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Closer Connection Exception | International Tax Lawyer & Attorney

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The Closer Connection Exception is a very important provision in US international tax law, because it provides a potential way for individuals who meet the Substantial Presence Test to still be treated as nonresident aliens for US income tax purposes. This article explores the Closer Connection Exception, its requirements and its implications for US and foreign taxpayers.

Understanding the Closer Connection Exception

The Closer Connection Exception is found in Internal Revenue Code (IRC) §7701(b)(3)(B) and is further elaborated in Treasury Regulation §301.7701(b)-2. This exception allows an individual who would otherwise be considered a US tax resident under the Substantial Presence Test to be treated as a nonresident alien for income tax purposes if he can demonstrate a “closer connection” to a foreign country.

Key Requirements for the Closer Connection Exception

IRC § 7701(b)(3)(B) and Treas. Reg. § 301.7701(b)-2(a) lay out the Closer Connection Exception eligibility criteria that an an individual must meet:

1.The individual must be present in the United States for fewer than 183 days in the current calendar year;

2.The individual must maintain a tax home in a foreign country during the year;

3.The individual must have a closer connection to that foreign country than to the United States; and

4. An individual must be an eligible individual.

Let’s explore each of these three requirements in detail.

Closer Connection Exception: The 183-Day Rule

The first requirement of the Closer Connection Exception is fairly straightforward: the individual must be present in the United States for fewer than 183 days in the current calendar year. This is a hard limit. Even one additional day of presence will disqualify an individual from claiming this exception.

It is important to emphasize that this 183-day threshold is different from the count of days used in the Substantial Presence Test, which includes a lookback period. For the Closer Connection Exception, only days of physical presence in the United States in the current year are considered. Treas. Reg. §301.7701(b)-2(a)(1).

Closer Connection Exception: Foreign Tax Home Requirement

The second requirement for the Closer Connection Exception is that the individual must maintain a tax home in a foreign country during the year.  IRC §911(d)(3) defines the concept of “tax home” as an individual’s principal place of business.  “If the individual has no regular or principal place of business because of the nature of the business, or because the individual is not engaged in carrying on any trade or business within the meaning of section 162(a), then the individual’s tax home is the individual’s regular place of abode in a real and substantial sense.” Treas. Reg. §301.7701(b)-2(c)(1).  This is obviously a very fact-dependent definition of tax home, which requires exploration of all relevant circumstances (such as the location of the individual’s permanent home, family and even personal belongings).

The individual’s foreign tax home must be in existence for the entire current year. It must also be located in the same foreign country for which the individual is claiming to have the closer connection. Treas. Reg. §301.7701(b)-2(c)(2).

Closer Connection Exception: Closer Connection to Foreign Country

The third and often most complex requirement of the Closer Connection Exception is demonstrating a closer connection to a foreign country than to the United States.  Treasury Regulations state that this requires establishing “that the individual has maintained more significant contacts with the foreign country than with the United States”. Treas. Reg. §301.7701(b)-2(d).  

This analysis of course requires a detailed exploration of all relevant facts and circumstances. Treas. Reg. § 301.7701(b)-2(d)(1) provide the following non-exclusive list of key factors that one must consider in determining whether a closer connection to a foreign country exists:

1.The location of the individual’s permanent home;

2.The location of the individual’s family;

3.The location of personal belongings;

4.The location of social, political, cultural, or religious organizations with which the individual has a relationship;

5.The location where the individual conducts routine personal banking activities;

6.The location where the individual conducts business activities;

7.The location of the jurisdiction in which the individual holds a driver’s license;

8.The location of the jurisdiction in which the individual votes;

9.The country of residence designated by the individual on his forms and documents; and

10. The types of official forms and documents filed by the individual, such as Form 1078 (Certificate of Alien Claiming Residence in the United States), Form W-8 (Certificate of Foreign Status) or Form W-9 (Payer’s Request for Taxpayer ldentification Number).

Regarding the first factor, individual’s permanent home, it does not matter whether a permanent home is a house, an apartment or a furnished room. It also does not matter whether the individual owns or rents his home. “It is material, however, that the dwelling be available at all times, continuously, and not solely for stays of short duration.” Treas. Reg. §301.7701(b)-2(d)(1).

