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Austin Business Trip | February 2022 | International Tax Lawyer & Attorney

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In early February of 2022, Mr. Sherayzen, an international tax attorney and owner of Sherayzen Law Office, Ltd., traveled to Austin, Texas. Let’s discuss this Austin business trip in more detail.

Austin Business Trip: Goals

While the business trip to Austin was very short, Mr. Sherayzen set forth three main goals for the trip: (1) meeting with a client; (2) familiarizing himself with the city, which is a major source of clients to the firm; and (3) conducting important marketing activities to promote the firm.

All of these goals were accomplished (though #2 may still need more work) despite the fact that he came to Austin at the worst possible moment – right after a winter storm when the temperatures plummeted to the twenties (Fahrenheit) from the usual upper fifties/lower sixties and there was still ice on the roads.

Austin Business Trip: Client Meeting

The first goal was very easy to achieve as the meeting with a client was set prior to his arrival to Austin.

Austin Business Trip: Getting to Know Austin

The weather and the brevity of the Austin business trip presented a formidable challenge to the second goal. Despite these problems, Mr. Sherayzen was able to familiarize himself with the old-city Austin. Even more important, he was able to visit the IRS campus in Austin that processes streamlined disclosures: Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. Both of these options are known as Streamlined Compliance Procedures.

Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures belong to the core practice of Sherayzen Law Office. This is why visiting the Austin IRS campus was an indispensable part of the Mr. Sherayzen’s trip to this city.

One may ask: why does Mr. Sherayzen want to know Austin in person? The answer is very simple: he wants to understand how his clients live, what their particular needs are, what logistical problems they may be facing and what are the peculiarities of their everyday life. At Sherayzen Law Office, we take an extra step in delivering customized services to our clients; for this reason, we strive to understand not only the financial situation of our clients, but also their logistics.

Austin Business Trip: Marketing

Marketing is Mr. Sherayzen’s crucial goal in almost every business trip. Nothing can replace the authenticity of marketing materials made in the city where the client lives. For this reason, more than two-thirds of his trip to Austin was devoted to marketing activities.

Given the presence of an IRS campus in Austin, offshore voluntary disclosures of course constituted the focus of these marketing activities. Besides Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures, Mr. Sherayzen also covered IRS Voluntary Disclosure Practice and other voluntary disclosure options.

Additionally, as always, Mr. Sherayzen promoted the awareness of the FBAR and FATCA reporting requirements in his marketing activities. The attorney also covered important US international tax information returns such as: Forms 8865, 5471, 3520, 3520-A, et cetera.

Austin Business Trip is Part of a Major Marketing Strategy

The Austin business trip is merely one part of a major marketing strategy that Sherayzen Law Office launched last year. It is projected that this strategy will run through the end of the year 2027.

Contact Sherayzen Law Office for Professional Help With Your Offshore Voluntary Disclosure and US International Tax Compliance

Sherayzen Law Office is an international tax law firm that specializes in US international tax compliance and offshore voluntary disclosures. We help clients with their US international tax compliance issues throughout the world, including in all fifty states of the United States.

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§318 Option Attribution | International Tax Lawyers United States

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A previous article defined “option” for the purposes of the IRC (Internal Revenue Code) §318(a)(4). Today, I will discuss the main §318 option attribution rule.

§318 Option Attribution: Main Rule

Under §318(a)(4), “if any person has an option to acquire stock, such stock shall be considered as owned by such person.” For the purposes of §318 option attribution rules, an option to acquire an option to acquire stock is also considered an option to acquire stock. Id. It does not matter whether the option to acquire an option is granted by the corporation or by a shareholder.

Additionally, a series of options to acquire an option to acquire stock is considered an option to acquire stock Id.; in other words, the owner of a series of options is the constructive owner of the stock. That is the subject of this series.

Let’s use the following example to illustrate §318 option attribution: A and B each own 10 shares in X, a C-corporation; A has an option to acquire 5 shares of X owned by B; A also has an option to acquire an option to acquire B’s other 5 shares of X; finally, A has an option to acquire 5 unissued shares of X. The issue is: how many shares does A own?

