6013(g).

Treas. Reg. § 1.6013-6(a)(4) provides that a 6013(g) election must be made on a signed statement attached with the tax return for the first year in which the election is made.

The issue in this case is whether a non-resident taxpayer that has filed jointly (and therefore as a U.S. tax resident) but has not made a 6013(g) election can be subject to U.S. tax on worldwide income.

Law

As discussed above, the 6013(g) election allows a non-resident spouse married to a U.S. citizen or resident to elect to be treated as a resident for tax purposes and file jointly.

The IRS argues that while the taxpayer did not make a 6013(g) election, the fact that they filed jointly should be construed as having made a valid election. The government seeks to apply two common law doctrines: substantial compliance and the duty of consistency.

Substantial compliance

The substantial compliance doctrine is a narrow equitable doctrine that we may apply to avoid hardship where one party establishes that the other party intended to comply with a provision, did everything reasonably possible to comply with the provision, but did not comply with the provision because of a failure to meet the provision’s specific requirements.

Under the substantial compliance doctrine, [taxpayers] must have both intended to make the section 6013(g) election and substantially complied with the requirements for the election. [The IRS] contends that by filing joint returns, [taxpayers] expressed their intent to make a section 6013(g) election. [Taxpayers], on the other hand, argue that they had no intent to make a section 6013(g) election. [Taxpayers’] intent is a matter of material fact in dispute, and thus, the issue of substantial compliance is inappropriate for summary judgment and requires trial.

Duty of consistency

We may also apply the equitable doctrine of “quasi-estoppel” or “the duty of consistency.” The “duty of consistency” is based on the theory that the taxpayer owes the Commissioner the duty to be consistent with his tax treatment of items and will not be permitted to benefit from his own prior error or omission.  The duty of consistency doctrine prevents a taxpayer from taking one position one year and a contrary position in a later year after the limitations period has run on the first year.

[The IRS] contends that the Court should treat [taxpayers] as if they had made a section 6013(g) election under the duty of consistency. [The IRS] argues that [taxpayers] represented that they were eligible to file joint returns by filing joint returns from 1992 through 2008. [The IRS]  further argues that because Esther was a nonresident alien, [taxpayers] were entitled to file joint returns only if: (1) they made a section 6013(g) election or (2) Esther satisfied the substantial presence test under section 7701(b)(3)…[The IRS] contends that he relied upon this representation by accepting [taxpayers’] joint returns and that [taxpayers] are now trying to change their representation about their joint-filing eligibility after the expiration of the period of limitations for 1992 through 1999.

Conclusion

The court finds that the application of the substantial compliance and duty of consistency doctrines require factual determinations which cannot be made in summary judgment, and that the case must proceed to trial.

Final word about IRC 6013 elections

It’s important that individuals immigrating to the U.S. with significant foreign income and assets have proper tax planning. Nonresident spouses should be cautious in making a 6013 election or filing jointly, which may unintentionally subject them to U.S. tax on foreign income and FBAR/FATCA reporting requirements.

A 6013(h) election is often advisable, especially since the taxpayer is a resident anyway for at least part of the year. It allows taxpayers to use lower married filing jointly tax rates, itemize deductions, and claim personal exemptions.

A 6013(g) election, on the other hand, will treat a nonresident alien spouse as a resident when they would have otherwise not been subject to U.S. tax. It should almost never be made, except where the nonresident spouse has insignificant foreign income and assets. Generally, where one spouse is a nonresident, the resident spouse should file separately. The nonresident spouse then has no U.S. tax return filing obligation, unless they have U.S. source income.

FATCA Conviction for Bank Executive

Kunal Patel

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First Ever FATCA Conviction with Bank Executive Enabler’s Plea

The DOJ has recently secured it’s first conviction under the relatively new FATCA law.