Closer Connection Exception: Multiple Foreign Countries

A question arises in this context: what if an individual has connections not to just one, but  two foreign countries? Can an individual have a tax home in two or more countries?

Generally, an individual can have a closer connection to only one foreign country. However, it is possible to have a closer connection to two foreign countries in a single year if the individual moved their tax home during the year. In such cases, the individual can have a closer connection to each country for the part of the year they maintained a tax home in that country.

Treas. Reg. §301.7701(b)-2(e) lays out a detailed legal test in this case of multiple foreign country connections.  In order for an individual to be able to claim the Closer Connection Exception in cases of close contacts with more than one foreign country, this individual must satisfy the following conditions:

(1) The individual maintains a tax home beginning on the first day of the current year in one foreign country;

(2) The individual changes his or her tax home during the current year to a second foreign country;

(3) The individual continues to maintain his or her tax home in the second foreign country for the remainder of the current year;

(4) The individual has a closer connection to each foreign country than to the United States for the period during which the individual maintains a tax home in that foreign country; and

(5) The individual is subject to taxation as a resident pursuant to the internal laws of either foreign country for the entire year or subject to taxation as a resident in both foreign countries for the period during which the individual maintains a tax home in each foreign country.

Closer Connection Exception: Eligible Individual

As stated above, the final condition for the Exception is that an individual must be an eligible individual. Ineligible individuals include: (a) individuals who have applied for status as a lawful permanent resident of the United States (i.e., applied for a green card), and (b) individuals who have an application pending for adjustment of status. IRC §7701(b)(3)(C). 

Treas. Reg. §301.7701(b)-2(f) specifically sets forth the following list of actions which would make an individual ineligible to claim the Closer Connection Exception:

“Affirmative steps to change status to that of a permanent resident include, but are not limited to, the following—

(1) The filing of Immigration and Naturalization Form I-508 (Waiver of Immunities) by the alien;

(2) The filing of Immigration and Naturalization Form I-485 (Application for Status as Permanent Resident) by the alien;

(3) The filing of Immigration and Naturalization Form I-130 (Petition for Alien Relative) on behalf of the alien;

(4) The filing of Immigration and Naturalization Form I-140 (Petition for Prospective Immigrant Employee) on behalf of the alien;

(5) The filing of Department of Labor Form ETA-750 (Application for Alien Employment Certification) on behalf of the alien; or

(6) The filing of Department of State Form OF-230 (Application for Immigrant Visa and Alien Registration) by the alien.”

Closer Connection Exception: Form 8840

To claim the Closer Connection Exception, eligible individuals must file Form 8840, Closer Connection Exception Statement for Aliens, with the IRS. This form must be filed by the due date of the individual’s nonresident alien income tax return (Form 1040-NR), including extensions. Form 8840 requires detailed information about the individual’s presence in the United States, tax home, and factors demonstrating a closer connection to a foreign country. Failure to timely file this form may result in the individual being unable to claim the exception. Treas. Reg. §301.7701(b)-8(c).

Closer Connection Exception: Interaction with Tax Treaties

It’s important to note that the Closer Connection Exception is separate from any residency determinations under tax treaties. An individual who does not qualify for the Closer Connection Exception may still be able to claim nonresident status under a tax treaty’s tie-breaker rules. Conversely, qualifying for the Closer Connection Exception may eliminate the need to rely on treaty provisions. See Treas. Reg. §301.7701(b)-7.

Closer Connection Exception: Implications for Other Reporting Requirements

While the Closer Connection Exception can significantly alter an individual’s US income tax obligations, it is very important to understand that it may not exempt the individual from all US reporting requirements, particularly information returns such as FBAR and Form 8938.

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

US international tax law is extremely complex.  The Closer Connection Exception and its potential impact on an individual’s tax status is just an example of this complexity. This is why, if you have assets in or income from foreign countries, you need to seek the professional help of Sherayzen Law Office.  We are a leading US international tax law firm which offers comprehensive support in US international tax compliance (including IRS offshore voluntary disclosures) and US international tax planning. Our deep understanding of and extensive experienced in US international tax law allows us to proffer a professional advice tailored to your specific circumstances.

