Retiring in Panama – Tax Traps for U.S. taxpayers

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In recent years, a new retirement trend emerged among U.S. citizens – retirement abroad in relatively peaceful countries of Latin America. Panama appears to be one of the preferred destinations. Retirement is a process, though, and it takes time to set up properly. Therefore, U.S. citizens typically start their preparation for retirement abroad in their 50s, before they actually retire. In this article, I wish to discuss some of the most prominent U.S. tax issues that these potential retirees may face.

Typical Retirement Process

At lot of U.S. citizens who make the decision to retire in Panama start the process by retaining a local attorney to acquire land. They open up an account in Panama to finance the deal. Then, they sign a contract with a construction company to build a house. At that point, most Panamanian lawyers typically advise to organize a Panamanian corporation and put the house into the corporation for the purported reasons of liability and privacy. The house construction is then financed by the owner’s funds through new Panamanian corporate accounts. After the house is built, the lawyers will then attempt to obtain an exoneration of the property from Panamanian taxation for a fixed number of years allowed by law.

Throughout the process, the U.S. citizens are advised by Panamanian tax advisors that there are no tax consequences for structuring the retirement home purchase and construction through a corporation.

Tax Problems with this Process

Despite the apparent innocence of this project, there are potentially large problems with it if the U.S. tax citizens are not independently advised of the U.S. tax consequences of structuring their retirement in this manner.

Let’s take this scenario apart and focus on the three most common problems here. First, the opening of the bank accounts. If the aggregate balance on these accounts exceeds $10,000, then the Report on Foreign Bank and Financial Accounts must be filed by U.S. taxpayers. Failure to do so may bring tremendous IRS penalties, civil and criminal.

The interesting point here is that, in calculation of the aggregate $10,000 balance, a U.S. taxpayer should take into account the corporate accounts over which he has signature authority if owns more than 50% of the corporation (directly or constructively).

Second, organizing a Panamanian corporation owned by U.S. taxpayers may bring forth another highly-complicated U.S. tax compliance feature – Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. Depending on the asset valuation (under US GAAP) and some other features of the corporation, Form 5471 can become a truly monstrous compliance requirement for this seemingly simple transaction of buying a retirement house through a corporation. Failure to file Form 5471 can lead to substantial penalties depending on circumstances.

Third, there is a new Form 8938 that requires U.S. taxpayers to disclose information with respect to specified foreign assets as long as these assets exceed a certain threshold. The Form has its own penalty structure.

The truly tragic aspect of this scenario is that a large number of Panamanian attorneys are completely oblivious to these U.S. tax reporting requirements as well as the penalties associated with them. Therefore, they fail to advise their U.S. clients about these IRS requirements and that the clients should consult a U.S. tax attorney experienced in these matters.

This is why it is highly important that you consult with a U.S.-based international tax attorney regarding U.S. tax consequences of your particular foreign retirement plan.

Contact Sherayzen Law Office to Learn About U.S. Tax Consequences of Your Foreign Asset Ownership and Retirement

The above article does not summarize all of the tax forms that should be filed in such situations, but merely points out the most prominent ones.  The exact U.S. tax compliance requirements will also depend on your particular situation.

If you are a U.S. citizen who is planning to retire in Panama or you wish own a property or do business there, contact Sherayzen Law Office. Our experienced international tax firm will analyze your situation in depth and offer professional legal advice with respect to your particular situation.

Dormant Foreign Corporation

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Certain categories of US shareholders of a foreign corporation are required to file Form 5471 with the IRS. Form 5471, however, is one of the most complex forms in the Internal Revenue Code and the compliance costs for such a corporation can be very high. Such costs can be especially disproportionate for an inactive corporation that does not do any business but merely exists.

In order to alleviate the compliance costs in these cases, the IRS allows certain foreign corporations, that satisfy the required criteria for being considered as “dormant foreign corporations”, to make a limited filing that does not include a detailed financial statements and supporting schedules. IRS Revenue Procedure (Rev. Proc.) 92-70 (1992-2 C.B. 435) details the requirements for the classification of dormant foreign corporation.

Under the Rev. Proc. 92-70, eight conditions must be met in order for a foreign corporation to be considered dormant:

(1) the foreign corporation conducted no business and owned no stock in any other corporation other than another dormant foreign corporation;

(2) no shares of the foreign corporation (other than directors’ qualifying shares) were sold, exchanged, redeemed, or otherwise transferred, nor was the foreign corporation a party to a reorganization;

(3) no assets of the foreign corporation were sold, exchanged, or otherwise transferred, except for de minimis transfers described in (4) and (5) below;

( 4) the foreign corporation received or accrued no more than $5,000 of gross income or gross receipts;

(5) the foreign corporation paid or accrued no more than $5,000 of expenses;

(6) the value of the foreign corporation’s assets as determined pursuant to U.S. generally accepted accounting principles (but not reduced by any mortgages or other liabilities) did not exceed $100,000;
(7) no distributions were made by the foreign corporation; and

(8) the foreign corporation either had no current or accumulated earnings and profits or had only de minimis changes in its beginning and ending accumulated earnings and profits balances by reason of income or expenses specified in (4) or (5) above.