Earlier today in federal court in Brooklyn, Adrian Baron, the former Chief Business Officer and former Chief Executive Officer of Loyal Bank Ltd, an off-shore bank with offices in Budapest, Hungary and Saint Vincent and the Grenadines, pleaded guilty to conspiring to defraud the United States by failing to comply with the Foreign Account Tax Compliance Act (FATCA).  Baron was extradited to the United States from Hungary in July 2018.  The guilty plea was entered before United States District Judge Kiyo A. Matsumoto.

According to court documents, in June 2017, an undercover agent met with Baron and explained that he was a U.S. citizen involved in stock manipulation schemes and was interested in opening multiple corporate bank accounts at Loyal Bank.  The undercover agent informed Baron that he did not want to appear on any of the account opening documents for his bank accounts at Loyal Bank, even though he would be the true owner of the accounts.  Baron responded that Loyal Bank could open such accounts and provide debit cards linked to them.

In July 2017, the undercover agent again met with Baron and described how his stock manipulation scheme operated, including the need to circumvent the IRS’s reporting requirements under FATCA.  During the meeting, Baron stated that Loyal Bank would not submit a FATCA declaration to regulators unless the paperwork indicated “obvious” U.S. involvement.  Subsequently, in July and August 2017, Loyal Bank opened multiple bank accounts for the undercover agent.  At no time did Baron or Loyal Bank request or collect FATCA Information from the undercover agent.

Baron’s guilty plea represents the first-ever conviction for failing to comply with FATCA.  When sentenced, Baron faces a maximum of five years in prison.

Baron is the second defendant to plead guilty in this case.  On July 26, 2018, Arvinsingh Canaye, formerly the General Manager of Beaufort Management Services Ltd. in Mauritius, pleaded guilty to conspiracy to commit money laundering.

Foreign Account Tax Compliance Act (FATCA)

The Foreign Account Tax Compliance Act (FATCA) is a law passed in 2010 requiring all non-U.S. financial institutions (FFIs) to report the identities of U.S. persons to the U.S. Department of Treasury. In addition, it includes an information reporting requirement for individuals on Form 8938. The purpose of these dual reporting requirements is for the IRS to identify individuals that have not disclosed their foreign financial assets on Form 8938 based on information received from FFIs.

Foreign financial institutions

FATCA requires financial institutions to report certain information about certain financial accounts held by United States taxpayers, or by foreign entities in which United States taxpayers hold a substantial ownership interest.

Intergovernmental Agreements (IGAs)

Foreign banks that are located in jurisdictions with which the U.S. has intergovernmental agreements (IGAs) are required to provide information as required under I.R.C. § 1471(c). A list of IGAs can be found on the Treasury website. Foreign financial institutions (FFIs) that are not located in jurisdictions with IGAs must comply with FATCA or be subject to harsh withholding rules under I.R.C. § 1471. And since most foreign financial institutions do business with the U.S. or with other financial institutions that conduct business with the U.S., a large number of FFIs not located in jurisdictions with IGAs choose to comply with FATCA. A list of FFIs can be found on the IRS website.

Information Provided by Foreign Financial Accounts under FATCA

I.R.C. § 1471(c) requires a foreign financial institution to report the following with respect to each United States account maintained by such institution:

(A) The name, address, and TIN of each account holder which is a specified United States person and, in the case of any account holder which is a United States owned foreign entity, the name, address, and TIN of each substantial United States owner of such entity.
(B) The account number.
(C) The account balance or value (determined at such time and in such manner as the Secretary may provide).
(D) Except to the extent provided by the Secretary, the gross receipts and gross withdrawals or payments from the account (determined for such period and in such manner as the Secretary may provide)

Individuals

The FATCA reporting requirement for individuals is codified in IRC 6038D. Individuals with specified foreign financial assets exceeding the thresholds identified in Treas. Reg. 1.6038D-2 must provide this form annual with their U.S. income tax return.

