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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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U.S. Shareholder and CFC Status

Kunal Patel

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U.S. Shareholder and Controlled Foreign Corporation Status

It is often the case that a U.S. shareholder of a foreign corporation jointly owns the entity with other family members. The constructive ownership rules under IRC 958 can be confusing. These rules were meant to eliminate abusive tax-deferral by large multi-national corporations. Unfortunately the same rules apply to small, closely-held foreign corporations which must also navigate through these complex rules.

What is a controlled foreign corporation?

A foreign corporation is a controlled foreign corporation (CFC) for a particular year if, on any day during such year, U.S. Shareholders own more than 50% of the:
– total combined voting power of all classes of stock, or
– total value of the stock

In general, a foreign corporation is a CFC if more than 50 percent of its voting power or value is owned by U.S. Shareholders. A U.S.
Shareholder of a foreign corporation is a U.S. person who owns 10 percent or more of the total voting power of that foreign corporation.

Is there constructive ownership?

Under IRC 958(b), an individual shall be considered as owning the stock owned, directly or indirectly, by:

(i) His spouse; and

(ii) His children, grandchildren, and parents.

Example 1: A, B, C, and D are U.S. persons. A and B are married and each own 25% of foreign Corporation X. Additionally, C, their daughter, and D, C’s daughter, each own 25% of Corporation X. A and B are each considered to own 100% of Corporation X because they are attributed each other’s stock, as well as the stock owned by C (their daughter) and D (their granddaughter).

Example 2: C also constructively owns 100% of Corporation X, because she is attributed her parents’ and daughter’s stock. D constructively owns 50% (only her own and her mother’s stock).

But the constructive ownership rules do not apply where the person is a non-resident:

Example 3: If in example 2 D was a non resident alien, A, B, and C would only constructively own 75% of Corporation X because stock of a nonresident alien is not considered to be owned by a U.S. person.

Why does this matter?

Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, is required to be filed by every U.S. shareholder (as defined in IRC § 951) of a foreign corporation. The form is filed annually with Form 1040, U.S. Individual Income Tax Return. U.S. shareholders of CFCs are category 4 and 5 filers and must provide much more detailed company financial information.

A U.S. individual shareholder of a non-CFC only reports income from dividend distributions. The undistributed income is tax deferred. However, U.S. taxpayers with ownership in a CFC are subject to special reporting requirements called Subpart F. The Subpart F provisions eliminate deferral of U.S. tax for some categories of income earned by controlled foreign corporations. The Subpart F rules operate by treating a U.S. Shareholder of a CFC as if it actually received its proportionate share of certain categories of the CFC’s current earnings. The U.S. shareholder is required to report this income (“Subpart F inclusion”) currently in the United States whether or not the CFC actually makes a distribution to the U.S. Shareholder. With the passing of the Tax Cuts and Jobs Act, the Subpart F inclusion has been broadly expanded to include all accumulated post-’86 deferred foreign income.

Streamlined Foreign Offshore Procedures

Kunal Patel

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IRS Streamlined Foreign Offshore Procedures

The streamlined foreign offshore procedures (SFOP) are part of the streamlined filing compliance procedures.

Unlike the streamlined domestic offshore procedures, there is no 5% misc. offshore penalty assessed on a streamlined foreign offshore procedures filing.

U.S. taxpayers eligible to use these procedures will file delinquent or amended returns, together with all required international information returns (Forms 3520, 3520-A, 5471, 5472, 8938, 926, or 8621), for the past three years and will file delinquent Report Of Foreign Bank & Financial Accounts (FBAR) (FinCEN Form 114) for the past six years.

Qualified filers must submit the above along with a signed certification statement attesting that the failures above resulted from non-willful conduct.

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FIRPTA Non-foreign Seller’s Certification

Kunal Patel

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FIRPTA Certification of Non-foreign Status

Previously, we discussed the general FIRPTA withholding requirements. Here we discuss the process where a seller is a U.S. tax resident and certifies his non-foreign status to the buyer.

FIRPTA: Non-U.S. Person

Withholding on a real estate transaction is required only if the seller is a non-U.S. person. IRC 7701 defines a “U.S. person” as one who meets any one of the following requirements:

  • Is a United States citizen;
  • Is a lawfully admitted permanent resident (“green card” holder); or
  • Meets the substantial presence test

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FIRPTA Withholding Requirements

Kunal Patel

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FIRPTA Withholding Requirements

The disposition of a U.S. real property interest by a foreign seller (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding. Persons purchasing U.S. real property from foreign sellers are required to withhold and remit 15% of the amount realized on the disposition (i.e., typically the sales price).

Below we’ll review the steps in determining whether a transaction is covered by FIRPTA.

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Closer Connection Exception

Kunal Patel

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Closer connection exception & the substantial presence test

An individual is a U.S. tax resident if they meet either the below tests.

1. Lawful permanent resident test: An individual who holds a green card is considered a resident for tax purposes for the period of time that he was a lawful permanent resident

2. Substantial presence test: An individual that spends at least 31 days during the current calendar year; and the sum of the total number of US presence days in the current year, plus 1/3 of the total US presence days in the preceding year, plus 1/6 of the US days during the second preceding year equals or exceeds 183 days.

U.S. tax residents must pay income tax on worldwide income. There are exceptions available for individuals who otherwise be considered U.S. tax residents to be treated as non-residents. One such exception is the closer connection exception to the substantial presence test.

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