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US GAAP Conversion of Foreign Financials: Most Common Issues | Form 5471 Lawyer

Form 5471 generally requires US GAAP (Generally Accepted Accounting Practices) conversion of foreign financial statements for the purposes of reporting book income, because foreign accountants usually prepare these statements based on a different foreign standard.  While Treas. Reg. Reg. §1.964-1(a)(2) contains a limited exception to the US GAAP conversion adjustments for “non-material” items (the same exception applies to tested/income loss calculation for GILTI purposes; see Treas. Reg. §1.951A-2(c)(2) (which refers to Treas. Reg. §1.952-2, which, in turn, mention the “materiality” rules of the §964 regulation)), the translation of foreign financial statements to US GAAP is a common problem for tax professionals who deal with Form 5471.

In this article, I will outline the most common issues related to the conversion of foreign financial statements to US GAAP.

US GAAP Conversion Issues: Depreciation

At the top of the US GAAP adjustments are different methods of depreciation and amortization. These differences cover pretty much all types of depreciable assets: fixed assets and intangible assets (including goodwill).

When we at Sherayzen Law Office prepare Forms 5471 for our clients, it is our standard practice to request that foreign accountants provide a detailed depreciation report, including amounts and dates concerning the purchase/sale of assets, the amortization/depreciation conventions used in foreign financial statements and the methods of accounting for increase/decrease in the value of depreciable assets.

US GAAP Conversion Issues: Inventory

Another very common area of US GAAP adjustments involves inventory. Here there could be an array of variations from FIFO/LIFO to expense capitalization methods and valuation of inventory.  Common problems arise when the inventory valuation adjustments result from related-party transactions.

For example, in one of our cases, our client had contracts of sale drafted between the head office in the United States and a foreign branch office (due to the foreign country’s requirements), making it impossible to directly rely on the foreign branch’s financial statements to determine the Cost of Goods Sold (COGS) due to varying mark-ups on tens of thousands of items.

US GAAP Conversion Issues: Valuation of Assets

One highly-problematic area for US GAAP adjustments is the valuation of assets in the foreign financial statements.  Oftentimes and in a large number of tax jurisdictions, historic cost of assets is replaced with another valuation method allowed by a local accounting standard but not by US GAAP.

We see this problem appear often in tax jurisdictions as varied as Czech Republic, Jamaica, Nigeria, Pakistan, Poland, et cetera.

US GAAP Conversion Issues: Mergers, Dissolutions and Acquisitions

Mergers, dissolutions and acquisitions may result in a bewildering array of differences between foreign financial statements and US GAAP requirements: from income recognition to asset valuation, treatment of reserve, E&P calculations and so on. Sometimes, there may be a break in the continuity of financial statements due to a dissolution of one entity and creation of another entity for US GAAP purposes while entities are treated as one entity in a foreign jurisdiction. I remember one case from Pakistan and one case from Poland where we had to make just an enormous amount of changes to bring these financial statements into compliance with US GAAP precisely due to the issues of mergers and acquisitions.

US GAAP Conversion Issues: Hyperinflation

Hyperinflation may present a US international tax attorney with its own challenges. As it is especially common in Latin America, local financials would incorporate inflationary adjustments that are incompatible with US GAAP.  An international tax lawyer has to identify these adjustments, reverse them and, if necessary, replace with adjustments required by GAAP.

US GAAP Conversion Issues: Reserves

Finally, the last most common area of problems has to do with reserves.  The problem usually arises in situations where local accounting rules permit allocation of certain reserves in a manner incompatible with US GAAP rules.

US GAAP Conversion Issues: Special Case of Consolidated Financial Statements

In a situation where a US parent company of a foreign subsidiary prepares consolidated financial statements, problems may arise with respect to whether these statements provide all relevant information needed to create a GAAP-compliant Form 5471. There are four main areas of concern in this type of cases: artificial consolidations through check-the-box rules, foreign currency fluctuations, deductions related to pensions and transfers within the group.  I will discuss these issues in more detail in a future article.

