Hindu Undivided Family (HUF) US Tax Classification | Foreign Trust Lawyer

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This article continues a series of articles concerning US tax classification of unusual foreign entities; our focus is on the determination whether these entities should be classified as foreign business entities or foreign trusts. Today’s topic is the Hindu Undivided Family, the preferred legal entity for managing family estates for a large number of wealthy Indian families.

A word of caution, the description of the Hindu Undivided Family (“HUF”) provided below is necessarily a general one. This article sacrifices detail for the sake of clarity.

Hindu Undivided Family: Purpose

The main purpose of HUF is to manage family-owned property. I want to emphasize that this is not a property owned by one or two members individually or jointly; rather, the entire family owns the property.

Hindu Undivided Family: Lineal Descendants From a Common Ancestor

HUF is an entity that applies to and gives rights only to lineal descendants from a common ancestor as well as their wives and unmarried daughters. Married daughters are not considered members of their fathers’ families; instead, upon marriage, they become members of their husbands’ families.

These lineal descendants are called coparceners. They have the right to enjoy distributions from HUF and even have a right to demand partition in the HUF property.

Hindu Undivided Family: Management

The head of the family (called “karta”) manages the HUF property on behalf of the family. Usually, karta is a senior male, but recently women also started to occupy this role. Karta is prohibited from contributing property to HUF.

Hindu Undivided Family: Legal Classification Under Indian Law

HUF exists as a separate juridical entity for Indian tax purposes. It is defined on the basis of Hindu personal law. The Hindu personal law states that the joint and undivided family is a normal condition of Hindu society where all members of a Hindu family are living in a state of union.

It is important to emphasize this special legal position of HUF, because all other Indian entities are defined in the Indian company law. HUF is an exception in having Hindu personal law as its legal basis.

Hindu Undivided Family: Potential US Tax Classification

As of the time of this writing, the IRS has not ruled on the proper US tax classification of HUF. Therefore, at this time, we can only speculate about how the IRS will treat HUF under US tax law.

Under 26 CFR §301.7701-4(a) “trust” is defined as an arrangement created by will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules provided in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust if it was created for the purposes of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally, an arrangement will be treated as a trust if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Thus, if it is established that HUF was created for the purpose of vesting trustees responsibility for the protection and conservation of property for beneficiaries and not to carry out business, then, it should be classified as a foreign trust under US tax law. If, however, the facts and circumstances in a particular case indicate that a HUF was established primarily for commercial purposes as opposed to the purpose of protecting or conserving property on behalf of the beneficiaries, then this HUF will most likely be classified as a business entity under §301.7701-2(a).

Additionally, there are certain additional features of HUF that may further support its classification as a foreign trust. For example, the role of karta appears to be analogous to a trustee in most cases, whereas coparceners are likely to be considered beneficiaries for US tax purposes (especially if they do not take any active role in the management of HUF property).

Thus, based on the analysis above, it appears that, in most cases, the IRS is likely to rule that HUF is a trust under US tax law. I want to emphasize the limitation “in most cases”; I believe that a US tax treatment of HUF will depend on the specific facts and circumstances concerning a specific HUF.

Hindu Undivided Family: US International Tax Compliance Implications

The precise US tax classification of HUF may have far-reaching consequences for US international tax compliance of coparceners who are US tax residents (i.e. green card holders or persons who satisfied the substantial presence test) and US citizens (collectively “US Persons”). A whole host of US international tax reporting requirements as well income tax requirements will apply to such individuals.

For example, if HUF is classified as a trust, then coparceners who are US persons may have to file Forms 3520 and 8938 as well as FBARs. Moreover, they may have to deal with the onerous consequences of the “throwback tax” on distributions of accumulated trust income. Other requirements may also apply in this situation.

If, however, HUF is classified as a corporation, then such coparceners may have to file Form 5471 and 8938. If this is a Controlled Foreign Corporation (“CFC”), they will have to deal with all kinds of anti-deferral regimes, including GILTI tax. If this is not a CFC, then the PFIC regime may be a problem. Again, additional requirements may apply in such situations.

If HUF is classified as a partnership, then Form 8865 will have to be filed every year and income from 8865 Schedule K-1 will have to be reported on such a coparcener’s US federal income tax return. Once again, additional requirements may apply in such situations.

