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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!

Partnership Related Party Loss Disallowance | Tax Lawyer & Attorney

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In a series of articles concerning Internal Revenue Code (“IRC”) §267, I discussed various rules concerning related party loss disallowance. In this article, I would like to focus on special rules concerning partnership related party loss disallowance.

Partnership Related Party Loss Disallowance: Main IRC Provisions

Three IRC sections are most relevant to special rules of partnership related party loss disallowance. §707(b)(1) governs the disallowance of losses with respect to transactions between a partnership and its members as well as certain transactions between partnerships with common partners. §267(a)(1) contains the main rule concerning losses on sales or exchanges between a partnership and any person other than a member of the partnership (a third party), including another partnership. Finally, there are special provisions under §267(a)(2) which are applicable to partnerships. Let’s discuss each of these provisions in more detail.

Partnership Related Party Loss Disallowance: §707(b)(1)

§707(b)(1) disallows a loss from a direct or indirect sale or exchange of property (other than a partnership interest) when such sale or exchange occurs between: “(A) a partnership and a person owning, directly or indirectly, more than 50 percent of the capital interest, or the profits interest, in such partnership, or (B) two partnerships in which the same persons own, directly or indirectly, more than 50 percent of the capital interests or profits interests.”

It is important to note that the ownership the capital or profits interest in a partnership by a partner may be direct or indirect. For example, in TAM 201737011, the IRS disallowed the losses of a hedge fund upon its transfer of securities to trading accounts owned by taxpayer who held greater than 50% interest in capital or profits of hedge fund.

Furthermore, it should be noted that §707(b)(1) incorporates §267(d) in order to mitigate the impact of loss disallowance. This means that the transferee may offset future gain on a sale or exchange of the affected property by the disallowed loss.

Partnership Related Party Loss Disallowance: Expansion of §707(b)(1) to Related Persons

Prior to 1985, §707(b)(1) applied strictly to partners. In September of 1985, the IRS dramatically expanded the application of §707(b)(1) to certain persons related to partners by incorporating the constructive ownership rules of §267(c)(1), §267(c)(2), §267(c)(4) and §267(c)(5). “Under these rules, ownership of a capital or profits interest in a partnership may be attributed to a person who is not a partner as defined in section 761(b) in order that another partner may be considered the constructive owner of such interest under section 267(c).” Treas. Reg. §1.707-1(b)(3). Note, however, that §707(b)(1)(A) does not apply to a constructive owner of a partnership interest since he is not a partner as defined in §761(b). Id.

Treas. Reg. §1.707-1(b)(3) provides an illustration of this expansion of §707(b)(1):

“For example, where trust T is a partner in the partnership ABT, and AW, A’s wife, is the sole beneficiary of the trust, the ownership of a capital and profits interest in the partnership by T will be attributed to AW only for the purpose of further attributing the ownership of such interest to A. See section 267(c) (1) and (5). If A, B, and T are equal partners, then A will be considered as owning more than 50 percent of the capital and profits interest in the partnership, and losses on transactions between him and the partnership will be disallowed by section 707(b)(1)(A). However, a loss sustained by AW on a sale or exchange of property with the partnership would not be disallowed by section 707, but will be disallowed to the extent provided in paragraph (b) of § 1.267(b)-1.”

In this context, it should be noted that the validity of Treas. Reg. §1.267(b)-1(b)(1) is currently in question. There is definitely an unsettled conflict between these regulations and the expanded version of §707(b)(1).

Partnership Related Party Loss Disallowance: Transactions Between Partnerships and Third Parties

As it was mentioned above, the IRC §267(a)(1) contains a special rule concerning losses which occur between between a partnership and a third party (i.e. someone other than a partner). Under this rule, the transaction is treated as if it happened between the third party and individual members of the partnership; this is a type of a look-through rule.

The disallowance rules of §267 govern as long as the third party and a partner are considered to be related parties under any of the relationships described in §267(b). In other words, if 267(b) applies in this context, then no deductions will be allowed with respect to transactions between the third party and the partnership “ (i) To the related partner to the extent of his distributive share of partnership deductions for losses or unpaid expenses or interest resulting from such transactions, and (ii) To the other person to the extent the related partner acquires an interest in any property sold to or exchanged with the partnership by such other person at a loss, or to the extent of the related partner’s distributive share of the unpaid expenses or interest payable to the partnership by the other person as a result of such transaction.” Treas. Reg. §1.267(b)-1(b)(1).

