Introduction to US International Tax Anti-Deferral Regimes

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Despite their enormous importance to tax compliance, there is a shocking level of ignorance of the US international tax anti-deferral regimes that is being displayed by US taxpayers, foreign bankers, foreign accountants, foreign attorneys, US accountants and even many US tax attorneys. In this article, for educational purposes only, I would like to provide a brief overview of the history and features of the main US international tax anti-deferral regimes.

What is a US International Tax Anti-Deferral Regime?

A US international tax anti-deferral regime is a set of US tax laws designed to prevent US taxpayers from utilizing various offshore strategies to defer US taxation of their income for a period of time or indefinitely.

Three Main US International Tax Anti-Deferral Regimes

Since 1937, there have been three main US international tax anti-deferral regimes: Foreign Personal Holding Company (“FPHC”) rules, subpart F rules, and PFIC rules. Let’s review the brief history and main features of each of these US international tax anti-deferral regimes.

First US International Tax Anti-Deferral Regime: FPHC

In 1937, the Congress for the first time addressed the offshore investment strategy problems by enacting the FPHC regime, which were designed to contemporaneously (i.e. in the year the income was earned) tax certain types of foreign corporations. In particular, FPHC rules targeted foreign corporations that had substantial investment income (i.e. passive income) compared to active business income – i.e. the FPHC rules effectively treat certain corporations as pass-through companies for the purposes of certain categories of passive income..

The FPHC rules were triggered only if both conditions of the then-Code §552(a) were satisfied. First, at least 60% of a foreign corporation’s gross income from the taxable year had to consist of “foreign personal holding company income”. The FPHC income included interest income, dividends, royalties, gains from the sale of securities or commodities, certain rents and certain income from personal services provided by shareholders of the FPHC. This was called the “income test”.

The second condition of the §552(a) was known as the “ownership test”. The ownership test was satisfied if at least 50% of either the total voting power or total value of the stock of the foreign corporation was owned by 5 or fewer individuals who were citizens or residents of the United States.

Despite the appearances, the FPHC regime was not very effective. It was actually not very hard to work around the FPHC rules with careful and creative tax planning. This is why, after the enactment of the Subpart F rules and the PFIC rules (which addressed some of the main inefficacies of the FPCH rules and made them redundant as a US international tax anti-deferral regime), the FPHC regime was finally repealed in the year 2004.

Second US International Tax Anti-Deferral Regime: Subpart F Rules

The second US international tax anti-deferral regime, the Subpart F rules, was enacted in 1962 and, despite numerous amendments, forms the core of the anti-deferral rules with respect to Controlled Foreign Corporations (“CFCs”). It is definitely one of the most important and complex pieces of US tax legislation.

The most important feature of the Subpart F regime is that it greatly expands the scope of the former FPHC regime by expanding the contemporaneous (i.e. pass-through) taxation to a much broader range of income and activities, including many kinds of active business activities as well as passive investment activities of a foreign corporation. Obviously, the focus of this US international tax anti-deferral regime is still on passive income or attempts to disguise passive income as active income.

Third US International Tax Anti-Deferral Regime: PFIC Rules

The third US international tax anti-deferral regime consists of the passive foreign investment company (“PFIC”) rules that were adopted by US Congress in 1986. Perhaps because it is the youngest of all US international tax anti-deferral regimes, the PFIC regime is more aggressive and less forgiving than Subpart F rules or FPHC regime. A lot of innocent taxpayers have fallen victims to this severe law.

The PFIC rules impose a unique additional US income tax in two circumstances: where (1) there is a gain on the disposition of the PFIC stock by the US person; or (2) there are PFIC distributions that are considered “excess distributions”. The PFIC rules also impose an additional PFIC interest (calculated similarly to underpayment interest) on the PFIC tax.

The definition of a PFIC is in some ways reminiscent of FPHC rules, but the PFIC regime is a lot more aggressive. Generally, a PFIC is any foreign corporation if it meets either the income tax or the assets test. The income tax is met if 75% of a foreign corporation’s gross income is passive; the assets test is satisfied if at least an average of 50% of a foreign corporation’s assets produce passive income.

Notice that the PFIC rules apply irrespective of the US ownership percentage of the company. This elimination of the FPHC and Subpart F ownership rules makes PFIC rules a much more comprehensive US international anti-deferral tax regime, because it is very easy to trigger PFIC rules – a lot of US naturalized citizens and permanent residents fall into the PFIC trap by simply owning foreign mutual funds as part of their former home countries’ investment portfolio.

