Getting Started Tax Compliance Seminar January 31, 2012 Grand Cayman Islands Shawn P. Wolf, Esq....

Getting Started Tax Compliance Seminar

January 31, 2012Grand Cayman Islands

Shawn P. Wolf, Esq.Packman, Neuwahl & Rosenberg

E-mail: [email protected]

1500 San Remo Ave. Suite 125 750 South Dixie Highway

Coral Gables, Florida 33146 Boca Raton, Florida 33432

Telephone: (305) 665-3311 Telephone: (561) 393-8700

Facsimile: (305) 665-1244 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 non-citizen 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 2006-87 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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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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The following principles have emerged, however, and are well established with respect to §162(a)(2):

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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Bona Fide Resident Test 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:

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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Physical Presence Test 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 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!

U.S. Compliance Considerations

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Summary of Filing Considerations

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!

Penalties for Non-Compliance and (Hopefully) How to They

Can be Avoided (Cont.).

Reasonable Cause. 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 foreign-related 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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Offshore Voluntary Disclosure Program.

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 non-income 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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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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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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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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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.

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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Getting Started Tax Compliance Seminar January 31, 2012 Grand Cayman Islands Shawn P. Wolf, Esq....

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