Non-Deductible Taxes: General Summary

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The Internal Revenue Code (IRC) permits individual and business taxpayers to deduct various types of taxes imposed by some tax authorities. However, some types of taxes are not deductible under the IRC.

Here is a brief summary of most common non-deductible taxes:

1. Generally, federal income taxes, including social security and railroad retirement taxes paid by employees, are not deductible either as taxes or as business businesses. This also include one-half of the self-employment tax imposed by the IRC Section 1401;

2. Federal war profits and excess profits taxes;

3. Estate, inheritance, legacy, succession, and gift taxes;

4. Income, war profits and excess profits taxes imposed by a foreign government (or even a U.S. possession) if the taxpayer decides to take a foreign tax credit for these taxes;

5. Taxes on real property that must be treated as imposed on another taxpayer because of the apportionment between buyer and seller;

6. Certain fees and taxes under the Patient Protection and Affordable Care Act (P.L. 111-148). For example, annual fee imposed on drug manufacturers and importers for U.S. branded prescription drug sales after 2010; the 2.3 percent excise tax imposed on manufacturers, producers and importers of certain medical devices after 2012; and the annual fee imposed on certain health insurance providers after 2013 are all non-deductible taxes; and

7. Certain other taxes, such as certain additions to taxes imposed on public charities, private foundations, qualified pension plans, REITs (real estate investment trusts), stock compensation of insiders in expatriated corporations, golden parachute payments, greenmail, and other taxes.

Contact Sherayzen Law Office for Tax Planning Advice

If you need a tax advice regarding structuring your business transactions in a tax-responsible way or if you need an advice regarding deductibility of your taxes, contact Sherayzen Law Office. Our experienced tax firm will analyze your situation and propose various tax plans that will strive to reduce the risk of unfavorable treatment of your business transactions under the IRC.

Controlled Foreign Corporations: Subpart F History through 1962

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The purpose of the article is to provide a brief historical overview of the circumstances leading up to the enactment of the famous “Subpart F” rules through the year 1962.

Subpart F of Subtitle A, Chapter 1, Subchapter N, Part III of the Internal Revenue Code (IRC Sections 951-965) was first enacted by the U.S. Congress in 1962 in response to the general perception that the then current tax rules as applicable to foreign corporations provided a major tax loophole for U.S. taxpayers to defer the U.S. tax on their foreign-source income as long as this income was earned by foreign corporations.

Prior to Subpart F, the general Code rules allowed U.S. taxpayers to avoid any U.S. tax on the earnings of a foreign corporation owned by these U.S. taxpayers, at least until those earnings were actually distributed or until the disposition of the stock of the foreign corporation. Thus, a U.S. taxpayer could potentially defer U.S. taxation for an indefinite period of time on all profits earned by the foreign corporation by retaining the earnings in the foreign corporation (or, using the earnings in a way other than a taxable distribution, such as a loan or a lease of property).

This situation was also combined with the favorable tax gain rules on the disposition of stock in a corporation. This allowed a U.S. shareholder to pay only a capital gains rate on income earned by a foreign corporation (rather than taxed as ordinary income) through a disposition of appreciated stock in a foreign corporation (if the foreign corporation retained its earnings).

In fact, the only effective limitation on this freedom were the special rules regarding personal holding company taxation. The personal holding company provisions were enacted by Congress in 1934 (these rules are repealed as of this writing) to limit, through imposition of a penalty tax at the corporate level, the practice of transferring passive assets to a corporation, thereby avoiding the high individual income tax rates.

The personal holding company rules, however, originally applied only to U.S. companies and were not effective in a situation where a U.S. person would transfer passive assets to a foreign corporation (because the foreign corporation would be outside the U.S. jurisdiction). This loophole was immediately recognized and utilized with the effect that U.S. passive assets not only escaped the U.S. individual income tax but also U.S. corporate taxes.

In 1937, Congress acted against this loophole by enacting foreign personal holding company (FPHC) rules. There was a key difference between the FPHC and regular personal holding company rules – the regular rules imposed a penalty tax at the corporate level, whereas the foreign rules taxed certain U.S. shareholders directly on the undistributed foreign personal holding company income of such corporations.