Filing statusLiving in:Meets reporting threshold if value of specified foreign financial assets is greater than …
Unmarried/ Married Filing SeparatelyUnited States$50,000 on last day of tax year; or $75,000 at any time during tax year
Married Filing JointlyUnited States$100,000 on last day of tax year; or $150,000 at any time during tax year
Unmarried / Married Filing SeparatelyForeign Country$200,000 on last day of tax year; or $300,000 at any time during tax year
Married Filing JointlyForeign Country$400,000 on last day of tax year; or $600,000 at any time during tax year

Exchange of Information Pursuant to Income Tax Treaties and Tax Information Exchange Agreements

In addition to automatic exchange of information under FATCA, specific and spontaneous exchanges of information may occur pursuant to tax treaties and tax information exchange agreements (TIEAs). In matters involving criminal tax evasion, the DOJ may request cooperation through mutual legal assistance treaties (MLATs).

Specific requests may arise from collection matters, criminal investigations, or other tax administrative or court procedures. Information must be first sought domestically, such as by issuance of an Information Document Request or a summons on a 3rd party possessing relevant records.

Spontaneous exchange of information, which operates through the exchange of information provisions of tax treaties and TIEAs, involves the transmission of information that has not been specifically requested by a Competent Authority, but which in the judgment of the providing authority may be of interest to a foreign partner for tax purposes. The exchange typically involves information discovered during a tax examination, investigation, or other administrative procedure that suggests or establishes noncompliance with the tax laws of a foreign partner, or that is otherwise determined to be potentially useful to a foreign partner for tax purposes. The information may pertain to nonresident aliens, United States citizens, domestic or foreign corporations, or other taxpayers.

Simultaneous examinations involve the United States and one or more of its foreign partners conducting separate independent examinations of selected taxpayer(s) within their respective jurisdictions in which the partners have a common or related interest

Tax treaty EOI – Article 26 of the U.S. Model Income Tax Convention

This following is an excerpt from the Exchange of Information Article (Article 26) of the U.S. Model Income Tax Convention (2006).

EXCHANGE OF INFORMATION AND ADMINISTRATIVE ASSISTANCE

  1. The competent authorities of the Contracting States shall exchange such information as may be relevant for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes of every kind imposed by a Contracting State to the extent that the taxation thereunder is not contrary to the Convention, including information relating to the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, such taxes. The exchange of information is not restricted by paragraph 1 of Article 1 (General Scope) or Article 2 (Taxes Covered).
  2. Any information received under this Article by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to persons or authorities (including courts and administrative bodies) involved in the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes referred to above, or the oversight of such functions. Such persons or authorities shall use the information only for such purposes. They may disclose the information in public court proceedings or in judicial decisions.

Deferred Prosecution Agreements

In addition to the above sources of information, certain FFIs, namely Swiss, are required to provide information pursuant to deferred prosecution agreements with the USDOJ. For example. The Swiss Bank Program, which was announced on August 29, 2013, provides a path for Swiss banks to resolve potential criminal liabilities in the United States.  Swiss banks eligible to enter the program were required to advise the department by Dec. 31, 2013, that they had reason to believe that they had committed tax-related criminal offenses in connection with undeclared U.S.-related accounts. Banks already under criminal investigation related to their Swiss-banking activities and all individuals were expressly excluded from the program.

Under the program, banks were required to:

  • Make a complete disclosure of their cross-border activities;
  • Provide detailed information on an account-by-account basis for accounts in which U.S. taxpayers have a direct or indirect interest;
  • Cooperate in treaty requests for account information;
  • Provide detailed information as to other banks that transferred funds into secret accounts or that accepted funds when secret accounts were closed;
  • Agree to close accounts of accountholders who fail to come into compliance with U.S. reporting obligations; and
  • Pay appropriate penalties.

Once the IRS is in possession of the information relating to undisclosed accounts, whether by an automatic exchange, specific request, or through a deferred prosecution agreement, any non-compliance by a U.S. account holder will subject that person to civil and criminal penalties, and in rare situations a risk of prosecution.

What should non-compliant taxpayers do?

Despite all the fear-mongering online, the vast majority of individuals with undisclosed offshore accounts will not be subject to criminal prosecution. A small percentage of  individuals with offshore accounts have ever been contacted by the IRS regarding undisclosed accounts.  A recent TIGTA audit found that the IRS is not prepared to enforce FATCA and has recommended some changes.

