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Introduction to Corporate Distributions | US Business Tax Law Firm

This essay opens our new series of articles which focuses on corporate distributions. The new series will cover the classification, statutory structure and tax treatment of various types of corporation distributions, including redemptions of corporate stock. This first article seeks to introduce the readers to the overall US statutory tax structure concerning corporate distributions.

Corporation Distributions: Legal Philosophy for Varying Treatment

In the United States, the tax code provisions with respect to corporate distributions were written based on the belief that stock ownership bestows on its owner an inherent right to determine the right to receive distributions from a corporation.

Generally, a corporation can make distributions from three types of sources. First, a corporation can distribute funds from its accumulated earnings, to be even more precise accumulated Earnings and Profits (E&P). Second, a corporation may also distribute some or all of the invested capital to its shareholders. Finally, in certain circumstances, a corporation may distribute funds or property in excess of invested capital.

Moreover, certain corporate distributions may in reality be made in lieu of other types of transactions, such as payment for services. Additionally, some corporate distributions may be made in the form of stocks in the corporation, which may or may not modify the ownership of the corporation and which may or may not entitle shareholders to additional (perhaps unequal) future distribution of profits.

This varied nature of corporate distributions lays the foundation for their dissimilar tax treatment under the Internal Revenue Code (IRC).

Corporation Distributions: General Treatment under §301

IRC §301 generally governs the tax treatment of corporation distributions. This section classifies these distributions either as dividends, return of capital or capital gain (most likely, long-term capital gain). In a future article, I will discuss §301 in more detail.

Corporation Distributions: Special Case of Stock Dividends

The IRC treats distribution of stock dividends in a different manner than distribution of cash and property. Under §305(a), certain stock distributions are not taxable distributions. However, §305 contains numerous exceptions to this general rule; if any of these exceptions apply, then such stock distributions are governed by §301.

Moreover, additional exceptions to §305(a) are contained in §306. If a stock distribution is classified as a §306 stock, then the disposition of this stock will be treated as ordinary income. In a future article, I will discuss §§305 and 306 in more detail.

Corporation Distributions: Special Case of Stock Redemptions

Stock redemptions is a special kind of a corporate distribution. §317(b) defines redemption of stock as a corporation’s acquisition of “its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.”

§302 governs the tax treatment of stock redemptions. In general, it provides for two potential legal paths of stock redemptions. First, if a stock redemption satisfies any of the four §302(b) tests, then it will be treated as a sales transaction under §1001. Assuming that the redeemed stock satisfied the §1221 definition of a capital asset, the capital gain/loss tax provisions will apply.

On the other hand, if none of the §302(b) tests are met, then the stock redemption will be treated as a corporate distribution under §301. Again, in a future article, I will discuss stock redemptions in more detail.

Corporate Distributions in the Context of US International Tax Law

All of these tax provisions concerning corporate distributions are relevant to US shareholders of foreign corporations. In fact, in the context of US international tax law, these tax sections become even more complex and may have far graver consequences for US shareholders than under purely domestic tax law. These consequences may be in the form of higher tax burden (for example, due to an anti-deferral tax regime such as Subpart F rules) or increased compliance burden (for example, triggering the filing of international information returns such as Form 5471 or Form 926).

A failure to recognize these differences between the application of aforementioned tax provisions in the domestic context from the international one may result in the imposition of severe IRS noncompliance penalties.

Contact Sherayzen Law Office for Professional Tax Help Concerning Corporation Distributions

Sherayzen Law Office is an international tax law firm highly-experienced in US and foreign corporate transactions, including corporate distributions. We have helped our clients around the world not only to engage in proper US tax planning concerning cash, property and stock distributions from US and foreign corporations, but also resolve any prior US tax noncompliance issues (including conducting offshore voluntary disclosures). We can help you!

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July 15 Deferral: More Deadlines Affected | US International Tax News

On April 9, 2020, the IRS announced additional relief to taxpayers by moving the due date for more deadlines to July 15, 2020. Let’s discuss this additional July 15 Deferral in more detail.

