Several changes in tax reform have a disparate impact on non-corporate US shareholders of foreign corporations compared with their corporate counterparts. Many such non-corporate shareholders face an expensive tax increase. They may attempt to mitigate this increase by transferring their shares to a US corporation or making a Section 962 election. This article examines the
Leigh-Alexandra Basha focuses her practice on domestic and international estate and tax planning. She counsels an affluent international client base on a wide range of sophisticated matters, including estate and trust administration, family wealth preservation, tax compliance, as well as business succession, expatriation and pre-immigration planning. Leigh is head of the Firm’s Washington, DC, Private Client Practice Group. Read Leigh-Alexandra Basha's full bio.
On December 13, 2017, the US Tax Court (Tax Court) held that a family office was appropriately treated as a business, and permitted to deduct its expenses pursuant to Internal Revenue Code (Code) Section 162. In Lender Management LLC v. Commissioner, T.C. Memo. 2017-246, the Internal Revenue Service (IRS) argued that the taxpayer’s expenses should be properly claimed pursuant to Code Section 212 because the family office was not a business for federal income tax purposes, and instead its expenses were merely costs of its investment activities. Whether or not a family office is a business is important because deductions under Code Section 212 are substantially limited.
The taxpayer was the family office to the Lender’s Bagels fortune. It was owned by two Lender family trusts. In 2010 and 2011, the taxpayer reported net losses on its returns and reported net income in 2012 and 2013. The taxpayer provided direct management services to three limited liability companies (LLCs), each of which elected to be treated as a partnership. The owners of the LLCs were the children, grandchildren and great grandchildren of the founder.
The Internal Revenue Service (IRS) currently offers non-compliant US taxpayers several different relief programs in which to report foreign assets and/or income and become compliant with US rules related to the disclosure of foreign assets. One option is the Offshore Voluntary Disclosure Program (OVDP). Another is the Streamlined Filing Compliance Procedures (SFCP). SFCP is further bifurcated into two sub-programs—one for US residents (Streamlined Domestic Offshore Procedures or “SDOP”) and one for non-US residents (Streamlined Foreign Offshore Procedures or “SFOP”). Each program has its own set of tailored procedures and eligibility requirements.
The critical differences between OVDP and SFCP are: (1) the non-willfulness requirement; (2) the look-back period; and (3) the amounts of penalties the US taxpayer must pay. Specifically, OVDP does not require the US taxpayer to certify that his or her failure to disclose foreign assets was non-willful. On the other hand, SFCP requires the US taxpayer to certify that his or her failure to disclose foreign assets was non-willful and to also include a narrative explaining such non-willful conduct. The incentive to demonstrate non-willfulness can be significant. In general, US taxpayers who enroll in OVDP must pay a 27.5 percent penalty (and in some cases a 50 percent penalty) of the highest aggregate value of undisclosed foreign assets for the OVDP disclosure period (eight years). However, US taxpayers who enter SDOP must only pay a five percent penalty of undisclosed foreign assets during the disclosure period (three years), and US taxpayers who enter SFOP pay no penalty.…
On April 3, 2016, the International Consortium of Investigative Journalists (ICIJ) indicated that it acquired sensitive documents that belonged to the Panamanian law firm, Mossack Fonseca & Co., about the offshore holdings of some of the world’s most prominent and wealthy individuals. The leak has received substantial mainstream media coverage due to the identity of the individuals named.
To date, the ICIJ has not released the identities of all of the hundreds of thousands of offshore entities or the persons related to those entities, which were referenced in the leaked documents. The ICIJ indicated that it would wait until May 2016 to release the full list. By waiting to May, the ICIJ is putting certain US persons on notice that they should consider starting the process to disclose previously undisclosed foreign assets to the Internal Revenue Service (IRS).
The United States subjects US persons to worldwide income taxation. As part of this taxing system, the IRS requires US persons to fulfill certain information reporting obligations related to foreign assets. For example, US persons must report a financial interest or signature authority over a foreign financial account on FinCEN Form 114, Report of Foreign Bank and Financial Account (FBAR). Non-compliance may result in a penalty of up to 50 percent of the highest aggregate value of the foreign financial account as well as criminal sanctions if done so willfully.
The IRS has implemented programs to encourage previously non-compliant US persons to disclose foreign assets and become compliant. One such program is the Offshore Voluntary Disclosure Program (OVDP). OVDP is designed for taxpayers who may have willfully failed to disclose foreign assets to the IRS. The primary benefits of participating in the OVDP are that the IRS will not recommend criminal prosecution to the Department of Justice (DOJ) for non-compliance up to the date of the disclosure and the taxpayer will no longer be subject to civil examination for the years covered by the OVDP disclosure.…