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Noncompetition Agreement Income Sourcing | International Tax Lawyer

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Oftentimes, as part of their noncompetition agreement, a taxpayer may receive income for restraining from competing with another party in certain areas. An issue often arises with respect to international noncompetition agreement income sourcing rules – i.e. should the income paid as part of such a noncompetition agreement be considered US-source income or foreign-source income? Let’s explore the answer to this question in this essay.

Noncompetition Agreement Income Sourcing: General Rule

The general rule with respect to income sourcing for noncompetition agreements was settled in the distant year 1943. In that year, the Tax Court held that the source of income from a noncompetition agreement is the location of the forbearance. Korfund Co., Inc. v. Commissioner, 1 T.C. 1180, 1187 (1943). In other words, income received from an agreement not to compete is deemed to be income earned in a place where the agreement prohibits the taxpayer from competing.

The reasoning of the Tax Court is clearly laid out in its opinion. The Court stated that the rights that a party enjoys from the noncompetition agreement “were interests in property in [the] country [of forbearance]. … The situs of the right was in the United States, not elsewhere, and the income that flowed from the privileges was necessarily earned and produced here. … These rights were property of value and the income in question was derived from the use thereof in the [country of forbearance].” Id.

In 1996, in its Field Service Advice, the IRS restated its commitment to the position adopted by the Tax Court in Korfund: “income from covenants not to compete covering areas outside of the United States is foreign source income because the income from a covenant covering areas outside the United States is from the use of a property right outside the United States.” 1996 FSA LEXIS 191, *5 (I.R.S. August 30, 1996).

Noncompetition Agreement Income Sourcing: Apportionment

What if a noncompetition agreement covers both, part of the United States and a foreign country? In this case, the IRS is likely to take a position that an apportionment of some sort is necessary. In other words, only part of the income will be deemed as US-source income, while the rest will be considered foreign-source income.

Contact Sherayzen Law Office for Professional Help With Noncompetition Agreement Income Sourcing

If you are dealing with an international noncompetition agreement, you should contact Sherayzen Law Office for professional help with US international tax compliance. Our firm has helped hundreds of US taxpayers around the world with their US international tax issues. We Can Help You!

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Mexican Bank Accounts & US Tax Obligations | International Tax Lawyers

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In this essay, I would like to discuss three main US tax obligations concerning Mexican bank accounts: the worldwide income reporting requirement, FBAR and Form 8938. I will only concentrate on the obligations concerning individuals, not business entities.

Mexican Bank Accounts and US Tax Residents

Before we delve into the discussion concerning US tax obligations, we should establish who is required to comply with these obligations. In other words, who needs to report their Mexican bank accounts to the IRS?

The answer to this question is clear: US tax residents. Only US tax residents must disclose their worldwide income and report their Mexican bank accounts on FBAR and Form 8938. Non-resident aliens who have never declared themselves as US tax residents do not need to comply with these requirements.

US tax residents include US citizens, US Permanent Residents, an individual who satisfied the Substantial Presence test and an individual who properly declares himself a US tax resident. This is, of course, the general rule; important exceptions exist to this rule.

Mexican Bank Accounts: Worldwide Income Reporting Requirement

US tax residents must disclose their worldwide income on their US tax returns, including any income generated by Mexican bank accounts. In other words, all interest, dividend and royalty income produced by these accounts must be reported on Form 1040. Similarly, any capital gains from sales of investments held in Mexican bank accounts should also be disclosed on Form 1040. US taxpayers should pay special attention to the reporting of PFIC distributions and PFIC sales.

It is also possible that you may have to disclose passive income generated by your Mexican business entities through the operation of Subpart F rules and the GILTI regime, but this is a topic for a separate discussion.

Mexican Bank Accounts: FBAR

US tax residents must disclose on FBAR their ownership interest in or signatory authority or any other authority over Mexican bank and financial accounts if the aggregate highest balance of these accounts exceeds $10,000. FBAR is a common acronym for the Report of Foreign Bank and Financial Accounts, FinCEN Form 114. Even though this is a FinCEN Form, the IRS is charged with the enforcement of this form since 2001.

While seemingly simple, FBAR contains a number of traps for the unwary. One of the most common trap is the definition of “account”. For the FBAR purposes, “account” has a much broader definition than what people generally think of as an account. ‘Account” includes not just regular checking and savings accounts, but also investment accounts, life insurance policies with a cash surrender value, precious metals accounts, earth mineral accounts, et cetera. In fact, it is very likely that the IRS will find that an account exists whenever there is a custodial relationship between a financial institution and a US person’s foreign asset.