July 15 Deferral: Background Information

On March 13, 2020, in response to the 2019 coronavirus (also called “COVID-19″) pandemic, President Trump issued an emergency declaration under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. This declaration instructed the Treasury Department to provide relief from tax deadlines to Americans who have been adversely affected by the COVID-19 emergency pursuant to 26 U.S.C. §7508A(a).

Section 7508A of the Internal Revenue Code provides the Secretary of the Treasury with authority to postpone the time for performing certain acts under the internal revenue laws for a taxpayer determined by the Secretary to be affected by a federally-declared disaster as defined in section 165(i)(5)(A). Pursuant to section 7508A(a), a period of up to one year may be disregarded in determining whether the performance of certain acts is timely under the internal revenue laws.

On March 18, 2020, the IRS issued Notice 2020-17 to postpone April 15 tax payment deadlines from April 15 to July 15, 2020. A few days later, on March 21, 2020 (the actual relief occurred even earlier on March 20, 2020), among other measures, the IRS announced a new notice 2020-18 for the extension of all April 15 deadlines to July 15, 2020. This extension applied only to the April 15 deadlines.

Later, on March 27, 2020, the IRS issued Notice 2020-20, which amplified the earlier notice 2020-18 and postponed certain federal gift tax return filings and payments to July 15, 2020.

July 15 Deferral: More Deadlines Affected

On April 9, 2020, the IRS took another decisive step forward and issued Notice 2020-23. This notice extends to July 15 all tax deadlines that fall on or after April 1, 2020 and July 14, 2020. This deferral applies to all tax filing and tax payment deadlines.

The July 15 deferral of deadlines applies to all taxpayers – individuals, trusts, estates, corporations and other non-corporate tax filers.

July 15 Deferral: Taxpayers Residing Abroad

Americans who reside abroad usually get an automatic extension to file their tax returns until June 15, but they are required to pay taxes due by April 15. Notice 2020-23 defers the tax payment and the tax filing deadlines from April 15 and June 15 respectively to July 15, 2020.

July 15 Deferral: Individual Tax Returns

Notice 2020-23 applies to the following types of individual tax returns and tax payments:

  1. Form 1040, U.S. Individual Income Tax Return, 1040-SR, U.S. Tax Return for Seniors;
  2. 1040-NR, U.S. Nonresident Alien Income Tax Return;
  3. 1040-NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents;
  4. 1040-PR, Self-Employment Tax Return – Puerto Rico; and
  5. 1040-SS, U.S. Self-Employment Tax Return (Including the Additional Child Tax Credit for Bona Fide Residents of Puerto Rico);

July 15 Deferral: Corporate Tax Returns

Notice 2020-23 applies to the following types of corporate tax returns and tax payments (irrespective of whether they are calendar-year or fiscal-year taxpayers):

  1. Form 1120, U.S. Corporation Income Tax Return;
  2. 1120-C, U.S. Income Tax Return for Cooperative Associations;
  3. 1120-F, U.S. Income Tax Return of a Foreign Corporation;
  4. 1120-FSC, U.S. Income Tax Return of a Foreign Sales Corporation;
  5. 1120-H, U.S. Income Tax Return for Homeowners Associations;
  6. 1120-L, U.S. Life Insurance Company Income Tax Return;
  7. 1120-ND, Return for Nuclear Decommissioning Funds and Certain Related Persons;
  8. 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return;
  9. 1120-POL, U.S. Income Tax Return for Certain Political Organizations;
  10. 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts;
  11. 1120-RIC, U.S. Income Tax Return for Regulated Investment Companies;
  12. 1120-S, U.S. Income Tax Return for an S Corporation; and
  13. 1120-SF, U.S. Income Tax Return for Settlement Funds (Under Section 468B).

July 15 Deferral: Partnership Tax Returns

Notice 2020-23 applies to the following types of partnership calendar-year and fiscal-year tax returns:

  1. Form 1065, U.S. Return of Partnership Income; and
  2. Form 1066, U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return.