With FBAR examinations the IRS must show that the FBAR is a Title 31 requirement and the IRS must show that the FBAR non-compliance was in furtherance of an apparent Title 26 violation before commencing an FBAR examination. When the IRS begins acting on information received through FATCA, Form 8938 non-compliance would be a Title 26 violation, allowing the IRS to investigate without requiring a related statute determination.

While it is clear that the IRS is sitting on a treasure trove of information received through FATCA, it’s not known when it will act on it or how heavy-handed it would be in assessing penalties when conducting taxpayer examinations for FATCA noncompliance. IRC 6038D authorizes substantial penalties for non-compliance, in addition to even more substantial 31 USC 5321 FBAR penalties. All non-compliant taxpayers should minimize their risks by filing original or amended tax returns under one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.

IRS Reminds Taxpayers of OVDP Ending

Kunal Patel

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IRS Reminds Taxpayers of OVDP Ending and Hints at Updated Procedures

Earlier this year the IRS announced that the OVDP would end on September 28th and the IRS issued a reminder to taxpayers last week of the program ending.

More importantly the IRS states that it will maintain a pathway for such taxpayers to come into compliance after the OVDP ends. The IRS will be announcing updated procedures soon. The full text of the IRS news release appears below.

IR-2018-176, Sept. 4, 2018

WASHINGTON – The Internal Revenue Service today reminded taxpayers they have until Sept. 28 to apply for the Offshore Voluntary Disclosure Program (OVDP).

Since the OVDP’s initial launch in 2009, more than 56,000 taxpayers have used the various terms of the program to comply voluntarily with U.S. tax laws. These taxpayers with undisclosed offshore accounts have paid a total of $11.1 billion in back taxes, interest and penalties. The planned end of the current OVDP also reflects advances in third-party reporting and increased awareness of U.S. taxpayers of their offshore tax and reporting obligations.

In March, the IRS announced the program would end on Sept. 28, 2018. The IRS will continue to hold taxpayers with undisclosed offshore accounts accountable after the program closes.

The number of taxpayer disclosures under the OVDP peaked in 2011, when about 18,000 people came forward. The number steadily declined through the years, falling to only 600 disclosures in 2017.

Since the announcement, the IRS has not received any public comments addressing a continued need for the OVDP. The IRS will maintain a pathway for taxpayers who may have committed criminal acts to voluntarily disclose their past actions and come into compliance with the tax system. Updated procedures will be announced soon.

Separately, the IRS continues to combat offshore tax avoidance and evasion using whistleblower leads, civil examination and criminal prosecution. Since 2009, 1,545 taxpayers have been indicted related to international activities through the work of IRS Criminal Investigation.

A separate program, the Streamlined Filing Compliance Procedures, for taxpayers who may have been unaware of their filing obligations, has helped about 65,000 additional taxpayers come into compliance. These streamlined procedures will continue to be available for now, but as with OVDP, the IRS has said it may end this program too at some point.

The implementation of the Foreign Account Tax Compliance Act (FATCA) and the ongoing efforts of the IRS and the Department of Justice to ensure compliance by those with U.S. tax obligations have raised awareness of U.S. tax and information reporting obligations related to undisclosed foreign financial assets.  Taxpayers who made non-willful mistakes or omissions on their tax returns should file amended returns or delinquent returns as soon as possible.

Full details of the options available for U.S. taxpayers with undisclosed foreign financial assets can be found on IRS.gov.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.

Late Filed Foreign Earned Income Exclusion

Kunal Patel

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Foreign Earned Income Exclusion – Late Elections

Can the foreign earned income exclusion be elected on a late-filed return? Redfield v. Comm’r, T.C. Memo 2017-71 (T.C. April 26, 2017) answers this question.

