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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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§318 Partnership Attribution | International Corporate Tax Lawyers

This article continues a series of articles on the Internal Revenue Code (“IRC”) §318 constructive ownership rules. In this essay, we will discuss the §318 partnership attribution rules – i.e. attribution of ownership of shares from partnership to partners and vice versa.

§318 Partnership Attribution Rules: Two Types

There are two types of the IRC §318 partnership attribution rules: downstream and upstream. The downstream attribution rules attribute the ownership of corporate stocks owned by a partnership to its partners. The upstream attribution rules attribute the ownership of corporate stocks owned by partners to the partnership. Let’s explore both types of attribution rules in more detail.

§318 Partnership Attribution Rules: Attribution from Partnership to Partners

Pursuant to §318(a)(2)(A), corporate stocks owned, either directly or indirectly, by or on behalf of a partnership is deemed constructively owned by its partners proportionately. Interestingly, the attribution of corporate stock from a partnership to its partners continues to happen even if the partnership does not do any business or stops all of its operation. See Baker Commodities, Inc. v. Commissioner 415 F.2d 519 (9th Cir. 1969); Sorem v. Commissioner 40 T.C. 206 (1963), rev’d on other grounds, 334 F.2d 275 (10th Cir. 1964).

The biggest problem with applying §318(a)(2)(A) is determining what “proportionate attribution” means. Where a partner owns the same interest in capital, profits and losses of a partnership, the proportionality is easy to apply. However, in situations where a partner owns varying interests in capital, profits and losses, it is much more difficult.

Unfortunately, this problem is not addressed at all by the IRS or courts – the proportionality of attribution is not defined in any IRC provision, Treasury Regulations and even case law. Looking at Treas. Reg. §1.318-2(c) Ex. 1, however, it is likely that the IRS will accept a position where proportionality of attribution is based on the “facts-and-circumstances” test of §704(b).

§318 Partnership Attribution Rules: Attribution from Partners to Partnership

Under §318(a)(3)(A), a partnership constructively owns corporate stocks owned by a partner. There are no limitations on the attribution – all stocks held by a partner are deemed to be owned by the partnership irrespective of the percentage of an ownership interest in the partnership held by the partner. There is no de minimis rule that would apply to §318(a)(3)(A).

For example, assume that partner P (an individual) owns 25% in a partnership X. P also owns 100 shares out of the total 200 shares outstanding of Y corporation; X owns the remaining 100 shares. Under §318(a)(3)(A), X actually owns 100 shares of Y and constructively owns P’s 100 shares of Y; in other words, X owns 100% of Y.

§318 Partnership Attribution Rules: Certain Attributions Not Allowed

There are two special §318 rules concerning partnership attributions that I would like to mention in this article. First, there is no partner-to-partner attribution of stock under the §318 partnership attribution rules. In other words, stocks owned by a partner will not be owned by another partner simply by virtue of both partners having an ownership interest in the same partnership (however, this does not mean that stocks may not be attributed through another provision of §318).

Second, §318(a)(5)(C) prevents re-attribution of stocks that were already attributed from a partner to the partnership. This means that, where stocks are attributed from a partner to a partnership, they cannot be then re-attributed from the partnership to another partner.

§318 Partnership Attribution Rules: S-Corporations

Under §318(a)(5)(E), an S-corporation and its shareholders are respectively considered to be a partnership and its partners. Hence, corporate stocks owned by an S-corporation are attributed to its shareholders proportionately to each shareholder’s ownership of the S-corporation’s stock. Also, stocks owned by shareholders are deemed to be owned by the S-corporation.

It is important to emphasize that §318 partnership attribution rules do not apply to the stock of the S-corporation. Id. In other words, §318 does not treat shareholders in an S-corporation as being constructive owners of the stock of the S-corporation itself.

§318 Partnership Attribution Rules: Comprehensive Example

I would like to finish this article with a comprehensive example of how §318 partnership attribution rules work. Let’s suppose that A and B own Y partnership in equal portions (i.e. 50% each); Y owns 120 shares of X, a C-corporation, out of the total 200 outstanding shares; another 80 shares are owned by A.