July 15 Deferral: Estate, Gift and Trust Tax Returns

Notice 2020-23 applies to the following types of estate, gift and trust tax returns (including all tax payments required to be made under these returns):

  1. Form 1041, U.S. Income Tax Return for Estates and Trusts;
  2. 1041-N, U.S. Income Tax Return for Electing Alaska Native Settlement Trusts;
  3. 1041-QFT, U.S. Income Tax Return for Qualified Funeral Trusts;
  4. Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return (for estate of a citizen or resident of the United States), including for filings pursuant to Revenue Procedure 2017-34;
  5. 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return (for estate of a nonresident not a citizen of the United States);
  6. 706-A, United States Additional Estate Tax Return;
  7. 706-QDT, U.S. Estate Tax Return for Qualified Domestic Trusts;
  8. 706-GS(T), Generation-Skipping Transfer Tax Return for Terminations;
  9. 706-GS(D), Generation-Skipping Transfer Tax Return for Distributions;
  10. 706-GS(D-1), Notification of Distribution from a Generation-Skipping Trust (including the due date for providing such form to a beneficiary);
  11. Form 8971, Information Regarding Beneficiaries Acquiring Property from a Decedent and any supplemental Form 8971, including all requirements contained in section 6035(a) of the Code; and
  12. Estate tax payments of principal or interest due as a result of an election made under sections 6166, 6161, or 6163 and annual recertification requirements under section 6166 of the Code.

July 15 Deferral: Tax-Exempt Tax Returns

Notice 2020-23 applies to Form 990-T, Exempt Organization Business Income Tax Return (and proxy tax under section 6033(e) of the Code).

July 15 Deferral: Excise Taxes

Notice 2020-23 applies to excise tax payments on investment income and return filings on Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation as well as excise tax payments and return filings on Form 4720, Return of Certain Excise Taxes under Chapters 41 and 42 of the Internal Revenue Code.

July 15 Deferral: Quarterly Estimated Tax Payments

Notice 2020-23 applies to various types of quarterly estimated income tax payments calculated on or submitted with the following forms:

  1. 990-W, Estimated Tax on Unrelated Business Taxable Income for Tax-Exempt Organizations,
  2. 1040-ES, Estimated Tax for Individuals;
  3. 1040-ES (NR), U.S. Estimated Tax for Nonresident Alien Individuals;
  4. 1040-ES (PR), Estimated Federal Tax on Self Employment Income and on Household Employees (Residents of Puerto Rico);
  5. 1041-ES, Estimated Income Tax for Estates; and Trusts; and
  6. 1120-W, Estimated Tax for Corporations.

July 15 Deferral: Certain Other Affected Taxpayers and Elections; Tax Court Deadlines

Notice 2020-23 also applies to any person performing a time-sensitive action listed in either § 301.7508A-1(c)(1)(iv) – (vi) of the Procedure and Administration Regulations or Revenue Procedure 2018-58, 2018-50 IRB 990 (December 10, 2018), which is due to be performed on or after April 1, 2020, and before July 15, 2020 (“Specified Time-Sensitive Action”). For purposes of this notice, the term Specified Time-Sensitive Action also includes an investment at the election of a taxpayer due to be made during the 180-day period described in the IRS §1400Z-2(a)(1)(A).

Affected Taxpayers also have until July 15, 2020, to perform all Specified Time-Sensitive Actions, that are due to be performed on or after April 1, 2020, and before July 15, 2020. This relief includes the time for filing all petitions with the Tax Court, or for review of a decision rendered by the Tax Court, filing a claim for credit or refund of any tax, and bringing suit upon a claim for credit or refund of any tax. This notice does not provide relief for the time period for filing a petition with the Tax Court, or for filing a claim or bringing a suit for credit or refund if that period expired before April 1, 2020.

July 15 Deferral: Schedules, Elections and Other Forms

Notice 2020-23 applies not only to the aforementioned forms (hereinafter “Specified Forms), but also to schedules, returns, and other forms that are filed as attachments to the Specified Forms or are required to be filed by the due date of the Specified Forms. For example, this affects Schedule H and Schedule SE.

Moreover, elections that are made or required to be made on a timely filed Specified Form (or attachment to a Specified Form) shall be timely made if filed on such Specified Form or attachment, as appropriate, on or before July 15, 2020

July 15 Deferral: International Information Returns and 965 Tax Payments

Notice 2020-23 applies to all US international information returns including forms 3520, 5471, 5472, 8621 (including PFIC elections), 8858, 8865, and 8938. Furthermore, the Notice applies to installment payments under section 965(h) due on or after April 1, 2020, and before July 15, 2020.