Facts

Below are the facts in the case:

  • Taxpayer worked in a civilian position at Kandahar Air Field in Kandahar Province, Afghanistan in 2010
  • Taxpayer received an extension of time until October 15, 2011, to file his 2010 Federal income tax return
  • Since taxpayer did not file his 2010 tax return, in 2014 the IRS prepared a substitute for return (SFR)
  • Subsequently, the taxpayer submitted to the IRS a delinquent return for 2010 on which he included with this return Form 2555, Foreign Earned Income Exclusion to exclude his foreign income
  • The IRS disallowed petitioner’s claim for a foreign earned income exclusion (FEIE) because he had not elected to exclude foreign earned income on a prior Federal income tax return and had failed to make a valid election for 2010.

Foreign earned income exclusion – timely filing requirement

In addition to satisfying the tests for foreign earned income exclusion the taxpayer must also make a timely “election” to exclude foreign earned income.

Treasury Reg. 1.911-7(a)(2), establishes the timing requirements under which a valid election can be made.

In general, an election to claim foreign earned income exclusion must be made on an income tax return that is timely filed (including any extensions of time to file). The IRS allows a grace period – the exclusion may be claimed on an income tax return that is filed within one year after the due date of the return.

For taxpayers that are claiming the exclusion on a tax return that is more than 1 year late, the foreign earned exclusion may be elected if:

  1. The taxpayer owes no federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached either before or after the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion; or
  2. The taxpayer owes federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached before the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion.

A taxpayer filing an income tax return pursuant to either of these sections must type or legibly print the following statement at the top of the first page of the Form 1040: “Filed Pursuant to Section 1.911-7(a)(2)(i)(D).”

Analysis

In Redfield, taxpayer conceded that the foreign earned income was not timely elected. The issue was whether the taxpayer qualified under one of the alternative timing methods. Since taxpayer did owe taxes after the foreign earned income exclusion, the question was whether taxpayer filed the Form 1040 with Form 2555 before the IRS discovered that the taxpayer filed to elect the exclusion.

The court reasons that because the IRS filed a substitute return, it effectively discovered the taxpayer’s failure to make a timely election. Therefore no relief is available under the alternative timing methods, and taxpayer is not allowed to now claim the foreign earned income exclusion.

By preparing for petitioner on May 27, 2014, an SFR that treated all of his wages for 2010 as gross income, the IRS evidenced its “discovery” that he had failed to elect the FEIE for that year by filing a Form 1040 accompanied by a properly completed Form 2555. Petitioner did not file his delinquent 2010 return accompanied by a Form 2555 until October 7, 2014, more than four months later.

As to whether a taxpayer who does qualify for the exclusion under one of the alternative timing methods but fails to type or legibly print “Filed Pursuant to Section 1.911-7(a)(2)(i)(D)’”, the court does not decide whether that would invalidate an FEIE election. Likely it should not invalidate an election based on a technicality alone. Moreover, a taxpayer could simply file an amended return to include the language, for example, if the FEIE return is filed late but owes no taxes after the election, regardless of whether it’s filed before or after the IRS discovers the failure to make the election.

Estate Tax Planning for Non-Residents Owning U.S. Real Estate

Kunal Patel

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Estate Tax Planning for Non-Residents Owning U.S. Real Estate

IRC § 2101 imposes a tax on the transfer of the taxable estate of a person who was not a U.S. nonresident alien (NRA) at the time of death.

The 2017 Tax Cuts and Jobs Act increased the basic exclusion amount for estates of U.S. residents and citizens, doubling it from $5.5 million to $11.2 million. However, the IRC sections relating to the taxation of estates of non-U.S. residents remained the same – the excluded amount remains at a paltry $60,000.

A common situation is where a foreign investor has purchased U.S. real property and owns the property directly. Upon death, the value of that real property would be included in the estate and subject to tax on its gross estate exceeding $60,000.

While there are planning opportunities for NRAs to purchase U.S. real estate to avoid estate tax (such as owning U.S. real estate through a foreign corporation), opportunities are limited when an NRA already owns real property that is held directly.

