international tax lawyers

Impact of Form 8938 on the International Tax Compliance Structure

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The new IRS Form 8938 is not just another tax form that a taxpayer needs to file. Its reach and impact on taxpayer compliance and IRS ability to verify it are far more profound.

Yet, while the addition of Form 8938 to the long list of international tax compliance forms has created a burst of interest among various international tax attorneys (as evidenced in their writings), a very important assessment of the impact of Form 8938 on the rest of the IRS international tax compliance structure appears to be missing in these writings. It is this crucial strategic aspect of the new Form that I wish to address in this article.

Pre-8938 Structure of the IRS International Tax Compliance Requirements

In order to assess the impact of the IRS Form 8938 on the rest of the international tax compliance requirements, it is necessary to briefly explore the pre-8938 (or pre-FATCA (Foreign Account Tax Compliance Act) international tax compliance structure.

Prior to Form 8938, the IRS has already imposed a tremendous variety of reporting requirements on U.S. taxpayers with economic ties to the overseas. First and foremost, the FBAR (the Report on Foreign Bank and Financial Accounts) already forced the disclosure of the foreign bank and financial accounts which are either owned by the U.S. taxpayers or over which these taxpayers have signatory or other authority. Moreover, the FBAR disclosure is tied to the taxpayers’ tax returns through Section III of Schedule B.

From the business side, the IRS required the taxpayers to file a relevant tax form if to report partial or full ownership of a business entity (or if the taxpayer were a director or officer of such entity), including a disregarded business entity. The most prominent examples are Forms 5471, 8865, and 8858. On top of that, Form 3520 and 3520-A address foreign trust ownership and income issues.

Then, there are numerous other reporting requirements addressing such diverse issues as foreign gifts and inheritances, PFIC (Passive Foreign Investment Company) income, Controlled Foreign Corporations, and so on.

In essence, the IRS managed to cover huge areas of international economic activity with various forms and regulations. Moreover, in the past decade, all of these forms were supported by a radical, almost atrocious, increase in penalties in case of non-compliance.

Main Enforcement Problem With Pre-8938 Structure

If the IRS had all of these tools before FATCA, why did the IRS then need any additional forms?

A careful analysis reveals that, despite the presence of the multitude of various forms, it is still not easy to spot a taxpayer’s non-compliance or address all of the non-compliance issues in a given situation for one important reasons – these forms are not connected. Prior to FATCA, there was no form that would allow the IRS to immediately assess the extent of a taxpayer’s non-compliance.

Moreover, despite the number of various tax compliance forms, a lot of information still escaped the IRS. For example, suppose that T (a U.S. taxpayer) owns 15 percent of a business entity B in a country X; other owners are not U.S. taxpayers under any definition. Let us further suppose that business entity B possesses characteristics of a corporation and of a partnership. Assuming all other conditions are met, if B is a foreign corporation, then T would have to file Form 5471. However, if B is a partnership (and assuming all other conditions are met), T would not have to file Form 8865. T was able to classify it as a partnership for U.S. tax purposes, therefore, he needs to file neither Form 5471 nor 8865, leaving the IRS with no information (again, assuming this information would not fall under any other reporting requirement) of T’s foreign business ownership.

Form 8938 is a “Catch-All” Form That Fixes Enforcement Problem for the IRS

This is where Form 8938 comes in. In an example above, the Form 8938 may potentially force T to disclose the ownership information that did not need to be disclosed on Form 8865. If T is particularly unlucky, the IRS may decide to challenge his classification of the business entity, require him to file Form 5471 and impose non-compliance penalties under Form 5471.

This is just one possible scenario. In fact, Form 8938‘s reach is far more ambitious – it is the catch-all form that the IRS desired so much. The Form is directly tied to Forms 3520, 3520-A, 5471, 8621, 8865 and 8891. Moreover, it forces the taxpayers to re-state their foreign bank and financial accounts that should be reported on the FBAR, thereby allowing the IRS to identify with ease if a taxpayer has not complied with the FBAR requirements. Then, it imposes additional reporting requirements that may potentially expose any other taxpayer non-compliance (as in example above).

If that were not enough, failure to file Form 8938 will render the filing of a tax return incomplete, keeping the Statute of Limitations open until the Form is actually filed.

Impact of Form 8938: Breeding Ground for IRS Audits

Thus, Form 8938 is not just another tax compliance form. Rather, it is a fundamental, crucially-important tool which the IRS needs in order to effectively identify potential taxpayer non-compliance.

Hence, the most likely consequence of Form 8938 will the commencement of numerous IRS audits and investigations (which will also feed on the mountain of information obtained by the IRS through various voluntary disclosure programs) of the potentially non-compliant taxpayers. I also expect that the IRS ability to identify and challenge problematic classifications will be increased manifold.