This is highly important to Sherayzen Law Office clients’ because almost all of our clients must file these forms and many are required to make 965 installment tax payments.

July 15 Deferral: 2016 Unclaimed Refunds

For 2016 tax returns, the normal April 15 deadline to claim a refund has also been extended to July 15, 2020. The law provides a three-year window of opportunity to claim a refund. If taxpayers do not file a return within three years, the money becomes property of the U.S. Treasury. Notice 2020-23 requires taxpayers to properly address, mail and ensure the tax return is postmarked by the July 15, 2020, date.

July 15 Deferral: IRS Audits, IRS Appeals and Amended Tax Returns

Notice 2020-23 provides a 30-day postponement for “Affected Taxpayers” with respect to “Time-Sensitive IRS Actions” if the last date for performance of the action is on or after April 6, 2020, and before July 15, 2020.

Notice 2020-23 defines “Affected Taxpayers” as:

  1. Persons who are currently under examination (including an investigation to determine liability for an assessable penalty under subchapter B of Chapter 68);
  2. Persons whose cases are with the Independent Office of Appeals; and
  3. Persons who, during the period beginning on or after April 6, 2020 and ending before July 15, 2020, file written documents described in section 6501(c)(7) of the Code (amended returns) or submit payments with respect to a tax for which the time for assessment would otherwise expire during this period.

Notice 2020-23 defines “Time Sensitive IRS Action” as actions described in § 301.7508A-1(c)(2).

July 15 Deferral: Extension of time to file beyond July 15

It is still possible to request an extension of time beyond July 15, 2020 (to October 15, 2020). In order to do it, individual taxpayers must file Form 4868 and business taxpayers must file Form 7004. Both forms should be filed by July 15, 2020.

Taxpayers should keep in mind that an extension to file is not an extension to pay taxes. Taxpayers must estimated their tax liability and pay any taxes owed by July 15, 2020, even if they request an extension to file forms.

§318 Sidewise Attribution Limitation | US International Tax Attorney

This article explores the third main limitation on the general IRC (Internal Revenue Code) §318 corporate stock re-attribution rules – §318 Sidewise Attribution Limitation.

§318 Sidewise Attribution Limitation: What is “Sidewise Attribution”?

A sidewise attribution occurs when corporate stock owned by an owner of a business entity (or a beneficiary of a trust or estate) is first attributed to this business entity (or estate or trust) and then re-attributed again to another owner of the same business entity (or another beneficiary of the same trust or estate). In other words, stock deemed to be owned by an entity due to the ownership of that stock by an owner or beneficiary of the entity is re-attributed “sidewise” to another owner or beneficiary of the same entity.

Sidewise attribution may have far-reaching income tax and tax reporting consequences, because it may result in a person with no real ownership of a corporation being treated as an owner of this corporation’s stock simply because a member of another entity (in which the first person also has an ownership interest) happens to own corporate stock of this corporation.

§318 Sidewise Attribution Limitation: §318(a)(5)(C) Prohibition

§318(a)(5)(C) describes the §318 Sidewise Attribution Limitation. Under §318(a)(5)(C), stock constructively owned by a partnership, estate, trust or corporation pursuant to §318(a)(3) is not treated as owned by this partnership, estate, trust or corporation for the purpose of treating a partner, beneficiary, or shareholder as owner of the stock. In other words, the sidewise attribution limitation prevents re-attribution of corporate stock to an owner of an entity where such stock is constructively-owned by an entity solely by virtue of ownership of this stock by another owner of the entity.

Let’s look at the following example to illustrate the §318 Sidewise Attribution Limitation: A and B are unrelated persons, they equally own a partnership P and A owns 100 shares of corporation X’s stock. In this situation, partnership P is a constructive owner of A’s 100 shares of X under §318(a)(3)(A). Without any sideways limitation, B would have been also treated as an owner of these 100 shares of X due to §318(a)(2)(A). Under §318(a)(5)(C), however, none of these stocks are attributed to B.

§318 Sidewise Attribution Limitation: Attribution from Actual Ownership Not Affected

It is important to emphasize that §318(a)(5)(C) applies only to the re-attribution of stock constructively owned as a result of the application of §318(a)(3). This prohibition does not affect the §318(a)(2) attribution of stock actually owned by an entity to its beneficiary, partner, or shareholder.