Let’s analyze each parties’ actual and constructive ownership of X. A actually owns 80 shares and constructively owns half of Y’s ownership of X shares (60 shares) under §318(a)(2)(A) – i.e. he owns a total of 140 shares.

B constructively owns half of Y’s ownership of X shares – i.e. 60 shares. He does not constructively own any of A’s shares, because there is no partner-to-partner attribution of stocks and there is no attribution to B of A’s shares that were attributed to Y.

Finally, Y actually owns 120 shares and constructively owns all of A’s 80 shares. In other words, Y is deemed to be a 100% owner of X.

Contact Sherayzen Law Office for Professional Help With §318 Partnership Attribution Rules

The constructive ownership rules of §318 are crucial to proper identification of US tax reporting requirements with respect domestic and especially foreign business entities. Hence, if you are a partner in a partnership that owns stocks in a domestic or foreign corporation, contact Sherayzen Law Office for professional help with §318 partnership attribution rules.

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§267 Constructive Ownership Rules | International Tax Lawyer & Attorney

In a previous article, I discussed the related person definition for the purposes of the Internal Revenue Code (“IRC”) §267. That article, however, focused on the definition itself rather than on a host of supplementary rules necessary to fully understand this definition. In this article, I would like to discuss one set of these rules – §267 constructive ownership rules.

§267 Constructive Ownership Rules: Purpose of §267(c)

During my initial discussion of the §267 related person definition, I focused only on the actual ownership by related persons. Congress, however, realized that the actual ownership limitations can be easily circumvented by utilizing individuals and entities closely connected to the related persons.

Hence, it enacted §267(c) and §267(e)(3) to expand the application of the related person definition to include the ownership by closely-connected individuals and entities. In other words, even where an individual or entity does not meet any of the §267(a) and (b) tests through his actual ownership, these tests may be met when his actual ownership is added to other persons’ ownership through the operation of §267(c) and §267(e) rules. These are the so-called §267 constructive ownership rules.

§267 Constructive Ownership Rules: Two Parts of the Rules

As explained in a previous article, the related person definition can be found in two different parts of §267 – thirteen categories of §267(b) and one category of §267(a)(2). Similarly, the constructive ownership rules are divided into two separate sections: §267(c) applies to the entire section and §267(e)(3) applies only to §267(a)(2).

§267 Constructive Ownership Rules: Three General Types of Ownership Attribution

§267(c) sets forth three general types of constructive ownership attribution rules:

  1. Entity-to-owner or beneficiary stock attribution – i.e. “stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries” §267(c)(1). I wish to emphasize there that §267(c)(1) applies to any type of an entity: corporations, partnerships, estates and trusts;
  2. Family member stock attribution – i.e. stocks owned by family members are treated as constructively owned by the related person (see §267(c)(2)). §267(c)(4) defines “family of an individual” to include: “only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants”; and
  3. Partner-to-partner stock attribution – i.e. “an individual owning … any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner” §267(c)(3). This is a unique rule which is rarely found among other constructive ownership rules of the Internal Revenue Code.

§267 Constructive Ownership Rules: Chain Ownership Attribution

Generally, a taxpayer who is deemed to own stock under the §267 constructive ownership rules is treated as the actual owner of the stock. In other words, the stock that he constructively owns can be used for further attribution of ownership to others – this is the so-called “chain ownership attribution”.

There are three exceptions to this rule. I will mention here only one: §267(c)(5) limits attribution of ownership through a chain of related persons in the case of family member or partnership attribution.

§267 Constructive Ownership Rules: Fourth Type of Ownership Attribution

§267(e)(3) sets forth special constructive ownership rules for determining ownership of a capital or profits interest in a partnership; as it was mentioned above, this rule applies only to the deduction limitation rules of §267(a)(2). This fourth type of ownership attribution is basically an exception to the first three types of §267(c).

