201706.26
0

10 Ways Owning a Foreign Business Impacts U.S. Taxes – Golding & Golding

10 Ways Owning a Foreign Business Impacts U.S. Taxes - Golding & Golding

10 Ways Owning a Foreign Business Impacts U.S. Taxes – Golding & Golding

Whether it is because you started your own business, or invested in another business — business can be very exciting. With that said, there are very specific tax laws, rules, and nuances that come into play when a person has an interest in, or ownership of a business.

These rules are amplified when the business involves a foreign, offshore or overseas business. Whether it is because the business is located outside of the United States, and/or the business generates U.S. and/or Foreign based source income — issues involving foreign business can be unnecessarily complex and burdensome.

Golding & Golding

We represent clients in over 50 countries with IRS Offshore Voluntary Disclosure Programs, and a large number of these submissions involved foreign business issues.

As such, we are providing a list of common issues we come across in representing clients in the IRS Voluntary Disclosure Programs.

Please not, we do not provide business advice. We are not a tax planning firm and while we have extensive experience getting clients into compliance, when it comes to tax planning, we recommend that you speak with a business tax planning firm.

If you contact us for such advice, we will not be able to assist you.

Is it a Controlled Foreign Corporation?

One of the most important preliminary issues is to determine whether the foreign corporation is a Controlled Foreign Corporation (CFC). If it is a Controlled Foreign Corporation that means more than 50% of the foreign business is owned by US persons who each own at least 10% of the foreign business (attribution rules apply).

If it is a Controlled Foreign Corporation, then it is subject to very strict rules and regulations in accordance with subpart F and other related laws. From a basic tax standpoint, the idea is that the IRS wants to prevent you from hoarding passive monies in a foreign businesses that are otherwise owned in majority by US persons, and would be presently taxable if the money was located in the United States.

If you have a Controlled Foreign Corporation, and this is the first you are hearing about it, it is very important to speak with an attorney to better understand the ramifications and reporting requirements of your Controlled Foreign Corporation.

Do You Have Subpart F Income?

Even if it is a Controlled Foreign Corporation, that does not mean all of the income being earned abroad by the business is immediately taxable. But, it does mean that any prorated subpart F income in any year in which you had current Earnings and Profit (E&P) may be immediately taxable, even if it is not distributed.

The concept is again, that the IRS does not want you to hide passive income abroad. If you do, the IRS is going to penalize you and they can do so heavily – especially if the IRS determines that your foreign business is a PFIC (aka Passive Foreign Investment Company)

Typically, these are companies that are foreign holding corporations or other businesses that may or may not conduct any business aside from earning passive income.

For example, if you own a BVI that holds 10 different mutual funds and other types of trading funds, in addition to conducting active business – then you are probably going to have subpart F income on matters involving your passive earnings.

As with any IRS rule, exemptions and exclusions to apply.

PFIC

A PFIC is a Passive Foreign Investment Company. Typically, unless your PFIC has made the necessary MTM or QEF election, chances are your foreign PFIC is going to be taxed so heavily, that it should be considered a penalty.

The IRS truly despises the PFIC. That is because the IRS does not want you to shelter passive income that would ordinarily be taxed in the United States, into one of these offshore investment companies.

Here’s a basic example: Steve owns a foreign mutual fund (yes, foreign mutual funds are almost by default considered to be a PFIC). Steve’s initial investment into the fund was $100,000 and five years later it is worth $200,000. It miraculously earned $20,000 a year in passive income that was never distributed.

In a US version of the mutual fund, oftentimes the fund will have to distribute at least 90% of its income to avoid two layers of tax. Therefore, even if your earnings are distributed and then immediately reinvested, they will be taxed and you will receive a 1099.

The same cannot be said with a foreign investment into a foreign mutual fund, which may sit in the fund indefinitely until it is distributed. From the IRS’ perspective, all the while you should have been paying tax. Therefore you get hit with a monster tax bill in addition to interest payments on the unpaid tax of earnings that were actually never distributed, but to which the IRS believes there should have been distributions, and income tax paid.

PFICs are no fun and if you have one, you should speak with an experienced tax lawyer to figure out the smoothest way to get out of it.

Schedule B

If you have ownership in a foreign business and through this ownership you have access to, or signature authority over foreign accounts — then you must identify this on a schedule B.

Question seven (7) on schedule B will ask you to identify whether you have ownership or signature authority over foreign accounts (whether or not the money is yours) and if you do, it will ask you to identify which countries. It includes signature authority through your foreign business.

Moreover, question seven will also ask you whether you are required to file an FBAR.

FBAR

The FBAR’s bark is usually much worse than its bite. Be careful what you read online about this form, since unscrupulous attorneys, CPAs and other tax professionals will try to scare the living daylights out of you regarding penalties that can be issued involving this form. Yes, the IRS may issue penalties, which far exceed any ‘crime’ you may have committed, but there’s a few things to keep in mind.

First, oftentimes (though usually through an attorney) you can submit late FBARs through one of the approved voluntary disclosure programs or with reasonable cause and avoid (or severely reduce) any penalties the IRS issues. Moreover, the IRS may issue a warning letter in lieu of penalties. Finally, the burden the IRS must meet in order to issue the worst of the worst penalties is a very heavy burden.