Contact Sherayzen Law Office for Professional Help With Your US International Tax Obligations Concerning Hindu Undivided Family

If you are a coparcener who is a US Person, contact Sherayzen Law Office for professional help concerning your US international tax compliance. Sherayzen Law Office is a US-based tax law firm dedicated to helping clients in the United States and throughout the world with their US international tax compliance issues.

We have successfully helped hundreds of Indian clients with their US income tax compliance issues, and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

§318 Double-Inclusion Prohibition | International Tax Lawyers Tampa FL

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In a previous article, I discussed the IRC (Internal Revenue Code) §318 general rule on the re-attribution of corporate stock; in that context, I mentioned that there are certain restrictions on §318 re-attribution. Today, I would like to discuss one of such restrictions – §318 double-inclusion prohibition.

§318 Double-Inclusion Prohibition: General Re-Attribution Rule

Before we discuss the §318 double-inclusion prohibition, let’s recall the general §318 re-attribution rule. Under §318(a)(5)(A), stock constructively owned by a shareholder under any of the §318 attribution rules is deemed to be actually owned for the purposes of re-attribution to others.

The problem with this rule is that it can allow the re-attribution of stock to spread uncontrollably to include persons who have little to no relationship to the actual stock owners. This is precisely why Congress chose to impose certain limitations on the general rule so that the §318 re-attribution applies only to related persons with a real connection to the actual owners. One of these limitations is the prohibition on double-inclusion.

§318 Double-Inclusion Prohibition: Re-Attribution is Counted Only Once

Under Treas. Reg. §1.318-1(b)(2), corporate stock held by any one person will be included only once in the computation of ownership. This is the §318 double-inclusion prohibition rule.

It is important to note, however, that even though the stock ownership is counted only once, it should be counted “in the manner in which it will impute to the person concerned the largest total stock ownership”. Id.

§318 Double-Inclusion Prohibition: Example

The best way to understand the §318 double-inclusion prohibition is to look at the following example. Assume that husband and wife, H and W, equally own a partnership P (i.e. 50% each); H also owns 100% of the outstanding stocks of a C-corporation X.

Under §318(a)(1)(A)(i), W constructively owns all of her husband’s shares of X. Since H and W are partners of P, under the partnership upstream attribution rules, all stock owned by them is attributed to P. Since each spouse owns 100% of X (one actually and one constructively), does it mean that P owns 200% of X? No, this absurd result is prevented by Treas. Reg. §1.318-1(b)(2), which limits the attribution of X’s shares from H and W to P to a total of 100%.

Contact Sherayzen Law Office for Professional Help With US International Tax Law Compliance

US international tax law is incredibly complex and the penalties for noncompliance are exceptionally severe. This means that an attempt to navigate through the maze of US international tax laws without assistance of an experienced professional will most likely produce unfavorable and even catastrophic results.

This is why you should contact Sherayzen Law Office for professional help with US international tax law. We are a highly experienced, creative and ethical team of professionals dedicated to helping our clients resolve their past, present and future US international tax compliance issues. We have helped clients with assets in over 70 countries around the world, and we can help you!

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2020 2Q IRS Interest Rates | US International Tax Law Firm

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On February 28, 2020, the Internal Revenue Service (“IRS”) announced that the 2020 Second Quarter IRS underpayment and overpayment interest rates (“2020 2Q IRS Interest Rates”) will not change from the first quarter of 2020. This means that, the 2020 2Q IRS interest rates will be as follows:

  • five (5) percent for overpayments (four (4) percent in the case of a corporation);
  • two and one-half (2.5) percent for the portion of a corporate overpayment exceeding $10,000;
  • five (5) percent for underpayments; and
  • seven (7) percent for large corporate underpayments.

Under the Internal Revenue Code, these interest rates are determined on a quarterly basis. The IRS used the federal short-term rate for February of 2020 to determine the 2020 2Q IRS interest rates. The IRS interest is compounded on a daily basis.

The 2020 2Q IRS interest rates are important to not just US domestic tax law, but also US international tax law. For example, the IRS will use these rates to determine how much interest a taxpayer needs to pay on an additional tax liability that arose as a result of an amendment of his US tax return through Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. The IRS will also utilize 2020 2Q IRS interest rates with respect to the calculation of PFIC interest on Section 1291 tax.

