IRS Issue Statistics for CFC Holdings; Importance of Form 5471 Grows

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On March 6, 2013, the IRS issued statistics for the tax year 2008 with respect to foreign corporations controlled by U.S. corporations. These statistics emphasize the important growth in controlled foreign corporations (“CFCs”) and Form 5471.

IRS Statistics Published in Statics of Income Bulletin (Winter 2013)

In the tax year 2008, some 83,642 foreign corporations controlled by U.S. multinational corporations held $14.5 trillion in assets and reported receipts of $6.0 trillion. These controlled foreign corporations (CFCs) paid $125.2 billion in income taxes on $662.0 billion of earnings and profits (less deficit) before income taxes (“E&P”). Both CFC assets and receipts increased slightly more than 24 percent from tax year 2006, while “E&P” and foreign taxes income taxes paid increased by nearly 30 percent.

For the tax year 2008, these same CFCs were incorporated in 188 different countries (based on unpublished data). More than 42 percent, or 35,856, of these CFCs were incorporated in Europe. Nearly 91 percent of the European CFCs were located in European Union countries.

Almost 79 percent, or 65,740, of CFCs for Tax Year 2008 were concentrated in three major industrial sectors: (1) services; (2) goods production; and (3) distribution and transportation of goods. These three industrial sectors accounted for 81.2 percent of total receipts ($4.9 trillion), 74.9 percent of E&P (less deficit) before income taxes ($496.0 billion), and 57.5 percent of income taxes ($72.0 billion).

Furthermore, for the tax year 2008, controlled foreign corporations were tax owners of 17,548 foreign disregarded entities (FDEs). These foreign disregarded entities reported $4.9 trillion in assets and $230.1 billion in E&P (less deficit) after taxes.

Statistics Demonstrate the Continuous Growth of CFCs and Importance of Form 5471

The IRS statistics confirmed what is already well-known – with growing globalization, the importance of CFCs is increasing with each year. This further means that Form 5471 is also increasing in its importance for the IRS, which is already stepping up the enforcement of compliance with Form 5471 requirements.

Form 5471 is used by the IRS to satisfy the informational reporting requirements of 26 U.S.C. § 6038 (“Information reporting with respect to certain foreign corporations and partnerships”) and 26 U.S.C. § 6046 (“Returns as to organization or reorganization of foreign corporations and as to acquisitions of their stock”). It must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in specified foreign corporations, if various requirements are met. The penalties can be steep, so compliance with the reporting rules is crucial.

Contact Sherayzen Law Office for Help With Form 5471

If you own foreign corporations, you may need to comply with Form 5471 requirements. This is why you need to contact Sherayzen Law Office to schedule a consultation. Our international tax firm is highly experienced in dealing with Forms 5471 and we can help you comply with its requirements. If you are delinquent in your 5471 compliance, we can also advise you with respect to your voluntary disclosure options.

Accountants Beware: Offshore Disclosure with Form 8938 is a Legal Issue

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In an earlier article, I already explained why the FBAR disclosure is a legal issue. In terms of their lineage, Forms 8938 are very similar to the FBARs. While the FBARs are the creation of Bank Secrecy Act, Form 8938 is a creation of a legislation of a similar nature – FATCA (Foreign Account Tax Compliance Act).

The intent of both laws is similar – to produce legal disclosure of foreign assets by U.S. taxpayers. Notice that I am talking about legal disclosure, not an accounting calculation.

While the penalties associated with failure to file Form 8938 are not as severe as those of the FBAR, they are still substantial and have legal and tax repercussions. Where non-compliance is such that it requires voluntary disclosure, the issues associated with Form 8938 take on a new importance that requires the full protection of the attorney-client privilege and complex legal advocacy.

This is why it is so important for the accountants to avoid committing malpractice and recognize that an offshore disclosure that involves filing delinquent Forms 8938 is a legal issue that should be left to international tax attorneys who are trained and experienced in this area of law.

Contact Sherayzen Law Office for Legal Help with Your Voluntary Disclosure of Offshore Assets

If you have undisclosed offshore assets, contact Sherayzen Law Office . Our experienced international tax law firm will thoroughly analyze your case, estimate your potential FBAR penalties, identify all non-compliance issues, and develop a comprehensive approach to your offshore voluntary disclosure.

Can I Deduct My Rental Real Estate Losses?

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With the uncertain economic environment in the past few years, many individuals who own rental estate property have faced substantial losses. A question that often arises is whether such losses can be deducted, and if so, by how much? This article strives to answer these questions in general and provide a basic understanding of the deductibility of rental real estate losses. It is not intended to provide tax or legal advice. Renting real estate can be a complex area, full of many legal and tax obstacles, so you may wish to seek the advice of a competent, experienced attorney. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.

The General Rule of Passive Activity Losses

In general, passive activity losses and deductions are likely to be limited to offsetting income from only passive activities (similarly, credits from passive activities may only be used to offset taxes on passive activity income). Passive activity losses that are greater than passive activity income will be disallowed in a tax year. However, passive activity losses and credits may be carried forward to the next taxable year.