Contact Sherayzen Law Office for Professional Help With Dealing with US International Tax Anti-Deferral Regimes

If you have an ownership interest in a foreign business or have foreign investments, you may be facing the extremely complex rules of US international tax anti-deferral regimes.

Please contact Mr. Eugene Sherayzen, an experienced international tax attorney at Sherayzen Law Office. Our international tax firm has helped hundreds of clients around the globe and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

US International Tax Attorney On The Necessity of Anti-Deferral Regimes

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As a US international tax attorney, I am fully aware of the crucially important role that the US international tax anti-deferral regimes (the Subpart F rules and PFIC rules) play in the Internal Revenue Code. Yet, the enormous complexity of the US international anti-deferral regimes often makes some people wonder about why we even have them.

As a US international tax attorney, I feel that it is important to educate the general public about the necessity of the anti-deferral regimes and how this necessity is deeply grounded in our tax system. I also wish to address here the issue of why the US anti-deferral regimes are so complex.

US International Tax Attorney: Anti-Deferral Regimes are a Natural Product of Our Tax System

The anti-deferral regimes is a natural legislative response to the anti-deferral strategies that originate from the deep policy contradictions that form the core of the US tax system. The most important of these contradictions arose from the recognition of income rules.

Generally, the US government imposes an income tax only when income is “recognized.” The recognition rules are complex, but there is a basic asymmetry in the treatment of individuals and corporation. On the one hand, US citizens are taxed on their worldwide income which is usually (though, with important exceptions) recognized when it is earned.

On the other hand, in general and without taking into account any anti-deferral regimes, the individuals are not be taxed on the corporate income (even if this is a one-hundred percent owned corporation) until: (a) the income is distributed (for example, as a dividend), or (b) the shares of the corporation are sold.

In the past, US international tax attorneys would combine these rules with the fact that, in general, foreign corporation would not be subject on foreign-source income earned outside of the United States, to build an effective investment strategy – contribution of all investment assets to a foreign corporation in order to avoid current US taxation of the taxpayers’ investment income. If a US international tax attorney was able to extend this strategy indefinitely, then it brought his clients benefits almost as valuable as not paying taxes at all.

Obviously, such an indefinite offshore deferral of US taxation of otherwise taxable income was not considered consistent with the fundamental goals and policies of US government. This is why the US Congress deemed it necessary to enact various anti-deferral regimes to combat offshore tax avoidance.

US International Tax Attorney: Why Are There Two Anti-Deferral Regimes Instead of One?

Even a US international tax attorney would agree that having multiple esoteric anti-deferral regimes with complex interrelationship between each other cannot be the best way to combat offshore tax avoidance investment strategies. Yet, this is our present reality and it is important to understand why this is the case.

There are four reasons for having multiple anti-deferral regimes. First, the US Congress did not create all of the anti-deferral regimes at the same time. Rather, the anti-deferral regimes appeared gradually over time with multiple amendments and shifting IRS interpretations.

Second, undoubtedly, the political influence of various lobbies with competing policies has greatly hampered the creation of a more transparent anti-deferral regime and elimination of many loopholes and exceptions.

Third, as I explained above, the offshore investment policies arose from the basic contradiction between different income recognition rules of the Internal Revenue Code. This contradiction in itself necessitates a more complex approach to combating any strategies of US international tax attorneys that seek to exploit it. It is difficult to do so with only one anti-deferral regime.

Finally, the combination of the sheer complexity of international commerce, conflicting policy priorities (for example, Congress does not want to stifle the US companies’ ability to compete overseas just for the purpose of completely closing off some offshore investments) and the great variety of various fact patterns makes it virtually impossible to address the offshore investment strategies in a simple way. This factor partially explains why there is such a variety of international tax rules that form part of the anti-deferral regimes.

Contact Sherayzen Law Office for Help with Anti-Deferral Regime Compliance and Planning

If you are a US person who owns a foreign business or foreign brokerage accounts, you are very likely to run into either Subpart F rules or PFIC rules. At this point, the extremely complex nature of these anti-deferral regimes makes it a reckless gamble to attempt to conduct business overseas without an advice from an experienced US international tax attorney.