FBAR is a very dangerous form. Not only is the filing threshold very low, but there are huge penalties for FBAR noncompliance. For a willful violation, the penalties can go up to $100,000 (adjusted for inflation) per account per year or 50% of the highest value of the account per year, whichever is higher. In special circumstances, the IRS may refer FBAR noncompliance to the US Department of Justice for criminal prosecution. Even non-willful FBAR penalties may go up to $10,000 (again, adjusted for inflation) per account per year.

Mexican Bank Accounts: FATCA Form 8938

The final requirement that I wish to discuss today is the FATCA Form 8938. Born out of the Foreign Account Tax Compliance Act, Form 8938 occupies a unique role in US international tax compliance. On the one hand, it may result in the duplication of a taxpayer’s US tax disclosures (especially with respect to the accounts already disclosed on FBAR). On the other hand, however, Form 8938 is a “catch-all” form that fills the compliance gaps with respect to other US international tax forms.

For example, if a taxpayer holds a paper bond certificate, this asset would not be reported on FBAR, because it is not an account. For the Form 8938 purposes, however, the IRS would consider this certificate as part of assets that fall within the definition of the Specified Foreign Financial Assets (“SFFA”).

Hence, the scope of Form 8938 is very broad. It requires a specified person (this term is almost equivalent to a US tax resident) to disclose all SFFA as long as these SFFA, in the aggregate, exceed the applicable filing threshold.

SFFA includes a huge variety of foreign financial assets which are divided into two sub-categories: (a) foreign bank and financial accounts; and (b) “other” foreign financial assets. The definition of the “other” assets is impressive in its breadth: bonds, stocks, ownership interest in a closely-held business, beneficiary interest in a foreign trust, an interest rate swap, currency swap; basis swap; interest rate cap, interest rate floor, commodity swap; equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty; an option or other derivative instrument with respect to any currency or commodity that is entered into with a foreign counterparty or issuer; and so on.

Form 8938 requires not only the reporting of SFFA, but also the income generated by the SFFA. In essence, the worldwide income reporting requirement is incorporated directly into the form.

The filing threshold for Form 8938 is more reasonable than that of FBAR for specified persons who reside in the United States, but it is still fairly low (especially for individuals). For example, if a taxpayer lives in the United States, he will need to file Form 8938 if he has SFFA of $50,000 ($100,000 for a married couple) or higher at the end of the year or $75,000 ($150,000 for a married couple) or higher during any time during the year. Specified persons who reside outside of the United States enjoy much higher thresholds.

Form 8938 has its own penalty system which contains some unique elements. First of all, a failure to comply with the Form 8938 requirements may allow the IRS to impose a $10,000 failure-to-file penalty which may go up to as high as $50,000 in certain circumstances. Second, Form 8938 noncompliance will lead to an imposition of much higher accuracy-related penalties on the income tax side – 40% of the additional tax liability. Third, Form 8938 noncompliance will limit the taxpayer’s ability to utilize the Foreign Tax Credit.

Finally, a failure to file Form 8938 will directly affect the Statute of Limitations of the entire tax return by extending the Statute to the period that ends only three years after the form is filed. In other words, Form 8938 penalties may allow the IRS to audit tax years which otherwise would normally be outside of the general three-year statute of limitations.

Contact Sherayzen Law Office for Professional Help With the US Tax Reporting of Your Mexican Bank Accounts

Sherayzen Law Office’s core area of practice is international tax compliance, including offshore voluntary disclosures – i.e. helping US taxpayers with foreign assets and foreign income to stay in US tax compliance and, if a taxpayer fails failed to comply with US tax laws in the past, bring him into compliance through an offshore voluntary disclosure. We can help You!

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The IRS Large Business and International Division Organizational Structure

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Almost two years ago, the IRS Large Business and International Division announced long-term changes in its structure as well as its approach to tax enforcement. In the fall of 2015, the IRS completed the first phase of the structural changes in the Division – re-organization of its administrative structure. This structure exists intact today and we fully expect for it to last for a long while. Let’s discuss this current administrative structure of the IRS Large Business and International Division.

IRS Large Business and International Division: Areas of Responsibility

The IRS Large Business and International Division forms a huge part of the IRS. First, it is responsible for the tax compliance enforcement (US domestic and US international) with respect to all corporations, subchapter S corporations, and partnerships with assets greater than $10 million. Most of these businesses employ a large number of employees and their business affairs involve complex accounting principals and tax laws. Second, the Division deals with individual international tax compliance, including offshore voluntary disclosures.