Contact Sherayzen Law Office for Help With Form 8938

If you need help with Form 8938 or you are worried about your tax compliance exposure in light of Form 8938 or any other form, contact Sherayzen Law Office. Our experienced international tax firm will guide you through the complex web of international tax requirements, identify potential problem areas, create a plan of action to deal with these problems, and implement the plan while providing zealous ethical IRS representation.

Form 5472: Basic Information

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The focus of this article is to provide some basic information on the IRS Form 5472, an Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.

The purpose of Form 5472 is to provide information required by the IRS when “reportable transactions” occur during the tax year of a “reporting corporation”, with a foreign or domestic related party. In general, “reportable transactions” are defined to mean certain types of transactions listed in part IV of the form (such as sales, rents, royalties, interest), for which either monetary consideration was the sole consideration paid or received during the reporting corporation’s tax year, or if any part of the consideration paid or received was either not monetary consideration, or was less than full consideration.

“Reporting companies” that generally are required to file Form 5472 include both: 25% foreign-owned U.S. corporations and foreign corporations engaged in a trade or business within the United States.  Broadly speaking, the 25% ownership requirement is meant to apply to a foreign person who owns either directly or indirectly 25% of a US corporation, but not to multiple foreign persons owning only 25% in the aggregate.  However, the related party rules apply to determining ownership.  In certain situations, filing of Form 5472 may not be necessary if applicable exceptions are met.

For those required to file, Form 5472 must be filed with the reporting corporation’s tax return.  The IRS may consider a substantially incomplete Form 5472 to constitute a failure to file the Form.  For each foreign or domestic related party with which a reporting corporation had a reportable transaction during its tax year, a separate Form 5472 must be filed.  The IRS recently issued temporary and proposed regulations with the intent to remove a requirement under existing regulations mandating duplicate filing of the form.

Contact Sherayzen Law Office for Legal Help With Form 5472

If you have any legal or tax questions about Form 5472, contact Sherayzen Law Office for professional help.  Our experienced international tax firm will help you determine your 5472 filing requirements as well as assist you in properly completing the form.

Enterprise Value Tax Proposal

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As the United States government has increasingly searched for needed revenues, and some members of Congress have called for higher taxes on hedge fund managers and various other new tax proposals have been suggested.  One such proposal is the “Enterprise Value Tax”, which passed in the House of Representatives in 2010 (as part of “H.R. 4213, the “American Jobs and Closing Tax Loopholes Act”),  and was included in the “American Jobs Act” of 2011, recently submitted to Congress late last year.

While there has been various demands for Congress to address the “carried interest”  tax advantages that private-equity, venture-capital, and certain hedge fund managers enjoy, the proposed Enterprise Value Tax (EVT) takes a slightly different form.  While some have argued that such a tax is necessary for raising revenues, critics have objected that the proposal leads to onerous taxes that will impede investment and entrepreneurship.

Under the EVT (proposed IRC Section 710), investment management partnerships (such as private equity, venture capital, hedge fund firms, or certain real estate investment groups) would be taxed at ordinary income rates, rather than at capital gains rates, for the net proceeds from sales of “investment services partnership interest”.  In general, an investment services partnership interest is defined to be any interest (direct or indirect) in an investment partnership, acquired or held by a person who in the conduct of an active trade or business provides a substantial quantity certain services (such as managing, purchasing, selling, and advising, among others) related to “specified assets” held by the partnership.  Specified assets include items such as partnership interests, securities and real estate holdings.

In other words, unlike the standard capital gains tax rates applicable to almost all other sales of assets  of a business, under the EVT, sales by partnerships targeted by this proposal would be taxed at ordinary income rates.

Will the EVT, or some variation of it, eventually be part of the Internal Revenue Code?  Only time will tell.  But anyone subject to these new requirements may want be on the alert for that possibility.

Differences between 501(c)(3) and 501(c)(6) Organizations

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Are you thinking of creating a tax-exempt organization under federal income tax law? Tax-exempt organizations can provide extraordinary benefits to their members and society, but forming such organizations may entail significant knowledge of the law, as well as the ability to pay expensive application fees.

In this article I will briefly explain the basic differences between two common types of tax-exempt organizations, 501(c)(3) and 501(c)(6).

General Rules of Tax-Exempt Organizations

In general, net earnings may not inure to the benefit of individuals or private shareholders under either a 501(c)(3) or a 501(c)(6). Form 990 (Return of Organization Exempt From Income Tax) is the standard annual return required to be filed (and other forms, such as Form 990-EZ may be filed, depending upon size or characteristics of the organization).

In order to be granted tax-exempt federal income status, organizations must demonstrate when applying to the IRS that they meet various applicable tests. The rest of this article will explore some of the basic differences between 501(c)(3)’s and 501(c)(6)’s when it comes to these rules, such as the general purpose, and common interest requirements, as well as the advantages and disadvantages such organizations may have when it comes to tax deductions and influencing legislation through lobbying.

