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FDII Export Incentive | Foreign Business Income Tax Lawyer & Attorney

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The 2017 Tax Cuts and Jobs Act (the “2017 tax reform” or “TCJA”) enacted a highly-lucrative incentive for US corporations to export directly from the United States – the Foreign-Derived Intangible Income (“FDII”) regime. In this article, I would like to introduce the readers in a general manner to the FDII export incentive contained in the TCJA.

FDII Export Incentive: TCJA

The creation of the participation exemption system posed a problem for the drafters of the TCJA – how does one stop US corporations from running all of their foreign business through a foreign corporation since foreign corporate profits may actually be transferred to the United States tax-free? Among other provisions of this complex law, the drafters utilized two powerful incentives for US corporations to export directly overseas.

The first one was a “stick” – the Global Intangible Low-Taxed Income or GILTI. The GILTI regime established what can be best described as a global minimum tax on the earnings of foreign subsidiaries of a US business entity.

The second approach was a “carrot” – the FDII export incentive. The FDII regime creates a powerful incentive for US corporations to export goods and services from the United States by creating a deemed deduction of a large percentage of corporate export income. In other words, the effective corporate tax rate is reduced through the FDII regime because a portion of a corporation’s export income is being deducted and never subject to US taxation.

FDII Export Incentive: General Description of the Deemed Deduction

The deemed deduction applies only to a US corporation’s FDII. FDII is basically a certain portion of corporate income from foreign sources determined by a formula established by Congress.

The formula requires a multi-step process. The first steps involve the determination of the Deduction-Eligible Income (DEI), Qualified Business Asset Investment (“QBAI”), Foreign-Derived Deduction-Eligible Income (“FDDEI”). Once all of these items are calculated, then the Deemed Intangible Income (“DII”) is figured out.

FDII is calculated last. The basic formula for FDII is: DII times the ratio of FDDEI over DEI.

The last step is to calculate the tax liability which involves the reduction of FDII by 37.5%. Thus, the effective tax rate for a corporate taxpayer (assuming the current 21% corporate tax rate stays the same) with respect to its FDII is only 13.125%.

It should be mentioned that the current deemed deduction will stay at 37.5% only through December 31, 2025. For the years after December 31, 2025, the deemed deduction will go down to 21.875%. This means that the effective tax rate on FDII will be 16.406%. Unless the law changes (which is possible), non-FDII corporate income will continue to be taxed at 21%.

FDII Export Incentive: Net Impact of the Deemed Deduction

Based on even just this general analysis of FDII, we can understand why the FDII export incentive is such an important part of the US corporate tax law. First, in most cases, the FDII deduction is a disincentive to shift foreign-source income from a US corporation to a controlled foreign corporation (“CFC”). A CFC may be subject to taxation under two different anti-deferral regimes, Subpart F or GILTI tax. Subpart F income will just force the recognition of foreign income by the CFC right away without any deemed deduction (i.e. this would be the worst-case scenario).

If the Subpart F rules do not apply, then the corporation may be subject to the GILTI tax. It is true that the effective corporate tax rate for GILTI, after its current 50% deemed reduction is only 10.5%. Nevertheless, FDII”s effective tax rate of 13.125% significantly reduces the difference from that what it would have been otherwise (i.e. between 10.5% and 21%). Moreover, when one factors in the additional administrative, US tax compliance and local tax compliance expenses, this difference may become nonexistent.

Second, the FDII deemed deduction makes US corporations more competitive worldwide, because they may now realize a higher profit margin even if they lower the prices for their products and services sold overseas.

Contact Sherayzen Law Office for Professional Help With FDII Calculations and International Business Tax Planning

If your business engages in selling products or services overseas, there are opportunities for international business tax planning from US perspective. Contact Sherayzen Law Office to take advantage of these opportunities through professional, creative and ethical tax help.

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Noncompetition Agreement Income Sourcing | International Tax Lawyer

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Oftentimes, as part of their noncompetition agreement, a taxpayer may receive income for restraining from competing with another party in certain areas. An issue often arises with respect to international noncompetition agreement income sourcing rules – i.e. should the income paid as part of such a noncompetition agreement be considered US-source income or foreign-source income? Let’s explore the answer to this question in this essay.

Noncompetition Agreement Income Sourcing: General Rule

The general rule with respect to income sourcing for noncompetition agreements was settled in the distant year 1943. In that year, the Tax Court held that the source of income from a noncompetition agreement is the location of the forbearance. Korfund Co., Inc. v. Commissioner, 1 T.C. 1180, 1187 (1943). In other words, income received from an agreement not to compete is deemed to be income earned in a place where the agreement prohibits the taxpayer from competing.

