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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.

Why hire Mitchell & Patel?

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

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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Cryptocurrency Tax Compliance

Kunal Patel

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Cryptocurrency Tax Compliance

Despite the name, cryptocurrencies are not “currencies” at all for tax purposes. The IRS treats virtual currency as property (i.e., assets). General tax principles applicable to property transactions apply to purchase and sale of virtual currencies.

As an asset, the taxable income from the sale of a cryptocurrency unit is determined by subtracting the sales price minus the basis.

If purchased, the basis is the cost at with the units were purchased. If received as payment for goods or services, the basis is the fair market value of the virtual currency in U.S. dollars as of the date of receipt.

If mined, then when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.

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District Court says FBAR Civil Penalties Capped at $100,000

Kunal Patel

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District Court says FBAR Civil Penalties Capped at $100,000

A recent decision in an FBAR case (U.S. v. Colliot) in the Western District of Texas might be huge win for taxpayers who have been incorrectly assessed FBAR civil penalties under 31 U.S. Code 5321(a)(5)(C).

Background

In December 2016, the Internal Revenue Service (IRS) initiated a lawsuit to reduce to judgment outstanding civil penalties assessed against Colliot….The penalties were assessed for Colliot’s repeated and willful failures to timely file Form TD F 90-22.1, entitled “Report of Foreign Bank and Financial Accounts” and commonly referred to as an “FBAR,” from 2007 to 2010…For 2007, the IRS assessed penalties of $548,773 for four separate FBAR violations.

Defendant filed a motion for summary judgment arguing that while 31 U.S. Code 5321(a)(5)(C) provides a maximum penalty of the greater of (i) $100,000 or (ii) 50% of the undisclosed foreign accounts, the related regulation, 31 C.F.R. § 103.57 sets a lower ceiling. That regulation allows the assessment of a maximum penalty of the greater of (i) the balance in the account (not to exceed $100,000) or (ii) $25,000. Read more

Foreign Earned Income Exclusion

Kunal Patel

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Foreign earned income exclusion audits

The IRS has been increasingly auditing taxpayers who’ve claimed the foreign earned income exclusion (FEIE). It was identified as a compliance campaign by IRS LB&I last year (link).

It’s easy to see why the IRS would audit this issue. A qualifying individual may exclude up to $104,100 (for 2018) of foreign earned income from U.S. taxation, plus a housing exclusion. In a typical 3 year audit, an adjustment favorable to the IRS could lead to additional taxes (plus penalties and interest) on more than $300,000 of incorrectly-excluded income.

Sometimes FEIE is claimed along with foreign tax credits (although scaled down). Likely the taxpayers with the highest audit potential are those that rotated in foreign countries with no income tax since there would be no foreign tax credits to claim in lieu of the FEIE. Most notably are contractors working in Middle Eastern countries such as Saudi Arabia and UAE. Short-term rotators generally do not qualify for the FEIE – although a series of 1 year rotations may qualify (see Linde v. CIR, T.C. Memo 2017-180).

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What to do after the Offshore Voluntary Disclosure Program ends?

Kunal Patel

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What to do after the Offshore Voluntary Disclosure Program ends?

Earlier this year the IRS announced that it would be ending the offshore voluntary disclosure program on September 28, 2018. There are signs that the the program could be replaced by a new program. After the announcement, the IRS requested comments from the public for its federal register on the following topics pertaining to the OVDP (link):

  • whether the collection of information is necessary for the proper performance of the functions of the agency, including whether the information shall have practical utility;
  • the accuracy of the agency’s estimate of the burden of the collection of information;
  • ways to enhance the quality, utility, and clarity of the information to be collected;
  • ways to minimize the burden of the collection of information on respondents, including through the use of automated collection techniques or other forms of information technology; and
  • estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

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