Contact Us Today to Schedule Your Confidential Consultation!

Substantial Presence Test | US International Tax Lawyer & Attorney

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The substantial presence test is one of the most important legal tests in the Internal Revenue Code (IRC), because it determines whether a person is a US tax resident solely by virtue of his physical presence in the United States.  Additionally, this Test is essential to the determination of whether a person is a “US Person” for FBAR and Form 8938 purposes. In this article, I will explain the substantial presence test and highlight its main exceptions.

Substantial Presence Test: The Main Rule

In reality, there are two substantial presence tests; if either test is met, a person is considered to be a US tax resident unless an exception applies.

The first substantial presence test is met if a person is physically present in the United States for at least 183 days during the calendar year. 26 USC §7701(b)(3).  

The second substantial presence test (the so-called “lookback test”) is satisfied if two conditions are met: (1) the person is present in the United States for at least 31 days during the calendar year; and (2) the sum of the days on which this person was present in the United States during the current and the two preceding calendar years (multiplied by the fractions found in §7701(b)(3)(A)(ii)) equals to or exceeds 183 days. 26 USC 7701(b)(3)(A).  

Let’s discuss how exactly the lookback test works.  The way to determine to determine whether the 183-day test is met is to add: (a) all days present in the United States during the current calendar year (i.e. the year for which you are trying to determine whether the Substantial Presence Test is met) + (b) one-third of the days spent in the United States in the year immediately preceding the current year + (c) one-sixth of the days spent in the United States in the second year preceding the current calendar year. See 26 USC §7701(b)(3).

Substantial Presence Test: Presence

As one can easily see, a critical issue in the substantial presence test is to determine during which days a person is considered to be “present in the United States”. Pursuant to 26 USC §7701(b)(7)(A), a person is considered to be present in the United States if he is physically present in the United States at any time, however short, during the day, including the days of arrival and departure.

There are limited exceptions under 26 USC §§7701(b)(7)(B) and 7701(b)(7)(C) for: commuters from Canada and Mexico, foreign vessel crew members and persons who travel between two foreign countries with a less than a 24-hour layover in the United States.

Substantial Presence Test: Exempt Persons

In addition to the exceptions above, the Internal Revenue Code contains a large number of categories of persons exempt from the Substantial Presence Test. 26 USC §§7701(b). In other words, the days that these “exempt persons” spend in the United States do not count toward the Substantial Presence Test. Here is a most common list of exempt persons:

Foreign government-related individuals and their immediate family (26 USC §7701(b)(5)(B))

Teachers and trainees and their immediate family (26 USC §7701(b)(5)(C))

Foreign students on F-, J-, M- or Q-visas (26 USC §7701(b)(5)(D))

Professional athletes temporarily in the US for charitable sporting events (26 USC §7701(b)(5)(A)(iv))

Individuals unable to leave the US due to medical conditions (26 USC §7701(b)(3)(D)(ii))

A couple of notes on these categories. First, for the “professional athletes who are temporarily present in the United States to compete in a charitable sporting event” category, the sports event must meet the following requirements for the exemption to apply: (1) it must be organized primarily to benefit §503(c)(3) tax-exempt organization; (2) the net proceeds from the event must be contributed to the benefitted tax-exempt organization; and (3) the event must be carried out substantially by volunteers.

Second, concerning the last category “foreign aliens who are unable to leave the United States because of a medical condition”, Rev. Proc. 2020-20 expanded this medical condition exception to include “COVID-19 Medical Condition Travel Exception” for eligible individuals unable to leave United States during “COVID-19 Emergency Period”. The term COVID-19 Emergency Period is a single period of up to 60 consecutive calendar days selected by an individual starting on or after February 1, 2020 and on or before April 1, 2020 during which the individual is physically present in the United States on each day. An Eligible Individual may claim the COVID-19 Medical Condition Travel Exception in addition to, or instead of, claiming other exceptions from the substantial presence test for which the individual is eligible.

