H. Jacob Lager

Archive for the ‘IRS regulations’ Category

IRS slooooowwwlllly acknowledging electronic docs; Supreme Court takes on windfall tax circuit split

In IRS regulations, Windfall tax, You heard it here first on November 2, 2012 at 9:05 am

“Can you just scan that to me?”

If you’re like me, a “no” response to the above question generates nothing short incredulity, animosity, and exasperation.  At times, it can seem there is no logic as to which institutions will get you information easily and which will not.

For example:

  • My bank once required that I submit a faxed form to make an IRA contribution, even though I had made the previous 10 months’ contributions by phone without incident;
  • Just today, a potential buyer of a client’s real estate would only generate a hard copy offer letter to be transmitted by “snail mail”; and, of course
  • I’ve lost count of how many different ways the IRS and California’s FTB have changed their verification procedures for e-filing tax returns.  Some years, I have to actually submit a signature verification.  Some years I just point and click.  This year, for a corporate return, I actually had to print, scan, and upload a form for the first time.

Well, in a victory for people who hate paper, the IRS just recently issued published advice concluding that its Form W-8, “Certificate of Foreign Status,” may, under certain circumstances be successfully scanned into an electronic system and then transmitted directly to a withholding agent through that system.

What does all this mean?

When a foreign person is paid certain types of U.S. income (typically interest, dividends, rents, royalties, premiums, annuities, service income, and other periodic income items), the recipient is often subject to backup tax withholding of 30 percent on the payment.  The U.S. payor is generally charged with withholding and paying over this amount to the IRS.  The U.S. payor is only relieved of this obligation if the foreign payee issues to the responsible party documentation upon which the payor can rely to treat the payment as made to a U.S. person or to a foreign person entitled to a reduced rate of withholding.

The IRS “W-8” family of forms are often used to provide this very documentation.  These forms are generally certifications that either the recipient resides in a treaty-favored country (W-8BEN), a foreign pass-through entity (W-8IMY), receiving the payment as taxable US income otherwise effectively connected with a domestic trade or business, or a foreign government (W-8EXP).

The IRS issued guidance on August 8, 2012 liberalizing the manner in which these forms may be transmitted to payors.

According to the Service, Form W-8 that is signed with a handwritten signature, scanned into an electronic system, and then transmitted directly to a payor through that electronic system (for example, as a PDF or facsimile), may be relied upon to avoid withholding if the following requirements are met:

  • The system design and operation must make it reasonably certain that the person furnishing the form is the person named on the form (for example, verifying that the email address of the sender accompanying the electronically transmitted form indicates that the sender is the person named on the form);
  • The submitted Form W-8 must provide the payor with exactly the same information as the paper Form W-8 (the Service acknowledges that a complete and legible scanned copy of the form meets this requirement);
  • The submitted Form W-8 must contain an electronic signature by the person whose name is on the form (in a further display of profound trust, the IRS notes that signing, scanning, and transmitting a document “constitute a process associated with” the form that reflects that the form is uh . . . signed); and
  • The payor must be able to produce, upon IRS request, a hard copy of the electronic Form W-8.

But just before you crazy kids start faxing and scanning all willy-nilly, the Service gave itself an out:  “Whether a withholding agent may accept a Form W-8 that is transmitted to the withholding agent electronically will depend on the facts and circumstances.”

Whew!  That was close.


From the “you heard it here first” department:

On October 29, 2012 (which just so happened to be my birthday), the Supreme Court granted certiorari to the PPL Corp. decision in an effort to determine the split between the Third and Fifth circuits, which respectively have endorsed and rejected a mechanical framework for determining whether a taxpayer’s foreign tax is creditable under Code Section 901.

(You might remember our brief summary of the split.)

According to the taxpayer, the issue is whether creditability of a foreign tax should be determined using a formalistic or substance-based approach.  The government described the matter much more narrowly, arguing that the 1997 U.K. windfall tax (a one-time assessment) was not a creditable income tax.

PPL Corp. is the only tax case granted certiorari this term, so you know we’ll be following it closely.

Photo provided by jepoirrier.


An unpleasant surprise for expat family members: A look at Section 2801

In Expat taxes, IRS regulations, U.S. Tax policies on September 21, 2012 at 1:18 pm

Are you a family member or friend of an expat?  Get ready to be surprised!

I always hated surprises.

Actually, that’s not quite right.  I love being truly surprised.  Its terrific when someone actually keeps something totally secret and then drops it on me.  Especially when its good news.  In fact, that’s pretty much exactly what happened when my wife told me we were going to have a baby.