§318 Sidewise Attribution Limitation: Re-Attribution Under Other Rules

Additionally, stock constructively owned under §318(a)(3) may still be re-attributed under an attribution rule other than §318(a)(2). In other words, stock constructively owned under §318(a)(3) may still be re-attributed under the upstream corporate attribution rules or the option attribution rules of §318(a)(4) (see Treas. Reg. §1.318-4(c)(2)).

Moreover, re-attribution under the §318 family attribution rules still possible. A potential situation for such re-attribution would arise in a situation where corporate stock is attributed from an entity to its member and from this member to a qualified family member of the same entity. Berenbaum v. Commissioner, 369 F.2d 337 (10th Cir. 1966), rev’g T.C. Memo 1965-147.

Let’s look at a couple of examples to understand better the interaction between the §318 Sidewise Attribution Limitation and the re-attribution rules other than §318(a)(2).

Here is the first hypothetical fact pattern: A is a beneficiary of a trust T, B is another beneficiary of T, T is a beneficiary of an estate, and A owns 100 shares of a C-corporation X. Under §318(a)(3)(B), T is a constructive owner of 100 shares of X. Since T is a constructive owner of A’s shares of X, these shares are re-attributed to the estate under §318(a)(3)(A); §318(a)(5)(C) does not apply to this type of a re-attribution since it is not a sidewise attribution. On the other hand, the §318 Sidewise Attribution Limitation would prevent the re-attribution of A’s shares of X to B that otherwise would have occurred under §318(a)(2)(B).

Note, however, that, if B is A’s son (or other qualified relative under the §318 family attribution rules), then the re-attribution of A’s stocks of X to B is possible under §318(a)(1)(A).

Let’s now look at another fact pattern to understand the power of the option rule attribution vis-a-vis §318(a)(5)(C): A and B are beneficiaries of a trust T; T has an option to buy corporate stock from A. The most important point to understand here is the fact that T is considered here as an owner of A’s stock not under the upstream trust attribution rules of §318(a)(3)(B), but under the option attribution rules of §318(a)(4). Hence, the sidewise attribution limitation under §318(a)(5)(C) does not apply and B becomes a constructive owner of a his proportional part of A’s stock under the downstream trust attribution rules of §318(a)(2)(B).

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.

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!

Contact Us Today to Schedule Your Confidential Consultation!

Family Re-Attribution Limitation Under §318 | International Tax Lawyers

This article explores the second limitation on the IRC (Internal Revenue Code) §318 re-attribution rule – family re-attribution limitation.

Family Re-Attribution Limitation: General §318 Re-Attribution Rule

The general §318 re-attribution rule states that a constructively-owned corporate stock should be treated as actually owned for the purpose of further re-attribution of stock to other persons. §318(a)(5)(A). This re-attribution should occur with respect to other persons considered related persons under §318.

As I stated in another article, unless checked, the general §318 re-attribution rule may ultimately cause persons completely unrelated to the actual owners of corporate stock to be considered as constructive owners of this stock. For this reason, the IRS imposed a number of limitations on this re-attribution rule. One of the limitations concerns specifically §318 family attribution rules.

Family Re-Attribution Limitation: No Family Re-Attribution

Under §318(a)(5)(B), corporate stock constructively owned by a person pursuant to the §318 family attribution rules is not considered as owned by this person for the purpose of re-attributing stock ownership to another family member.

This rule is clear: stock attributed to one family member cannot be re-attributed for the second time to another family member. The idea of this rule is also very clear – to prevent re-attribution of stock to remote family members.

Family Re-Attribution Limitation: Examples

Let’s look at a couple of hypothetical examples to gain deeper understanding of the family re-attribution limitation.

First hypothetical: grandfather GF owns 100 shares of X corporation. Under the family attribution rules, this ownership is attributed to GF’s son, A. However, due to §318(a)(5)(B), this constructively-owned stock cannot be attributed for the second time to A’s wife and A’s son.