If you did not file FBARs for accounts you have with a form business then you should do so, but don’t let these individual scare you unnecessarily.

Form 8938 (FATCA)

Form 8938 is a relatively new form that was introduced by the IRS in about 2011. The form is similar to the above referenced FBAR, except it is filed directly with the IRS and assets the IRS wants more information. They want to know if these accounts generated any income and if so, the type of income and the amount of income.

Moreover, unlike the FBAR, form 8938 requires you to identify specified assets. For example, if you own a foreign business then you may have to file this form (although usually do not have duplicate it with a form 5471) in order to identify the asset. This will include the value of the asset, the date of acquisition, the address, and any income was earned through this particular asset.

Like the FBAR, the failure to file this form may result in very high penalties-but please see above for the different options you will have to try to avoid these penalties.

Form 5471

Form 5471 is required by individuals who meet one of four categories of individuals owning foreign corporations. Generally, it will include anybody who has ownership of, or has acquired more than 10% ownership of voting rights in a foreign business. Alternatively, they may have had control over the business for 30-days and therefore would also still have to report. Depending on which categories you fall into, a person may have to file one or more schedules to accompany the form 5471.

The IRS takes form 5471 very seriously. In fact, a recent case came down in which the IRS issued extensive fines and penalties against an individual who failed to properly file the form.

It should be noted that, while the facts show the individual may have been reckless or exhibited willful blindness in failing to file the form, it does show that the IRS is serious about ensuring individuals who have the requirement to file this form do so timely.

Foreign Retirement

Foreign Retirement is a key issue that seems to upset individuals the most – understandably so. Let’s say you own a foreign business or have an interest in it and also work for that business in that business set aside certain money for you in retirement. If the money was set aside in a US-based 401(k) there are a few rules that normally apply: the employer’s contributions are not taxable with your current income tax return, your contributions as an employee are deductible, and the annual growth or accumulation of income that is not yet distributed is not taxed until it is distributed.

The IRS sees it differently. Unless you have a foreign pension or retirement through an approved tax treaty countries such as the UK or Canada, the opposite applies. In other words, you have to report your employer’s contributions as current income, you do not receive a deduction for your contribution, and the annual growth may he currently taxed (although you receive a tax credit against future tax).

This is common in countries in which the United States does not have a tax treatment but in which Provident funds are common-such as Singapore, Thailand or Malaysia.

Per Se Corporations

As you may be aware, with Domestic LLC’s in the United States you can oftentimes disregard an entity to avoid current Tax reporting requirements. For example, let’s say David lives in California and owns an LLC, that owns three rental properties. David is the only member of the LLC and the main purpose (if not only purpose) of the LLC is to protect David in a lawsuit. In other words, there is no tax purpose to the LLC.

Under current IRS laws, David may be able to disregard the single-member LLC (married couples in California who own a business together also enjoy this benefit) and not have to file the necessary forms such as 1120S – if it elected to be an S corporation. Rather, they would just use a 1040 Schedule C

Even with foreign corporations, a person may also get the benefit of disregarding the entity, but it should be noted that there are certain foreign corporations in which a form must be filed because it is considered a per se corporation. In other words, the IRS will not allow the individual to disregard the entity.

This is very common in Latin American countries with the sociedad anonima. Even though the S.A. is often used as an estate planning tool for individuals living abroad, from the IRS perspective  –it makes you a per se corporation and you cannot disregard the S.A. at this time.

I am out of Compliance, What do I do?

If you are out of compliance because you failed to properly file the necessary forms in one or more prior years, you may qualify for one of the IRS offshore voluntary disclosure programs.

The following is a summary of the different programs:

Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.

When Do I Need to Use Voluntary Disclosure?

Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.

If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.

Golding & Golding – Offshore Disclosure

At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.

In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.

The Devil is in the Details…

If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.

It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.

Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.

What if You Never Report the Money?

If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported —  then you are in a bit of a predicament, which you will need to resolve before it is too late.

As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.

Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).

Getting into Compliance

There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.

We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlike the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.

After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.

If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.

Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.

1. OVDP 

OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.

The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.

The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.

Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property (reduced by any outstanding mortgage) would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.

An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.

What is Included in the Full OVDP Submission?

The full OVDP application includes:

  • Eight (8) years of Amended Tax Return filings;
  • Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
  • Penalty Computation Worksheet; and
  • Various OVDP specific documents in support of the application.

Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.

Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).

OVDP Penalties

The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.

Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank) on the highest year’s “annual aggregate total of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).

For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.

Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!

                         

2. Streamlined Domestic Offshore Disclosure

The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.

What am I supposed to Report?

There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.

In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.

Reporting Specified Foreign Assets – FATCA Form 8938

Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.

The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.

The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.

Other Forms – Foreign Business

While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:

  • If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
  • If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
  • If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
  • And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.

Reporting Foreign Income

If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.

It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.

In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.

                           

3. Streamlined Foreign Offshore Disclosure

What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?

If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.

Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)

*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.

                      

Call Today, Let us Help.