By applying the rules above, A would actually and constructively own a total of 25 shares: 10 shares that he actually owns and 15 shares the he constructively owns under §318(a)(4) (all 10 shares of X owned by B plus 5 unissued shares of X).

§318 Option Attribution: Special Case of Convertible Debentures

Pursuant to Rev. Rul. 68-601, an owner of a convertible debenture (i.e. a debenture that can be converted into stock of a corporation) is deemed to be in the same position as a an option owner for the purposes of §318(a)(4) as long as he has the right to obtain the stock at his election. In other words, an owner of such a convertible debenture is a constructive owner of the stock into which the debenture can be converted.

Moreover, by drawing an analogy to the main §318 option attribution rule, an option to acquire a convertible debenture would be treated in the same manner under §318 as an option to acquire an option to acquire stock. Hence, the owner of an option to acquire a convertible debenture is a constructive owner fo the stock into which this debenture can be converted.

§318 Option Attribution vs. §318 Family Member Attribution

There are certain situations where stocks may be attributed to an individual under both, §318(a)(1) (i.e. family attribution rules) and the §318(a)(4) (i.e. option attribution rules). Since there are differences in legal effect, it is important to understand which rule governs in such situations.

Under §318(a)(5)(D), §318 option attribution supercedes the §318 family attribution. In other words, where an individual is deemed to be a constructive owner of shares under both rules, only the §318 option constructive ownership rules will apply to him.

This primacy of option attribution over family attribution may have a highly important tax impact in certain situations, such as the tax treatment of redemption of stock by a corporation. Let’s analyze an example to illustrate the disparate impact of these two attribution rules in the context of the §302(c)(2) waiver.

Let’s use the following hypothetical situation: W, an individual, owns 10 shares of X, a C-corporation; her husband, H, owns the remaining 40 shares of X; W has an option to purchase all of H’s shares of X. W redeems all l0 shares of X with the idea to establish a complete termination of her interest in the corporation once she waives the attribution of H’s shares to her by using the §302(c)(2) waiver (we assume here that she also fulfills all other requirements under §302). Will this strategy work in this case?

The answer is no. The problem is that the waiver under §302(c)(2) is available only for attribution from a family member. While it is true that W is a constructive owner of H’s 40 shares by the operation of family attribution rules, she is also the constructive owner of the same shares under the §318 option attribution rules. Since option attribution supercedes family attribution, she cannot use the §302 waiver. This means that W cannot establish a complete termination of her interest in X and the redemption of her 10 stocks will be treated as a dividend (with no cost-basis offset against the proceeds) as opposed to a sale.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

If you own foreign assets, including foreign business entities, you have the daunting obligation to meet all of your complex US international tax compliance requirements; otherwise, you may have to face the wrath of the IRS in the form of high noncompliance penalties. In order to successfully meet your US international tax compliance obligations, you need the professional help of Sherayzen Law Office.

We are an international tax law firm that specializes in US international tax compliance and offshore voluntary disclosures. We have successfully helped hundreds of US taxpayers worldwide with their US international tax compliance, and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Dividend Income Sourcing | International Tax Lawyer & Attorney

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One of the most important issues in US international tax law is the sourcing of income – i.e. the determination of whether the income is foreign or domestic for US tax purposes. In this article, I will introduce readers to US tax rules concerning dividend income sourcing (note, I will not be discussing substitute dividends and so-called “fast-pay” stocks as part of this article).

Dividend Income Sourcing: General Rule

Aside from limited exceptions, the source of dividend income is determined by whether the corporation that pays the dividends is foreign or domestic.

Dividend Income Sourcing: Domestic Corporations

Generally, if a US domestic corporation pays a dividend to its shareholders, the income is sourced in the United States. IRC §861(a)(2)(A).

There are three limited exceptions to this general rule, but only the first exception is really relevant at this point. The first exception is found in the complex rules concerning a Domestic International Sales Corporation (“DISC”). Basically, under IRC §861(a)(2)(D), dividends from a DISC are US-source income unless the dividends are attributable to “qualified export receipts”. In other words, if all of the gross income of a DISC satisfies the definition of qualified export receipts, then the entire gross income will be considered as derived from a foreign source. This is the basic rule and there are important exceptions and considerations that must be considered if one engages in a detailed analysis.