§267(e)(3) states that, for the purposes of determining ownership of a capital interest or profits interest of a partnership, §267(c) constructive ownership rules apply except that: (1) partner-to-partner stock attribution of §267(c)(3) shall not apply, and (2) with respect to interest owned (directly and indirectly) by and for C-corporation “shall be considered as owned by or for any shareholder only if such shareholder owns (directly or indirectly) 5 percent or more in value of the stock of such corporation” §267(e)(3)(B).

Contact Sherayzen Law Office for Professional Help With US Tax Law

US tax law is extremely complex, especially US international tax law. An ordinary person will simply get lost in this labyrinth of tax rules, exceptions and requirements. Once you get into trouble with US tax law, it is much more difficult and expensive to extricate yourself from it due to high IRS penalties.

This is why it is important to contact Sherayzen Law Office for professional help with US tax law as soon as possible. We have helped hundreds of US taxpayers around the world to successfully resolve their US tax compliance and US tax planning issues. We can help you!

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The Pursley Case: Offshore Tax Evasion Leads to Criminal Conviction

On September 6, 2019, the Tax Division of the US Department of Justice (“DOJ”) announced another victory against Offshore Tax Evasion. This time, a Houston lawyer, Mr. Jack Stephen Pursley, was convicted of one count of conspiracy to defraud the United States and three counts of tax evasion. Let’s discuss this Pursley Case in more detail.

Facts of the Pursley Case

According to the evidence presented at trial, Mr. Pursley conspired with a former client to repatriate more than $18 million in untaxed income that the client had earned through his company, Southeastern Shipping. Southeastern Shipping had a business bank account located in the Isle of Man.

Knowing that his client had never paid taxes on these funds, Mr. Pursley designed and implemented a scheme whereby the untaxed funds were transferred from Southeastern Shipping’s foreign bank account to the United States. Mr. Pursley helped to conceal the movement of funds from the Internal Revenue Service (“IRS”) by disguising the transfers as stock purchases in domestic corporations in the United States, which Mr. Pursley owned and his client owned and controlled.

At trial, the DOJ proved that Mr. Pursley received more than $4.8 million and a 25% ownership interest in the co-conspirator’s ongoing business for his role in the fraudulent scheme. For tax years 2009 and 2010, Mr. Pursley evaded the assessment of and failed to pay the income taxes he owed on these payments by, among other means, withdrawing the funds as purported non-taxable loans and returns of capital. Mr. Pursley then used these funds for personal investments as well as purchase of properties, including a vacation home in Vail, Colorado and a property in Houston, Texas.

Potential Penalties in the Pursley Case

Judge Lynn Hughes has set sentencing for December 9, 2019. Mr. Pursley faces a statutory maximum sentence of five years in prison for the conspiracy count and five years in prison for each count of tax evasion. He also faces a period of supervised release, monetary penalties, and restitution.

Main Lesson from the Pursley Case

The main lesson from the Pursley case is for business lawyers. They should be very careful about involving themselves in schemes related to repatriation of overseas funds. These business lawyers should verify whether US taxes were paid on these funds and consult an international tax attorney concerning the legality of the proposed repatriation scheme.

Of course, if a business lawyer knows that his client never paid any US taxes on the funds, he should not participate in any stratagems which could be interpreted as conspiracy to defraud the United States. Otherwise, this lawyer would be at risk of finding himself in a situation similar to the Pursley case.

Contact Sherayzen Law Office for Professional Help With US International Tax Compliance

If a business lawyer finds out that he has a client with untaxed funds stored in an overseas account, he should urge the client to contact Sherayzen Law Office concerning the client’s offshore voluntary disclosure options. The main goal of such a voluntary disclosure would be to reduce and even eliminate the risk of a criminal prosecution.

Contact Sherayzen Law Office Today to Schedule Your Confidential Consultation!