The reasoning of the Tax Court is clearly laid out in its opinion. The Court stated that the rights that a party enjoys from the noncompetition agreement “were interests in property in [the] country [of forbearance]. … The situs of the right was in the United States, not elsewhere, and the income that flowed from the privileges was necessarily earned and produced here. … These rights were property of value and the income in question was derived from the use thereof in the [country of forbearance].” Id.

In 1996, in its Field Service Advice, the IRS restated its commitment to the position adopted by the Tax Court in Korfund: “income from covenants not to compete covering areas outside of the United States is foreign source income because the income from a covenant covering areas outside the United States is from the use of a property right outside the United States.” 1996 FSA LEXIS 191, *5 (I.R.S. August 30, 1996).

Noncompetition Agreement Income Sourcing: Apportionment

What if a noncompetition agreement covers both, part of the United States and a foreign country? In this case, the IRS is likely to take a position that an apportionment of some sort is necessary. In other words, only part of the income will be deemed as US-source income, while the rest will be considered foreign-source income.

Contact Sherayzen Law Office for Professional Help With Noncompetition Agreement Income Sourcing

If you are dealing with an international noncompetition agreement, you should contact Sherayzen Law Office for professional help with US international tax compliance. Our firm has helped hundreds of US taxpayers around the world with their US international tax issues. We Can Help You!

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Polish Bank Accounts | International Tax Lawyer & Attorney Chicago IL

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A large number of Polish immigrants in the United States continue to maintain close ties to Poland, including the ownership of Polish bank accounts. The same is true for Polish citizens with “green cards” who reside outside of the United States during most of the year. Many of these new American tax residents do not realize that these accounts may be subject to numerous reporting requirements in the United States. In this article, I will discuss, in a general manner, the top three US tax reporting requirements that may apply to these Polish bank accounts.

Polish Bank Accounts: Definition of a “Filer”

There is one critical term that we need to understand in order to properly apply US tax reporting requirements to Polish bank accounts – the concept of “filer”. In this context, “filer” means a person who fits into the category of taxpayers who are required to file a certain form.

It is important to understand that the definition of a filer changes from one form to another. In other words, a person may be required to file one form but not the other even though it concerns the same foreign account.

Despite these differences in the definition of a filer, we can identify a certain common definition that underlies all of the requirements we will discuss in this article, even if this definition is modified for the purposes of a particular form. This common definition can be found in the concept of a “US tax resident”.

All of the following persons are considered to be US tax residents: US citizens, US permanent residents, persons who satisfy the Substantial Presence Test and persons who declare themselves as US tax residents. This general definition of US tax residents is subject to a number of important exceptions.

All of the US international tax reporting requirements adopt the concept of US tax residency as the basis for their definitions of a filer. Where there are differences from the definition of US tax residency, they are mostly limited to the application of the Substantial Presence Test and/or the first-year and last-year definitions of a US tax resident.

For example, Form 8938 identifies its filers as “Specified Persons” (a concept that is applied increasingly throughout US tax code after the 2017 tax reform) while FBAR defines its filers as “US Persons”. Yet, the differences between these two terms mostly arise with respect to persons who declared themselves as US tax residents or non-residents. A common example can be found with respect to treaty “tie-breaker” provisions, which foreign persons use to escape the effects of the Substantial Presence Test for US tax residency purposes.

The determination of your US tax reporting requirements is the primary task of your international tax attorney. It is simply too dangerous for a common taxpayer or even an accountant to attempt to dabble in US international tax law.

Polish Bank Accounts: Worldwide Income Reporting

Now that we understand the concept of US tax residency and the fact that the definition of a filer may differ between different tax forms, we are ready to explore the aforementioned three US reporting requirements with respect to Polish bank accounts.

The first and most fundamental requirement is worldwide income reporting. It is also the requirement that applies to US tax residents as they are defined above (i.e. we are dealing here with the classic definition of US tax residency in its purest form).

All US tax residents must disclose their worldwide income on their US tax returns. This means that they must report to the IRS their US-source and foreign-source income. The worldwide income reporting requirement applies to all types of foreign-source income: bank interest income, dividends, royalties, capital gains and any other income.

Worldwide income reporting requirement applies even if the foreign income is subject to Polish tax withholding or reported on a Polish tax return. It also does not matter whether the income was transferred to the United States or stayed in Poland; the Polish-source income of a US tax resident must still be disclosed on his US tax returns.