This is why you should contact the experienced US international tax professionals of Sherayzen Law Office. We have helped clients around the globe to comply with and plan for the US anti-deferral regimes, and we can help you!

So, Contact Us Today to Schedule Your Initial Consultation!

FATCA Compliance Presents Challenges for Hedge Funds

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The Foreign Account Tax Compliance Act (FATCA) created a worldwide international tax compliance regime that has influenced more industries than simply foreign financial institutions. FATCA compliance presents a formidable challenge even to hedge funds.

FATCA Compliance Challenges for Hedge Funds

The challenges that FATCA compliance poses to hedge funds is best understood by analyzing what FATCA compliance requires of hedge funds – a multi-group coordination effort from various divisions within a business enterprise: business, operations, technology, finance and compliance.

The compliance department, most likely with the cooperation of the in-house counsel (and outside counsel who specializes in FATCA compliance, if in-house counsel lacks such knowledge) should lay out the FATCA compliance goals and make sure that the FATCA compliance process complies with these goals. The operations division should create the framework for the FATCA compliance process, including how this process should be controlled and managed for tax reporting and tax withholding purposes. The technology division needs to build the IT infrastructure to address the technological challenges of FATCA goals in a cost-effective way. The members of the business division (which incorporates the actual customer intake) should be thoroughly educated in the FATCA compliance process as well as the company’s specific IT solutions.

When this FATCA compliance process is applied to the hedge fund industry, one can clearly see the numerous challenges that the hedge funds face in the implementation of their FATCA compliance. The hedge funds need to register their funds for FATCA on the IRS portal, gather various investor data with respect to numerous (and often changing) customers, review and assess such data, and properly report customer data to the IRS.

Another challenge for hedge funds is the required tax withholding. Unlike previous attempts at international tax legislation, FATCA has very effective enforcement mechanisms which forces all US banks, brokers and financial institutions to essentially work for the IRS, including withholding taxes. In fact, the hedge funds that deal in US dollars are likely to be subject to the withholding tax requirement at an increasing rate in the near future.

However, the tax withholding challenge for hedge funds goes far beyond the more straightforward fact that it will need to withhold tax. Rather, the biggest headache for hedge funds is the identification of the beneficial owners and controlling persons of their clients. A lot of investors in hedge funds operate through unregulated legal vehicles or individual agents; this fact makes the FATCA data collection process a much more difficult challenge for hedge funds.

Finally, the variations in IGAs to implement FATCA present an additional challenge. While this problem is not specific to hedge funds, it is the one that they still have to manage.

Impact of FATCA Compliance By Hedge Funds On US Taxpayers

Despite these challenges, many hedge funds are successfully addressing FATCA compliance issues and are incorporating advanced software solutions to make their look-through process more efficient.

These successes of hedge funds in their FATCA compliance make it difficult for US persons investing in mutual funds through foreign entities to conceal their ownership of these entities. This means that one can expect an increase of the IRS discovery of such investors.

If these investors are not in full compliance with their US tax obligations – particularly with respect to FBAR, Form 8938, foreign business ownership reporting, foreign trust ownership and foreign income disclosure – they may be facing catastrophic US tax consequences, including draconian FBAR willful penalties as well as potential imprisonment.

Contact Sherayzen Law Office for Help With Undisclosed Foreign Assets and Income

If you have undisclosed foreign assets or foreign income, please contact Sherayzen Law Office as soon as possible. After reviewing the facts of your case and analyzing the available voluntary disclosure options, Mr. Sherayzen will conduct your voluntary disclosure process from the beginning through the end, including the preparation all of the required legal documents and tax forms.

Contact Us to Schedule Your Confidential Consultation Now!

Main Differences between Model FATCA IGAs

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As FATCA is being adopted by more and more countries, it is important to understand that there are two types of model FATCA IGAs (i.e. intergovernmental agreements to implement FATCA) that are signed between various countries and the United States. Both model FATCA IGAs were issued by the US Treasury Department and both model FATCA IGAs are perfectly valid, but some countries prefer one model FATCA IGA over the other. In this article, I would like briefly discuss the main differences between the two model FATCA IGAs.

Model FATCA IGAs Background

FATCA (Foreign Account Tax Compliance Act) was enacted by US Congress in 2010 to target tax non-compliance of U.S. taxpayers with foreign accounts. Since that time, this law has established the global standard for promoting tax transparency and has been adopted by a very large number of countries around the globe.