The second exception was a dividend paid by a Section 936 corporation. A Section 936 corporation was a special type of a domestic corporation that did business in the US possessions. At this point, the repeal of IRC §936 makes this section largely irrelevant.

Finally, the third exception existed mostly prior to 1987. At that time, if a taxpayer was able to show that 80% of the gross income of the payor corporation for the relevant period of time consisted of foreign-source income, then the dividend was also foreign-source even if it was paid by a domestic corporation. The relevant period of time for making this determination included the three fiscal years of the corporation preceding the year in which the dividend was declared (obviously, if the corporation existed for less than three years, then the period of time was reduced to the number of years the corporation had been in existence). Interestingly, with the exception of mergers and consolidations, the dividends were foreign-source even if the payor corporation filed a consolidated return with an affiliated group which did not meet what was known as the 80/20 rule.

This third exception became largely irrelevant as of January 1, 1987. However, the 80/20 corporations were exempted from tax withholding even as late as prior to 2010. At that time, the Congress finally repealed the 80/20 company rule, though it still left a grandfather clause for it.

Dividend Income Sourcing: Foreign Corporations

Dividend income sourcing with respect to foreign corporations is more complex. Generally, dividends from foreign corporations are considered to be foreign-source income unless 25% or more of the corporation’s gross income for the three years preceding the taxable year (in which the distribution occurred) was from income that was effectively connected with a trade or business in the United States. This is the so-called “25% exception”.

If the 25% threshold is satisfied, then the dividend is apportioned according to the percentage of the corporation’s income effectively connected to the United States versus foreign-source income. This rule obviously affects the ability of a US person to take full foreign tax credit.

Now, let’s look at the 25% exception from the perspective of a foreign person receiving a dividend from a foreign corporation. Again, if a foreign dividend was paid to a foreign person from a company that did not satisfy the 25% exception, then no part of the dividend was sourced to the United States. If, however, the 25% exception was satisfied, then a foreign person had US-source income according to the apportionment rule described above. In other words, a foreign dividend paid from a foreign company to a foreign individual may result in US-source income even though none of these persons are US tax residents!

Moreover, prior to 2005, such a foreign individual would have to declare this US-source income in the United States and, theoretically, pay tax on it. Obviously, this was unlikely to happen because either the foreign corporation was subject to the branch profits tax which offset the tax on dividends paid by the corporation or a tax treaty prevented the taxation of such dividend. Nevertheless, if neither exception applied, a foreign person could find himself in noncompliance with US tax laws (and there was even some litigation on this subject).

When it passed the American Jobs Creation Act of 2004, the US Congress finally relented and exempted from US taxation all dividends that fell within the 25% exception and were paid to foreign persons on or after January 1, 2005. IRC §871(i)(2)(D).

Contact Sherayzen Law Office for Professional Help with Dividend Income Sourcing

Sherayzen Law Office is a highly experienced international tax law firm that specializes in US international tax compliance, offshore voluntary disclosures and international tax planning. Our clients have greatly benefitted from our reliability, profound knowledge of international tax law (including dividend income sourcing), detailed and comprehensive approach to tax compliance and creative ethical tax planning (even during offshore voluntary disclosures). We can help You!

Contact Us Today to Schedule Your Confidential Consultation!

IRS Civil Penalties and Voluntary Compliance | US International Tax Lawyer

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There has been a spectacular growth in the number of the IRS civil penalties. In 1955, there were about 14 penalties in the entire Internal Revenue Code (“IRC”); on the other hand, today, there are over 150 penalties. The most recent growth in penalties has been driven mostly by offshore compliance concerns and the appearance of new requirements to address these concerns. FATCA Form 8938 is just the most recent example of this trend.

Does this growth in the IRS civil penalties mean that our tax system is shifting its focus from encouraging voluntary compliance to punishing abusive behavior? Let’s explore this issue from a historical perspective and try to answer the question.

