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US Information Returns: Introduction | International Tax Lawyer Minnesota

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In this article, I would like to introduce the readers to the concept of US information returns; I will also explore the differences between US information returns and US tax returns.

US Information Returns: Two Types of Returns

The US tax system is a self-assessment system where taxpayers must file certain forms or returns developed by the IRS in order to report information required by the Internal Revenue Code and the Treasury Regulations. The Internal Revenue Code specifies the due date for these returns.

There are two primary types of returns: tax returns and information returns. A tax return is a form that a taxpayer uses to compute the tax that he owes to the IRS. A tax return requires the taxpayer to set forth the relevant information and amounts for this computation.

On the other hand, the IRS requires US taxpayers to file information returns in order to obtain information on transactions and payments to taxpayers that may affect the information reflected on tax returns. In other words, the IRS uses information returns not to compute the tax liability, but to obtain information (or verification of information) to make sure that the tax returns were properly filed.

US Information Returns: Hybrid Returns

This ideal distinction between the two types of returns is often not preserved. Instead, there are many hybrid returns which possess the features of both, tax returns and information returns. For example, Part III of Form 1040 Schedule B is an information return which forms part of the overall tax return (i.e. Form 1040). Similarly, Form 8621 is a US international information return that is a hybrid return for the reporting of ownership of PFICs and calculation of PFIC tax at the same time.

US Information Returns: Domestic vs. International

The information returns are subdivided into two categories: domestic and international. The domestic information returns are usually filed by third parties with respect to US-source income or income under the supervision of a domestic financial institution. For example, US brokers provide Forms 1099-INT to report US-source interest income and foreign interest income that the taxpayer earned by investing through a domestic financial institution.

It should be mentioned that, due to the implementation of FATCA (Foreign Account Tax Compliance Act), some foreign subsidiaries of US banks also began to issue Forms 1099 to US taxpayers with respect to foreign income from their foreign accounts. The most prominent example is Citibank. However, this is a tiny minority of foreign financial institutions at this point.

On the other hand, international information returns primarily report information concerning foreign assets, foreign income and foreign transactions; there are even information returns concerning foreign owners of US businesses. Usually, these returns are filed not by third parties, but by taxpayers directly – individuals, businesses, trusts and estates. For example, Form 5471 is an international tax return which US taxpayers must file to report their ownership of a foreign corporation, its financial statements and its certain transactions.

US Information Returns: High Civil Penalties

One of the most distinguishing characteristics of information returns are high noncompliance civil penalties. This is very different from tax returns.

The tax return civil penalties are calculate based on a taxpayer’s unpaid income tax liability. The worst case scenario is a civil fraud penalty of 75% of unpaid tax liability. This is followed by negligence, failure-to-file and accuracy penalties.

The noncompliance penalties for information returns, however, do not depend on whether there was ever any tax liability connected with the failure to file an accurate information return; in fact, many information return penalties are imposed in a situation where there is no income tax noncompliance at all. This is logical, because pure information returns would never have any income tax noncompliance directly related to them.

Hence, in order to enforce compliance with information returns, the IRS imposes objective noncompliance penalties per each unfiled or incorrect information return. This divorce between income tax noncompliance and information return penalties, however, may produce extremely unjust results. For example, failure to file a Form 5471 for a foreign corporation which never produced any revenue may result in the imposition of a $10,000 penalty.

It should be emphasized that the domestic information return penalties are much smaller in size than those imposed for noncompliance with international information returns. Again the logic is clear: since the temptation to avoid compliance with US international tax laws is much greater overseas, Congress wanted to raise the stakes for such noncompliant taxpayers in order to make the risk of noncompliance intolerable for most taxpayers.

US Information Returns: Special Case of FBAR

The IRS may impose the most severe penalties out of all information returns for a failure to file a correct FinCEN Form 114, commonly known as “FBAR”. The paradox of these penalties is that FBAR is not a tax form, but a Bank Secrecy Act information return. FBAR was created to fight financial crimes, not for tax enforcement. Its penalties were originally meant to deter and punish criminals, not induce self-compliance with US tax laws – this is precisely why FBAR penalties may easily exceed the penalties imposed with respect to any other US international information return.

So, why is the IRS able to use FBAR as a tax information return and impose FBAR penalties? The reason is that the US Congress turned over FBAR enforcement to the IRS after September 11, 2001. Since then, even though FBAR is not part of the Internal Revenue Code, the IRS has used this form as an information return for tax purposes.

Contact Sherayzen Law Office for Professional Help With US International Information Return Compliance and Penalties

If the IRS imposed penalties on your noncompliance with US international information returns, contact Sherayzen Law Office for professional help.