Despite the appearances, however, the FPHC mechanism contained significant flaws. First, the rules applied only in special circumstances where more than 50% of a foreign corporation was owned by five or fewer individuals and where more than 50% (60% initially) of the corporation’s gross income was in the form of foreign personal holding company FPHC income. Second, FPHC rules applied only to passive types of income, but not where a foreign corporation also had substantial business income. Third, the FPHC provisions did not apply to US corporations with wholly-owned subsidiaries.

Due to the inadequacy of the FPHC regime and the evidence of significant outflow of U.S. capital overseas in the form of foreign investment (combined with favorable tax treatment of certain countries encouraging this trend), the Kennedy Administration presented to Congress a proposal to enact subpart F rules.

In 1961, the Administration grouped the tax problems associated with improper foreign investment into two categories – tax deferral and tax haven deferral. The first category included tax offenses of U.S. corporation such as using foreign subsidiaries to indefinitely postpone U.S. taxation of foreign income of a foreign subsidiary by reinvesting the foreign earnings in other foreign investments or by establishing a parent-subsidiary loan mechanism (under the then current rules, this arrangement would allow U.S. parent company to obtain foreign subsidiary’s case without triggering U.S. taxation). The second category involved an arrangement where a U.S. corporation would organized a foreign subsidiary in a tax-haven country (at that time, Switzerland, Bahamas or Panama) in order to receive passive income virtually tax-free or set up a base company for sales of products throughout the world without any income being subject to U.S. taxes. The latter problem was exacerbated by various parent-subsidiary mechanisms such as transfer pricing, fee shifting, and so on.

The recommendations of the Kennedy Administration were far-reaching and would virtually eliminate tax deferral practices by taxing U.S. companies (as well as individual shareholders of a closely held corporations) on their current share of the undistributed profits realized in a given year by subsidiary corporations in the developed countries. The original proposal also strived to eliminate the possible tax haven mechanisms throughout the world, including underdeveloped countries.

The Congress, however, was not prepared to go this far in 1962. The subpart F rules that were enacted that year fell short of the Administration’s proposal. The rules contained various exceptions and were not as effective in stopping tax deferral.

It should be noted, however, that numerous changes were enacted by Congress since 1962 with the main effect of widening the effect of the subpart F rules.

In a subsequent article, I will discuss the 1962 rules and how these were amended since then.

Foreign Qualified Dividend Income

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In U.S. tax law, classification of income plays a very important role in determining your tax liability. One of the most important classifications is whether you have qualified dividend income eligible reduced tax rates applicable to certain capital gains – in most case, this means 15% tax rate.

As with almost every issue in U.S. law, the qualified dividend classification is complicated if you receive foreign dividends. In this article, I will discuss the IRS rules on determining whether your foreign dividends may be considered “qualified dividend income”.

Qualified Dividend Income

The concept of “qualified dividend income” comes from the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27, 117 Stat. 752), which was enacted on May 28, 2003.

Prior to the Act, section 1(h)(1) of the Internal Revenue Code (the “IRC”) generally provided that a taxpayer’s “net capital gain” for any taxable year will be subject to a maximum tax rate of 15 percent (or 5 percent in the case of certain taxpayers). The new 2003 Act added section 1(h)(11), which provides that net capital gain for purposes of section 1(h) means net capital gain (determined without regard to section 1(h)(11)) increased by “qualified dividend income.”

The law clearly defines this concept of qualified dividend income in Section 1(h)(11)(B)(I). Qualified dividend income means dividends received during the taxable year from domestic corporations and “qualified foreign corporations.”.

Qualified Foreign Corporation

IRC Section 1(h)(11)(C)(i) defines the concept of qualified foreign corporation as (subject to certain exceptions) any foreign corporation that is either (i) incorporated in a possession of the United States, or (ii) eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory for purposes of this provision and that includes an exchange of information program (the so-called “treaty test”).

A foreign corporation that does not satisfy either of these two tests is treated as a qualified foreign corporation with respect to any dividend paid by such corporation if the stock with respect to which such dividend is paid is readily tradable on an established securities market in the United States. Section 1(h)(11)(C)(ii) (see Notice 2003-71, 2003-2 C.B. 922, for the definition, for taxable years beginning on or after January 1, 2003, of “readily tradable on an established securities market in the United States”).