E&P Adjustments

I want to mention here that, in addition to GAAP adjustments to local financial statements, Form 5471 also requires E&P adjustments to GAAP-compliant financial statements. I will explore this topic in a future article.

Contact Sherayzen Law Office For Professional Help with Form 5471 Preparation and Offshore Voluntary Disclosures

If you are a US person who owns (fully or partially) a foreign corporation and you need to prepare a Form 5471 for a current year or any previous years, then you should contact Sherayzen Law Office for professional help.

Our international tax team, led by an international tax attorney and founder of Sherayzen Law office, Mr. Eugene Sherayzen, is a group of highly experienced and creative tax professionals with profound knowledge of US international tax law and US international tax accounting rules. We have filed hundreds of Forms 5471 in the past helping clients around the globe with their current US tax compliance as well as offshore voluntary disclosures related to prior Form 5471 noncompliance. We can help You!

Contact Us Today to Schedule Your Confidential Consultation!

Happy New Year 2024 From International Tax Law Firm Sherayzen Law Office!!!

Dear clients, followers, readers and colleagues:

Mr. Eugene Sherayzen, an international tax attorney, and the entire international tax team of Sherayzen Law Office, Ltd. wishes you a very Happy New Year 2024!!!

Dear clients and prospective clients, in the New Year 2024, you can continue to rely on Sherayzen Law Office for:

  1. Resolution of your prior FBAR, FATCA and other US international tax noncompliance through offshore voluntary disclosure, including Streamlined Domestic Offshore Procedures (SDOP)Streamlined Foreign Offshore Procedures (SFOP)Delinquent FBAR Submission Procedures, Delinquent International Information Return Submission ProceduresIRS Voluntary Disclosure Practice and Reasonable Cause Disclosures;
  2. Help with your IRS audits and examination, including audits of: your prior SDOP and SFOP submissions (as well as other voluntary disclosure options) and your annual international tax compliance. We can also help you fight the imposition of IRS penalties for prior international tax noncompliance, including FBAR penalties, Form 8938 penaltiesForm 3520 and 3520-A penalties, Form 5471 penaltiesForm 5472 penaltiesForm 8865 penaltiesForm 926 penalties, et cetera;
  3. Preparation of your annual US international tax compliance, including the reporting of foreign income and preparation of FBAR, FATCA Form 8938 and other US international tax compliance forms such as: Forms 3520, 3520-A, 5471862188658938 and 926 and
  4. Your international tax planning (inbound and outbound), including individual and business tax planning, We intend to continue to help US firms with conducting business overseas, US owners of foreign businesses and foreign businesses who wish to expand their presence to the United States (including real estate investors).

In resolving all of your current US international tax issues, we will continue to employ ethical creativity, diligence, professionalism and many years of experience with helping other clients. We will also continue to utilize an individual, customized approach, understanding each client’s particular situation.

In 2024, the US international tax compliance requirements will likely grow even more complex, detailed and extensive. The IRS will continue to demand more and more information from US taxpayers, employing its expanding number of revenue agents to enforce US tax laws across the globe and especially in the United States.

In order to deal with this ever-increasing US tax compliance burden, you will need the professional help of Sherayzen Law Office. In this New Year 2024, we can help you!

Your professional US international tax help is but a phone call away from you! Contact us today to schedule a confidential consultation in this New Year 2024!


2023 IRS Quarterly Interest Rates on Overpayment/Underpayment of Tax

The 2023 IRS quarterly interest rates IRS interest rates are relevant for a great variety of purposes. Let’s highlight three of its most important uses. First, these rates will determine the interest a taxpayer will get on any IRS refunds.

Second, the 2023 IRS quarterly interest rates will also be used to establish the interest to be added to any additional US tax liability on amended or audited tax returns. This also applies to the tax returns that were amended under the Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures.