Current Organization of the IRS Large Business and International Division

The IRS Large Business and International Division is currently organized into Support Areas (a smaller part of the Division) and Practice Areas.

The Support areas concentrate on supporting the Practice Areas through data analysis and integrated feedback loop (which is a highly important feature that was incorporated into the Division’s reorganization plan in 2015). The Support areas include Headquarters, Program and Business Solutions (including Technology and Program Solutions and Resource Solutions), Compliance Integration (including Data solutions and the highly-important Compliance Planning and Analytics) and Assistant Deputy Commissioner – International.

The second part of the IRS Large Business and International Division is divided into five Practice Areas and four Compliance Practice Areas. The Practice Areas include: (1) Cross Border Activities, (2) Enterprise Activity, (3) Pass-Through Entities, (4) Treaty and Transfer Pricing Operations and (5) Withholding and International Individual Compliance. US international tax compliance concerns are especially important in areas 1, 4 and 5.

The Compliance Practice Areas basically represent a geographical division of the United States into four tax enforcement areas: Central (which consists of North Central and South Central Fields), Eastern (which consists of Great Lakes and Southeast Fields), Northeastern (which includes North-Atlantic and Mid-Atlantic Fields) and, finally, Western (which includes West and Southwest Fields).

The IRS Large Business and International Division Reorganization Now Entered Into the Second Phase

Since January 31, 2017, the IRS Large Business and International Division reorganization commenced the second phase with the enaction of the first thirteen issue-based IRS Compliance Campaigns. These campaigns represent a new approach to tax enforcement that is believed to fit best the new administrative structure of the division. In the near future, Sherayzen Law Office will update its website with articles dedicated to this important new development.

Hiding Assets and Income in Offshore Accounts Again Made the IRS “Dirty Dozen” List

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On February 5, 2016, the IRS again stated that avoiding U.S. taxes by hiding money or assets in unreported offshore accounts remains on its annual list of tax scams known as the “Dirty Dozen” for the 2015 filing season.

The problem with offshore accounts is two-fold. On the one hand, there are numerous con-artists who use offshore accounts to lure taxpayers into scams and schemes. The second and a much larger problem for the IRS is the fact that many U.S. taxpayers used offshore account to hide assets and income from the IRS.

Fighting the strategy of using offshore accounts to hide assets and income has been one of the top priorities of the IRS since the early 2000s. The problem has been complicated by the fact that there are many legitimate reasons for having an offshore account – a fact that, unfortunately, has been largely ignored by journalists and the public opinion in the United States. Therefore, it is necessary for the IRS to approach the problem of offshore accounts carefully in order to avoid hurting innocent people.

Over the years, the IRS (with the help of Congress) has chosen five different and interrelated strategies to fight tax evasion through offshore accounts.

1. IRS Civil and Criminal Enforcement

IRS examinations, audits, subpoenas, and criminal enforcement play a central role in the IRS war against using offshore accounts to hide assets and income. The ability of the IRS to enforce U.S. tax laws is amazingly broad and the IRS will use it whenever it wishes.

Since 2009, the IRS conducted thousands of offshore-related civil audits that have produced tens of millions of dollars. The IRS has also pursued criminal charges leading to billions of dollars in criminal fines and restitutions.

Hence, brute force still looms large in fighting tax evasion through offshore accounts and creates enormous (and fully justified) fear in the hearts of many U.S. taxpayers. This fear is also central to the IRS ability to use the other four strategies listed below.

2. Extensive Reporting Requirement for Owners of Offshore Accounts

As owners of offshore accounts have already noticed, the number of reporting requirements with respect to offshore accounts has risen dramatically. In addition to FBAR (which has existed since the 1970s), FATCA introduced Form 8938 in 2011. Furthermore, Form 8621 and Schedule B to Form 1040 have been modified to require additional reporting with respect to offshore accounts. Other forms also indirectly require reporting of foreign accounts (through reporting of ownership or a beneficial interest in a foreign entity or a foreign trust).

By forcing U.S .taxpayers to do extensive reporting with respect to their offshore accounts, the IRS has achieved two goals at the same time. First, it has collected an enormous amount of information with respect to U.S. offshore accounts and their owners. This information can be used in a later investigation to track fund and identify patterns of behavior. In a short while, due to the implementation of FATCA in many jurisdictions around the world, this information will also be used to compare the banks’ information with the information provided by the taxpayers on their information returns.