Second hypothetical: X, a C-corporation has 200 shares outstanding; A owns 100 shares, S (A’s son) owns 40 shares and D (A’s daughter) owns 60 shares. Under §318(a)(1)(A)(ii): A actually owns 100 shares and constructively owns his children’s 100 shares; S actually owns 40 shares and constructively owns his mother’s 100 shares; D actually owns 60 shares and constructively owns her mother’s 100 shares.

However, due to the re-attribution limitations under §318(a)(5)(B), the shares A constructively owns are not re-attributed from one child to another. Hence, 40 shares of S are not re-attributed to D through their father’s constructive ownership of shares actually owned by S. Similarly, D’s 60 shares are not re-attributed to S through A’s constructive ownership of D’s shares.

Family Re-Attribution Limitation: Interaction with the §318 Option Attribution Rule

It is important to understand that §318(a)(5)(B) does not per se prohibit the re-attribution of stock to another family member. Rather, this re-attribution limitation only applies to stock constructively owned under the §318 family attribution rules. However, the stock may still be re-attributed to another family member through the operation of another rule such as the §318 option attribution rule.

The most prominent example of such a situation is situations where ownership of stock is imputed under both §318 family attribution rule and §318 option attribution rule at the same time. Under §318(a)(5)(D), if a stock is attributed under both, §318 family attribution rules and §318 option attribution rules, then the option rules take priority. This means that, if both rules apply, the option rule governs and the person is deemed to own stock under the option rule rather than under the family rule.

In situations where corporate stock is deemed to be owned under both, family and option attribution rules, the option rule will allow the re-attribution of stock to another family member. In such cases, §318(a)(5)(B) is powerless to stop the application of re-attribution due to the precedence of the option rules.

Family Re-Attribution Limitation: Example of the Option Rule Family Re-Attribution

Let’s look at an example to illustrate the §318 option attribution rule and the §318 family attribution rules interaction with respect to family re-attribution limitation. Let’s suppose that S, son of F, directly owns 100 shares of X, a C-corporation; F has an option to buy all 100 shares from S; D, F’s daughter and S’ sister, does not actually own any shares of X or a contract to buy any shares of X. The issue is whether D is deemed to own any shares of X.

F constructively owns all of his son’s shares of X under the family attribution rules and the option attribution rules. Normally, no shares would be attributed to D due to the family re-attribution limitations, but, in this case, F actually owns an option to buy all 100 shares. The option attribution rule holds preeminence over the family re-attribution limitation. Hence, F is deemed to own S’ shares under the option rule first and foremost; as a consequence, these shares are then re-attributed to D. Thus, D is treated as an owner of all of S’ 100 shares of X.

Family Re-Attribution Limitation: Advanced Summary of Family Attribution Rules

Now that we have a more advanced understanding of the family attribution rules and the limits placed on the family re-attribution limitations, we can modify our earlier definition of the §318 family attribution rules in the following manner: where A and B are family members within the meaning of §318(a)(1), A is deemed to own: (1) all corporate stocks actually owned by B; (2) all corporate stocks constructively owned by B under the §318 option attribution rules; and (3) all stocks constructively owned by B pursuant to §318(a)(2) – i.e. due to the fact that he is a beneficiary of a trust, a partner in a partnership or a shareholder of a corporation.

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 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.

Contact Sherayzen Law Office for professional help with US international tax law. We are a highly experienced, creative and ethical team of tax professionals dedicated to helping our clients resolve US international tax compliance issues. Led by our founder, Mr. Eugene Sherayzen (an international tax attorney), we have helped hundreds of clients with assets in over 70 countries around the world, and we can help you!

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§318 Downstream Trust Attribution | Foreign Trust Tax Lawyer & Attorney

The attribution of stock ownership to constructive owners is a highly important feature of US domestic and international tax law. The Internal Revenue Code (“IRC”) §318 contains complex constructive ownership rules concerning corporate stock; these rules vary depending on a specific §318 relationship. This article focuses on an important category of §318 relationships – trusts. Since these rules are very broad, I will discuss today only the §318 downstream trust attribution rules; the upstream rules and important exceptions to both sets of rules will be covered in later articles.