Partnership Related Party Loss Disallowance: Transactions Between Certain Partnerships

As a result of the Tax Reform Act of 1984, §267(a)(1) rules were expanded to disallow loss realized on transactions between certain partnerships. “Certain partnerships” include two types of partnerships.

First, partnerships that have one or more common partners. A “common partner” is a partner who owns directly, indirectly, or constructively any capital or profits interest in each of the partnerships. Treas. Reg. §1.267(a)-2T(c) Q&A-2.

Second, a situation where a partner in one partnership and one or more partners in another partnership are related parties within the meaning of §267(b). Id.

The amount of the disallowed loss is generally the greater of: (1) either the amount that would have been disallowed if the transaction had occurred between the “selling partnership and the separate partners of the purchasing partnership (in proportion to their respective interests in the purchasing partnership)”; or (2) the amount that would have been disallowed if the transaction had occurred between “the separate partners of the selling partnership (in proportion to their respective interests in the selling partnership) and the purchasing partnership.” Id. There is an exception: there will be no disallowance of loss if the disallowed amount is less than 5% of the total loss from the sale or exchange. Id.

It should be noted that §267(a)(1) also applies to S-corporations. §267(a)(1) disallows losses realized in transactions between an S corporation and its shareholder holding more than 50%-in-value of the stock.

Partnership Related Party Loss Disallowance: Deferral of a Deductible Payment Under §267(a)(2)

The Tax Reform Act of 1984 affected not only §267(a)(1), but also expanded the deferral of an otherwise deductible payment between certain partnerships under §267(a)(2). These “certain partnerships” are the same as those described in the expanded rules of §267(a)(1): (i) partnerships that have one or more common partners and (ii) a partner in one partnership and one or more partners in another partnership are related parties within the meaning of §267(b) (without §267(e) modification). See Treas. Reg. §1.267(a)-2T(c) Q&A-3.

The amount of deferred deduction is the greater of: (1) the amount that would have been deferred if the transaction that gave rise to the otherwise allowable deduction had occurred “between the payor partnership and the separate partners of the payee partnership (in proportion to their respective interests in the payee partnership)”, or (2) the amount that would have been deferred if such transaction had occurred “between the separate partners of the payor partnership (in proportion to their respective interests in the payor partnership) and the payee partnership.” Id. Similarly to 267(a)(1), there is an exception: no deferral shall occur if the amount that would be deferred is less than 5% of the otherwise allowable deduction. Id.

It should be noted that the status of some provision of the expanded §267(a)(2) is unclear at this point, because §707(b)(1) was amended in 1986 specifically in reference to §267(a)(2) income-deduction matching rules. As amended, §707(b)(1) state that partnerships in which the same persons own more than 50% of the capital interest or profits interests are treated as related under §267(b). It appears that, with respect to such partnerships, §707(b)(1) overrides the rules described in Reg. §1.267(a)-2T(c) Q&A-3.

Partnership Related Party Loss Disallowance: Additional Deferrals Under §267(a)(2)

With respect to the §267(a)(2) limitations on deductions for payment to related persons, a partnership and its members are treated as related persons under §267(e). As already described above, §707(b)(1) (last sentence) extended this rule to transactions between commonly owned partnerships.

Additionally, under §§267(e)(1)(C) and §267(e)(1)(D), a partnership and a person owning any profits or capital interest in a partnership in which the partnership also holds such an interest (and any persons related to these parties within the meaning of §707(b)(1) or §267(b)) are also related persons.

Finally, §267(a)(2) also applies to S-corporations in an almost identical way as it applies to regular partnerships: the deduction for a payment to a related person is delayed until the recipient includes the payment in his gross income. As a result of the Tax Reform Act of 1984, §267(e) treats an S-corporation and any of its shareholders (regardless of amount of stock owned) as related persons.

§§267(e)(1)(C) and §267(e)(1)(D) further expand the definition of related persons to situations where a transaction occurs between an S-corporation and a person owning any profits or capital interest in a partnership in which the S-corporation also holds such an interest (and any persons related to these parties within the meaning of §707(b)(1) or §267(b)).

