International Tax Lawyers | Passive Foreign Investment Company

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Congress enacted the Passive Foreign Investment Company provisions (PFIC) as part of the Tax Reform Act of 1986 in order to deter U.S. investors from deferring or avoiding payment of U.S. taxes by investing in offshore entities. The PFIC rules are structured to provide a disincentive for U.S. investors to defer investment income taxes by owning passive investments in foreign companies that do not regularly distribute their earnings. If it is determined that a U.S. investor is a PFIC shareholder, there can be severe tax implications for the taxpayer.

U.S. taxpayers who are shareholders of PFIC are likely to pay a significant additional tax on realized gains from sales of PFIC shares, and on PFIC dividends that meet the definition of “excess distributions” (an “excess distribution” applies to gains or distributions that exceeds 125% of the average distributions for the previous three years, or less if applicable). In both cases, the tax is applied at the taxpayer’s ordinary income tax rate, regardless of whether capital gains rates would typically apply. Further, an interest charge may be imposed, to offset the years of tax deferral in holding the offshore investment. As an additional disincentive, PFIC shares may not receive a stepped-up cost basis at the shareholder’s death.

Definition of a PFIC and Two-Part Test

In general, a foreign corporation that is determined to be neither a “controlled foreign corporation” (CFC) as defined in IRC section 957, nor a “foreign personal holding company” (FPHC) as defined in IRC section 552, will be determined to be a PFIC if it includes at least one U.S. shareholder and meets either one of the two tests found in IRC section 1297. If at least 75% or more of its gross income is passive income (based upon investments as opposed to operating income), or if at least 50% of the average percentage of its assets are investments that produce, or are held for the production of passive income, the foreign corporation will meet the definition of a PFIC. Passive income generally includes interest, dividends, rents, capital gains, and similar items. There is no requirement of ownership of a certain minimum percentage of shares, as there is with CFCs or FPHCs. Thus, if the test is met, PFIC status will apply, even if a shareholder owns a minimal percentage of shares with no ability to influence the business decisions of the company.

The PFIC rules apply to each U.S. person (the precise definition of who constitutes U.S. person is beyond the scope of this article, but it may become an issue in many situations) rerarding who a shareholder of a PFIC is. PFIC rules, however, do not apply to foreign shareholders or the foreign corporation itself. PFICs may include different types of entities such as various investment vehicles and foreign-based mutual funds.

Two options are commonly suggested by the U.S. tax lawyers to the shareholders in order to avoid PFIC taxation burden: Qualified Election Fund and Mark-to-Market. Both of these options, however, have their own peculiar characteristics and impose different types of tax obligations on the shareholders.

Qualified Electing Fund

In general, U.S. shareholders who own shares either directly or indirectly in a PFIC may be able to avoid the burdensome standard PFIC taxation provisions by electing to treat the PFIC as a Qualified Electing Fund (QEF) on Form 8621. Shareholders making this annual election are taxed on their pro rata share of the PFIC’s ordinary earnings as ordinary income, and their pro rata share of the net capital gains as long-term capital gain. A shareholder’s basis in the stock of a QEF is increased by the earnings included in gross income and decreased by a distribution from the QEF to the extent of previously taxed amounts. Finally, U.S. shareholders interested in making this election must also be able to obtain the required information from the PFIC.

While treating a PFIC as a QEF may be beneficial in that it allows taxpayers to opt out of the standard PFIC tax and interest rules, it also forces shareholders to pay taxes currently on undistributed income earned by a foreign corporation. Thus, QEF may be of limited use to taxpayers who lack adequate liquidity to pay taxes. Another important point about a QEF is that, due to the complexity of the rules and possible additional tax amounts, if the decision is made to elect QEF treatment of PFIC, it may be advisable to elect a QEF in the first year of holding an offshore investment.