§318 Trust Attribution: Downstream vs. Upstream Attribution

Similarly to other §318 attribution rules, there are two types of §318 trust attribution: downstream and upstream. The downstream attribution rules attribute the ownership of corporate stocks owned by a trust to its beneficiaries. The upstream attribution rules are exactly the opposite: they attribute the ownership of corporate stocks owned by beneficiaries to the trust. As I stated above, this article focuses on the downstream attribution.

§318 Downstream Trust Attribution: Attribution from Trust to Beneficiary

Under §318(a)(2)(B)(i), corporate stocks owned, directly or indirectly, by or for a trust are considered owned by the trust’s beneficiaries in proportion to their actuarial interests in the trust.

Notice that the size of the actuarial interest does not matter. Moreover, §318(a)(2)(B) will apply even if the beneficiary does not have any present interest in a trust, but only a remainder interest (also calculated on an actuarial basis). This rule is the exact opposite of the §318 estate attribution rules.

Furthermore, the decision to attribute shares based on the actuarial interest, rather than actual one, may result in a paradoxical result where stocks are attributed to a person who will never become the actual owner of the shares.

§318 Downstream Trust Attribution: Determination of Actuarial Interest

Treas. Reg. §1.318-3 stated that, in determining a beneficiary’s actuarial interest in a trust, the IRS will use the factors and methods prescribed (for estate tax purposes) in 26 CFR § 20.2031-7.

The attribution of shares from the trust to its beneficiary should be made on the basis of the beneficiary’s actuarial interest at the time of the transaction affected by the stock ownership.

§318 Downstream Trust Attribution: Unstable Proportionality

The adoption of the attribution of stock based on the actuarial interest in a trust creates a constant calculation problem for beneficiaries, because the actuarial interest of the beneficiary in a trust varies from year to year. The variation of actuarial interest means that the number of shares attributed from a trust to its beneficiary will change every year.

For example, the actuarial interest of a beneficiary with a life estate in a trust will decrease every year as he ages. On the other hand, the actuarial interest of the owner of the remainder interest in the trust will increase with each year. Hence, the number of stocks attributed to the life tenant will decrease each year, while the attribution of stocks to the holder of the remainder interest will increase each year.

§318 Downstream Trust Attribution: Special Presumption Concerning Power of Appointment

Based on 95 Rev. Proc. 77-37, §3.05 (operating rules for private letter rulings), the IRS has adopted a special presumption with respect to when children will be considered beneficiaries for the purpose of §318 trust attribution rules. In order to understand this rule, we need to describe the setting in which it will most likely apply.

Oftentimes, estate plans are set up where the surviving spouse will have a life interest in a trust’s income and a power of appointment over the trust corpus. In such situation, estate planners often insert a clause that, if a spouse fails to exercise the power of appointment, the trust corpus will automatically go to the children.

In this situation, the IRS stated that, absent evidence that the power of appointment was exercised differently, it is presumed that it was exercised in favor of the children. By adopting this presumption, the children are immediately considered beneficiaries for the purpose of the stock attribution rules under §318.

§318 Downstream Trust Attribution: Planning to Avoid Attribution

In order to prevent the application of the trust attribution rules under §318, a beneficiary must renounce his entire interest in the trust. See Rev. Rul. 71-211. Such renunciation is valid only if it is irrevocable and binding under local law.

§318 Downstream Trust Attribution: Special Case of Voting Trusts

Under Rev. Rul. 71-262 and CCA 200409001, §318(a)(2)(B) does not apply in the context of a voting trust (i.e. where trustee has the right to vote the stock held in trust, but the dividends are paid to the certificate holder). This is because the certificate holder is deemed to be the owner of the shares and there is no attribution of ownership from the trust.

§318 Downstream Trust Attribution: Grantor Trusts and Employee Trusts

While it is beyond the scope of this article to describe them in detail, there are special rules that apply to the attribution of stock from grantor trusts and employee trusts. I will discuss these rules in more detail in the future.

Contact Sherayzen Law Office for Professional Help With US Tax Issues Concerning Foreign Trusts

If you are considered an owner or a beneficiary of a foreign trust, contact Sherayzen Law Office for professional help with your US tax compliance issues. Our firm is highly experienced in US international tax law, including foreign trust compliance. We have also helped taxpayers around the world with their offshore voluntary disclosures involving foreign trusts.

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