If all eight conditions are met, the filer only needs to fill-out and complete the first page of Form 5471 (which includes: filer information, such as name and address, Items A through C, and tax year; corporate information, such as the dormant corporation’s annual accounting period (below the title of the form) and Items 1a, 1b, 1c, and 1d), and label the top margin of the first page of Form 5471 with this exact phrase “Filed Pursuant to Rev. Proc. 92-70 for Dormant Foreign Corporations.”

The form should be filed in the manner described in “When and Where To File on page 1 of the Instructions for Form 5471“. For the tax year 2011, this means that it should be attached to and filed together with your income tax return by the relevant due date.

Contact Sherayzen Law Office for Help With U.S. Tax Compliance Regarding U.S. Ownership of a Foreign Corporation

If you own shares in a foreign corporation, contact Sherayzen Law Office for help with U.S. tax compliance. Our experienced international tax firm will thoroughly review the facts of your case, identify your U.S. tax compliance requirements, and complete the required forms and filings (including Form 5471).

If you only now became aware of your potential Form 5471 filing requirements and you have not filed the form with the IRS previously, our tax firm will assist you with finding the right type of voluntary disclosure and vigorously represent your interests during IRS negotiations.

IRS Revenue Procedure 92-70 (1992-2 C.B. 435)

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SECTION I. PURPOSE

This revenue procedure provides a summary filing procedure for filing Form 5471 with respect to dormant foreign corporations described in section 3 below. Persons complying with this revenue procedure satisfy their Form 5471 filing obligations under sections 6038(a)(1), 6038(a)( 4), and 6046(a)(3) with respect to dormant foreign corporations and will not be subject to penalties related to the failure to timely file a complete Form 5471 and to timely furnish information requested thereon.

SEC. 2. BACKGROUND

.01 Section 6038(a)(l) imposes information reporting requirements on any United States person who controls a foreign corporation. Pursuant to section 6038(a)(4), the information reporting requirements prescribed in section 6038 (a)( 1) also are imposed on any United States person who is treated as a United States shareholder of any foreign corporation that is treated as a controlled foreign corporation for any purpose under subpart F.

.02 Section 6046(a)(3) imposes reporting requirements on each person who is treated as a United States shareholder of a controlled foreign corporation under section 953(c).

.03 Section 1.6038-2 of the Income Tax Regulations requires a United States person controlling a foreign corporation to file an annual information return on Form 5471 specifying certain identifying information, stock, shareholder, earnings and profits, and financial information about the foreign corporation, as well as transactions between the foreign corporation, the filer, certain other shareholders, and entities related to the filer or the foreign corporation.

.04 Section 1.6038-2(j)(1) of the regulations allows two or more U.S. persons who are required to furnish information with respect to the same foreign corporation and for the same period to satisfy this obligation by filing a joint return. Pursuant to section 1.6038-2(j)(2) of the regulations, a U.S. person required to furnish information solely by reason of stock ownership attribution from another U.S. person is excepted from furnishing information if he does not directly own an interest in the corporation and all such required information otherwise is furnished by the person from whom the ownership is attributed. Section 1.6038-2(j)(3) of the regulations requires any U.S. person relying on section 1.6038-2(j)(1) or (2) to file a statement with his income tax return indicating that his filing liability will be satisfied by another return, identifying that return, and identifying the place of return filing.

.05 Section 1.6046-1(e)(1) of the regulations allows two or more U.S. persons who are required by section 1.6046-l(c) of the regulations to file a return with respect to the same corporation to satisfy this obligation by filing a joint return. Under section 1.6046-l(e)(4)(iii) of the regulations, a U.S. person required to file a return under section 1.6046-1(c) is excepted from this filing requirement if he is required to file solely by reason of stock ownership attribution from another U.S. person, he does not directly own an interest in the foreign corporation, and the information required by section 1.6046-1(c) is otherwise furnished by the U.S. person from whom the ownership is attributed. Pursuant to section 1.6046-1(e)(5) of the regulations, any U.S. person required by section 1.6046-1(c) to furnish information regarding a foreign corporation may, if such information is furnished by another person having an equal or greater stock interest (measured in terms of value of such stock) in such corporation, satisfy such requirement by filing a statement with his return on Form 5471 indicating that such liability has been satisfied and identifying the return in which such information was included .