Mark-to-Market

Another option for U.S. shareholders of a PFIC (who do not elect to treat a PFIC as a QEF), is to elect the mark-to-market method. This election is only available if the shares are considered “marketable stock”. Marketable stock is regularly traded stock with an ascertainable value on recognized exchanges as defined in the IRC regulations. If the shareholder elects to mark the stock to market, he will annually report, as ordinary income, the amount equal to any excess of the fair market value (FMV) of the PFIC stock as of the close of the taxable year over the adjusted basis of the shares (i.e. as if the shares had actually been sold at FMV). If the adjusted basis of the PFIC shares exceeds its FMV as of the close of the taxable year, the shareholder may generally deduct an ordinary loss (subject to certain statutory limitations).

Shareholders who directly own shares in a PFIC electing the mark-to-market method may increase their adjusted basis in PFIC shares through income recognized, and decrease the adjusted basis through deductions taken.

Conclusion

The tax issues surrounding PFICs are very complex and should be handled by a tax professional. Sherayzen Law Office can help you analyze your tax situation, determine whether PFIC rules apply, identify the alternatives in light of your whole tax situation, and implement the tax strategy most suited to your business and investment needs.

Call NOW to discuss your tax situation with an experienced tax lawyer!

Capital Gains and Losses: Tax Implications for Individuals and C-Corporations

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Capital gains and losses defined

Capital gains and losses result from the taxable realized sale or exchange of capital assets. In general, capital assets include investments (such as stocks and real estate) and fixed assets, as opposed to personal-use property.

Capital gains result when the sale or exchange price is greater than the adjusted basis of the capital asset. Conversely, capital losses occur when the adjusted basis is higher than the sale or exchange price, and certain expenses associated with the sale may be added to the loss. The holding period of the capital asset being sold or exchanged will determine whether the capital gain or loss is long-term (held for more than a year) or short-term (held for less than a year).

Netting Capital Gains and Losses (Individual taxpayers)

Each taxable year, capital gains and losses are aggregated or “netted” on Schedule D. First, long-term capital gains and losses are netted. Second, short-term capital gains and losses are netted. Four possible scenarios will result from this two-step process:

Scenario A: A long-term gain and short-term gain
Scenario B: A long-term gain and short-term loss
Scenario C: A long-term loss and short-term gain
Scenario D: A long-term loss and short-term loss

In scenario A, the short-term gain will be taxed with the taxpayer’s ordinary income at his or her marginal rate. For the long-term capital gain, the favorable long-term capital gains tax rate will apply, depending upon the taxpayer’s tax bracket.

In scenario B, there are two possible outcomes depending upon which result is larger, the loss or the gain. If the short-term loss is greater than the long-term gain, a net short-term loss will result, and up to $3,000 can be used to offset other income, with additional amounts can be carried forward to subsequent tax years. Alternatively, if the long-term gain is larger than the short-term loss, then a net long-term gain will result, and the favorable long-term capital gains tax rates will apply.

In scenario C, there are two possible outcomes depending upon which result is larger, the loss or the gain. If the long-term loss is larger than the short-term gain, then a net long-term loss will result, and (as with scenario B) up to $3,000 can be used to offset ordinary income. Any unused amount above $3,000 can be carried forward to subsequent years as long-term loss. Alternatively, if the short-term gain is larger than the long-term loss, then a net short-term gain will result, and it will be taxed at the taxpayer’s marginal rate.

In scenario D, there are several possible outcomes. First, if the total long-term and short-term losses combined total $3,000 or less, then the amount may be used to offset ordinary income. However, if the total amount of short-term losses exceed $3,000, then the first $3,000 of short-term loss will be applied to offset other income, and any remainder will be carried forward to subsequent years as a long-term loss. If the short-term loss is less than $3,000, then that amount will be applied to offset ordinary income, and any amount of available long-term loss making up the difference between the short-term loss applied and $3,000 will also be used to offset ordinary income (with the additional, unused amounts carried forward).

Capital Gains and Losses (C Corporations)
C corporations, unlike individuals, do not receive favorable tax rate on capital gains. Capital gains must be included as part of ordinary income, in their entirety.

Further, capital losses must be used only to offset capital gains, and are non-deductible against ordinary income for C corporations. Net capital losses can be carried back to the three preceding years (and are applied in chronological order, beginning with the earliest tax year) provided the corporation has capital gains to offset. Additionally, corporate taxpayers may carry forward the capital loss five years from the year of loss, again provided that there are capital gains to offset. Carryforwards expire after the fifth year. Importantly, all losses carried back or forward are considered to be short-term.