Second, the enormous fines associated with offshore accounts reporting can create huge tax liabilities for noncompliant taxpayers. This provides the IRS with a financial incentive to pursue these taxpayers. These potentially disastrous noncompliance fines also serve to deter many taxpayers from engaging in risky tax evasion schemes.

Of course, one of the biggest problems associated with these reporting requirements is that the majority of persons, including tax accountants, never heard of them until they were already in trouble. When the IRS pressure started to rise, it was already too late for a lot of U.S. taxpayers to do simply current compliance and they had to pay fines to the IRS. It is important to emphasize that the process is by no means over – on the contrary, as the complexity of U.S. tax compliance continues to rise, a lot of taxpayers (and their accountants) still do not know about a lot of these requirements.

3. Voluntary Disclosures

In order to alleviate the reporting noncompliance nightmares for U.S .taxpayers, the IRS created a number of voluntary disclosure programs. The early programs were not very successful; however, after the IRS stunning victory in the 2008 UBS case, the 2009 Offshore Voluntary Disclosure Initiative (OVDI) turned out to be a huge success. The 2011 OVDP, 2012 OVDP and 2014 OVDP with 2014 Streamlined Compliance Procedures followed in quick succession and with even bigger success. Since 2009, more than 54,000 OVDP disclosures took place and the IRS has collected more than $8 billion; this is not taking into account the huge surge in Streamlined disclosures since 2014.

The information that has been collected through OVDP is used to identify noncompliant individuals and entire schemes to evade U.S. taxes through offshore accounts. The IRS then uses this information to pursue taxpayers with undeclared offshore accounts, as well as the banks and bankers suspected of helping clients hide their assets overseas using offshore accounts. The IRS works closely with the Department of Justice (DOJ) to prosecute these tax evasion cases.

4. Swiss Bank Program

In addition to the voluntary disclosure program for individuals, the IRS also created a voluntary disclosure program for Swiss banks. Such voluntary disclosure program is, of course, an unprecedented event – never in history did one country force another country’s entire bank system to do a voluntary disclosure on the territory of that other country.

While the debate over this breach of Swiss sovereignty (although, technically, the Swiss government agreed to the Swiss Bank Program) is interesting, for the purposes of this article, it is important to note that Swiss Bank program was a huge step forward in attacking the usage of offshore accounts to hide assets and income.

By the end of February of 2016, about 80 Swiss banks went through Category 2 voluntary disclosure and paid penalties to the U.S. government. They also turned over enormous amount of information regarding their U.S. accountholders and the various schemes that Swiss bankers developed to hide assets and funds from the IRS. In essence, the Swiss bankers turned over to the IRS substantially all of the blueprints for tax evasion that they had created.

5. FATCA

The final major strategy for fighting the practice of using offshore accounts to hide assets and income from the IRS is the famous Foreign Account Tax Compliance Act or FATCA. Ever since FATCA entered into force, it has changed the global landscape of international tax compliance. One of the most salient features of FATCA is the fact that it forces foreign banks to report to the IRS all of the offshore accounts that they can identify as owned by U.S. persons.

This groundbreaking piece of legislation has had an enormous impact on the ability of the IRS to identify noncompliance by U.S. persons, because foreign banks now act as its agents and voluntarily disclose U.S. persons and their offshore accounts.

Contact Sherayzen Law Office for Help With Your Offshore Accounts

If you have undisclosed offshore accounts, you should contact Sherayzen Law Office as soon as possible. We have helped hundreds of U.S. taxpayers to bring their U.S. tax affairs in order while saving millions of dollars in potential penalty reductions. We furthermore help to reduce your income tax liability as a result of your voluntary disclosure and post-voluntary disclosure tax planning.

Contact Us NOW to Schedule Your Initial Consultation!

IRS Notice 2014-52 Regarding Inversions and “Hopscotch Loans”

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On September 22, 2014, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued Notice 2014-52, “Rules Regarding Inversions and Related Transactions” (“Notice”) in the wake of recent inversions conducted by many US companies such as by Medtronic, Chiquita Brands, Pfizer and others.  Treasury and the IRS highlighted in the Notice that they were “concerned that certain recent inversion transactions are inconsistent with the purposes of sections 7874 and 367 of the Internal Revenue Code… certain inversion transactions are motivated in substantial part by the ability to engage in certain tax avoidance transactions after the inversion that would not be possible in the absence of the inversion.”