But when you keep something from me AND  let me know you are doing so?  That stinks.  This is pretty much how my wife tortured me for 15 awful seconds when she discovered before me that our baby was going to be a girl.

So you might imagine how I react when the IRS says, “Yeah, your clients might owe that tax, or they might not.  We’re not really sure when we’re going to start enforcing that tax, but when we do it’s going to be retroactive to … sometime in the past.”

Don’t believe that the IRS says that?  Then you’ve never read Section 2801.  That section imposes a gift tax liability on U.S. taxpayers who receive gifts or bequests from tax expatriates.  So if you’re anticipating any looming generosity from Ed Saverin or Denise Rich, you may want to pay attention.

Regardless of whether one finds this tax a travesty to liberty or a justified clawback, the real sinister element here is that Treasury has not issued forms on which to report a subject gift and has publicly stated that it’s not going to enforce the tax until . . . it does.  In Notice 2009-85, the IRS stated that expatriate gifts received on or after June 17, 2008, are subject to tax, but that “[s]atisfaction of the reporting and tax obligations for covered gifts or bequests received will be deferred, pending the issuance of guidance.”

That was three years ago.  So far – no guidance.

Even the government doesn’t really know what to do about this one.  Last week, Catherine Hughes, attorney-adviser, Treasury Office of Tax Legislative Counsel, attempted to address the issue at the American Bar Association Section of Taxation meeting in Boston.  According to Hughes, issuing 2801 guidance is a “top priority” for Treasury, but she also acknowledged that “figuring out when to say these returns are due is a huge issue.” The statute itself provides no due date and savvy taxpayers who reported the gift may be able to avail themselves of statute of limitation protection if the gift is old enough.  Others may not know whether the tax is owed until after the due date for those returns.


Mr. Tax Lawyer goes to Washington

In FATCA, IRS regulations, U.S. Tax policies on August 31, 2012 at 9:24 am

I’ll admit it. I’m a mark for Capra films. I cheer for every ulcer Grandpa gives the IRS agent. I cry every Christmas Eve when Clarence gets his wings. And like Mr. Smith, I’ve always wanted to go to Washington and tell ’em what’s what. Sadly, the opportunity rarely arises.

However, a few brave California tax attorneys courageously face the DC humidity every summer to do that which I only dream: tell the IRS and Congress how to better administer taxes. It’s as sexy as it sounds.

This past May, the taxation section of California State Bar sent its annual Washington, DC delegation to our nation’s capital to discuss current tax issues with Treasury officials, congressmen, and other policy-makers. Their reports were just published, which included the following recommendations relating to international tax issues:

Jenna Shih, Esq. and CPA Po Han Chen recommended that regulations be issued clarifying the rules to determine whether a US-owned foreign company may be treated as engaged in the active business of developing its own intellectual property (and therefore escape US taxation on its profits). The authors noted that current case law allows such treatment where the company’s direct employees manage the business, even if independent contractors develop the IP.

Pracitioners Pedro Corona and Enrique Hernandez issued a report suggesting that Mexican pension participants should be exempted from PFIC reporting requirements.

In particular, the authors noted that participation in Mexican retirement funds represents a low-risk of tax evasion because such pensions are not created to allow foreign investment, but are actually part of a mandatory condition of Mexican employment.

Finally, Patrick W. Martin and Liliana Menzie proposed expanding the FATCA definition of “local foreign financial institutions” to ease compliance burdens for foreign banks whose clients are considered “accidental Americans” (i.e. individuals who live in other countries but retain U.S. citizenship).

If you have any interest in preparing a report or a recommendation for next year’s delegation, click here for more information, or contact me and I can put you in touch with one of the organizers.

Forget the Olympics; Boycott This!

In IRS regulations, U.S. Tax policies on August 24, 2012 at 7:32 am

Pop Quiz:  what do Iraq, Kuwait, Lebanon, Libya, Qatar, Saudi Arabia, Syria, the UAE, and Yemen have in common?

Exemplary human rights record?  Demonstrated historic dedication to religious tolerance? Main streets named after George W. Bush?

Nope.  But if you answered “routinely named by the US Government as countries which require participation in, or cooperation with, an international boycott,” you win.  So, what exactly does this mean?

Well, in 1976, Congress sought to deter participation in non-U.S.-sanctioned boycotts by the imposition of the tax penalties codified at Code Section 999.