Passive activities are defined to mean trade or business activities in which an individual does not “materially participate”. According to the IRS, material participation means that a taxpayer is involved with the business operations on a “[r]egular, continuous, and substantial basis.” Certain real estate professionals may meet the material participation requirements.

Exceptions

Generally speaking, rental real estate activities will be treated as passive activities, subject to the limitations stated above, unless certain requirements are met. As noted above, one such exception is for material participation in rental real estate activities.

Another limited exception exists for “active participation” in such activities. In general, active participation means that an individual (or married couple) owned at least 10% of the fair market value of the rental property interests, and made management decisions or arranged for others to provide services in a significant and bona fide manner. According to the IRS, “management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.” Thus, generally, limited partners will not meet the active participation test.

For those who qualify for the “active participation” exception, individuals may offset a maximum of $25,000 per year of passive losses from rental real estate against active and portfolio income. More specifically, $25,000 for single individuals and married couples filing jointly for a tax year, $12,500 for married individuals who lived apart from their spouses for a year filing separately, and $25,000 for a qualifying estate reduced by the special allowance for which a surviving spouse qualified.

Provided the requirements are met, losses may be deducted in full by individuals with a modified adjusted gross income (MAGI) of $100,000 or less ($50,000 or less for married couples filing separately). For incomes greater than MAGI of $100,000, the deduction will be limited to half of the amount greater than $100,000 up to $150,000 of MAGI ($75,000 for married filing separately). For individuals with income greater than MAGI of $150,000, the deduction may not be taken.

Contact Sherayzen Law Office For Advice With Respect to Rental Income and Losses

If you have any questions with respect to rental income or losses, contact the experienced tax law firm of Sherayzen Law Office.

Pursuant to IRS Circular 230, any advice rendered in this communication on U.S. tax issues (i) is not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties imposed by the U.S. Internal Revenue Service, and (ii) may not be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement.

S Corporation At-Risk Rules

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Do you own interest in an S-Corporation (“S-Corp”)? If so, the IRS at-risk rules may apply to you and may limit the loss deductions you will be allowed to take. The IRS at-risk rules may also apply to partnerships, LLCs and closely-held C corporations (subject to certain exceptions), so they may be important to learn if you hold an interest in such entities.

This article will explain the basics of the at-risk rules in the context of S-Corps. It is not intended to provide tax or legal advice. S-Corp taxation can be a very complex area, so you may wish to seek the advice of a competent, experienced attorney. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.

A Taxpayer’s At-Risk Amount

In an S-Corp, the deductibility of a distributed loss may be determined by three separate limitations: (1) The shareholder’s adjusted basis of an interest, or the shareholder’s stock plus any loans made by the shareholder to the entity, (2) the at-risk rules, and (3) the passive activity rules. As noted, this article will cover the at-risk rules (the other limitations will be covered in future articles).

Under the Internal Revenue Code Section 465, a taxpayer is considered to be at-risk for an activity with respect to amounts including, “(A) the amount of money and the adjusted basis of other property contributed by the taxpayer to the activity, and (B) amounts borrowed with respect to such activity” to the extent that the taxpayer is, “(A) is personally liable for the repayment of such amounts, or (B) has pledged property, other than property used in such activity, as security for such borrowed amount [to the extent of the net fair market value of the taxpayer’s interest in such property].”

According to the IRS, any of the following activities for a trade or business that produce income will subject a taxpayer to the at-risk rules: “Holding, producing, or distributing motion picture films or video tapes. 2. Farming. 3. Leasing section 1245 property, including personal property and certain other tangible property that is depreciable or amortizable… 4. Exploring for, or exploiting, oil and gas. 5. Exploring for, or exploiting, geothermal deposits [for wells started after September 1978]. 6. Any other activity not included in (1) through (5) that is carried on as a trade or business or for the production of income.” Taxpayers will not be considered at-risk for amounts of nonrecourse financing that protects against losses, guarantees, and other related arrangements.

In general, the at-risk rules do not apply to the holding of real property placed in service before 1987 or to the holding of an interest in a pass-through entity acquired before 1987 that holds real property placed in service prior to 1987. Mineral property holdings, however, are not included in this exception.

Separate Activities or One Activity?

In most S-Corps, the business will be engaged in many different types of transactions and activities. Thus, it will often be necessary to determine whether the loss limitation at-risk rules apply to each activity, determined separately. Every shareholder in an S-Corp should receive a schedule stating their profit or loss share of each separate activity.

However, activities that constitute a trade or business must be aggregated into one activity if a shareholder actively participates in the management of the trade or business, or 65% or more of the losses in a partnership or S-Corp are allocable to individuals who actively participate in the management of the trade or business. Additionally, certain leased items, among others, may be treated as one activity.

Contact Sherayzen Law Office for Help With S-Corporation Tax Issues

If you have any tax questions regarding your S-Corp, contact the experienced tax law firm of Sherayzen Law Office.