Substantial Presence Test: “Closer Connection” Exception

In addition to exceptions and exemptions listed above, there is one more highly important exception to the Substantial Presence Test called the “Closer Connection” Exception. Under 26 USC §§7701(b)(3)(C), a person is exempt from the application of the Substantial Presence Test if the following four conditions are met:

1) the person is present less than 183 days in the United States during the current year;

2) the person can establish that, during the current year, he had a tax home in a foreign country (obviously, “tax home” is a term of art that has its special significance for the purposes of the “closer connection” exception;

3) the person has a “closer connection” to that foreign country than to the United States; and

4) the person has not applied for a lawful permanent residency status in the United States.

I have addressed the Closer Connection Exception in detail here.

Substantial Presence Test:  Tax Treaty Exception

Tax treaties provide another exception. IRC §7701(b)(6) and Treas. Reg. §301.7701(b)-7 provide that an individual who meets the substantial presence test but is a resident of a treaty country under a tie-breaker provision of an income tax treaty may elect to be treated as a nonresident alien for US tax purposes. This election is made on Form 8833, Treaty-Based Return Position Disclosure.

It’s important to note that while this treaty election can significantly affect an individual’s US tax obligations, it does not negate the fact that the individual met the substantial presence test. This distinction is crucial for certain reporting requirements, such as FBAR and Form 8938.

Substantial Presence Test: Closer Connection Exception and Treaty Election vs. FBAR

One of the most common pitfalls of US international tax compliance relates to a situation where the substantial presence test is met but either a closer connection exception is claimed or an election is made to be taxed as a resident of another country.  In such a situation, even many practitioners incorrectly conclude that the taxpayer is not required to file FBAR.  This is not the case; even where a tax treaty foreign tax residency election or a closer connection exception claim is made, the taxpayer may still need to file an FBAR. 76 Fed. Reg. 10,234, 10,238; IRM 4.26.16.2.1.2(6) (11-06-15).

I will discuss this FBAR exception to the closer connection and tax treaty exceptions in another article.

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

Understanding the nuances of the US international tax law, including the Substantial Presence Test with its numerous exceptions and its implications for both tax residency and FBAR reporting, is essential for individuals who spend significant time in the United States. Given the complexity of these rules and their potential US tax impact, you need qualified professional help to properly navigate these complex rules.

This is why you need to contact Sherayzen Law Office.  Our international tax team is highly knowledgeable and experienced in this area of law. We have helped hundreds of US taxpayers to determine their US tax residency status, and we can help you!  

Contact us today to schedule your confidential consultation!

Minnesota Streamlined Disclosure Lawyer | International Tax Attorney

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Minnesota has a sizable immigrant community with over 9% of the population foreign-born and another more than 7% of the population that has at least one immigrant parent. The top countries of original for immigrants are: Mexico, Somalia, India, Laos and Ethiopia. Many of these new US taxpayers own assets in foreign countries and receive income generated by these assets. Unfortunately some of these taxpayers are not in compliance with their US international tax obligations and want to participate in Streamlined Domestic Offshore Procedures (SDOP) or Streamlined Foreign Offshore Procedures (SFOP). These individuals often look for a Minnesota streamlined disclosure lawyer for professional help, but they do not understand what this term really means. In this essay, I would like to explain the definition of Minnesota streamlined disclosure lawyer and outline who belongs to this category of lawyers.

Minnesota Streamlined Disclosure Lawyer: International Tax Attorney

From the outset, It is important to understand that all voluntary disclosures, including the Streamlined options, form part of US international tax compliance, because these options deal with US international tax laws concerning foreign assets and foreign income. The knowledge that SDOP and SFOP are part of US international tax law makes you better understand what kind of lawyer you are looking for when you search for a Minnesota streamlined disclosure lawyer. In reality, when you are seeking help with the SDOP and SFOP filings, you are searching for an international tax attorney.

Minnesota Streamlined Disclosure Lawyer: Specialty in Offshore Voluntary Disclosures

As I stated above, SDOP and SFOP form part of a very specific sub-area of offshore voluntary disclosures. This means that not every international tax attorney would be able to conduct the necessary legal analysis required to successfully complete an offshore voluntary disclosure, including Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. Only a lawyer who has developed expertise in a very narrow sub-field of offshore voluntary disclosures within US international tax law will be fit for this job.