Generally speaking, the section features two parts:  the risk of losing certain income tax benefits from boycott participation and (surprise!) a reporting requirement.

Taxpayers who actually participate in a boycott risk losing certain foreign tax credit and DISC benefits, increasing their Subpart F income, and may be fined.

But what about that reporting requirement?  That rule is surprisingly broad.  If a taxpayer has operations in or related to a boycotting country and that country is on the above-mentioned list, those operations must be reported.  And by “operations,” Treasury really means “any meaningful commercial contact.”  Also, a taxpayer must report any operations in a non-listed country when the taxpayer “has reason to know” that participation in or cooperation with an international boycott is a condition of such activities.  Needless to say, this “has reason to know” qualifier greatly expands the world of potentially reportable transactions well beyond the Middle Eastern countries listed above.  Failure to report could subject a taxpayer to a fine of $25,000 plus a year in jail.

Iraq’s re-emergence on the list is notable, given that it had been removed as recently as August, 2010.  Other notable “alumni” include Bahrain and Oman.

While not as onerous as an FBAR report, or as frightening as the looming FATCA requirements, the Section 999 reporting requirement should not be ignored.  The generality with which it may be applied makes it a dangerous IRS weapon, even if rarely wielded.

Image provided by 8jin_design.

The dramatic tale of “A True FBAR Criminal”

In FBAR, Foreign taxes, IRS regulations, Tax Crime on July 27, 2012 at 8:02 am

One question I often hear when explaining FBAR liability is, “Are they really going to come after me?”

It’s not an unreasonable question.  Oftentimes, the penalties for FBAR non-compliance can seem very severe, especially when dealing with a foreign client who may have recently become a U.S. taxpayer and unknowingly retained reportable accounts abroad.

This week, the U.S. Attorney’s Office for the Southern District of Florida issued a press release that provides an example of just who “they” are truly “going after.”

The presser announced yesterday’s sentencing of Miami Beach resident Luis A. Quintero for willful failure to file his FBARs.  So what was the sentence?  Roddy, tell him what he won!

  • Four months in federal prison;
  • Three years of supervised release;
  • 250 hours of community service; and
  • A $20,000 criminal fine.

But wait!  There’s more!

Is that 27.5% OVDP penalty looking more attractive?

Before anyone panics, lets take a look at what Quintero actually did.  Court documents indicate that he formed two offshore corporations, which were then used to open certain Swiss UBS accounts, which housed (and hid) roughly $4 million.  Quintero then facilitated multiple transfers to and from the subject accounts.  Of course, none of that is necessarily illegal had he disclosed the accounts’ existence and their activities.

Which he didn’t.

The U.S. Attorney’s Office also noted that there was no question that Quintero knew that he was required to file an FBAR for the subject accounts.  In fact, Quintero had previously filed FBARs for other Mexican bank accounts to which he was attached.  That’s a bad fact if you’re trying to argue that your subsequent failure wasn’t “willful.”

The press release further indicates that the Quintero prosecution was a direct result of UBS’s 2009 agreement to cooperate with U.S. authorities in identifying suspected tax cheats.  If you have a U.S. client that is, or was, a Swiss UBS customer in the recent past, you may want to suggest a review of their reportable foreign accounts.

Foreign partner? Read this.

In IRS regulations on July 5, 2012 at 8:16 am

On June 22, IRS announced new changes to its procedures for issuing individual taxpayer identification numbers (ITINs).

So, what’s an ITIN?

ITIN literally stands for Individual Tax Identification Number.  As you likely know, every taxpayer who reports US income needs some kind of identifying number.  For individuals who are US citizens or resident aliens, that’s typically a social security number.  For business entities, that number is typically an Employer Identification Number (EIN).

An ITIN fills the same function for foreign individuals.  ITINs are typically required when a US payor intends to transfer, and withhold US taxes from, US-source income to a foreign individual.  The ITIN is the tracking mechanism that ensures the foreign person is paying his or her US tax liability.  Generally, a US withholding agent will require that its foreign payee obtain an ITIN before issuing payments abroad.  Such withholding agents often include US LLCs or partnerships or employers who hire temporary workers from overseas.

Obtaining an ITIN used to be a fairly painless operation involving a simple form application.   After 9/11, the Service tightened procedures for obtaining ITINs so as to prevent their abuse by international criminals seeking to move illicit funds.

So what’s changed?  As of last week, the IRS has announced that ITINs will only be issued to applicants who submit original identifying documents (like a passport or birth certificate) or copies of those documents certified by the issuing agency.  Notarized copies of those documents will no longer be accepted.

