copyright 8/29/2019 lgutef international tax issues...

© 2019 Land Grant University Tax Education Foundation, Inc. 535

INTERNATIONAL TAX ISSUES

13Issue 1: Foreign Investment in

Real Property Tax Act � � � � � � � � � � � � � 536Issue 2: Delinquent FBAR Filings

and Streamlined Offshore Filing Procedures � � � � � � � � � � � � � � � � � 542

Issue 3: Gifts or Bequests from a Foreign Person � � � � � � � � � � � � � � � � � 547

Issue 4: US Shareholders of Foreign Corporations � � � � � � � � � � � � � � � � � � � � 549

Land Grant University Tax Education Foundation

Land Grant University Tax Education Foundation

LEARNING OBJECTIVESAfter completing this session, participants will be able to do the following:

✔ Understand the tax reporting requirements for the disposition of US real estate interests by foreign owners

✔ Determine when to file delinquent FBARs

✔ Know when to use the Streamlined Offshore Filing Procedure

✔ Report gifts and bequests from a foreign person

✔ Understand the filing requirements for US shareholders of controlled foreign corporations

✔ Explain ways to reduce the tax on US shareholders of controlled foreign corporations

COPYRIGHT 8/29/2019 LGUTEF

536 INTRODUCTION

INTRODUCTIONThis chapter provides guidance on the disposi-tion of US real property interests by foreign prop-erty owners� US taxpayers (including those living abroad) must annually disclose information about foreign financial accounts� This chapter describes some of the programs available to delinquent taxpayers� It also explains the reporting require-ments for gifts from foreign trusts and bequests from foreign estates�

The Tax Cuts and Jobs Act (TCJA) of 2017 imposes new requirements for US shareholders of controlled foreign corporations� This chapter explains when these rules apply, and it provides practical suggestions to reduce taxes owed under the new laws�

ISSUE 1: FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT Tax withholding may be required on a non-US person’s disposition of a US real property interest�

The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) [I.R.C. § 1445] requires withholding on a disposition of a US real prop-erty interest to a non-US person. The tax is with-held from the gross purchase price to be paid to the transferor. Some exemptions apply, and there is a procedure to reduce the withholding when the transferor’s actual tax obligation is less than the required withholding.

General Withholding Requirements

With some exceptions, the disposition of a US real property interest by a foreign person or entity is subject to FIRPTA withholding. In most cases, the transferee is the withholding agent and has the following responsibilities:

■■ Determine if the transferor is a foreign per-son or entity.

■■ Determine if any exemption applies.■■ Withhold and remit a portion of the sale pro-ceeds to the IRS.

If the transferee fails to withhold and remit the correct amount, he or she may be held liable for the transferor’s tax deficiencies, including interest and penalties on the failure to comply with the withholding requirement.

DefinitionsTreas. Reg. § 1.1445-1 provides the general with-holding rules and definitions. If not specified in section 1.1445-1, the definitions of terms in Treas. Reg. § 1.897-1 apply.

DispositionThe term disposition means any transfer that would constitute a disposition by the trans-feror for any purpose of the Internal Revenue Code and accompanying regulations. The sever-ance of crops or timber and the extraction of min-erals do not alone constitute the disposition of a US real property interest. The most common dis-position is a sale. However, it also includes the transfer of shares of a corporation that is a real property holding company, and certain distribu-tions by domestic or foreign partnerships, trusts, and estates.

Foreign PersonA foreign person is a nonresident alien individual, a foreign corporation that has not made an election to be treated as a domestic corporation [I.R.C. § 897(i)], a foreign partnership, a foreign trust, or a foreign estate. It does not include a resident alien individual.


General Withholding Requirements 537

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US Real Property Holding Company A corporation will be deemed to be a US real property holding company (USRPHC) if the FMV of the US real property interests held by the cor-poration equals or exceeds 50% of the sum of the FMV of all real property interests (domestic and foreign) and certain fixed business assets [Treas. Reg. § 1.897-2].

US Real Property InterestA US real property interest means an interest in real property located in the United States or the US Virgin Islands. It includes growing crops and tim-ber, and an ownership interest in a mine, well, or other natural deposit. It also includes certain per-sonal property that is associated with the use of the real property (such as farm machinery or min-ing equipment or hotel property). In addition, it means any interest, other than as a creditor, in any domestic corporation unless the taxpayer establishes that the corporation was at no time a USRPHC during the shorter of the period during which the interest was held or the 5-year period ending on the date of disposition.

