Controlled Foreign Corporation (CFC) Avoidance Leads to PFIC Taint – Be Careful
If you have a corporation overseas that is identified by the U.S. government as a Controlled Foreign Corporation or CFC, there are tax consequences.
You may think by performing some sort of CFC avoidance, you can outsmart the IRS – and while maybe you can – often times with tax, sidestepping one problem will only result in you knee deep in a different one.
Moreover, when it comes to CFC and PFIC Penalties, the IRS is empowered to level you with tens of thousands of dollars in fines and penalties.
From a general reporting and tax standpoint (exceptions apply) if you have current earnings & profit, and subpart F income, then you have to report your respective share of the income on your tax return – even though the money has not been distributed yet.
Of course, your goal is to avoid paying any tax to the United States government for your foreign money (or at least minimize tax implications). In order to avoid the Controlled Foreign corporation, individuals will try to plan around it. Usually, there are two options:
– Make sure that at least 50% of the business is owned by foreign persons (to be a controlled foreign corporation it must be more than 50% of our US persons); or
– Make sure that it is owned by US persons, that no shareholder owns at least 10% share in the company.
While this is an effective method to avoid the CFC Taint, it will do little in the way of assisting you in avoiding PFIC status.
What is a PFIC?
A PFIC is a Passive Foreign Investment Company. It is highly frowned upon by the U.S. government for many reasons. The main reason is that since it is a foreign investment company or foreign holding company/foreign mutual fund, unless certain elections have been made by the investment, the U.S. does not have any control or authority over the investment — and annual reporting on a Form 8621 when there were no distributions was not necessary prior to 2013; this makes it harder for the US government to track your foreign investment.
PFICs receive the harshest tax consequences possible. Why? Because not only do you pay “Income Tax” on earnings (no Capital Gains or Foreign Qualified Dividend treatment), but depending on the amount of the earnings in your current year distribution (excluding the first year of the investment) relative to the three prior years worth of earnings, you may be paying extensive taxes for the prior years in which the investment remained in the fund or holding company at the highest income tax bracket for each years the investment was undistributed — as well as interest and other tax penalties.
No Ownership Threshold Requirements…
In order to have to report your interest in a foreign corporation or controlled foreign corporation on a form 5471, there are threshold requirements that you must meet. While the threshold requirements vary, they generally require at least 10% ownership of the company
This is not apply to a PFIC. Technically, even if you had fractional ownership in a PFIC, you have to report it to the US government (unless you meant certain exemptions/exclusions – which are rare).
Most importantly, if the U.S. learns about these investments before you had a chance to get into compliance (usually through the IRS offshore voluntary disclosure program), you may be subject to extremely high fines and penalties, including FBAR and 8938 penalties (8621 penalties are routed through the 8938). Moreover, the statute of limitations will linger forever for the years you did not previously file an 8621.
If you have for new investments such as a PFIC and are out of compliance you should speak with an experienced international tax lawyer to weigh your options.
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. Unlikes 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.