The Stated Purpose of the IRS Civil Penalties

The US tax system is based on the taxpayers’ voluntary compliance with US tax laws. As I explained in a previous article, “voluntary compliance” really means the self-assessment of tax and the filing of tax returns by US taxpayers; the actual compliance with US tax laws is compulsory.

In other words, the Congress burdened the taxpayers with all of the hassle and complexity of US tax compliance and it still wants them to do it accurately, timely and in direct opposition to their self-interest of paying the least amount of tax. How can such a system function?

The solution lies in the creation of a system of the IRS civil penalties (a discussion of criminal penalties is outside of the scope of this article). The threat of the imposition of the IRS civil penalties during a random audit is meant to “encourage” voluntary compliance. This is the official purpose of the IRS penalties.

How exactly do the IRS civil penalties encourage voluntary compliance according to Congress? First, the penalties establish the standard of compliant behavior by defining noncompliance. Second, the penalties are meant to define the “remedial consequences” for noncompliant behavior. Finally, the IRS civil penalties impose monetary sanctions against the taxpayers and tax professionals who fail to comply with the aforementioned standard.

IRS Civil Penalties Must be Viewed as Precise and Proportional

Yet, in order to properly function and accomplish their goal of encouraging voluntary compliance, the IRS Civil Penalties must be viewed by the taxpayers as precise and proportional to the fault committed and the harm that resulted from that fault. In other words, the taxpayers must view the IRS Civil Penalties as a deterrence of improper conduct rather than punishing innocent taxpayers. If these penalties are viewed as excessive, the goal of voluntary compliance will be undermined.

Unfortunately, with respect to many IRS Civil Penalties, the taxpayers feel that they are disproportionate and imprecise. This is especially true with respect to international information tax returns, such as FBAR, Form 8938, Form 5471 and so on. The FBAR penalties are especially abhorred by the taxpayers because they apply to even non-willful conduct.
IRS Past Efforts to Change the Taxpayers’ Perspective on the IRS Civil Penalties

The IRS has been trying to battle this impression of unfairness of the IRS civil penalties, though we cannot say that it has been entirely successful in this respect.

Already in February of 1989, the IRS Commissioner’s Executive Task Force issued a “Report on Civil Tax Penalties” which emphasized the complexity and perceived unfairness of the IRS Civil Penalties. This Report remains one of the key documents which has not been substantially modified for past twenty some years.

The report established a philosophy of penalties, provided a statutory analysis of the three broad categories of penalties (filing of returns, payment of tax and accuracy of information), and proposed a list of action items to resolve the inconsistencies between civil penalties.

Among these recommendations, the IRS proposed to:

(1) develop and adopt a single-penalty policy statement emphasizing that civil tax penalties exist for the purpose of encouraging voluntary compliance;

(2) develop a single consolidated handbook on penalties for all employees. The IRS emphasized that the handbook should be sufficiently detailed to serve as a practical everyday guide for most issues of penalty administration and provide clear guidance on computing penalties;

(3) revise existing training programs to ensure consistent administration of penalties in all functions for the purpose of encouraging voluntary compliance;

(4) examine its communications with taxpayers to determine whether these communications do the best possible job of explaining why the penalty was imposed and how to avoid the penalty in the future;

(5) finalize its review and analysis of the quality and clarity of machine-generated letters and notices used in various divisions within the IRS;

(6) consider ways to develop better information concerning the administration and effects of penalties; and

(7) develop a Master File database to provide statistical information regarding the administration of penalties. That IRS envisioned that the information would be continuously reviewed for the purpose of suggesting changes in compliance programs, educational programs, and penalty design and penalty administration.

1989 IMPACT’s Effect on the IRS Civil Penalties

The IRS efforts did not go unnoticed. The Congress responded by enacting the Improved Penalty and Compliance Tax Act (“IMPACT”) as part of its Omnibus Budget Reconciliation Act of 1989.

It appears IMPACT had an overall salutary effect on the IRS civil penalties with respect to domestic activities. However, IMPACT’s role in curbing the perceived unfairness with respect to US international tax penalties has been minimal.