Polish Bank Accounts: FinCEN Form 114 – FBAR

The second requirement that I would like to discuss today is FinCEN Form 114, the Report of Foreign Bank and Financial Accounts (commonly known as “FBAR”). Under the Bank Secrecy Act of 1970, the US government requires all US Persons to disclose their ownership interest in or signatory authority or any other authority over Polish (and any other foreign country) bank and financial accounts if the aggregate highest balance of these accounts exceeds $10,000. If these requirements are met, the disclosure requirement is satisfied by filing an FBAR.

It is important to understand all parts of the FBAR requirement are terms of arts that require further exploration and understanding. I encourage you to search our firm’s website, sherayzenlaw.com, for the definition of “US Persons” and the explanation of other parts of the FBAR requirement.

There is one part of the FBAR requirement, however, that I wish to explore here in more detail – the definition of “account”. The reason for this special treatment is the fact that the definition of an account for FBAR purposes is a primary source of confusion among US Persons with respect to what needs to be disclosed on FBAR.

The FBAR definition of an account is substantially broader than what this word generally means in our society. “Account” for FBAR purposes includes: checking accounts, savings accounts, fixed-deposit accounts, investments accounts, mutual funds, options/commodity futures accounts, life insurance policies with a cash surrender value, precious metals accounts, earth mineral accounts, et cetera. In fact, whenever there is a custodial relationship between a foreign financial institution and a US person’s foreign asset, there is a very high probability that the IRS will find that an account exists for FBAR purposes.

Despite the fact that FBAR compliance is neither easy nor straightforward, FBAR has a very severe penalty system. On the criminal side, FBAR noncompliance may lead to as many as ten years in jail (of course, these penalties come into effect in extreme situations). On the civil side, the most dreaded penalties are FBAR willful civil penalties which can easily exceed a person’s net worth. Even FBAR non-willful penalties can wreak a havoc in a person’s financial life.

Civil FBAR penalties have their own complex web of penalty mitigation layers, which depend on the facts and circumstances of one’s case. In 2015, the IRS added another layer of limitations on the FBAR penalty imposition. One must remember, however, that these are voluntary IRS actions and may be disregarded by the IRS whenever circumstances warrant such an action.

Polish Bank Accounts: FATCA Form 8938

The third requirement that I wish to discuss today is a relative newcomer, FATCA Form 8938. This form requires “Specified Persons” to disclose all of their Specified Foreign Financial Assets (“SFFA”) as long as these Persons meet the applicable filing threshold. The filing threshold depends on a Specified Person’s tax return filing status and his physical residency.

The IRS defines SFFA very broadly to include an enormous variety of financial instruments, including foreign bank accounts, foreign business ownership, foreign trust beneficiary interests, bond certificates, various types of swaps, et cetera. In some ways, FBAR and Form 8938 require the reporting of the same assets, but these two forms are completely independent from each other. This means that a taxpayer may have to report same foreign assets on FBAR and Form 8938.

Specified Persons consist of two categories of filers: Specified Individuals and Specified Domestic Entities. You can find a detailed explanation of both categories by searching our website sherayzenlaw.com.

Finally, Form 8938 has its own penalty system which has far-reaching income tax consequences (including disallowance of foreign tax credit and imposition of 40% accuracy-related income tax penalties). There is also a $10,000 failure-to-file penalty.

One must also remember that, unlike FBAR, Form 8938 is filed with a federal tax return and forms part of the tax return. This means that a failure to file Form 8938 may render the entire tax return incomplete and potentially subject to an IRS audit.

Contact Sherayzen Law Office for Professional Help With the US Tax Reporting of Your Polish Bank Accounts

If you have Polish bank accounts, contact Sherayzen Law Office for professional help with your US international tax compliance. We have helped hundreds of US taxpayers with their US international tax issues (including numerous taxpayers with Polish bank accounts), and We can help You!

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Business Service Income Sourcing | Business Tax Lawyer & Attorney Delaware

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Business service income sourcing is a highly important issue in US international tax law. In this article, I will explain the concept of business service income sourcing and discuss the general rules that apply to it. Please, note that this is a discussion of general rules only; there are important complications with respect to the application of these rules.

What is Business Service Income Sourcing?

Business service income sourcing refers to the classification of income derived from services rendered by a business entity as “domestic” or “foreign”. In other words, if a corporation performs services for another business entity or individual, should it be considered US-source income or foreign-source income?