Rate of WithholdingThe rate of withholding is 15% of the gross amount realized. For certain dispositions where the amount realized is $1,000,000 or less and the transferee meets the personal residence test (dis-cussed later), the withholding is 10% of the gross amount realized. Different rates apply to sales by certain entities (discussed next).

Planning PointerState Withholding Laws

Many states have enacted legislation that imposes a mandatory flat rate withholding tax on disposi-tions of property by nonresidents of that state� This could include US residents of other states or foreign transferors�

Practitioner NoteResident Alien

A permanent resident of the United States is not a foreign person� However, certain persons temporarily residing in the United States may be foreign persons� For example, a foreign student residing in the United States to attend school may be a foreign person�

TransferorTransferor means any person, foreign or domes-tic, that disposes of a US real property interest by sale, exchange, gift, or any other transfer. The owner of a disregarded entity is treated as the transferor of the property, not the disregarded entity.

TransfereeThe term transferee means any person or entity, foreign or domestic, that acquires an interest in US real property by purchase, exchange, gift, or any other transfer.

Amount RealizedThe amount realized by the transferor is the sum of the following:

■■ The cash paid or to be paid ■■ The FMV of any property transferred or to be transferred

■■ The amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer

Practitioner NoteLiability Relief

Amounts realized can include liability relief� If the transferee pays a transferor’s obligations, such as delinquent homeowner’s association dues or past-due property taxes, the payment is an amount realized by the transferor�


538 ISSUE 1: FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT

REITs and RICs The sale of an interest in a domestically con-trolled qualified investment entity is not the sale of a US real property interest. A qualified invest-ment entity is any real estate investment trust (REIT) or any regulated investment company (RIC). An entity is domestically controlled if, dur-ing the testing period, less than 50% in value of its stock was held, directly or indirectly, by foreign persons. The testing period is the shorter of the 5-year period ending on the date of the disposi-tion or the period during which the entity was in existence. Withholding may be required on cer-tain distributions to foreign persons.

Reporting US Real Property Dispositions

Transferees must use Forms 8288, U.S. With-holding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and 8288-A, Statement of Withholding on Disposi-tions by Foreign Persons of U.S. Real Property Interests, to report and pay to the IRS any tax withheld on the acquisition of a US real property interest. The forms must include the US taxpayer identification number [individual taxpayer iden-tification number (ITIN), social security number (SSN), or employer identification number (EIN)] of both the transferor and transferee.

Form 8288The transferee must complete and send Form 8288 to the IRS (with the withheld funds) by the twentieth day after the date of the transfer. If the transferor submits an application for a withhold-ing certificate (discussed later) on or before the date of the transfer, and the application is pend-ing with the IRS on the date of transfer, the trans-feree must withhold the correct amount of tax, but does not have to file Form 8288 and remit the funds within the 20-day period. The transferee has 20 days following the date of the withholding certificate (or notice of denial) to report and remit funds.

Entity Withholding Requirements

Withholding requirements for dispositions by entities are set forth in I.R.C. § 1445(e).

CorporationsA foreign corporation that distributes a US real property interest must withhold a tax equal to 21% of the gain it recognizes on the distribu-tion to its shareholders, unless it has elected to be treated as a domestic corporation. A domestic corporation that is or has been a USRPHC must withhold a tax equal to 15% of the FMV of the property on a distribution to a foreign person if the foreign shareholder’s interest in the corpora-tion is a US real property interest and the prop-erty distributed is either in redemption of stock or in liquidation of the corporation.

PartnershipsIf a domestic partnership that is not publicly traded disposes of a US real property interest at a gain, and the gain is treated as effectively con-nected income and is subject to the withhold-ing rules under I.R.C. § 1446, it is not subject to FIRPTA withholding. Otherwise, a domestic partnership that disposes of a US real property interest must withhold 21% of the gain allocable to a foreign partner.

Trusts and EstatesIf a domestic trust or estate has one or more for-eign beneficiaries, the trustee, fiduciary, or execu-tor becomes a FIRPTA withholding agent. The withholding agent must track all gains or losses realized from the disposition of US real property interests by creating a US real property interest account. The agent must withhold 21% of the gain allocable to a foreign beneficiary. The trans-feree of a beneficial interest in a trust or estate must withhold 15% percent of the amount real-ized on the disposition.