Contact Sherayzen Law Office for Professional Help With US Tax Law Concerning Partnerships and S-Corporations

US tax law concerning partnerships and S-corporations is incredibly complex. The rules concerning the partnership related party loss disallowance is just one example of this complexity.

This is why you need the professional help of the experienced tax law firm of Sherayzen Law Office. We have helped clients throughout the United States and the world with US tax laws concerning partnerships (domestic and foreign) and S-corporations. We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Attribution Rules: Introduction | International Tax Lawyer & Attorney

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One of the most popular tax reduction strategies is based on shifting an ownership interest in an entity or property to related persons or related entities. In order to prevent the abuse of this strategy, the US Congress has enacted a large number of attribution rules. In this brief essay, I will introduce the concept of attribution rules and list the most important attribution rules in the Internal Revenue Code (“IRC”).

Attribution Rules: Definition and Purpose

The IRC attribution rules are designed to prevent taxpayers from shifting an ownership interest to related persons or entities. They achieve this result through a set of indirect and constructive ownership rules that shift the ownership interest assigned to third parties back to the taxpayer. In other words, the rules disregard the formal assignment of an ownership interest to a related third party and re-assign the ownership interest back to the assignor for specific determination purposes.

For example, in the context of determining whether a foreign corporation is a Controlled Foreign Corporation, all shares owned by the spouse of a taxpayer are deemed to be owned by the taxpayer if both spouses are US persons.

Attribution Rules: Design Similarities and Differences

The IRC contains a great variety of attribution rules. All of them are very detailed and have achieved a remarkable degree of specificity. Behind this specificity, all of the rules are always concerned with the substance of a transaction rather than its form. Hence, there always lurks a general question of whether there was a tax avoidance motive when a taxpayer entered into a transaction.

In spite of the fact that they share similar goals, the rules differ from each other in design. Most of these differences can be traced back to legislative history.

List of Most Important Attribution Rules

Here is a list of the most important attribution rules in the IRC (all section references are to the IRC):

1. The constructive ownership rules of §267, which apply to disallow certain deductions and losses incurred in transactions between related parties;

2. The constructive ownership rules of §318, which apply in corporate-shareholder transactions and other transactions, including certain foreign transactions expressly referenced in §6038(e).

3. The constructive ownership rules of §544; these are the personal holding company rules which apply to determine when a corporation will be subject to income tax on undistributed income.

3a. While they are now repealed, the foreign personal holding company rules of §554 are still important. In the past, they applied to determine whether US shareholders of a foreign corporation would be taxed on deemed distributions which were not actually made;

4. Highly important Subpart F constructive ownership rules of §958, which apply to determine when US shareholders of a Controlled Foreign Corporation should be taxed on deemed distributions which are not actually made;

5. The PFIC constructive ownership rules of §1298, which apply to determine whether a US shareholder is subject to the unfavorable rules concerning certain distributions by a PFIC and sales of PFIC stock; and

6. The controlled group constructive ownership rules of §1563 which determine whether related corporations are subject to the limitations and benefits prescribed for commonly controlled groups.

This is not a comprehensive list of all attribution rules, there are other rules which apply in more specific situations.

Contact Sherayzen Law Office for Professional Help With the Attribution Rules

The rules of ownership attribution are highly complex. A failure to comply with them may result in the imposition of high IRS penalties.

This is why you need to contact the highly experienced international tax law firm of Sherayzen Law Office. We have helped US taxpayers around the globe to deal with the US tax rules concerning ownership attribution, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!

2020 First Quarter IRS Interest Rates | International Tax Lawyers

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On December 6, 2019, the Internal Revenue Service (“IRS”) announced that the 2020 First Quarter IRS underpayment and overpayment interest rates will not change from the 4th Quarter of 2019. This means that, the 2020 First Quarter IRS underpayment and overpayment interest rates will be as follows:

  • five (5) percent for overpayments (four (4) percent in the case of a corporation);
  • two and one-half (2.5) percent for the portion of a corporate overpayment exceeding $10,000;
  • five (5) percent for underpayments; and
  • seven (7) percent for large corporate underpayments.

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. The IRS used the federal short-term rate for October of 2019 to determine the 2020 First Quarter IRS interest rates. The IRS interest is compounded on a daily basis.