The Restructuring and Reform Act of 1998 Changed the Way the IRS Civil Penalties Are Imposed

At the end of the 1990s, the Congress made one more effort to solidify the image of fairness with respect to the imposition of the IRS civil penalties. The Restructuring and Reform Act of 1998 made a valuable contribution to maintaining the focus on encouraging voluntary compliance by creating the IRC Section 6751(b). IRC Section 6751(b) states that most of the IRS Civil Penalties (other than those automatically calculated by a computer) imposed after June 30, 2001, require a written managerial approval by the immediate manager or higher-level official of the employee who initially proposed the penalty.

The idea behind Section 6751(b) is to bring some restrain in the imposition of penalties by the “trigger-happy” employees. The extra level of review is further meant to promote the image of fairness of process during the imposition of the IRS Civil Penalties.

Conclusion: Encouragement of Voluntary Compliance Remains A Priority in General but the Emphasis on Abusive Transactions Dominates International Tax Law Compliance

Now that we have analyzed the IRS Civil Penalties from a historical perspective, let’s return to the original questions that I posed at the beginning of this article: does the growth in the number of the IRS civil penalties mean that our tax system is shifting its focus from encouraging voluntary compliance to punishing abusive behavior?

Based on the IRS past efforts to improve the taxpayer’s perception of the tax system and civil penalties and the Congress’ effort to encourage voluntary compliance through laws like IMPACT, one can say that, in general, the encouragement of voluntary compliance remains the main purpose of the IRS civil penalties.

There is one area, however, where the application of civil penalties has been driven not by only voluntary compliance considerations, but also by the desire to punish certain modes of behavior. This area is international tax law and, more precisely, abusive offshore transactions.

In fact, it appears more and more that the focus of the current tax policy is on punishing abusive offshore transactions irrespective of how it may affect innocent taxpayers. Since 2001, millions of taxpayers found themselves potentially facing draconian FBAR penalties solely for not reporting their foreign accounts. Thousands of small businesses also face large penalties associated with Forms 5471 and 8865 as well as other US international information return penalties. Finally, FATCA Form 8938 created with a new array of penalties and an added compliance burden to US taxpayers.

The fact that all of these forms may be necessary is not the issue. The problem is that the application of these forms has been indiscriminate almost irrespective of the actual income tax impact and the net worth of the taxpayer. For example, small businesses now have to comply with the burden of US GAAP compliance (normally applied only to publicly-traded companies) on Form 5471 or face severe IRS civil penalties for noncompliance. One non-willfully unreported foreign account which could have produced a few dollars of interest may be subject to a $10,000 FBAR penalty.

Naturally, the disproportionate and imprecise application of the IRS civil penalties in the area of the US international tax compliance has generated a great amount of discontent and resentment among the affected US taxpayers. This is precisely what IMPACT tried to avoid in order to encourage voluntary compliance.

This is why the IRS and Congress should work together to make the application of the IRS civil penalties more precise with respect to who should be paying these penalties and more proportionate to the actual fault (i.e. the damage sustained by the US treasury).

Form 872 Refund Claims | Foreign Accounts International Tax Lawyer

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The subject of this article is the discussion of the Form 872 Refund Claims, particularly whether filing Form 872 can extend the time for the taxpayer to claim a refund for the relevant years. Stated broadly, the key question that this article seeks to explore is whether an extension of time for assessment of tax can effect the taxpayer’s ability to file a refund claim for the extended years.

Form 872 Refund Claims – Form 872 and Offshore Voluntary Disclosures

Form 872 is a form used by the IRS to obtain the consent from the taxpayer to extend the time to assess tax. This consent can be obtained for income tax, self-employment tax of FICA tax on tips.

The form is used in a great variety of cases, but, in the US international tax context, it is mostly known for its use in the IRS Offshore Voluntary Disclosure Program (OVDP) now closed. Form 872 is in fact obligatory in the OVDP due to the fact that the OVDP voluntary disclosure period is eight years whereas the standard statute of limitations is only three years (even with 25% gross income, there are still at least two years that cannot be opened by the IRS without claiming fraud). Moreover, Form 872 is also used to prevent the statute of limitations from expiring for the rest of the years while the OVDP case is pending.