The adoption of FATCA usually occurs as a two-step process. First, a foreign jurisdiction signs one of the two model FATCA IGAs with the IRS. Second, the foreign jurisdiction’s legislature modifies domestic law to implement the provisions of whatever one of the two model FATCA IGAs that the country signed.

Model FATCA IGAs: Model 1

The first of the two Model FATCA IGAs is called “Model 1IGA”. Its principal feature is that it requires foreign financial institutions (FFIs) to report all information required under FATCA to their domestic government tax agencies. The domestic tax agencies would collect all of the FATCA information and turn it over of the IRS.

Since the FFIs would do all of their reporting domestically to their own agencies, Model 1 IGA is sometimes negotiated as a reciprocal agreement. This means that some Model 1 IGAs require the IRS to provide certain information with respect to the tax residents of the country that signed such a reciprocal Model 1 IGA.

Finally, the FFIs covered by a Model 1 IGA do not need to sign an FFI agreement. However, the FFIs will still need to register on the IRS’s FATCA Registration Portal or file IRS Form 8957.

Model FATCA IGAs: Model 2

The second of the two Model FATCA IGAs is called “Model 2 IGA”. Unlike the other model IGA, Model 2 IGA requires FFIs to report the FATCA-related information directly to the IRS and without any intermediaries.

Since the FFIs report all FATCA-related information directly to he IRS, they need to register with the IRS and sign an FFI agreement (which should reflect the specific changes to the model FATCA IGAs negotiated by the foreign jurisdiction).

Both Model FATCA IGAs Lead to Disclosure of Foreign Accounts Held by US Persons

Irrespective of the type of the agreement, it is important to remember that both model FATCA IGAs are designed to perform the same function – disclosure of foreign accounts held by US persons (directly or indirectly). This means that the spread of both types of model FATCA IGAs presents a direct threat to any undisclosed foreign accounts of US persons with potentially catastrophic consequences for these US persons, including potential criminal prosecution and willful FBAR penalties in excess of the balances of these secret accounts.

Contact Sherayzen Law Office for Help with Undisclosed Foreign Accounts

If you have undisclosed foreign accounts, please contact Sherayzen Law Office as soon as possible. Our international tax lawyers will first carefully review the facts of your case and identify the best voluntary disclosure options available to you.  Our international tax professionals will conduct your voluntary disclosure process from the beginning through the end, including the preparation all of the required legal documents and tax forms.

Contact Us Now to Schedule Your Confidential Consultation!

Prison Sentence for Quiet Disclosure: the Kaminsky Case

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On March 4, 2015, Gregg A. Kaminsky, a former UBS client, was sentenced for willfully failing to file a Foreign Bank Account Report (the “FBAR”) with the U.S. Department of Treasury in connection with his concealment of income and assets in accounts in Switzerland, Hong Kong, and Thailand over several years, as well as his failure to report certain income earned in the virtual world, “Second Life.”

“Federal tax revenue is crucial to protecting our borders; fighting terrorism, cybercrime, and other national security threats; providing disaster relief; and to performing other critical government functions,” said Acting U. S. Attorney John Horn. “This office is committed to investigating and prosecuting those who intentionally avoid paying their fair share, whether their schemes involve income earned or hidden offshore, here at home, or even in a virtual world.”

“U.S. citizens who seek to avoid their tax obligations by hiding income in undeclared bank accounts abroad should by now be fully on notice that they will be held accountable for their actions, both civilly and criminally,” stated IRS Criminal Investigation Special Agent in Charge, Veronica F. Hyman-Pillot. “Americans who file accurate, honest and timely returns can be assured that the government will hold accountable those who don’t.”

Facts of the Case

According to Acting U.S. Attorney Horn, the charges and other information presented in court:

Kaminsky was an Internet entrepreneur who served as the Chief Executive Officer of Circlenet LLC, based in Atlanta, Georgia. From 2000 through mid-2009, Kaminsky owned and controlled a foreign bank account with Union Bank of Switzerland AG (“UBS”). By 2006, Kaminsky’s UBS account held approximately $1.1 million. From time to time between 2002 and 2009, Kaminsky caused funds to be wire-transferred from his UBS account in Switzerland to other foreign bank accounts controlled by him in Thailand and Hong Kong. Also during that time, Kaminsky caused his income from at least two different U.S. companies to be direct-deposited into his UBS account in Switzerland.