This means that you are looking for an international tax attorney who specializes in offshore voluntary disclosures and who is familiar with the various offshore voluntary disclosure options. Offshore voluntary disclosure options include: SDOP (Streamlined Domestic Offshore Procedures), SFOP (Streamlined Foreign Offshore Procedures), DFSP (Delinquent FBAR Submission Procedures), DIIRSP (Delinquent International Information Return Submission Procedures), IRS VDP (IRS Voluntary Disclosure Practice) and Reasonable Cause disclosures. Each of these options has it pros and cons, which may have tremendous legal and tax (and, in certain cases, even immigration) implications for your case.

Minnesota Streamlined Disclosure Lawyer: Geographical Location Does Not Matter

While the expertise and experience in offshore voluntary disclosures is highly important in choosing your international tax lawyer, the geographical location (i.e. the city where the lawyer lives and works) does not matter. I already hinted at why this is the case above: offshore voluntary disclosure options were all created by the IRS and form part of US international (i.e. federal) law. In other words, the local law has no connection whatsoever to the SDOP and SFOP.

This means that you are not limited to Minnesota when you are looking for a lawyer who can help you with your streamlined disclosure. Any international tax lawyer who specializes in this field may be able to help you, irrespective of whether this lawyer resides in Minnesota or Minnesota.

Moreover, the development of modern means of communications has pretty much eliminated any communication advantages that a lawyer in Minnesota might have had in the past over the out-of-state lawyers. This has already been established in today’s post-pandemic world which greatly reduced the number of face-to-face meetings.

Sherayzen Law Office Can Be Your Minnesota Streamlined Disclosure Lawyer

Sherayzen Law Office, Ltd. is a highly-experienced international tax Minnesota law firm that specializes in all types of offshore voluntary disclosures, including SDOP, SFOP, DFSP, DIIRSP, IRS VDP and Reasonable Cause disclosures. Our professional tax team, led by attorney Eugene Sherayzen, has successfully helped our US clients around the globe, including in Minnesota, with the preparation and filing of their Streamlined Domestic Offshore Procedures disclosure. We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

IRS Civil Penalties and Voluntary Compliance | US International Tax Lawyer

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There has been a spectacular growth in the number of the IRS civil penalties. In 1955, there were about 14 penalties in the entire Internal Revenue Code (“IRC”); on the other hand, today, there are over 150 penalties. The most recent growth in penalties has been driven mostly by offshore compliance concerns and the appearance of new requirements to address these concerns. FATCA Form 8938 is just the most recent example of this trend.

Does this growth in the IRS civil penalties mean that our tax system is shifting its focus from encouraging voluntary compliance to punishing abusive behavior? Let’s explore this issue from a historical perspective and try to answer the question.

The Stated Purpose of the IRS Civil Penalties

The US tax system is based on the taxpayers’ voluntary compliance with US tax laws. As I explained in a previous article, “voluntary compliance” really means the self-assessment of tax and the filing of tax returns by US taxpayers; the actual compliance with US tax laws is compulsory.

In other words, the Congress burdened the taxpayers with all of the hassle and complexity of US tax compliance and it still wants them to do it accurately, timely and in direct opposition to their self-interest of paying the least amount of tax. How can such a system function?

The solution lies in the creation of a system of the IRS civil penalties (a discussion of criminal penalties is outside of the scope of this article). The threat of the imposition of the IRS civil penalties during a random audit is meant to “encourage” voluntary compliance. This is the official purpose of the IRS penalties.

How exactly do the IRS civil penalties encourage voluntary compliance according to Congress? First, the penalties establish the standard of compliant behavior by defining noncompliance. Second, the penalties are meant to define the “remedial consequences” for noncompliant behavior. Finally, the IRS civil penalties impose monetary sanctions against the taxpayers and tax professionals who fail to comply with the aforementioned standard.

IRS Civil Penalties Must be Viewed as Precise and Proportional

Yet, in order to properly function and accomplish their goal of encouraging voluntary compliance, the IRS Civil Penalties must be viewed by the taxpayers as precise and proportional to the fault committed and the harm that resulted from that fault. In other words, the taxpayers must view the IRS Civil Penalties as a deterrence of improper conduct rather than punishing innocent taxpayers. If these penalties are viewed as excessive, the goal of voluntary compliance will be undermined.