Finally, the 2023 IRS quarterly interest rates will be used to calculate PFIC interest on any relevant §1291 PFIC tax. This PFIC interest will be reported on the relevant Form 8621 and ultimately Form 1040.

We at Sherayzen Law Office constantly deal with the IRS interest rates on overpayments and underpayments of tax. This is why we closely follow any changes in these IRS interest rates, including the 2023 IRS quarterly interest rates.

Below, I lay our the 2023 IRS quarterly interest rates for each quarter.

How the 2023 IRS quarterly Interest Rates Are Calculated

Internal Revenue Code (“IRC”) §6621 establishes the IRS interest rates on overpayments and underpayments of tax. Under §6621(a)(1), the overpayment rate is the sum of the federal short-term rate plus 3 percentage points for individuals and 2 percentage points in cases of a corporation. There is an exception to this rule: with respect to a corporate overpayment of tax exceeding $10,000 for a taxable period of time, the rate is the sum of the federal short-term rate plus one-half of a percentage point.

Under §6621(a)(2), the underpayment rate is the sum of the federal short-term rate plus 3 percentage points. Again, there is an exception for a large corporate underpayment: in such cases, §6621(c) requires the underpayment rate to be the sum of the relevant federal short-term rate plus 5 percentage points. The readers should see §6621(c) and §301.6621-3 of the Regulations on Procedure and Administration for the definition of a large corporate underpayment and for the rules for determining the applicable date.

2023 First Quarter IRS Interest Rates

On November 29, 2022, the IRS announced another increase in the IRS interest rates on overpayment and underpayment of tax.

This means that, effective on January 1, 2023 the First Quarter 2023 IRS interest rates are as follows:

seven (7) percent for overpayments (six (6) percent in the case of a corporation);

seven (7) percent for underpayments;

nine (9) percent for large corporate underpayments; and

four and a half (4.5) of a percent for the portion of a corporate underpayment exceeding $10,000.

2023 Second Quarter IRS Interest Rates

On February 13, 2023, the Internal Revenue Service announced that interest rates would remain the same for the calendar quarter beginning April 1, 2023.  In other words, the first quarter and the second quarter IRS interest rates were exactly the same.

2023 Third Quarter IRS Interest Rates

On May 22, 2023, the Internal Revenue Service announced that interest rates would remain the same for the calendar quarter beginning July 1, 2023.  In other words, the IRS interest rates remained the same for the first three quarters of 2023.

2023 Fourth Quarter IRS Interest Rates

On August 25, 2023, the Internal Revenue Service announced that it would increase the interest rates for the calendar quarter beginning October 1, 2023.

  • This means that, the Fourth Quarter 2023 IRS interest rates are as follows:
  • eight (8) percent for overpayments (seven (7) percent in the case of a corporation);
  • eight (8) percent for underpayments;
  • ten (10) percent for large corporate underpayments; and
  • five and a half (5.5) of a percent for the portion of a corporate underpayment exceeding $10,000.

2022 Required Minimum Distributions | Tax Lawyer Minneapolis

On December 12, 2022, the Internal Revenue Service reminded those who were born in 1950 or earlier that funds in their retirement plans and individual retirement arrangements face important upcoming deadlines for the 2022 required minimum distributions to avoid penalties.

What are the 2022 Required Minimum Distributions?

Required minimum distributions, or RMDs, are minimum amounts that many retirement plans and IRA account owners must generally withdraw annually after they reach age 72. Account owners can delay taking their first RMD until April 1 following the later of the calendar year they reach age 72 or, in a workplace retirement plan, retire. RMDs are taxable income and may be subject to penalties if not timely taken.

IRA 2022 Required Minimum Distributions

IRAs: The RMD rules require traditional IRA, and SEP, SARSEP, and SIMPLE IRA account holders to begin taking distributions at age 72, even if they’re still working. Account holders reaching age 72 in 2022 must take their first RMD by April 1, 2023, and the second RMD by December 31, 2023, and each year thereafter.