To address these concerns regarding inversions, Treasury and the IRS announced in the Notice that they intend to issue new regulations under Internal Revenue Code (“IRC”) Sections 304(b)(5)(B), 367, 956(e), 7701(l), and 7874. In this article we will briefly explain the new regulations intended to be issued under IRC Section 956 that seek to prevent the avoidance of tax in this section “[T]hrough post-inversion acquisitions by controlled foreign corporations (“CFC’s”) of obligations of (or equity investments in) the new foreign parent corporation or certain foreign affiliates”. Such obligations are also commonly referred to as “Hopscotch loans”. Notice Section 3.01, “Regulations to Address Acquisitions of Obligations and Stock that Avoid Section 956” specifically addresses such issues.

This article is intended to provide explanatory material regarding the new inversion regulations as they relate to IRC Section 956 aspects; the article does not convey legal or tax advice. Please contact experienced international tax attorney Eugene Sherayzen for questions about your tax and legal needs.

Inversions and the Use of “Hopscotch Loans” to Avoid U.S. Taxation under Pre-Notice Rules

In general, under IRC Section 956, if a CFC subsidiary of a U.S. parent makes a loan to (or equity investment in) the U.S. parent, it will be treated as a deemed repatriation of the CFC’s earnings and profits, even though no actual dividend may be distributed. IRC Section 956(c)(1) specifically provides that U.S. property is “[A] any property acquired after December 31, 1962, which is… (B) stock of a domestic corporation; (C) an obligation of a United States person…” (See Section 956 for additional definitions of “U.S. property” for the purposes of this provision).

This deemed repatriation will be taxable to the CFC’s U.S. shareholders. As stated in the Notice, the taxable amount for any taxable year is the lesser of, “(1) the excess (if any) of—(A) such shareholder’s pro rata share of the average of the amounts of United States property held (directly or indirectly) by the controlled foreign corporation as of the close of each quarter of such taxable year, over (B) the amount of earnings and profits described in section 959(c)(1)(A) with respect to such shareholder, or (2) such shareholder’s pro rata share of the applicable earnings of such controlled foreign corporation.”

This is why many U.S. parents and CFC subsidiaries sought to avoid taxation by doing inversions in which new foreign parent companies would be formed that were not CFCs; the existing CFC would then make a loan to the new foreign parent (the “Hopscotch loan”), and the amount could at some future point then be lent to the former U.S. parent. As Treasury and the IRS stated in the Notice, “The ability of the new foreign parent to access deferred CFC earnings and profits would in many cases eliminate the need for the CFCs to pay dividends to the U.S. shareholders, thereby circumventing the purposes of section 956.”

Changes to Inversions under Notice 2014-52, Section 3.10(b)

Under IRC Section 956(e) the Treasury Secretary is directed to prescribe regulations to prevent tax avoidance of the provisions of section 956 through reorganizations or otherwise, and the Notice specified that inversions constitute such transactions. To address the inversions strategy, Treasury and the IRS noted that they intend to issue regulations, “[P]roviding that, solely for purposes of section 956, any obligation or stock of a foreign related person (within the meaning of section 7874(d)(3) other than an “expatriated foreign subsidiary”) (such person, a “non-CFC foreign related person”) will be treated as United States property within the meaning of section 956(c)(1) to the extent such obligation or stock is acquired by an expatriated foreign subsidiary during the applicable period (within the meaning of section 7874(d)(1)).”

An “expatriated foreign subsidiary” is defined in the Notice (except as provided in the succeeding paragraph) as a “CFC with respect to which an expatriated entity… is a U.S. shareholder”, but it does not include a “CFC that is a member of the EAG immediately after the acquisition and all transactions related to the acquisition are completed (completion date) if the domestic entity is not a U.S. shareholder with respect to the CFC on or before the completion date” (“EAG” is defined in the Notice to mean an “expanded affiliated group”). Additionally, under the Notice, “[A]n expatriated foreign subsidiary that is a pledgor or guarantor of an obligation of a non-CFC foreign related person under the principles of section 956(d) and §1.956-2(c) will be considered as holding such obligation.”

Effective Dates of the New Regulation Concerning Inversions

Subject to certain exceptions, the regulations under Notice section 3.01(b), “[W]ill apply to acquisitions of obligations or stock of a non-CFC foreign related person by an expatriated foreign subsidiary completed on or after September 22, 2014, but only if the inversion transaction is completed on or after September 22, 2014.”

Contact Sherayzen Law Office for Help With International Tax Matters

International tax matters often involve very complex issues, and it is advisable to seek the assistance of a tax attorney in this area. If you have questions regarding taxation of CFC’s, are in need of international tax planning, or have any other tax and legal questions, please contact Sherayzen Law Office, Ltd.