Unfortunately, with respect to many IRS Civil Penalties, the taxpayers feel that they are disproportionate and imprecise. This is especially true with respect to international information tax returns, such as FBAR, Form 8938, Form 5471 and so on. The FBAR penalties are especially abhorred by the taxpayers because they apply to even non-willful conduct.

IRS Past Efforts to Change Taxpayers’ Perspective on the IRS Civil Penalties

The IRS has been trying to battle this impression of unfairness of the IRS civil penalties, though we cannot say that it has been entirely successful in this respect.

Already in February of 1989, the IRS Commissioner’s Executive Task Force issued a “Report on Civil Tax Penalties” which emphasized the complexity and perceived unfairness of the IRS Civil Penalties. This Report remains one of the key documents which has not been substantially modified for past twenty some years.

The report established a philosophy of penalties, provided a statutory analysis of the three broad categories of penalties (filing of returns, payment of tax and accuracy of information), and proposed a list of action items to resolve the inconsistencies between civil penalties.

Among these recommendations, the IRS proposed to:

(1) develop and adopt a single-penalty policy statement emphasizing that civil tax penalties exist for the purpose of encouraging voluntary compliance;

(2) develop a single consolidated handbook on penalties for all employees. The IRS emphasized that the handbook should be sufficiently detailed to serve as a practical everyday guide for most issues of penalty administration and provide clear guidance on computing penalties;

(3) revise existing training programs to ensure consistent administration of penalties in all functions for the purpose of encouraging voluntary compliance;

(4) examine its communications with taxpayers to determine whether these communications do the best possible job of explaining why the penalty was imposed and how to avoid the penalty in the future;

(5) finalize its review and analysis of the quality and clarity of machine-generated letters and notices used in various divisions within the IRS;

(6) consider ways to develop better information concerning the administration and effects of penalties; and

(7) develop a Master File database to provide statistical information regarding the administration of penalties. That IRS envisioned that the information would be continuously reviewed for the purpose of suggesting changes in compliance programs, educational programs, and penalty design and penalty administration.

1989 IMPACT’s Effect on the IRS Civil Penalties

The IRS efforts did not go unnoticed. The Congress responded by enacting the Improved Penalty and Compliance Tax Act (“IMPACT”) as part of its Omnibus Budget Reconciliation Act of 1989.

It appears IMPACT had an overall salutary effect on the IRS civil penalties with respect to domestic activities. However, IMPACT’s role in curbing the perceived unfairness with respect to US international tax penalties has been minimal.

The Restructuring and Reform Act of 1998 Changed the Way the IRS Civil Penalties Are Imposed

At the end of the 1990s, the Congress made one more effort to solidify the image of fairness with respect to the imposition of the IRS civil penalties. The Restructuring and Reform Act of 1998 made a valuable contribution to maintaining the focus on encouraging voluntary compliance by creating the IRC Section 6751(b). IRC Section 6751(b) states that most of the IRS Civil Penalties (other than those automatically calculated by a computer) imposed after June 30, 2001, require a written managerial approval by the immediate manager or higher-level official of the employee who initially proposed the penalty.

The idea behind Section 6751(b) is to bring some restrain in the imposition of penalties by the “trigger-happy” employees. The extra level of review is further meant to promote the image of fairness of process during the imposition of the IRS Civil Penalties.

Conclusion: Encouragement of Voluntary Compliance Remains A Priority in General but the Emphasis on Abusive Transactions Dominates International Tax Law Compliance

Now that we have analyzed the IRS Civil Penalties from a historical perspective, let’s return to the original questions that I posed at the beginning of this article: does the growth in the number of the IRS civil penalties mean that our tax system is shifting its focus from encouraging voluntary compliance to punishing abusive behavior?

Based on the IRS past efforts to improve the taxpayer’s perception of the tax system and civil penalties and the Congress’ effort to encourage voluntary compliance through laws like IMPACT, one can say that, in general, the encouragement of voluntary compliance remains the main purpose of the IRS civil penalties.