Offsetting Capital Gains and Losses
Are you a taxpayer interested in benefiting from the capital gains and losses tax rules? Do you have questions about selling capital assets such as stocks or real estate for tax purposes, and how to best time your transactions in order to pay less taxes? Are you concerned about how new capital gains and loss tax changes may affect your situation?

Sherayzen Law Office can guide you with all of your capital gains and losses questions, and help you plan ahead so that you pay less taxes.

Call NOW to discuss your case with an experienced tax attorney!

Preparing for Business Contract Litigation in Minnesota: Recordkeeping Techniques

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Since most of the business-to-business relationships are organized on the basis of written business contracts, it is inevitable that contract disputes would arise between businesses. Frequently, these disputes are serious enough to lead to business contract litigation between the relevant parties

Therefore, it is important for any business to prepare for such a possibility ahead of the actual commencement of the contract litigation. One of the most crucial (to the success of such litigation) tasks of a business owner is to maintain good records. Proper recordkeeping is essential to successful contract litigation, and, hence, this article lists the following five techniques for the business owners on what type of business records should be kept and how to best organize them.

1. Keep an original copy of your contract

Keeping your original copy is the most basic step in preparation for a contract litigation. Yet, it is shocking how many business owners ignore this. By “original copy” of a contract, I mean one of the counterparts of the contract which bears the original signatures of all parties. Where only one copy of a contract is signed, then you should keep this original. If, for some reason, the decision is made that the other party would keep a copy of a contract, you should request a copy of the contract for your records. This situation is especially common in joint ventures and inter-corporate agreements, but it is very unusual in business-to-business dealings.

The contract should be kept in a separate folder in a safe place. However, do not file your contract in a place that you would not remember. If your business has designated an officer of your company to keep business records, you should make sure that you know the filing system adopted by that officer and where the most important files are.

2. File “negotiation” notes and documents

In addition to the contract itself, you should file all notes, documents, and printed copies of e-mails that were produced in connection with the negotiation of a contract. “All” means “all” – any of these documents may be important to resolve an ambiguity in the contract later as well as to demonstrate a party’s intent.

There are two types of “negotiation” materials: exchanged and internal. The exchanged materials are the notes and documents that were shared with the other parties to the contract during the negotiation process. Generally, in a business-to-business setting, these types of documents are not covered by the attorney-client privileged. Absent a non-disclosure agreement stating to the contrary, it is likely that these documents would not even be considered as proprietary.

The internal materials are the notes and documents that were produced in connection with the negotiation process but were never shared with anyone outside of the company (with the exception of the company’s business lawyer). Examples could include: internal profit-loss assessments, corporate documents (such as board memorandums), assessment of risk, and so on. These documents should be marked as “proprietary information” and filed in a separate folder also marked as “proprietary information.”

Moreover, the internal documents produced by the company’s lawyer should be marked as “attorney-client privileged”; such documents should be filed in a separate folder also marked as “attorney-client privileged”.

All folders of exchanged and internal materials, including the folder containing attorney-client privileged information, should be kept together with the contact. Such organization of documents will be very useful for discovery purposes during the litigation and can save you thousands of dollars in attorney and accounting fees.

3. File Contract-Modification Materials

Documents discussing and potentially modifying the already executed contract should also be filed in a separate folder and kept together with the rest of the documents described above. While some of these documents may be obvious (such as a letter entitled “Request for Contract Modification), others may be much more difficult to classify, especially if the potentially modifying circumstances are not explicitly discussed in the contract.

Therefore, in order to take full advantage of this advanced recordkeeping technique, the business owner should consult his lawyer. An experienced legal professional with deep understanding of contact law and the facts of a specific case is in the best position to determine which documentary materials may be construed as contract modification.

4. Document Contract Performance

This is another sophisticated recordkeeping technique that requires understanding of the term “usage of trade”. Armed with this knowledge, your business lawyer will be able to determine how to document the parties’ contract performance and whether this performance is modifying or has modified the contract.