Roth IRAs do not require distributions while the original owner is alive.

Retirement Plans 2022 Required Minimum Distributions

Retirement Plans: In 401(k), 403(b) and 457(b) plans; profit-sharing and other defined contribution plans; and defined benefit plans, the first RMD is due by April 1 of the later of the year they reach age 72, or the participant is no longer employed (if allowed by the plan). A 5% owner of the employer must begin taking RMDs at age 72. Remember, RMDs may not be rolled over to another IRA or retirement plan.

Who Does the Required Minimum Distributions?

An IRA trustee, or plan administrator, must either report the amount of the RMD to the IRA owner or offer to calculate it. An IRA owner, or trustee, must calculate the RMD separately for each IRA owned. They may be able to withdraw the total amount from one or more of the IRAs. However, RMDs from workplace retirement plans must be taken separately from each plan.

50% tax on the Missed 2022 Required Minimum Distributions

Not taking a required distribution, or not withdrawing enough, could mean a 50% excise tax on the amount not distributed. The IRS has worksheets to calculate the RMD and payout periods.

Special Case: Inherited IRAs

An RMD may be required for an IRA, retirement plan account or Roth IRA inherited from the original owner. Retirement Topics – Beneficiary has information on taking RMDs from an inherited IRA or retirement account and reporting taxable distributions as part of gross income. Publication 559, Survivors, Executors and Administrators, can help those in charge of the estate complete and file federal income tax returns, and explains their responsibility to pay any taxes due on behalf of the decedent or person who has died.

Note on the 2020 Coronavirus-Related Distributions

Since 2020 RMDs were waived, an account owner or beneficiary who received an RMD in 2020 had the option of returning it to their IRA or other qualified plan to avoid paying taxes on that distribution. A 2020 RMD that qualified as a coronavirus-related distribution may be repaid over a 3-year period or have the taxes due on the distribution spread over three years.

A 2020 withdrawal from an inherited IRA could not be repaid to the inherited IRA but may be spread over three years for income inclusion.

Sherayzen Law Office will continue to monitor any news concerning the 2022 RMDs.

Establishing Cost-Basis in Foreign Real Estate | IRS Audit Tax Lawyer & Attorney

One of the most challenging issues during an IRS audit is establishing cost-basis in foreign real estate.  This issue most frequently comes up in the context of real estate that was obtained through inheritance or gift many years ago.  In this article, based on my IRS audit experiences, I would like to discuss the main challenges and case strategies associated with establishing the cost-basis in foreign real estate in a manner that would satisfy the IRS during an audit.

An important note: I will not be discussing this issue in the context of an IRS audit of an offshore voluntary disclosure and how it would affect the calculation of an Offshore Penalty.  This essay is strictly limited to an IRS audit that involves US international tax issues without the taxpayer ever going through a voluntary disclosure.

Another important note: this article is written more for the benefit of other international tax lawyers, not the general public.

Establishing Cost-Basis in Foreign Real Estate: Importance

Before we discuss the problems associated with establishing the cost-basis in foreign real estate, we need to first understand why this issue is so important.  There are three main consequences to establishing cost-basis in the context of an IRS audit. 

First, the income tax impact of failure to establish cost-basis in a foreign property on the audited taxpayer may be truly disastrous.  Obviously, if you cannot prove any cost-basis in a property (or you can only convince the IRS that there was minimal cost-basis), you will have to recognize all proceeds from the sale of this property as capital gains (or potentially subpart F income if you owned a property though a foreign corporation).

Second, there is a very important psychological impact on the entire audit if you have a large unreported gain from sale of foreign real estate.  The IRS agent in charge of an audit is likely to take a more aggressive position not only on this issue, but also on other issues irrespective of whether they are directly related to unreported gain.   The most frequent victims of this hardened attitude of an IRS agent are the legal arguments in support of a reasonable cause.