Pursuant to IRS Circular 230, any advice rendered in this communication on U.S. tax issues (i) is not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties imposed by the U.S. Internal Revenue Service, and (ii) may not be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement.

Accountants Beware: FBAR Disclosure is a Legal Matter

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Paradoxically, one of the obstacles currently facing U.S. taxpayers who wish to file their delinquent FBARs and conduct a voluntary disclosure of their foreign assets are their own accountants – more precisely, the inability of many accountants to understand that FBAR disclosure is a legal matter to a much greater extent than an accounting matter.

Special Nature of the FBAR

FBAR is unlike any other information return issued by the IRS. While there are many reasons for it, I just want to point out the four most important considerations that make FBAR disclosures so radically different from other disclosures. First of all, FBAR is issued under the auspices of the Department of the Treasury, but only in the early 2000s was the enforcement of FBARs transferred to the IRS. This is why FBAR does not constitute a part of a taxpayer’s tax return and should be filed separately to a different address by June 30 of each calendar year. The importance of this distinction is that the FBAR is not a regular tax form involving tax calculations, but a legal disclosure form which the taxpayer uses to report his or her foreign financial accounts.

Second, failure to file the FBAR timely is likely to have tremendous consequences for the taxpayer. The civil penalties can be overwhelming, and there are significant criminal penalties associated with the FBAR.

Third, the FBAR penalty structure is complex and allows for many instances of mitigation and exceptions, depending on the taxpayer’s particular situation and ability of the taxpayer’s representative to recognize this situation. There are very important strategies that may be employed during FBAR disclosures to the benefit of the taxpayers.

Finally, the mode of the offshore assets disclosure (i.e. the official IRS voluntary disclosure program and its alternatives) is closely tied to other international tax issues that must be recognized by the taxpayer’s representative. It is rare for the FBAR issue to come alone; usually, the taxpayer would have other international tax issues such as foreign rental income, PFICs, foreign tax credit, foreign earned income exclusion, ownership of foreign business entities, foreign trusts, foreign gifts, foreign inheritance, et cetera. All of these factors must be carefully considered in assessing the existing FBAR penalties (see point three above) and what penalties the taxpayer is likely to face depending on the mode of the offshore assets disclosure.

Accountants Mistakenly Treat FBAR Disclosure as an Accounting Matter

Unfortunately, most accountants have not learned to distinguish the special nature of the FBARs and the enormous complications associated with offshore assets disclosure. There are many reasons for it. First, the great majority of the accountants are not trained to recognize the international tax issues and has very little, if any, familiarity with international tax issues. Therefore, they fail to understand the very special nature of the FBAR and they treat it as simply another form to fill-out, ignoring the legal nature of the disclosure.

Second, even the accountants who are more familiar with international tax obligations of US taxpayers still fail to recognize the fact that FBARs carry criminal penalties and the taxpayers must be adequately protected while discussing the FBAR matters with their representatives.

Third, many accountants are unaware or simply ignore the complexity of the offshore disclosure involving FBARs. This results in taking the simplest approach of herding their clients into the official IRS offshore voluntary disclosure program, often without adequate explanation of the consequences of such a move to their clients.

Fourth, the accountants are not trained for advocacy. Therefore, instead of analyzing their clients’ particular facts and coming up with solutions for their clients, they simply calculate the penalties and present these calculations to their clients as a fact.

Finally, many taxpayers are used to dealing with tax accountants a lot more than with tax attorneys. Similarly, the accountants are aware of these expectations and they attempt to meet these expectations even at the cost of taking on the tasks about which they have little understand and virtually no training.

FBAR is a Legal Matter and Should Be Resolved By Tax Attorneys

Yet, it is highly important to understand that, by undertaking the task of advising their clients on FBAR disclosures, the accountants may be committing malpractice because FBAR is first and foremost a legal matter, not an accounting one. This is why all FBAR disclosures should be handled by tax attorneys who have the right tools and privileges to help their clients.

Let’s emphasize some of the advantages of legal profession that make attorneys so well-fit for FBAR disclosures.

First, the taxpayers with delinquent FBARs need to be able to relate the facts of their particular situations freely to their tax advisors. Since your accountant can be forced to testify against you by the IRS, the best and only protection is the Attorney-Client Privilege.

Second, FBAR is a legal disclosure document, not a tax document. International tax attorneys should use their experience and judgment in advising their clients on how the FBARs should be completed.

Third – and this is a critical factor – attorneys are experienced advocates who are trained to recognize problems and develop comprehensive ethical solutions aimed to minimize the risk of adverse legal exposure of their clients. This means that an experienced international tax attorney will analyze the facts of the particular case in front of him, identify all non-compliance issues, estimate the potential penalties and look for solutions to the problems of a particular case.

Contact Sherayzen Law Office for Legal Help with Your FBAR Disclosure

If you have undisclosed offshore assets, contact Sherayzen Law Office . Our experienced international tax firm will thoroughly analyze your case, estimate your potential FBAR penalties, identify all non-compliance issues, and develop a comprehensive approach to your offshore voluntary disclosure.