5. Record Your Company’s Intent and Understanding

This is probably the most flexible advanced recordkeeping technique aimed specifically at the possible future contract dispute. Basically, this is a technique that uses the management structure of the company to create business records regarding the intention and interpretation of a contract. As business records, this evidence of intent and understanding will most likely be admissible in court. The most common example of this technique are corporate board minutes (in the corporate context) or Board of Governors resolutions (for the LLCs).

Again, due to the level of sophistication and legal knowledge required to accurately record a company’s intent and understanding of a contract, it highly advisable that you hire a business lawyer to draft the relevant documents.

Conclusion

Good recordkeeping is crucial to successful business contract litigation. The techniques listed above do not constitute an exhaustive list of recordkeeping suggestions, but they should provide the minimal necessary structure that is likely to be cost-effective and highly efficient in a contract litigation context. Not all of the techniques cited in this article can be implemented by a business owner. Therefore, it is crucial to retain the services of a business contract attorney to fully protect from and prepare your business for the possible contract litigation in the future.

Sherayzen Law Office can help you create and implement a recordkeeping system appropriate for your industry and compatible with your business model.

Call NOW to discuss your case with an experienced business contract lawyer!

Contract Lawyers Minneapolis | Getting Out of Contract in Minnesota

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This is an odd article to write for a Minnesota contract lawyer who spends most of his contract law practice making sure that the terms of a contract are enforceable. Yet, occasionally, I have clients who are looking for a way to get out of a contract for many reasons. Some of these clients suddenly found themselves in a situation where compliance with the contract terms is no longer economically feasible or desirable. Others have personal reasons which make continuation of compliance with a contract non-practical and even personally disagreeable (especially in business partnerships).

Lawyer-Written versus Non-Lawyer Written Contracts

For the purposes of getting out of contract, the situations where one party suddenly wishes to attack the enforceability of a contract can be divided into two large categories. The first category involves contracts written, or rather copied from other sources (especially Internet), by the parties themselves. In this case, the contracts are usually inadequately drafted and contain many errors and omissions. Naturally, this type of contracts is much easier to attack for someone who wishes to avoid his contractual obligations.

On the other hand, the contracts in the second category are drafted by Minnesota contract attorneys. Usually, these contracts are based on the court-tested provisions, involve multiple levels of defense, constrict venues of attack, and prescribe certain procedures for disputing the enforceability of the contract. These contracts present a much more difficult target than those in the first category.

Methods for Getting Out of Contract

Irrespective of the category to which a contract belongs, Minnesota contract litigation lawyers usually utilize five broad methods for helping their clients avoid their contractual obligations.

1. Exit Provision in the Contract

First, the most simple method is to take advantage of the provisions that a contract already contains. Most of the contracts I draft for my clients contain negotiated “exit” provisions, which prescribe the procedure for either contract termination or withdrawal of a party from a contract.

This is especially true in the case of entity governance contracts such as Partnership Agreements, Member Control and Operating Agreements (for multi-member LLCs), corporate Bylaws, and so on. Also, Independent Contractor Agreements, in order to comply with law, often include a very detailed contract termination procedure. Sales contracts often utilize a “liquidated damages” clause to cap the amount of damages.

2. Validity of Contract

The second method is to attack the validity of the contract itself. Some of these attacks, such as lack of adequate consideration or the Statute of Frauds, will be based on the terms or form (i.e. oral versus written) of a contract; others, such as lack of legal capacity or the doctrine of unconscionability, will focus on the broad factual context which led to the creation of the contract. The precise method of attacking the validity of the contract should be chosen by a Minnesota contract litigation lawyer (if you live in Twin Cities, try locating a Minneapolis contract litigation attorney or St. Paul contract litigation attorney).

3. Contract Construction

The third method is to reinterpret the contract in such a way as to modify parties’ obligations. Here, the issue is the contract construction – interpretation of contractual terms based on the rules of contract construction and the facts of a specific case, including the parties’ course of dealing. If this is a contract for a sale of goods, UCC terms may determine the outcome. This method requires a very deep understanding of contract law. Therefore, only Minnesota contract litigation lawyers should be involved in implementing this strategy (again, if you live in Twin Cities, try locating a Minneapolis contract litigation attorney or St. Paul contract litigation attorney).