Estate tax for non-residents – generally

The U.S. estate tax filing requirements of a decedent’s estate are determined by whether, at death, the decedent was a U.S. citizen or resident for estate tax purposes. And if the decedent was not a U.S. citizen nor a U.S. resident, whether the decedent had U.S. situs property.

A non-citizen non-resident decedent will be subject to U.S. estate tax on U.S. situs assets.  The executor of an estate of a non-citizen, non-resident decedent is required to file a Form 706-NA to report property located within the United States worth more than $60,000.

If the decedent owned property with a surviving spouse who is not a citizen of the United States, the value of that property must be reported in full on Form 706. Under IRC 2056(d)(1), the unlimited marital deduction is generally not available for property passing to a surviving spouse who is not a United States citizen. Under IRC 2056A, bequeathing property to a noncitizen surviving spouse through a qualified domestic trust (QDOT) allows an estate to receive a marital deduction. For the marital deduction to apply, property must be transferred to the QDOT prior to the death of the decedent. However, a QDOT merely defers the tax and upon the death of the surviving spouse, the U.S. situs assets will be subject to estate tax.

The rates applicable to estates of NRAs are the same as those that apply to U.S. citizens, at a maximum tax rate 40%.

U.S. situs property

The following are a non-exclusive list of assets treated as U.S. situs property:

  1. Real estate located in the U.S.
  2. Tangible personal property is deemed to be U.S. situs property if physically present in the United States on the date of death. There is an exception for works of art which are imported solely for public exhibition, on loan to a non-profit gallery or museum or on exhibition or en route to or from an exhibition.
  3. Stock of U.S. corporations (those located in the United States or organized under U.S. law) is considered property in the United States.
  4. Generally, debt obligations are property located in the United States if they are debts of a U.S. citizen or resident, a domestic partnership or corporation, a domestic estate or trust, the United States, a state or a political subdivision of a state or the District of Columbia.
  5. Deposits with a U.S. branch of a foreign corporation that is engaged in the commercial banking business are treated as property located in the United States.

When an NRA investor has already acquired U.S. property

Once a NRA directly owns a U.S. real property interest, there aren’t many great options to avoid estate tax, but there are options.

The following options lead to unintended tax consequences:

  1. Making a lifetime gift. There is no lifetime gift tax exemption for NRAs. An annual exclusion of $14,000 is available, which is never sufficient, subjecting the transfer to gift tax.
  2. Exchanging the interest in the real property for stock in a foreign corporation. Transfers of USRPIs for foreign corporation stock generally do not qualify for nonrecognition treatment, subjecting the transfer to U.S. income tax.

The following approaches are worth looking into:

  1. The NRA becomes a U.S. resident for estate tax purposes to take advantage of the $11.2 million exclusion ($22.4 million if married filing jointly). However, doing so will also expose the individual’s worldwide assets to U.S. estate tax and to tax on worldwide income.
  2. The NRA transfers the U.S. real property interest for a U.S. partnership interest. The exchange of an interest in a U.S. real property for an interest in a partnership will receive non-recognition treatment for the transfer. Partnership situs rules come with uncertainty as the IRS has not provided much guidance on whether partnership interests are considered U.S. situs. It is unclear whether the IRS would apply a look-through test, or possibly a combination of factors including where the partnership was organized, the domicile of the decedent, or the partnership’s place of management. Depending on the circumstances, it can be a reasonable argument by the decedent’s executors that the partnership interest is not U.S. situs property. The risk is that the IRS may disagree with the position in the event of an audit.
  3. A foreign corporation owned by the NRA encumbers the asset with nonrecourse debt, which would limit estate tax exposure to the net value above the amount of debt.
  4. Purchasing life insurance to cover the estimated estate tax liability.

Despite Spending $380 Million, IRS is not Prepared to Enforce FATCA

Kunal Patel

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TIGTA Reports that IRS is not Prepared for FATCA Enforcement

In a recent report by the Treasury Inspector General for Tax Administration (TIGTA), the IRS has taken limited or no action on a majority of the planned activities outlined in the FATCA Compliance Roadmap.