.06 Section 6038(b)(l) imposes monetary penalties for a failure to timely furnish any information required by section 6038(a)(l) with respect to a foreign corporation (including entities treated as controlled foreign corporations under sections 957 and 953). Additional penalty amounts may apply under section 6038(b)(2) where the failure to furnish information continues for more than 90 days after notification by the Secretary.

.07 Section 6038(c) mandates a reduction in certain foreign tax credits for a failure to timely furnish information required by section 6038(a)(l) absent a showing of reasonable cause for the delay. Additional credit reductions may apply where such failures continue for more than 90 days after notice by the Secretary.

.08 Section 6679 imposes monetary penalties for a failure to timely file a return or to provide information specified in any return required by section 6046 absent a showing of reasonable cause for the failure.

. 09 Criminal penalties (fines and imprisonment) are imposed by section 7203 for a willful failure to file a return, including an information return required by section 6038 or 6046.

SEC. 3. SCOPE

This revenue procedure applies to persons required under section 6038(a)(1), 6038(a)(4) or 6046(a)(3) to file a Form 5471 with respect to a foreign corporation that is a dormant foreign corporation. For purposes of this revenue procedure, a foreign corporation is a dormant foreign corporation if, at all times during the foreign corporation’s annual accounting period (within the meaning of section 6038(e)(2)):

(1) the foreign corporation conducted no business and owned no stock in any other corporation other than another dormant foreign corporation;

(2) no shares of the foreign corporation (other than directors’ qualifying shares) were sold, exchanged, redeemed, or otherwise transferred, nor was the foreign corporation a party to a reorganization;

(3) no assets of the foreign corporation were sold, exchanged, or otherwise transferred, except for de minimis transfers described in (4) and (5) below;

(4) the foreign corporation received or accrued no more than $5,000 of gross income or gross receipts;

(5) the foreign corporation paid or accrued no more than $5,000 of expenses;

(6) the value of the foreign corporation’s assets as determined pursuant to U.S. generally accepted accounting principles (but not reduced by any mortgages or other liabilities) did not exceed $100,000;

(7) no distributions were made by the foreign corporation; and

(8) the foreign corporation either had no current or accumulated earnings and profits or had only de minimis changes in its beginning and ending accumulated earnings and profits balances by reason of income or expenses specified in (4) or (5) above.

SEC. 4. GENERAL PROCEDURE

.01 In lieu of filing a complete Form 5471 for each dormant foreign corporation, the filer may use the summary filing procedure described in this section. A filer may not use this summary filing procedure to report an interest in a foreign corporation that was a dormant foreign corporation in a prior year but that does not meet the requirements of section 3 above in the current filing year.

.02 To elect the summary filing procedure, the filer must attach and file Page One of the Form 5471 (the summary return) for each dormant foreign corporation with its regularly filed income tax return. The filer also must file a copy of each summary return with the Internal Revenue Service Center, Philadelphia, PA, along with the filer’s other Forms 5471 (if any). The top margin of each summary return must be labeled “Filed Pursuant to Rev. Proc. 92-70 for Dormant Foreign Corporations.”

.03 The summary return must be completed for the following filer items: the filer’s name and address, identifying number, filing category, stock ownership percentage, and tax year.

.04 The summary return must be completed for the following corporate items: the dormant foreign corporation’s annual accounting period (within the meaning of section 6038(e)(2)), name and address, employer identification number (if any), country of incorporation, and date of incorporation.

.05 By using the summary filing procedure, the filer agrees that it will provide any information required by sections 6038 and 6046, the regulations thereunder, or on Form 5471 and not specified in sections 4.03 or 4.04, within 90 days of being asked to do so on audit.

SEC. 5. RELIEF

.01 Persons complying with the summary filing procedure described in section 4 satisfy their Form 5471 filing obligations arising under sections 6038(a)(1), 6038(a)(4), and 6046(a)(3) as to the specified dormant foreign corporations. Accordingly, sections 6038(b)(1), 6038(c), 6679, and 7203 will not apply to a filer properly employing the procedure. However, penalties and foreign tax credit reductions under sections 6038(b)(2) and 6038(c)(1) can be imposed (pursuant to sections 1.6038-2(k)(l)(ii) and l.6038-2(k)(2)(iv) of the regulations) for a failure to timely furnish information under section 4.05 of this revenue procedure.