Exceptions from FIRPTA Withholding 539

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Exceptions from FIRPTA Withholding

Generally, withholding is not required in the fol-lowing circumstances:

1. An individual transferee acquires the prop-erty for use as a residence and the amount realized is not more than $300,000. To qual-ify, the transferee or a member of the transfer-ee’s family must have definite plans to reside at the property for at least 50% of the num-ber of days that the property is used by any person during each of the first two 12-month periods following the date of the transfer (the personal residence test). When counting the number of days that the property is used, the taxpayer does not include the days that the property will be vacant.

Practitioner NotePrincipal Residence

The personal residence exception does not apply to a nonindividual transferee (e�g�, a corporation, partnership, or trust)� It also does not apply to land without a dwelling� The residence does not have to be the transferee’s principal residence, and it can be a vacation home�

2. The property disposed of is an interest in a domestic corporation and any class of the stock is regularly traded on an established securities market. However, this exception does not apply to certain dispositions of sub-stantial amounts of nonpublicly traded inter-ests in publicly traded corporations.

3. The disposition is of an interest in a domestic corporation and that corporation furnishes a certificate stating, under penalties of per-jury, that the interest disposed of is not a real property interest. The corporation can make this certification only if during the previous 5 years (or, if shorter, the period the interest was held by its present owner), the corpora-tion was not a USRPHC; or, as of the date of disposition, the interest in the corporation is

Practitioner NoteAntiabuse Rule

If the principal purpose of applying for a with-holding certificate is to delay paying the withheld tax to the IRS, the transferee will be subject to interest and penalties from the twenty-first day after the date of transfer until the full amount of withheld tax is paid to the IRS�

Form 8288-AThe withholding agent must prepare a Form 8288-A for each person from whom tax has been withheld. Copies A and B of Form(s) 8288-A must be attached to Form 8288. The IRS will receipt-stamp copy B and send it directly to the person subject to withholding. The foreign person must file a US income tax return for the year of the transfer and include the stamped copy B.

If the transferor sends Forms 8288 and 8288-A to the IRS for processing but does not include a taxpayer identification number, the IRS will not send a receipt-stamped copy of Form 8288-A to the foreign transferor. For individuals, the IRS will mail a letter to the foreign transferor instruct-ing him or her to apply for an ITIN by filing Form W-7, Application for IRS Individual Taxpayer Identification Number.

Practitioner NoteForm 1099-S

Generally, the title company or other person responsible for closing the transaction must report the sale of the property to the IRS using Form 1099-S, Proceeds from Real Estate Trans-actions� Form 1099-S reports the gross sale pro-ceeds, and the seller must file a US income tax return to report actual gain� Compliance with the FIRPTA withholding requirements does not relieve a seller from his or her obligation to file a US income tax return (generally Form 1040NR, U�S� Nonresident Alien Income Tax Return for an individual transferor)�


540 ISSUE 1: FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT

Practitioner NoteFalse Certifications

The transferee cannot rely on a transferor’s cer-tification if the transferee has actual knowledge that it is false or receives notice from an agent that the certification is false�

FIRPTA Withholding Certificate

Transferors can use Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests, to apply for a withholding certificate to reduce or eliminate the required withholding. The transferor must file Form 8288-B, along with all required supporting documentation, on or before the date of the transfer.

All applications must be signed by the indi-vidual transferor or transferee; a duly authorized agent with a power of attorney; a responsible officer of a corporation; a general partner in a partnership; or a trustee, executor, or equivalent fiduciary of a trust or estate. The person signing Form 8288-B verifies under penalties of perjury that all representations are true, correct, and com-plete to that person’s knowledge and belief. If the application is based in whole or in part on infor-mation provided by another party to the trans-action, that information must be supported by a written verification signed by that party under penalties of perjury and attached to Form 8288-B.

The following is required to support an appli-cation for a withholding certificate to reduce or eliminate the required withholding:

1. A calculation of the maximum tax that can be imposed on the disposition, using the maxi-mum tax rate that can be applied to the trans-feror, not considering any graduated tax rates or other deductions

2. A statement signed by the transferor under penalties of perjury that the calculation and all supporting evidence is true and correct to the best knowledge of the transferor

not a US real property interest under I.R.C. § 897(c)(1)(B). The certification must be dated not more than 30 days before the date of the transfer.