Yet, over this period, Kaminsky did not disclose his UBS account or other foreign financial accounts to the U. S. Treasury Department as required, and thereby concealed several hundred thousand dollars in taxable income, interest, and dividends from the U.S. Internal Revenue Service (IRS).

In addition, in 2007 and 2008, Kaminsky omitted his UBS account and associated income from Free Applications for Federal Student Aid (FAFSA) that he electronically filed with the U.S. Department of Education in order to qualify for need-based federal financial aid to fund his tuition for an Executive MBA program at Emory University. At the time of the FAFSA applications, Kaminsky controlled over a half million dollars in his UBS account, which would have made him ineligible for federal student loan assistance.

On June 30, 2008, the U.S. Department of Justice sought court approval to compel UBS to disclose the identities of U.S. account holders who may be using UBS accounts to hide assets overseas and thereby evade U.S. taxes. The request and the order authorizing it were widely reported by the media throughout the United States, and this coverage continued throughout 2008 and 2009 as the U.S., UBS, and Switzerland negotiated a resolution and UBS began disclosing U.S. account holders to the IRS.

Following this news, Kaminsky closed his UBS account and transferred the balance of his UBS account to an account that he controlled at HSBC Bank in Hong Kong. Further, in spring 2010, Kaminsky filed FBARs for his Swiss and Hong Kong accounts for the very first time, also filing amended individual income tax returns for 2007 and 2008 that disclosed the previously unreported income in his UBS account. However, in his amended 2007 and 2008 returns, and in his subsequently filed returns for 2009 through 2012, Kaminsky still failed to report nearly $150,000 in taxable income earned from his business activities in the virtual world, “Second Life.”

Participants in Second Life, referred to as “residents,” can engage in a wide variety of business activities, including buying, renting, and sub-leasing virtual land and buying and selling other virtual goods, services, and experiences for their “avatars.” Transactions are conducted using a virtual currency, “Linden Dollars.” Linden Dollars can be bought and traded on the “Linden Exchange,” and are redeemable for cash.

Including his virtual world income, Kaminsky failed to report over $400,000 in income to the IRS between 2000 and 2012, resulting in a loss to the IRS of approximately $125,000.

Kaminsky’s Sentence

Kaminsky was sentenced to serve four months in federal prison to be followed by two years of supervised release, two months of home confinement, and 200 hours of community service. Kaminsky was also ordered to pay restitution to the IRS in the amount of $91,983. Kaminsky was convicted on these charges on December 18, 2014, after he pleaded guilty. As part of his plea agreement with the United States, Kaminsky was also required to pay a civil penalty to the IRS in the amount of $250,635.20, which is equivalent to fifty percent of the value of the balance in Kaminsky’s HSBC account in Hong Kong as of June 30, 2009.

Lesson from the Kaminsky’s Case – the Dangers of Attempting Incomplete Quiet Disclosure

Kaminsky’s case is a good illustration of my last year’s article on the how quiet disclosure in the current enforcement environment can be a very dangerous option. Kaminsky amended two tax returns and disclosed income from his UBS account for those two years and filed the FBARs for 2009. This was a fairly standard way of doing quiet disclosure, but it could not in any form qualify as a voluntary disclosure – and Kaminsky paid dearly for this attempt.

However, there is another important lesson of Kaminsky’s case for the persons who intend to engage in a voluntary disclosure – you cannot do a partial voluntary disclosure. Kaminsky failed to report his worldwide income on his amended tax returns – he only reported income that was directly relevant to the foreign accounts. Failure to submit complete and accurate amended tax returns undoubtedly contributed to the criminal sentence in this case.

Contact Sherayzen Law Office for Help with Conducting Proper Voluntary Disclosure

If you have undisclosed foreign accounts and foreign income, contact Sherayzen Law Office for professional legal and tax help. Our international tax lawyer, Mr. Eugene Sherayzen will thoroughly analyze your case and advise you on your voluntary disclosure options. Once you choose your voluntary disclosure path, our firm will prepare all of the necessary documents and legal forms, and conduct your voluntary disclosure in a proper and expeditious manner.

We have helped hundreds of US taxpayers around the globe, and we can help you. So, Call Us Now to Schedule Your Confidential Consultation!