General Purpose – 501(c)(6)

Typically, a 501(c)(6) organization must demonstrate that improvement of business
conditions is the general purpose of the organization (this information should be included with the application form). The improvement of business conditions should relate to one or more “lines of business”, rather than the performance of “particular services” for individual persons. A line of business commonly refers to either a certain geographic area’s entire industr, or to all of its components of an industry, but would not include a group comprised of businesses that market a particular brand within an industry. Performance of particular services such as advertising that carries the name of members, interest-free loans, assigning exclusive franchise areas, operation of a real estate multiple listing system, or operation of a credit reporting agency, are examples of what would not be sufficient to show an improvement in business conditions.

General Purpose – 501(c)(3)

In contrast, 501(c)(3)’s include entities organized for charitable, educational, religious, literary, scientific, or other limited (such as amateur athletic organizations, or prevention of cruelty to children or animals) purposes.

Common Interest – 501(c)(6)

A 501(c)(6) organization must be able to show in the application documents that a common business interest of the community, or the conditions of a particular trade, will be advanced. Some examples as noted by the IRS of a common business interest would be: promotion of higher business standards and better business methods and encouragement of uniformity and cooperation by a retail merchants association; education of the public in the use of credit; establishment and maintenance of the integrity of a local commercial market; and encouragement of the use of goods and services of an entire industry. Some examples of membership associations include chambers of commerce, real estate boards, boards of trade, or professional sports leagues. Form 1024 is filed to apply for tax-exempt status for such organizations.

Common Interest – 501(c)(3)

Unlike a 501(c)(6), owners of a 501(c)(3) generally do not need to share a common interest. Form 1023 is filed to apply for tax-exempt status for such 501(c)(3) organizations.

Tax Deductions for Donations – 501(c)(6)

Contributions to 501(c)(6) organizations are not deductible as charitable contributions on a donor’s federal income tax return. However, donations may be deductible provided that they are ordinary and necessary trade or business expenses in the conduct of the taxpayer’s business.

Tax Deductions for Donations – 501(c)(3)

In contrast to 501(c)(6) organizations, taxpayers may deduct gifts, cash, or other items as charitable deductions to 501(c)(3) organizations on their federal income tax returns.

Lobbying – 501(c)(6)

501(c)(6) organizations are allowed to engage in substantial lobbying activities in order to attempt to influence legislation. However, 501(c)(6) organizations may need to disclose to their members the percentage of annual dues paid related to lobbying.

Lobbying – 501(c)(3)

In contrast, lobbying activities are significantly limited for 501(c)(3) organizations. If it is determined that an organization engages in a substantial part of its activities in lobbying, it may risk the loss of its tax-exempt status. An organization will be considered to be attempting to influence legislation, “[I]f it contacts, or urges the public to contact, members or employees of a legislative body for the purpose of proposing, supporting, or opposing legislation, or if the organization advocates the adoption or rejection of legislation.”

Depending upon the facts, it may be possible for a tax-exempt organization to have a separate components (such as entity having separate 501(c)(3) and 501(c)(6) components) in order maximize allowable lobbying, or other, activities. But both components would need to go through separate application processes in order for this to occur.

In future articles, we will cover the possibility of converting a tax-exempt organization into a different type of tax-exempt entity. However, this process, like the application process can be complex, and an experienced attorney is often necessary.

Contact Sherayzen Law Office for Tax and Business Questions About 501(c) Organizations

Due to the complexity of the topic, this article only provides a very general background to the differences about these two common types of 501(c) organizations, and it should not be relied upon to make a decision in your particular situation. If you have any further questions with respect to 501(c) organizations, please contact Sherayzen Law Office for legal and tax help.

IRS Tax Gaps Estimates Show Taxpayers owe $385 Billion in 2006 Taxes

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The Internal Revenue Service recently released new “tax gap” estimates for tax year 2006, showing that taxpayers owe $385 Billion (an increase of about 1/3 over the tax gap from tax year 2001).  The tax gap is defined as the amount of tax liability owed by taxpayers that is not timely paid.

The tax gap is divided into three components: non-filing, underreporting and underpayment.  Most of the increase in the tax gap from tax years 2001-2006 occurred in underreporting and underpayment; in the non-filing segment, the numbers were largely unchanged.

Underreporting in 2006, as in 2001, was the largest contributing factor to the tax gap, increasing to $376 billion (and $67 billion on corporate income taxes) from $285 billion five years earlier.  Underpayment of tax in 2006 increased to $46 billion, up from $33 billion in 2001.  Non-filing accounted for $28 billion in 2006, up a billion from five years before.

Despite the increase in the tax gap over the five years, the voluntary compliance rate (the percentage of total tax revenues paid on a timely basis) stayed almost statistically unchanged, at around 83%.

The 2006 gross tax gap (the amount that was not timely paid), was estimated at $450 billion, an increase from $345 billion in 2001.  The 2006 net tax gap, (the amount of tax that was never paid), was $385 billion, up from $290 billion from five years earlier.