What is FATCA?

The Foreign Account Tax Compliance Act (FATCA) is a law passed in 2010 requiring all non-U.S. financial institutions (FFIs) to report the identities of U.S. persons to the U.S. Department of Treasury.

The U.S. Congress intended the Foreign Account Tax Compliance Act (FATCA) to improve U.S. taxpayer compliance with reporting foreign financial assets and offshore accounts.

It was estimated that revenue from the FATCA’s offset provision would be $8.7 billion from Fiscal Years 2010 to 2020.

Under the FATCA, individual taxpayers with specified foreign financial assets that meet a certain dollar threshold should report this information to the IRS, beginning with Tax Year 2011, by filing Form 8938, Statement of Specified Foreign Financial Assets, with their income tax return. This requirement is established under IRC § 6038D. Individuals are required to file Form 8938 with their income tax returns if the aggregate value of their foreign financial assets exceed certain dollar thresholds.5

To avoid being subject to a 30 percent withholding rate on U.S. source payments, the FATCA also requires foreign financial institutions (FFI) to register and agree to report to the IRS certain information about financial accounts held by U.S. taxpayers or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest. The intent was for the IRS to use this information to verify that U.S. persons have reported such financial accounts on Form 8938.

TIGTA’s Findings and Recommendations

TIGTA determined that, despite spending nearly $380 million, the IRS has taken limited or no action on a majority of the planned activities outlined in the FATCA Compliance Roadmap.

Of the 31 activities, the IRS indicated that it has taken action on 24 activities. However, TIGTA found that for 16 of those 24 activities, action was either limited or in the early stages of
development.

A large number of reports filed by the FFIs did not include (or included invalid) Taxpayer Identification Numbers (TIN). Consequently, the IRS has not been able to successfully identify and enforce FATCA requirements for individual taxpayers.

TIGTA recommends that the IRS:

  1. Establish follow-up procedures and initiate action to address error notices related to file submissions rejected by the  International Compliance Management Model (ICMM);
  2. Initiate compliance efforts to address taxpayers who did not file a Form 8938 but who were reported on a Form 8966 filed by an FFI;
  3. Add guidance to the Form 8938 instructions to inform taxpayers on how to use the FFI List Search and Download Tool on the IRS’s website;
  4. Initiate compliance efforts to address and correct missing or invalid TINs on Form 8966 filings by non-IGA FFIs and Model 2 IGA FFIs;

Moreover, it does not appear the IRS is using standardized procedures for working a Form 8938 (§ 6038D) penalty case.  Revenue agents use judgment in selecting the techniques that apply to each taxpayer. The IRS noted that a lead sheet is available to revenue agents when conducting an examination. The lead sheet was finalized and placed on the IRS website in July 2016. However, there is currently no requirement to use the lead sheet for selecting and reviewing cases under the FATCA.

The IRS responded that it will continue its efforts to systemically match FFI information and Form 8938 data to identify nonfilers and underreporting related to U.S. holders of foreign accounts and to the FFIs. The IRS has initiated development of a data product to automate risk assessments across the FATCA filing population.

Based on the recommendations in this TIGTA audit, we should expect that the IRS will soon begin identifying and acting on Form 8938 non-compliance based on financial information provided by foreign financial institutions.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.

U.S. Tax on Australian Superannuation Funds

Kunal Patel

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U.S. Tax on Australian Superannuation Funds

An Australian superannuation fund is a partly compulsory pension program put in place by the Government of Australia. The employer contribution rate has been 9.5% since 1 July 2014, and as of 2015, was planned to increase gradually from 2021 to 12% in 2025.

An individual can withdraw funds out of a superannuation fund when the person meets one of the conditions of release, such as retirement, terminal medical condition, or permanent incapacity.

U.S. taxation of these plans can be confusing.

Classification of Australian supers for U.S. tax purposes

An Australian superannuation is a hybrid plan that the U.S. doesn’t have a parallel. It has characteristics of both a social security program and a private pension.