Form 872 Refund Claims: Form 872 Extends the Statute of Limitations for Refund Claims

According to IRC §6511(c), if the taxpayer and the IRS agree to extend the time within which the IRS can assess a tax, the taxpayer receives a corresponding extension of the time within which he may file a credit or refund claim. Form 872 itself states in paragraph 4 that:

Without otherwise limiting the applicability of this agreement, this agreement also extends the period of limitations for assessing any tax (including penalties, additions to tax and interest) attributable to any partnership items (see section 6231 (a)(3)), affected items (see section 6231(a)(5)), computational adjustments (see section 6231(a)(6)), and partnership items converted to nonpartnership items (see section 6231(b)). Additionally, this agreement extends the period of limitations for assessing any tax (including penalties, additions to tax, and interest) relating to any amounts carried over from the taxable year specified in paragraph (1) to any other taxable year(s). This agreement extends the period for filing a petition for adjustment under section 6228(b) but only if a timely request for administrative adjustment is filed under section 6227. For partnership items which have converted to nonpartnership items, this agreement extends the period for filing a suit for refund or credit under section 6532, but only if a timely claim for refund is filed for such items.

Limitations on Form 872 Refund Claims

There is an important limitation on Form 872 Refund Claims. Form 872 Refund Claims will only be accepted if the extension agreement is entered into before the expiration of the claim period. See IRC §6511(c)(1). This means that, if Form 872 is entered into by the parties by the time that the statute of limitations had already expired, the taxpayer is unlikely to succeed in his Form 872 Refund Claims.

The Form 872 agreement becomes effective when signed by the taxpayer and the District Director or an Assistant Regional Commissioner (See Treas. Reg. § 301.6511(c)-1).

Let’s look at a basic example to understand this limitation on Form 872 Refund Claims better.  Let’s suppose that a taxpayer X filed his 2003 US tax return on April 15, 2004. In March of 2007, the IRS decided to audit X’s 2003 US tax return and Form 872 was entered into by both parties at that time. In this case, without an agreement (and absent other special circumstances such as foreign tax credit issues, 25% under-reporting of income, et cetera), the presumed expiration of the assessment period would be on April 15, 2007; similarly, X’s refund claim period would have expired on April 15, 2007. Since Form 872 was entered into by both parties in March of 2007 (i.e. prior to the expiration of the normal refund claim period), however, X can file his Form 872 refund claims during the period that covers the duration of the extension plus six months thereafter.

Time to File Form 872 Refund Claims

As it was hinted in the example above, the period within which a taxpayer may file a credit or refund claim arising from the tax liability covered by Form 872 is extended for the period of the extension plus an additional six months. See IRC §6511(c)(1).

What Can Be Claimed on Form 872 Refund Claims

With respect to timely Form 872 Refund Claims, the taxpayer can claim an amount limited to the amount that would have been allowable under the normal limitation rules if the claim had been filed on the date the agreement was executed AND any tax paid after the execution of the agreement but before the filing of the claim. IRC §6511(c)(2).

What is the amount allowable under the normal limitation rules? It varies widely based on for what the refund is claimed (i.e. the type of the claim) and what is the filing period. For example, if Form 872 Refund Claims are filed within the three-year filing period, the amount of the refund or credit is limited to the tax paid on the liability at issue within the three years immediately preceding the filing of the claim plus the period of any extension of time for filing the return. IRC §6511(b)(2)(A). On the other hand, Form 872 Refund Claims based on a foreign tax credit adjustment can be granted many years back because the statute of limitations is ten years.

Form 872 Cannot Reduce the Claim Period for Form 872 Refund Claims

One final point that should be mentioned is that Form 872 and any other agreement to extend the assessment period cannot reduce the refund and credit claim period. The law clearly states that, when an extension agreement is executed, the taxpayer’s claim period shall not expire before the expiration of the additional assessment period plus six months.

Contact Sherayzen Law Office for Help With Your Form 872 Refund Claims

If you entered into a Form 872 agreement to extend the time to assess tax (whether as a result of OVDP, opt-out OVDP audit, FBAR Audit or regular audit) or any other type of agreement to extend the assessment period, contact Sherayzen Law Office for help with filing your Form 872 refund claims.