It is important to remember that a dividend from a qualified foreign corporation is also subject to the various limitations in section 1(h)(11). For example, a shareholder receiving a dividend from a qualified foreign corporation must satisfy the holding period requirements of section 1(h)(11)(B)(iii).

Interaction Between PFICs and Section 1(h)(11)

The current law is clear that a qualified foreign corporation does not include any foreign corporation that for the taxable year of the corporation in which the dividend was paid, or the preceding taxable year, is a passive foreign investment company (“PFIC”) as defined in section 1297. See IRC section 1(h)(11)(C)(iii).

Thus, PFIC dividends are not eligible for IRC Section 1(h)(11) favorable treatment. Rather, they will be treated according to the complex PFIC rules described elsewhere in the IRC.

The Treaty Test – Key Threshold

As stated above, subject to certain limitations and exceptions, foreign dividends are likely to be treated as qualified dividend income if a foreign corporation is eligible under the “treaty test”.

A treaty test is passed if the treaty is on the list of the U.S. income tax treaties that met the IRC requirements. The IRS published the first list of such treaties on October 20, 2003 (IRS Notice 2003-69, 2003-2 C.B. 851). Since then, the list has been periodically.

The most recent notice is IRS Notice 2011-64. The new additions since 2006 have been the treaty with Bulgaria (which entered into force on December 15, 2008) and the treaty with Malta (which entered into force on November 23, 2010).

Three U.S. income tax treaties do not meet the requirements of section 1(h)(11)(C)(i)(II). They are the U.S.-U.S.S.R. income tax treaty (which was signed on June 20, 1973, and currently applies to certain former Soviet Republics), and the tax treaties with Bermuda and the Netherlands Antilles.

There are also other requirements under the treaty test. As stated above, in order to be treated as a qualified foreign corporation under the treaty test, a foreign corporation must be eligible for benefits of one of the approved U.S. income tax treaties. Accordingly, the foreign corporation must be a resident within the meaning of such term under the relevant treaty and must satisfy any other requirements of that treaty, including the requirements under any applicable limitation on benefits provision. For purposes of determining whether it satisfies these requirements, a foreign corporation is treated as though it were claiming treaty benefits, even if it does not derive income from sources within the United States. See H.R. Conf. Rep. No. 108-126, at 42 (2003) (stating that a company will be treated as eligible for treaty benefits if it “would qualify” for benefits under the treaty).

Effective Date

It is always important to check the effective dates for each of the treaty for determining when the eligibility for the preferential IRC Section 1(h)(11) arises.

As of the time of this article, IRS Notice 2011-64 is effective with respect to Bulgaria for dividends paid on or after December 15, 2008; Malta – on or after November 23, 2010; Bangladesh – August 7, 2006; Barbados – December 20, 2004; Sri Lanka – July 12, 2004; all other US income tax treaties listed in the Notice – after December 31, 2002.

List of Eligible Treaties

For the reader’s convenience, I listed below all of the U.S. Income Tax Treaties that satisfied the requirements of the IRC Section 1(h)(11)(C)(i)(II) as described in the Appendix to the IRS Notice 2011-64.

Australia
Austria
Bangladesh
Barbados
Belgium
Bulgaria
Canada
China
Cyprus
Czech Republic
Denmark
Egypt
Estonia
Finland
France
Germany
Greece
Hungary
Iceland
India
Indonesia
Ireland
Israel
Italy
Jamaica
Japan
Kazakhstan
Korea
Latvia
Lithuania
Luxembourg
Malta
Mexico
Morocco
Netherlands
New Zealand
Norway
Pakistan
Philippines
Poland
Portugal
Romania
Russian Federation
Slovak Republic
Slovenia
South Africa
Spain
Sri Lanka
Sweden
Switzerland
Thailand
Trinidad and Tobago
Tunisia
Turkey
Ukraine
United Kingdom
Venezuela

Contact Sherayzen Law Office for International Tax Planning

If you have any questions regarding international tax planning, contact Sherayzen Law Office.
Our experienced international tax firm will thoroughly analyze the facts of your case and create an ethical efficient tax plan applicable to your fact situation under the Internal Revenue Code.