.02 To the extent that a Form 5471 filing by a filer could satisfy the filing obligation of another person (the “other person”) under section 1.6038-2(j) of the regulations, such other person may use the provisions of section 1.6038-2(j) if the other person satisfies the requirements of section 1.6038-2(j)(3) and the filer complies with this revenue procedure and attaches a statement providing the name, address, identifying number, and corporate status of the other person. If the provisions of section 1.6038-2(j) are used as provided in this section 5.02, the other person on whose behalf the Form is filed satisfies his Form 5471 filing obligations arising under sections 6038(a)(1) and 6038(a)(4) as to the specified dormant foreign corporations and is not liable for penalties as specified in section 5.01 above.

.03 Persons described in section 6046(a)(3) are treated, for purposes of this revenue procedure, as described in section 1.6046-1(c)(1) of the regulations. Therefore, to the extent that a Form 5471 filing by a filer could satisfy the filing obligation of another person (the “other person”) under section 1.6046-1(e) of the regulations, such other person may use the provisions of section 1.6046-1(e) if the other person satisfies the filing requirement of section 1.6046-1(e)(5) (if applicable) and the filer complies with this revenue procedure and attaches a statement providing the name, address, identifying number, and corporate status of the other person. If the provisions of section 1.6046-l(e) are used as provided in this section 5.03, the other person on whose behalf the Form is filed satisfies his Form 5471 filing obligations arising under section 6046(a)(3) as to the specified dormant foreign corporations and is not liable for penalties as specified in section 5.01 above.

.04 The relief afforded by this revenue procedure relates solely to a filer’s information reporting obligations and does not affect a filer’s liability for tax on income distributed or deemed distributed from a dormant foreign corporation. Thus, for example, de minimis amounts of subpart F income derived by a controlled foreign corporation that qualifies as a dormant foreign corporation under section 3 above are taxable to the corporation’s United States shareholders to the extent provided in sections 951 and 952 and should be reported on each shareholder’s federal income tax return.

SEC. 6. EFFECTIVE DATE

This revenue procedure is effective for Forms 5471 required to be filed (including extensions) on or after September 15, 1992.

First Quarter of 2013 Underpayment and Overpayment Interest Rates

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On November 30, 2012, the IRS announced that the underpayment and overpayment interest rates will remain the same for the calendar quarter beginning January 1, 2013. The rates will be:

  • three (3) percent for overpayments [two (2) percent in the case of a corporation];
  • three (3) percent for underpayments;
  • five (5) percent for large corporate underpayments; and
  • one-half (0.5) percent for the portion of a corporate overpayment exceeding $10,000.

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points.

Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus 3 percentage points and the overpayment rate is the federal short-term rate plus 2 percentage points. The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

Interest factors for daily compound interest for annual rates of 0.5 percent are published in Appendix A of Revenue Ruling 2011-32. Interest factors for daily compound interest for annual rates of 2 percent, 3 percent and 5 percent are published in Tables 7, 9, 11, and 15 of Rev. Proc. 95-17, 1995-1 C.B. 561, 563, 565, and 569.

Committee on Foreign Investment in the United States: General Overview

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In 1988, the United States Congress enacted the Exon–Florio Amendment to authorize the executive branch’s review foreign investment within the United States. The amendment was passed into law under the Omnibus Trade and Competitiveness Act of 1988 and amended Section 721 of Defense Production Act of 1950. Generally, pursuant to this provision the President of the United States may block any foreign investments that may pose a threat to national security.

As a direct result of this law, President Reagan delegated the process of reviewing foreign investments to the Committee on Foreign Investment in the United States (commonly known under its acronym “CFIUS”).

CFIUS is an inter-agency committee authorized to review transactions that could result in control of a U.S. business by a foreign person (“covered transactions”), in order to determine the effect of such transactions on the national security of the United States. As mentioned above, CFIUS operates pursuant to section 721 of the Defense Production Act of 1950, as amended by the Foreign Investment and National Security Act of 2007 (FINSA) (section 721) and as implemented by Executive Order 11858, as amended, and regulations at 31 C.F.R. Part 800.

CFIUS review consists of a fairly complicated process, which has been the subject of significant reforms over the past several years (including numerous improvements in internal CFIUS procedures, enactment of FINSA in July 2007, amendment of Executive Order 11858 in January 2008, revision of the CFIUS regulations in November 2008, and publication of guidance on CFIUS’s national security considerations in December 2008).

CFIUS review can result from a voluntary notification by a domestic firm that is being acquired by a foreign firm or it can result from CFIUS’ own initiative. CFIUS reviews begin with a 30-day decision to authorize a transaction or begin a statutory investigation. If the latter is chosen, the committee has another 45 days to decide whether to permit the acquisition or order divestment.

While, most transactions submitted to CFIUS were approved without the statutory investigation, others were investigated by CFIUS. In some cases, CFIUS investigation had a material impact on proposed acquisitions.