As an international tax law firm, Sherayzen Law Office keeps track of the IRS underpayment and overpayment interest rates on a regular basis. Since our specialty is offshore voluntary disclosures, we often amend our client’s tax returns as part of an offshore voluntary disclosure process and calculate the interest owed on any additional US tax liability. We also need to take interest payments into account with respect to additional tax liability that arises out of an IRS audit.

Moreover, we very often have to do PFIC calculations for our clients under the default IRC Section 1291 methodology. This calculation requires the usage of the IRS underpayment interest rates in order to determine the amount of PFIC interest on the IRC Section 1291 tax.

Finally, it is important to point out that the IRS will use the 2020 2Q IRS interest rates to determine the amount of interest that needs to be paid to a taxpayer who is due a tax refund as a result of an IRS audit or amendment of the taxpayer’s US tax return. This situation may also often arise in the context of offshore voluntary disclosures.

Thus, the IRS underpayment and overpayment interest rates have an impact on a lot of basic items in US tax law. Hence, it is important to keep track of changes in these rates on a quarterly basis.

§318 Re-attribution: General Rule | International Tax Lawyers Miami

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This article continues a series of articles on the Internal Revenue Code (“IRC”) §318 constructive ownership rules. Today, I would like to focus on the §318 re-attribution rule. In this article, I will explain the general §318 re-attribution rule and mention the exceptions. I will discuss the exceptions in more detail in future articles.

§318 Re-attribution: General Rule

Generally, under the IRC §318(a)(5)(A), stock constructively owned by a shareholder under any of the §318 attribution rule is deemed to be actually owned for the purposes of re-attribution to others. In other words, except for limitations mentioned below, the constructive ownership of stock can be further attributed to other persons.

For example, if a husband owns stocks in Corporation Y and his wife is deemed to owned these stocks under the family attribution rules of §318(a)(1)(A)(i), then these constructively-owned stocks can be further attributed from the wife to Corporation X under the shareholder-to-corporation rules of §318(a)(3)(C) if the wife owns 50% or more of the value of stocks issued by Corporation X.

§318 Re-attribution: Great Burden on Taxpayers

The breadth of the §318 re-attribution rule can present a huge challenge to taxpayers. Both individuals and entities must maintain correct ownership records to allow their tax attorneys to properly determine their ownership of stock under §318 and their consequent tax obligations.

The dangerous reach of the §318 re-attribution rule can be demonstrated by the following example. Let’s suppose that corporation X has 200 shares outstanding and all of the shares are owned as follows: H owns 100 shares, his wife W owns 60 shares and his son S owns 40 shares. Additionally, H owns 25% in partnership P.

Under the §318 family attribution rules, H actually owns 100 shares and constructively owns another 100 shares (i.e. his wife’s and his son’s shares) of X. Under §318(a)(5)(A), H’s constructive ownership of 100 shares is deemed to be actual ownership for the purposes of re-attribution of stock. Consequently, under the partner-to-partnership rules of §318(a)(3)(A), 100% ownership of X is now attributed to P.

This can get even worse. Assuming the same facts, what if P also actually owns 50% of the value of the stock of corporation Y? Then, under §318(a)(3)(C), Y would be a constructive owner of 100% of X, because these shares were attributed first to H and, then, from H to P.

§318 Re-attribution: Restrictions

It is obvious that, without any limitations, such an extensive re-attribution of stock can easily get out of hand and spread to cover persons who have no relationship to the original owners. For this purpose, the US Congress imposed certain restrictions on the re-attribution of stock under §318(a)(5)(A). Each provision §318(a)(5)(B)–§318(a)(5)(D) imposes limitations on re-attribution of stock where the relationship between the original owner and the person subject to stock re-attribution no longer justifies the assertion of constructive ownership. I will detail these restrictions in future articles.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

If you own foreign assets, including foreign business entities, you have the daunting obligation to meet all of your complex US international tax compliance requirements; otherwise, you may have to face the wrath of the IRS in the form of high noncompliance penalties. In order to successfully meet your US international tax compliance obligations, you need the professional help of Sherayzen Law Office.

We are an international tax law firm that specializes in US international tax compliance and offshore voluntary disclosures. We have successfully helped hundreds of US taxpayers worldwide with their US international tax compliance, and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!