2010 First Quarter IRS interest rates are important to US international tax lawyers and taxpayers. The IRS uses these rates to determine how much interest a taxpayer needs to pay on an additional tax liability that arose as a result of an IRS audit or an amendment of his US tax return. The IRS also utilizes these rates with respect to the calculation of PFIC interest on Section 1291 tax.

As an international tax law firm, Sherayzen Law Office keeps track of the IRS underpayment interest rates on a regular basis. We often amend our client’s tax returns as part of an offshore voluntary disclosure process. For example, both Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures require that a taxpayer amends his prior US tax returns, determines the additional tax liability and calculates the interest on this liability.

Moreover, we very often have to do PFIC calculations for our clients under the default IRC Section 1291 methodology. This calculation requires the usage of the IRS underpayment interest rates in order to determine the amount of PFIC interest on the IRC Section 1291 tax.

Finally, it is important to point out that the IRS will use the 2020 First Quarter IRS overpayment interest rates to determine the amount of interest that needs to be paid to a taxpayer who is due a tax refund as a result of an IRS audit or amendment of the taxpayer’s US tax return. This situation may often arise in the context of offshore voluntary disclosures.

Foreign Income Reporting Without Forms W-2 or 1099 | Tax Lawyer

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There is a surprisingly large number of US taxpayers who believe that reporting foreign income that was not disclosed on a Form W-2 or 1099 is unnecessary. Even if they honestly believe it to be true, this erroneous belief exposes these taxpayers to an elevated risk of imposition of high IRS penalties. In this article, I will discuss the US tax rules concerning foreign income reporting which was never disclosed on a Form W-2 or 1099 and how the IRS targets tax noncompliance in this area.

Foreign Income Reporting: Worldwide Income Reporting Requirement

If you are a US tax resident, you are subject to the worldwide income reporting requirement. In other words, you are required to disclose your US-source income and your foreign-source income on your US tax return.

This requirement applies to you irrespective of whether this income was ever disclosed to the IRS on a Form W-2 or Form 1099. It is important to understand that Forms W-2 and 1099 are only third-party reporting requirements. They do not impact your foreign income reporting on your US tax return in any way, because such a disclosure is your personal obligation as a US tax resident.

This means that, if your foreign employer pays you a salary for the work performed in a foreign country, you must disclose it on your US tax return. Similarly, if you are a contractor who receives payments for services performed overseas, you are obligated to disclose these payments on your US tax return. The fact that neither your foreign employer nor your clients ever filed any information returns, such as Forms W-2 or 1099, with the IRS is irrelevant to your foreign income reporting obligations in the United States.

Foreign Income Reporting: Many US Taxpayers Are Noncompliant

Unfortunately, many US taxpayers are not complying with their foreign income reporting obligations. Some of them are doing it willfully, taking advantage of the absence of third-party IRS reporting (such as Forms W-2 and 1099). Others have fallen victims to numerous online false claims of exceptions to the worldwide income reporting.

Foreign Income Reporting: Noncompliant Taxpayers at Elevated Risk of IRS Penalties

The noncompliance in this area is so great that it drew the attention of the IRS. In July of 2019, the IRS announced a specific compliance campaign that targets high-income US citizens and resident aliens who receive compensation from overseas that is not reported on a Form W-2 or Form 1099.

The IRS has adopted a tough approach to noncompliance with the worldwide income reporting requirement – IRS audits only. The IRS did not mention any other, more lenient treatment streams for this campaign.

This means that we will see an increase in the number of IRS audits devoted mainly to discovering unreported foreign income and punishing noncompliant US taxpayers. Of course, these audits may further expand depending on other facts that the IRS discovers during these audits. For example, if foreign income comes from a foreign corporation owned by the taxpayer, the IRS may also impose Form 5471 penalties. If this corporation owns undisclosed foreign accounts, then the taxpayer may also face draconian FBAR civil as well as criminal penalties.

Contact Sherayzen Law Office for Professional Help With Your Foreign Income Reporting Obligations and Your Voluntary Disclosure of Unreported Foreign Income

If you are a US taxpayer who earns income overseas, contact Sherayzen Law Office for professional help with your US tax compliance. Furthermore, if you have not reported your overseas income for prior years, you should explore your voluntary disclosure options as soon as possible in order to reduce your IRS civil penalties and avoid potential IRS criminal prosecution. We have helped hundreds of US taxpayers like you to resolve their US tax noncompliance issues, including those concerning foreign income reporting, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!