AMT Exemption Amounts for the Tax Year 2011

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The Alternative Minimum Tax (the “AMT”) attempts to ensure that anyone who benefits from certain tax advantages pays at least a minimum amount of tax. Congress created the AMT in 1969, targeting higher-income taxpayers who could claim so many deductions they owed little or no income tax. The AMT provides an alternative set of rules for calculating your income tax. In general, these rules should determine the minimum amount of tax that someone with your income should be required to pay. If your regular tax falls below this minimum, you have to make up the difference by paying alternative minimum tax.

Unfortunately, because the AMT is not indexed for inflation, a growing number of middle-income taxpayers are discovering they are subject to the AMT.

You may have to pay the AMT if your taxable income for regular tax purposes, plus any adjustments and preference items that apply to you, are more than the AMT exemption amount. Congress sets the AMT exemption amounts are by law for each filing status.

For tax year 2011, Congress raised the AMT exemption amounts to the following levels:

$74,450 for a married couple filing a joint return and qualifying widows and widowers;
$48,450 for singles and heads of household;
$37,225 for a married person filing separately.

Moreover, the minimum AMT exemption amount for a child whose unearned income is taxed at the parents’ tax rate has increased to $6,800 for 2011.

Contact Sherayzen Law Office for Tax Planning Advice

If you are potentially facing the AMT, contact Sherayzen Law Office for tax planning advice. Our experienced tax firm will review the facts of your case and identify the available strategies to make sure that you do not overpay federal taxes.

IRS Announces Procedures Adjusted for APA and Certain Competent Authority Requests

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The Internal Revenue Service, Deputy Commissioner (International), Large Business and International Division (“LB&I”), announced certain organizational and administrative changes and transitional procedures in connection with the creation of the Advance Pricing and Mutual Agreement (“APMA”) program.

Prior to February 26, 2012, the Advance Pricing Agreement (“APA”) program was part of the Office of the Associate Chief Counsel (International), and the functions of the U.S. Competent Authority were generally exercised by the office of the Director, Competent Authority & International Coordination within the LB&I Division of the IRS. Effective February 26, 2012, the APA program and those Competent Authority functions (including mutual agreement procedures) related to transfer pricing and other allocation issues, as well as determinations of permanent establishment status, are realigned and consolidated into APMA, a single program within LB&I.

The Director of APMA reports to the Director, Transfer Pricing Operations. Other Competent Authority functions are the responsibility of a new LB&I Treaty Assistance and Interpretation team in the office of the Assistant Deputy Commissioner (International), LB&I.

Pursuant to this realignment, the administration of requests for Competent Authority assistance is shared by two separate units within LB&I. Requests for APAs or regarding other transfer pricing, permanent establishment and allocation issues are addressed by APMA. Competent Authority requests regarding non-allocation issues are addressed by the LB&I Treaty Assistance and Interpretation team.

The IRS intends to revise the existing published guidance with respect to requests for APAs and Competent Authority assistance. Before issuing such updated guidance, the IRS will seek public comment.

Pending issuance of such guidance, taxpayers should continue to follow and rely on Rev. Proc. 2006-9, 2006-1 C.B. 278, as modified by Rev. Proc. 2008-31, 2008-1 C.B. 1133 with respect to requests for APAs and Rev. Proc. 2006-54, 2006-2 C.B. 1035 with respect to requests for Competent Authority assistance, except as follows:

1. References to the APA program should be understood to refer to APMA.

2. For determinations regarding limitation on benefits, the user fee under Rev. Proc. 2006-54, §14.02 is $27,500, effective for requests received after Feb. 4, 2012. See Rev. Proc. 2012-1 (Appendix A), 2012-1 I.R.B. 1.

3. Taxpayers should send APA requests and requests for Competent Authority assistance to the following address:

Deputy Commissioner (International)
Large Business and International Division
Internal Revenue Service
1111 Constitution Avenue, N.W.
Routing: MA2-209
Washington, D.C. 20224
Attention: Katina Cooper