In other words, you need purple ink.

If you or your client is a new US business with individual foreign investors, or if you anticipate bringing in foreign talent to your US business for a short period of time, you may encounter these new rules.  Obtaining an ITIN. Can be tricky since the Service prefer that the foreign national actually submit the application concurrently with the person’s first US return.  This somewhat backward time frame can be particularly annoying for US partnerships seeking to issue K-1s to their foreign partners in advance of April 15.

When this kind of administrative Gordian Knot needs cleaving, that’s a good sign your client might need tax counsel.

When do I become a US “estate tax” resident? The shocking truth revealed!

In IRS regulations on April 16, 2012 at 12:32 pm

Well, maybe it’s not “shocking,” but it may be a bit surprising.  Last week, we discussed the estate tax planning benefits of “drop off” trusts for incoming foreign nationals.  One major point to remember from that post is that a drop off trust will only work if it’s funded prior to your estate becoming subject to US estate taxes.

The question remains, when are you subject to estate taxes?  Surprisingly, your subjectability to estate tax does not necessarily coincide with time you become subject to US income taxation.

While income tax residence is governed by a series of objective rules (the “green card” test, the “183 day” test, and a number of tax treaty modifications), estate tax “domiciliary” is determined by a much more subjective facts-and-circumstances test.  This means your estate may not be subject to US estate tax even though you have already obtained lawful permanent residence status.

A US estate tax domicile is established if you: (a) are living in the US and have the intention to remain in the US indefinitely; or (b) have lived in the US with such an intention and have not formed the intention to remain indefinitely in another country.   The focus on “intent” introduces a wide breadth of subjectivity (some might say “planning opportunity”) to when US domiciliary is established.  Often, the determination can turn on the location of your primary residence and where you carry on your family, social, religious, and business relations and activities.

Some of the factors which the IRS examines are: (i) the length of time you spent in the US and abroad and the amount of your travel to and from the US and between other countries; (ii) the value, size, and locations of your homes and whether they are owned or rented; (iii) whether you reside in a locale due to poor health, for pleasure, or for political reasons; (iv) where your valuable or meaningful tangible personal property is located; (v) where your close friends and family reside; (vi) where your religious and social and civic affiliations are located; (vii) where your main business interests are situated; (viii) your visa status; (ix) your stated residence on legal documents; (x)  your voter’s registration; (xi)  your driver’s license issuing jurisdiction; and (xii) your income tax filing status.

So, let’s assume you, a foreign national, are comfortable with claiming non-US domiciliary status and that you want to go forward with a drop-off trust.  What could go wrong? (Enter foreboding music.)

Answer coming next week in Part Three!


Photo courtesy of lalunablanca

The Internal Revenue Code and the Infield Fly Rule

In Foreign taxes, IRS regulations, Uncategorized on April 4, 2012 at 7:59 pm

In honor of tomorrow’s opening day festivities, I give you my favorite Law Review article ever.


EPIC: “Fails charges” guidance provided by IRS

In Fails charges, IRS regulations on February 27, 2012 at 8:00 am

Which sovereign jurisdiction can tax an item of income?

This eternal question arises whenever Wall Street creates a new financial product involving multinational parties.

For “fails charges,” the Service just issued a new batch of rules (found at Regulation Sec. 1.863-10) to determine whether these fees should be treated as US or foreign income.

So, uh, what’s a “fails charge?”

These payments developed in the world of high-stakes bond trading as a response to persistent failures to deliver Treasury securities in 2008.  Under certain arrangements, if one party fails to deliver Treasury securities to another by an agreed-upon date, the failing party pays an amount (the “fails charge”) to the other party. For US taxpayers, the treatment of these fees are relatively straightforward.

However, until this week, the general income-sourcing rules provided little guidance for foreign traders who become entitled to such fees.

Now, the final IRS regulations provide that the source of income from a qualified fails charge is generally determined by reference to the residence of the recipient.

With two exceptions.

First, qualified fails charge income earned by a qualified business unit of a taxpayer will be sourced to the country in which the qualified business unit is engaged in a trade or business.  Second, qualified fails charge income arising from a transaction effectively connected to a U.S. trade or business will be sourced to the United States.

Oddly, the final IRS regulations do not address the proper sourcing of a non-qualified fails charge, which begs the question of the “qualified” designation’s relevance.

Er, slight “regulation fail?”

Photo provided by Chris Griffith.