4. The transferor provides a certification stat-ing, under penalties of perjury, that the trans-feror is not a foreign person. The certification must include the transferor’s full name, US taxpayer identification number, and home address (or office address in the case of an entity). See Treas. Reg. § 1.1445-2 for a sam-ple certification.

5. The transferor provides a certification to a qualified substitute. The qualified substitute then provides a statement, under penalties of perjury, that he or she is in possession of the transferor’s certification. For this purpose, a qualified substitute is the person respon-sible for closing the transaction (including any attorney or title company) other than the transferor’s agent, or the transferee’s agent.

6. The transferor receives a withholding certifi-cate that eliminates withholding.

7. The transferor provides written notice that no recognition of any gain or loss on the trans-fer is required because of a nonrecognition provision in the Internal Revenue Code or a provision in a US tax treaty. The transferee must file a copy of the notice with the IRS by the twentieth day after the date of the transfer.

8. The amount realized by the transferor on the transfer of a US real property interest is zero.

9. The property is acquired by the United States, a US state or possession, a political subdivi-sion, or the District of Columbia.

10. The taxpayer realizes an amount on the grant or lapse of an option to acquire a US real property interest. However, withholding applies on the sale, exchange, or exercise of that option.

11. The disposition is of an interest in a publicly traded partnership or trust. However, this exception does not apply to certain disposi-tions of substantial amounts of nonpublicly traded interests in publicly traded partner-ships or trusts.

[Treas. Reg. § 1.1445-2]


FIRPTA Withholding Certificate 541

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If the IRS approves a withholding certificate that reduces (but does not eliminate) withhold-ing, the transferee must send the tax specified in the certificate (with Forms 8288 and 8288-A) to the IRS within 20 days from the date of the with-holding certificate. The remaining funds held in escrow can then be released to the foreign trans-feror. If the IRS denies an application for a with-holding certificate, the transferee must remit the full amount of withheld tax (and the reporting forms) to the IRS within 20 days of the date of the rejection notice.

3. Evidence of the amount to be realized by the transferor, such as a copy of a fully signed contract of transfer or purchase and sale agreement

4. Evidence of the adjusted cost basis of the property, such as closing statements from the acquisition of the property, any invoices for capital improvements made to the property, and all depreciation schedules

5. If no depreciation schedules are submit-ted, a statement explaining the nature of the use of the property and why depreciation was not allowed or not applicable

6. An explanation of any amounts to be recaptured for depreciation, investment tax credits, or other items subject to recapture

7. Evidence showing the amount of any increase or reduction of tax to which the transferor is subject, including any reduction to which the transferor is entitled under a US income tax treaty

8. If the purchase price includes personal prop-erty not subject to tax under FIRPTA, a state-ment listing each item of personal property transferred and the FMV attributable to each item

Practitioner NoteApplication Costs

The cost of preparing and filing an application for a withholding certificate can be significant� The transferor should consider the required withholding amount, whether the disposition is occurring early in the year, and the availability of supporting documentation� The transferor must submit evidence of his or her basis with an application for a withholding certificate� On the contrary, unless requested on examination, the foreign transferor is not required to submit evi-dence of basis with Form 1040-NR�


542 ISSUE 2: DELINQUENT FBAR FILINGS/STREAMLINED OFFSHORE FILINGS

Cross-ReferenceFBAR Requirements

The Foreign Account Tax Compliance Act (FATCA), Pub� L� No� 114-147, and the Bank Secrecy Act (BSA), Pub� L� No� 91-508, require certain US per-sons who have a financial interest in or signature authority over a foreign financial account to report the account annually to the Department of Treasury� See the “Foreign Income Issues” chapter in the 2014 National Income Tax Work-book for information about the calculation of the reporting threshold, how to determine the exchange rate, the definition of a foreign finan-cial account, and a discussion of when someone has a financial interest in a foreign financial account or signature authority over the account�

Filing ProcedureAll FBARs must be filed electronically at the Financial Crimes Enforcement Network (Fin-CEN) through the Bank Secrecy Act (BSA) E-filing System [https://bsaefiling.fincen.treas.gov/main.html]. If the taxpayer is unable to file electronically, he or she should contact FinCEN’s Regulatory Helpline to determine possible filing alternatives [800.949.2732 or 703.905.3975 (if calling outside the United States)].