Finally, a large gain from a sale of foreign real estate is likely to encourage the IRS to dig deeper and even expand the audit to more years.  In one of my audit cases, an IRS agent initially believed that there was a large capital gain and expanded the audit to five prior years; however, he reversed this decision once I was able to show that the sold real property had a much higher cost-basis due to numerous improvements that were made by my client over a number of years.

In other words, establishing cost-basis in a sold real estate property may be one of the most crucial issues in an IRS audit.

Establishing Cost-Basis in Foreign Real Estate: Top 3 Challenges

The challenges to establishing cost-basis in foreign real estate are highly dependent on the facts of the case.  However, there are three main themes that usually appear in one form or another in every IRS audit case.

The first challenge is absence of documentation.  This is by far the most common and most important battleground between the IRS and the taxpayer during the vast majority of IRS audits in this area, especially if the direct documentation is absent due to passage of time.

The second challenge is the potential opposition from the IRS to proving cost-basis indirectly through usage of circumstantial evidence and third-parties.

The third challenge is establishing the credibility of evidence. For example, in one of my cases, the IRS initially refused to accept a valuation report prepared by a local professional valuation expert because the report lacked a proper explanation of how he arrived at the proposed values.

Establishing Cost-Basis in Foreign Real Estate: Top 4 Strategies for Overcoming Challenges

There are numerous strategies to deal with the cost-basis establishment challenges. Your choice among them should depend on the facts and circumstances of your case.  Sometimes, you will even come up with a brand-new strategy tailored specifically to the unique challenges of your case.

Nevertheless, there are four common themes to the strategies used in overcoming the aforementioned challenges.  First, you need to recreate the logical history of the property and capital improvements to the property in order to convince the IRS that the valuation your client supplied is logical and reasonable.

Second, demonstrate to the IRS agent in charge of your client’s audit that you are a reliable source of information.  The more objective you appear (and you actually are), the more the IRS sees that you will not allow false facts or statements to enter the record, the more the IRS sees that your client shares both of these traits, the more likely the IRS agent will accept your position or be willing to achieve a compromise with you (see below).

Third, utilize indirect and circumstantial evidence as well as third-party affidavits/testimony to support the valuation of the property.  In other words, if you have no ability to directly establish the cost-basis of a property, then you need to find creative ways to build the necessary records and establish their credibility through usage of supporting documents and/or testimony. 

For example, in one of my previous audits, the client had no documentation whatsoever except one isolated receipt to prove the substantial improvements made to her foreign real estate over the past almost forty (!) years.  My solution to this problem was to first get an affidavit from my client fully stating all improvements made with approximate cost based purely on her memory.  Then, I obtained additional signed statements from neighbors largely supporting the estimates as well as the fact that these improvements were indeed made. Finally, I obtained a statement from a local construction company owner who stated that he recalled these improvements and confirmed the estimated amounts.  Additionally, all of the improvements were properly explained by the history of how the property was obtained, for what purpose and why so many improvements were needed.  All of these facts and circumstances were explained in a letter to the IRS agent together with the legal basis (i.e., case law) showing how courts have accepted similar evidence in the past. Under the weight of this substantial record (and some other circumstances of this case), the IRS finally agreed to accept all improvements as part of an overall compromise.

Finally, use creative legal strategies to convince the IRS to accept a different cost-basis in a property through operation of tax rules.  This is a very complex strategy, but it is more commonly employed than one may believe.  For example, in one of my prior audit cases, the IRS agreed to disregard the foreign corporation that owned the foreign property allowing the stepped-up basis for this inherited property.

Contact Sherayzen Law office for Professional Help with IRS Audits Involving Foreign Real Estate

If you have foreign assets and you are audited by the IRS, contact Sherayzen Law Office for professional help.  We have helped hundreds of US taxpayers around the world to bring their tax affairs in full compliance with US tax laws, including during IRS audits.  We can help you!

Contact Us Today to Schedule a Confidential Consultation!