Contributions to Australian superannuation funds are treated as social security contributions in the U.S-Australia totalization agreement.

However, unlike a government social security program, an Australian super is not mandatory upon the employee to contribute.  Moreover, it’s not a public fund; it’s privatized.

Unfortunately, the IRS has not provided much guidance on this hybrid plan. Most practitioners treat them as private pensions.

We’ve heard about practitioners who take the position that they’re social security funds and completely exclude super earnings and distributions from U.S. taxation relying on Article 18 the U.S.-Australian income tax treaty:

Social Security payments and other public pensions paid by one of the Contracting States to an individual who is a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first-mentioned State.

And Article 1 section 3 excepts the Savings Clause from Article 18, which otherwise would’ve subjected social security plans to U.S. tax.

To take this treaty position on Australian supers is almost certainly incorrect because Australian superannuation funds are not social security or public pensions:

  • Australia has a system of social welfare payments provided by the Government of Australia. Superannuation funds are privately managed and are not paid directly by the Government of Australia, although it could be argued that Australian employers are acting as agents of the Government of Australia. Note that in Article 18 it specifically states that the payment must be “paid by one of the Contracting States.”
  • The IRS has provided guidance on the tax treatment of similar funds such as the Singapore Central Provident Fund, which the IRS treats as a nonexempt employees’ trust.
[W]e have concluded that the Fund is a nonexempt employees’ trust described in § 402(b). It appears that contributions to the Fund generally are made as a uniform percentage of salary for the vast majority of each employer’s employees.

  • In a 2005 private letter ruling, the IRS concluded that “Under the Treaty, the payment to Taxpayer from an Australian superannuation fund is subject to U.S. tax.”

Is the growth in a superannuation taxable in the U.S.?

It depends on the plan and whether it’s considered a foreign grantor trust or an employees trust.

(1) Foreign grantor trust

A foreign grantor trust arises when more than 50% of the contributions to the fund were made by the individual. And if so, a portion attributable to the after-tax contributions would be reported on Form 3520 as a grantor trust. The earnings inside the funds would be taxed concurrently. Self-managed super funds are usually considered grantor trusts.

(2) Employees trust

If employer contributions are greater than 50%, the employer is the owner of the entire trust and the plan is considered a non-qualified employee’s trust.

In that case, it must be then determined whether the participant is highly compensated under IRC 410(B). If the participant is not highly compensated, then fund earnings are not subject to tax until distribution under IRC 402(b)(2). For highly compensated employees, the increase in the value of the plan is included as taxable income annually.

Section 414(q) defines highly compensated employees as one who:

(A) was a 5-percent owner at any time during the year or the preceding year, or

(B)for the preceding year—
(i) had compensation from the employer in excess of $80,000, and
(ii) if the employer elects the application of this clause for such preceding year, was in the top-paid group of employees for such preceding year.
The Secretary shall adjust the $80,000 amount under subparagraph (B) at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter ending September 30, 1996.

How are Australian supers taxed on distributions in the U.S.?

Upon distribution, the funds are taxable in the U.S. to the extent that the distributions exceed basis.

The basis in a super are amounts that were previously included in taxable income. This would include funds contributed by the employee but would not include fund-level taxes paid.

Required international information reporting forms

If the fund is a grantor trust, it’ll require Form 3520, 3520-A, Form 8621, FBAR, and Form 8938. As a non-grantor trust, only Form 8938 and FBAR are required.

FBAR Compliance for U.S. Entities

Kunal Patel

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FBAR Instruction Guide for U.S. Entities

U.S. Person

For FBAR compliance purposes, a “U.S. person” includes U.S. citizens, U.S. residents, and entities which include corporations, partnerships, limited liability companies, trusts, and estate formed under the laws of the United States. Such entities must file FBARs if they have financial interest in a bank, securities or other financial account located in a foreign country.

Financial Interest: Owner of record or holder of legal title

A domestic entity has a financial interest in a foreign financial account for which the entity is the owner of record or has legal title, regardless of whether that account is maintained for its benefit or the benefit of another.

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