Sherayzen Law Office Successfully Completes its 2019 Fall Tax Season

On October 15, 2019, Sherayzen Law Office, Ltd., successfully completed its 2019 Fall Tax Season. It was a challenging and interesting tax season. Let’s discuss it in more detail.

2019 Fall Tax Season: Sherayzen Law Office’s Annual Compliance Clients

Annual tax compliance is one of the major services offered by Sherayzen Law Office to its clients. The majority of our annual compliance clients are individuals and businesses who earlier retained our firm to help them with their offshore voluntary disclosures. They liked the quality of our services so much that they preferred our firm above all others to assure that they stay in full compliance with US tax laws.

It is natural that this group of clients is the largest among all other groups, because the unique specialty of our firm is conducting offshore voluntary disclosures.

A smaller group of our annual compliance clients consists of tax planning clients who also asked Sherayzen Law Office to do their annual compliance for them.

Finally, the last group of our annual compliance clients consists of businesses and individuals who were referred to our firm specifically for help with their annual compliance. These are usually foreign businesses who just expanded to the United States and foreign executives and professionals who just arrived to the United States to start working here.

2019 Fall Tax Season: Sherayzen Law Office’s Annual Compliance Services

Virtually all of our clients have exposure to foreign assets and international transactions. Hence, in addition to their domestic US tax compliance, Sherayzen Law Office prepares the full array of US international tax compliance forms related to foreign accounts (FBAR and Form 8938), PFIC calculations (Forms 8621), foreign business ownership and Section 367 notices (Forms 926, 5471, 8858, 8865, et cetera), foreign trusts (Form 3520 and Form 3520-A), and other relevant US international tax compliance issues.

2019 Fall Tax Season: Unique Challenges and Opportunities

The 2019 Fall Tax Season was especially challenging because of the record number of deadlines that needed to be completed. During the season, Sherayzen Law Office filed hundreds of FBARs, US income tax returns and US international tax returns such as Forms 3520, 5471, 8865, 8621 and 926.

The great time pressure created opportunities for our firm to further streamline our tax preparation and scheduling processes, ultimately creating an even more efficient yet still comprehensive and detail-oriented organization.

The 2019 Fall Tax Season was unique in one more aspect – the implementation of the 2017 tax reform changes. The 2017 Tax Cuts and Jobs Act (“TCJA” or “2017 tax reform”) introduced the most radical changes to the Internal Revenue Code since 1986. Form 1040 was greatly modified and numerous other US domestic tax laws and forms were affected.

The greatest change, however, befell the US international tax law, particularly US international corporate tax law. The introduction of GILTI (Global Intangible Low-Taxed Income) tax, FDII (Foreign-Derived Intangible Income) deduction, full participation exemption and many other rules and regulations has profoundly modified this area of law.

No form felt these changes greater than Form 5471. Due to the 2017 tax reform, it has almost tripled in size and has acquired a qualitatively new level of complexity. Many new questions appeared and only some of them were definitely resolved by the IRS in the summer of 2019 when it issued new regulations.

Since Sherayzen Law Office has a lot of clients who own partially or fully foreign corporations, Forms 5471 were a constantly-present challenge during the 2019 Fall Tax Season. Nevertheless, we were able to timely complete all Forms 5471 for all of clients. We were even able to develop and incorporate important strategic and tactical tax planning techniques, such as IRC Section 962 election, helping our clients lower their tax burden.

Looking Forward to Completing Offshore Voluntary Disclosures, End-of-Year Tax Planning and 2020 Spring Tax Season

Having completed such a difficult 2019 Fall Tax Season, Sherayzen Law Office now looks forward to working on the offshore voluntary disclosures and IRS audits through the end of the year. We also have a sizeable portfolio of end-of-year tax planning cases. Finally, we look forward to the 2020 Spring Tax Season for the tax year 2019.

If you have foreign assets or foreign income, contact Sherayzen Law Office for professional help. Our firm specializes in US international tax compliance. We have helped hundreds of US taxpayers to bring themselves into full compliance with US tax laws, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!