There is one area, however, where the application of civil penalties has been driven not by only voluntary compliance considerations, but also by the desire to punish certain modes of behavior. This area is international tax law and, more precisely, abusive offshore transactions.

In fact, it appears more and more that the focus of the current tax policy is on punishing abusive offshore transactions irrespective of how it may affect innocent taxpayers. Since 2001, millions of taxpayers found themselves potentially facing draconian FBAR penalties solely for not reporting their foreign accounts. Thousands of small businesses also face large penalties associated with Forms 5471 and 8865 as well as other US international information return penalties. Finally, FATCA Form 8938 created with a new array of penalties and an added compliance burden to US taxpayers.

The fact that all of these forms may be necessary is not the issue. The problem is that the application of these forms has been indiscriminate almost irrespective of the actual income tax impact and the net worth of the taxpayer. For example, small businesses now have to comply with the burden of US GAAP compliance (normally applied only to publicly-traded companies) on Form 5471 or face severe IRS civil penalties for noncompliance. One non-willfully unreported foreign account which could have produced a few dollars of interest may be subject to a $10,000 FBAR penalty.

Naturally, the disproportionate and imprecise application of the IRS civil penalties in the area of the US international tax compliance has generated a great amount of discontent and resentment among the affected US taxpayers. This is precisely what IMPACT tried to avoid in order to encourage voluntary compliance.

This is why the IRS and Congress should work together to make the application of the IRS civil penalties more precise with respect to who should be paying these penalties and more proportionate to the actual fault (i.e. the damage sustained by the US treasury).

US Airspace and the Definition of the United States | US Tax Lawyers

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This article is a continuation of a recent series of articles on the exploration of the definition of the United States. As it was mentioned in a prior article, the general definition of the United States found in IRC § 7701(a)(9) has numerous exceptions throughout the Internal Revenue Code (“IRC”). The US airspace is another example of such exceptions. In this article, I would like to outline some of the ways in which the borders of the United States are defined in the context of the US airspace.

General Tax Definition of the United States Does Not Mention US Airspace

The general tax definition of the United States is found in IRC § 7701(a)(9). According to IRC § 7701(a)(9), the United States is comprised of the 50 states, the District of Columbia and the territorial waters. There is no mention of the US airspace.

This, of course, does not mean that US airspace never constitutes part of the United States. Rather, as I had explained it in a prior article, one needs to look at the specific tax provisions and determine if there is a special definition of the United States that applies to them.

Examples of Various IRC Provisions Including and Excluding US Airspace from the Definition of the United states

Indeed, there is a rich variety of treatment of US airspace that can be found within the IRC. Here, I will just mentioned three examples that demonstrate how differently the IRC provisions define the United States with respect to its airspace.

1. There is an esoteric but important IRC § 965 which deals with the Dividends Received deduction for repatriated corporate earnings. IRS Notice 2005-64 provides foreign tax credit guidance under IRC § 965 and specifically follows the general definition of the United States with the addition of the Continental Shelf. Then, the Notice states: “the term ‘United States’ does not include possessions and territories of the United States or the airspace over the United States and these areas”. Thus, the US airspace is excluded from the tax definition of the United States under IRC § 965.

2. The treatment of the US airspace is the opposite for the purposes of the Foreign Earned Income Exclusion (“FEIE”). Since FEIE allows a taxpayer to exclude only “foreign” earned income, the tax definition of the United States is crucial for this part of the IRC.

In general, the courts have ruled that the airspace over the United States is included within the definition of the United States with respect to IRC § 911. This means that, if you are flying over the United States, you are considered to be within the United States for the purposes of FEIE.

3. When we are dealing with the analysis of whether an individual is a US tax resident under the Substantial Presence Test, we are again back to the same situation as in example 1 – the US airspace is not included in the definition of the United States.

Contact Sherayzen Law Office for Professional Legal and Tax Help

Sherayzen Law Office is a premier international tax law firm that helps individuals and businesses with US tax compliance, including Offshore Voluntary Disclosures. We can help you with any US international tax law issues.

Contact Us Today to Schedule Your Confidential Consultation!