Importance of Business Service Income Sourcing

The importance of business service income sourcing cannot be overstated. With respect to foreign businesses, these income sourcing rules determine whether the income derived from these services will be subject to US taxation or not. For US business entities, the sourcing of income will be a key factor in their ability to utilize foreign tax credit.

Moreover, in light of the 2017 tax reform, the sourcing rules are now important for qualification of various benefits that the new tax laws offer to US corporations.

Business Service Income Sourcing: General Rule

Now that we understand the importance of the business services income sourcing rules, we are ready to explore the General Rule that applies in these situations. Generally, the services are sourced to the country where the services are performed.

In other words, if the services are performed in the United States, then, the income generated by these services is considered US-source income. If the services are performed outside of the United States, then, the income is considered foreign-source income.

Business Service Income Sourcing: Services Performed Partially in the United States and Partially Outside of the United States

The general rule is clear, but what happens if services were only partially performed in the United States? Here, we are now getting into practical complications and we have to look at the Treasury Regulations.

The Regulations begin with the general proposition that the sourcing of income from services rendered by a corporation, partnership, or trust, should be “on the basis that most correctly reflects the proper source of the income under the facts and circumstances of the particular case.” Treas. Reg. §1.861-4(b)(1)(i). This is the so-called “facts and circumstances test”.

Then, the Regulations clarify that usually “the facts and circumstances will be such that an apportionment on the time basis, as defined in paragraph (b)(2)(ii)(E) of this section, will be acceptable.” Id. In other words, the Time Basis Allocation will be the default method for business service income sourcing, but it is possible to use other tests where it is reasonable to do so.

Curiously, the Regulations provide only one example of business service income allocation that involves a corporation, and this example does not utilize the Time Basis Allocation method.

Business Service Income Sourcing: Time Basis Allocation

The Time Basis Allocation method offers two ways to source income: the “number of days” allocation and the “time periods” allocation. Under the “number of days” variation, the business entity adds together the number of days worked by its employees who worked in the United States and the number of days they worked in a foreign country, figures out the percentages for each country and sources the income according to the percentage allocation. See Treas. Reg. §1.861-4(b)(2)(ii)(F).

Under the “time periods” variation, a tax year is split into distinct time periods: one where the employees of a business entity spent all of their time in the United States and one where they spent all of their time in a foreign country. The compensation paid in the first period is allocated entirely to the United States, whereas the proceeds paid in the second time period is considered to be foreign-source income. Id.

The Time Basis Allocation methodology works better for specific employees rather than a business entity as a whole, particularly the “time periods” variation. Often, a business entity would have its employees working at the same time in the United States and outside of the United States making it very difficult to use the “time periods” allocation. Even the “number of days” allocation becomes fairly complex if one has a large number of employees working back and forth between the countries.

Contact Sherayzen Law Office for Help With Your Business Service Income Sourcing

Sherayzen Law Office is a premier US international tax law firm that helps businesses and individuals with their US international tax compliance, including business service income sourcing. If you have employees who work in the United States and overseas, you need the professional help from our law firm.

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IRS Interest Rates for the Second Quarter of 2019 | PFIC Tax Lawyer & Attorney

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On February 25, 2019, the IRS announced that the IRS underpayment and overpayment interest rates will remain the same for the second quarter of 2019 as they were in the first quarter of 2019. The second quarter of 2019 begins on April 1, 2019 and ends on June 30, 2019.

This is an important announcement because these rates will have impact on various calculations and affect many US taxpayers. In particular, the second quarter of 2019 IRS interest rates will apply to the calculation of interest owed on any underpayment of tax as calculated on the amended tax returns. This includes the payments that US taxpayers must make pursuant to the Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures.

Moreover, the increase in the interest rates for the second quarter of 2019 directly affects the calculation of PFIC interest due on any PFIC tax. It is important to remember that PFIC interest cannot be offset by foreign tax credit.

According to the aforementioned IRS announcement, the second quarter of 2019 IRS interest rates will be as follows: 

six (6) percent for overpayments (five (5) percent in the case of a corporation);
three and one-half (3.5) percent for the portion of a corporate overpayment exceeding $10,000;
six (6) percent for underpayments; and
eight (8) percent for large corporate underpayments.

Under the Internal Revenue Code, the rate of interest for the second quarter of 2019 is determined on a quarterly basis. The current year’s overpayment and underpayment interest rates are computed from the federal short-term rate determined during January 2019 to take effect February 1, 2019, based on daily compounding.

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.