It should be noted that contract construction is involved to a varying degree in all of the methods described in this article. This is why it is crucial to retain a Minnesota contact lawyer as soon as possible.

4. Excuse for Non-Performance

The fourth method is to find an excuse for the non-performance of a party’s obligations under the contract. Notice the difference between the fourth and the second method – in the fourth method, the contract is assumed to be valid, but a party’s breach of this contract is discharged for some reason. Examples of this method include: doctrines of Impossibility and Frustration of Purpose, discharge by a later contract (for example: rescission, release, et cetera), change in law, and so on. It is up to your particular Minnesota contract litigation lawyer to determine which of these excuses applies and how to prove it in court.

5. Breach

Finally, the fifth method is to just breach the contract. Generally, there are two situations where a Minnesota contract lawyer may advise this course of action. First, whether the benefits of the breach of contract are likely to substantially outweigh the damages the breaching party will need to pay. Second, where the contact is breached in such a way as to significantly reduce the damages. Again, the circumstances of a particular case will determine whether this method should be utilized.

Conclusion

Getting out of contract in Minnesota is not easy. Yet, it may be possible if there is a right combination of facts and legal strategy. Once the plan of attack is established, its implementation will require skillful implementation by your contract lawyer.

Sherayzen Law Office can help you analyze your case, choose the legal strategy right for you, and vigorously and skillfully implement this strategy in negotiations as well as in court.

Call NOW to talk with an experienced contract law attorney!

Contract Litigation Lawyers Minnesota | Understanding Contract Litigation

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Contract litigation permeates the very fabric of advanced economic societies. The primary reason for this widespread presence of this type of litigation is because contracts provide the most common and basic means of conducting transactions between individuals and especially businesses. Contracts, whether written or oral, govern the everyday economic relations. Every time you buy something for a certain price at a store, you agree to a contract. Every time your business hires a worker, it enters a contract.

Since contracts can be found almost everywhere in our economic lives, it is little wonder that disputes often arise between the parties about the exact terms of what they have agreed to or what their contractual obligations are.

Contract litigation is a civilized way to settling these contract disputes. It is a process where the parties to a contract, usually represented by contract litigation attorneys, present their respective arguments to an impartial judge of the relevant jurisdiction the laws of which govern the interpretation of the contracts and even which laws apply. Usually, the parties’ arguments revolve around three common themes. First, interpretation of the contract and the parties’ rights and obligations. Second, enforcement of a party’s contractual rights or obligations. Third, obtaining remedy for whatever damage produced as a result of the other party’s breach of contract. Usually, the remedy is limited to recovering damages, but there are situations where a party will seek an order from the court to compel the other party to perform as promised (this is known as “specific performance”). In some situations, an injunction prohibiting a party from doing something may be appropriate.

A lot of people unfamiliar with contract litigation commit a common mistake of thinking that contract interpretation is limited solely to the language that can be found in the contract itself. While ambiguous, competing or contradictory clauses may form the core of a party’s argument, contract litigation lawyers usually have to also analyze the particular facts of a case which may be relevant to the interpretation of the disputed language of the contract.

Beyond these basic litigation themes, contract litigation involves a myriad of other procedural and substantive decisions: assessment by contract litigation lawyers of whether a case should be litigated, where to file the case, the laws of which jurisdiction of should apply, what evidence should be presented, who should testify, how would a judge interpret the contract given the trends in the laws of a relevant jurisdiction, and so on. Therefore, it is very important to involve a contract litigation lawyer as early as possible in the contract litigation process.

Sherayzen Law Office can guide you through this labyrinth of procedural and substantive issues and litigate the case for you. When you retain Sherayzen Law Office to represent you in a contract dispute litigation, you get a vigorous advocate of your legal position who is thorough, detail-orientated and possesses strong litigation skills, with the analytical ability to identify and achieve effective resolutions. We recognize that litigation is a means to an end and structure our litigation strategies in such a way as to protect and enforce your business interests.

Call NOW  to discuss your case with a Minnesota contract litigation lawyer!