We are a highly experienced US international tax law firm dedicated to helping US taxpayers around the world with their US international tax compliance. In particular, we have helped hundreds of US taxpayers to avoid or lower their IRS penalties with respect to virtually all types of US international information returns, including FBARs, Forms 8938, 8865, 8621, 5471, 3520, 926, et cetera. We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Introduction to US International Tax Anti-Deferral Regimes

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Despite their enormous importance to tax compliance, there is a shocking level of ignorance of the US international tax anti-deferral regimes that is being displayed by US taxpayers, foreign bankers, foreign accountants, foreign attorneys, US accountants and even many US tax attorneys. In this article, for educational purposes only, I would like to provide a brief overview of the history and features of the main US international tax anti-deferral regimes.

What is a US International Tax Anti-Deferral Regime?

A US international tax anti-deferral regime is a set of US tax laws designed to prevent US taxpayers from utilizing various offshore strategies to defer US taxation of their income for a period of time or indefinitely.

Three Main US International Tax Anti-Deferral Regimes

Since 1937, there have been three main US international tax anti-deferral regimes: Foreign Personal Holding Company (“FPHC”) rules, subpart F rules, and PFIC rules. Let’s review the brief history and main features of each of these US international tax anti-deferral regimes.

First US International Tax Anti-Deferral Regime: FPHC

In 1937, the Congress for the first time addressed the offshore investment strategy problems by enacting the FPHC regime, which were designed to contemporaneously (i.e. in the year the income was earned) tax certain types of foreign corporations. In particular, FPHC rules targeted foreign corporations that had substantial investment income (i.e. passive income) compared to active business income – i.e. the FPHC rules effectively treat certain corporations as pass-through companies for the purposes of certain categories of passive income..

The FPHC rules were triggered only if both conditions of the then-Code §552(a) were satisfied. First, at least 60% of a foreign corporation’s gross income from the taxable year had to consist of “foreign personal holding company income”. The FPHC income included interest income, dividends, royalties, gains from the sale of securities or commodities, certain rents and certain income from personal services provided by shareholders of the FPHC. This was called the “income test”.

The second condition of the §552(a) was known as the “ownership test”. The ownership test was satisfied if at least 50% of either the total voting power or total value of the stock of the foreign corporation was owned by 5 or fewer individuals who were citizens or residents of the United States.

Despite the appearances, the FPHC regime was not very effective. It was actually not very hard to work around the FPHC rules with careful and creative tax planning. This is why, after the enactment of the Subpart F rules and the PFIC rules (which addressed some of the main inefficacies of the FPCH rules and made them redundant as a US international tax anti-deferral regime), the FPHC regime was finally repealed in the year 2004.

Second US International Tax Anti-Deferral Regime: Subpart F Rules

The second US international tax anti-deferral regime, the Subpart F rules, was enacted in 1962 and, despite numerous amendments, forms the core of the anti-deferral rules with respect to Controlled Foreign Corporations (“CFCs”). It is definitely one of the most important and complex pieces of US tax legislation.

The most important feature of the Subpart F regime is that it greatly expands the scope of the former FPHC regime by expanding the contemporaneous (i.e. pass-through) taxation to a much broader range of income and activities, including many kinds of active business activities as well as passive investment activities of a foreign corporation. Obviously, the focus of this US international tax anti-deferral regime is still on passive income or attempts to disguise passive income as active income.

Third US International Tax Anti-Deferral Regime: PFIC Rules

The third US international tax anti-deferral regime consists of the passive foreign investment company (“PFIC”) rules that were adopted by US Congress in 1986. Perhaps because it is the youngest of all US international tax anti-deferral regimes, the PFIC regime is more aggressive and less forgiving than Subpart F rules or FPHC regime. A lot of innocent taxpayers have fallen victims to this severe law.

The PFIC rules impose a unique additional US income tax in two circumstances: where (1) there is a gain on the disposition of the PFIC stock by the US person; or (2) there are PFIC distributions that are considered “excess distributions”. The PFIC rules also impose an additional PFIC interest (calculated similarly to underpayment interest) on the PFIC tax.

The definition of a PFIC is in some ways reminiscent of FPHC rules, but the PFIC regime is a lot more aggressive. Generally, a PFIC is any foreign corporation if it meets either the income tax or the assets test. The income tax is met if 75% of a foreign corporation’s gross income is passive; the assets test is satisfied if at least an average of 50% of a foreign corporation’s assets produce passive income.

Notice that the PFIC rules apply irrespective of the US ownership percentage of the company. This elimination of the FPHC and Subpart F ownership rules makes PFIC rules a much more comprehensive US international anti-deferral tax regime, because it is very easy to trigger PFIC rules – a lot of US naturalized citizens and permanent residents fall into the PFIC trap by simply owning foreign mutual funds as part of their former home countries’ investment portfolio.

Contact Sherayzen Law Office for Professional Help With Dealing with US International Tax Anti-Deferral Regimes

If you have an ownership interest in a foreign business or have foreign investments, you may be facing the extremely complex rules of US international tax anti-deferral regimes.

Please contact Mr. Eugene Sherayzen, an experienced international tax attorney at Sherayzen Law Office. Our international tax firm has helped hundreds of clients around the globe and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!