Practitioner NoteSoftware

Many tax preparation software programs have the capacity to electronically file FBARs, which removes the need to register for an online filing account at FinCEN�

The first page of a delinquently filed FBAR requires a disclosure of the reason for late filing. The taxpayer has the following choices:

■■ Forgot to file■■ Did not know that I had to file

ISSUE 2: DELINQUENT FBAR FILINGS AND STREAMLINED OFFSHORE FILING PROCEDURES This section explains programs for taxpayers to comply with delinquent foreign filings�

Several voluntary disclosure programs and streamlined filing procedures offered lower penalties and an opportunity to avoid criminal prosecution for taxpayers who became compli-ant with foreign financial reporting and payment obligations. The Offshore Voluntary Disclosure Program (OVDP) for willful offenders terminated on September 28, 2018. It was replaced with new stricter rules and procedures. However, the streamlined offshore filing procedures continue for nonwillful offenders.

This section explains the filing procedures for a delinquent Report of Foreign Bank and Finan-cial Accounts (FBAR) and international informa-tion returns. It then discusses the streamlined offshore filing procedures.

Delinquent FBAR Submission Procedures

Taxpayers who do not need to use the stream-lined offshore filing procedures (discussed later) to file delinquent or amended FBARs and report and pay additional tax can file delinquent FBARs under the submission procedures described in this section. The taxpayer must have prop-erly reported all income from foreign financial accounts on a US tax return and paid all tax on that income. If the taxpayer did not report and pay tax, he or she should consider filing under the streamlined offshore filing procedures. The tax-payer must not be under an IRS civil or criminal examination, and the IRS must not have already contacted the taxpayer about the delinquent FBARs.


Delinquent International Information Return Submission Procedures 543

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Practitioner NoteQuiet Disclosure

A quiet disclosure is filing a delinquent return or reports without following the delinquent sub-mission procedures� Taxpayers filing quiet disclo-sures will have no penalty protection�

Delinquent International Information Return Submission Procedures

Taxpayers who do not need to use the stream-lined offshore filing procedures to file delinquent or amended international tax returns and report and pay additional tax should file any delinquent international information returns under the sub-mission procedures described in this section. The taxpayer must have reasonable cause for not timely filing the information return.

If the taxpayer did not report and pay tax, he or she should consider filing under the stream-lined offshore filing procedures. In addition, the taxpayer must not be under a civil or criminal examination by the IRS, and the IRS must not have already contacted the taxpayer about the delinquent information returns.

Filing ProcedureOther than Forms 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, all delinquent international information returns must be attached to an amended tax return and filed according to the applicable instructions for the amended return. All delinquent Forms 3520 and 3520-A must be filed according to the applicable instructions for those forms.

The taxpayer must attach a reasonable cause statement (discussed later) to each delin-quent information return. Delinquent informa-tion returns filed with amended tax returns are not automatically subject to audit but may be selected for examination under the regular IRS audit selection process.

■■ Thought account balance was below report-ing threshold

■■ Did not know my account qualifies as foreign

■■ Account statement not received in time■■ Account statement lost (replacement requested)

■■ Late receiving missing required account information

■■ Unable to obtain joint spouse signature in time

■■ Unable to access BSA E-Filing System■■ Other (please provide explanation below)

Practitioner NoteAdditional Statement

The IRS instructions for delinquent FBAR submis-sion procedures direct the taxpayer to include a statement explaining why the taxpayer is filing the FBARs late� However, it is unclear how to file a statement with the electronic form� Choosing a reason for late filing may fulfill the requirement to provide a statement� However, if the taxpayer chooses the “other” reason, he or she should include a more specific explanation using the text box provided�

PenaltiesThe IRS will not impose a penalty for late filing if the taxpayer complies with the delinquent FBAR submission procedures. Late-filed FBARs are not automatically subject to audit but may be selected for examination through the regular audit pro-cesses that applies to other tax or information returns.

The penalty for a nonwillful failure to file delinquent FBARs is limited to $10,000 per year, regardless of the number of unreported accounts. The total penalty for nonwillful failures to file is also limited to 50% of the highest aggregate bal-ance of all unreported accounts for the years under examination.



1. They are a US resident.2. They previously filed a US tax return (if

required) for each of the most recent 3 years for which the US tax return due date or extended due date has passed.

3. They failed to report gross income from a for-eign financial asset and pay tax as required by US law and may have failed to file FBARs and/or one or more international informa-tion returns.

4. The filing and disclosure failures were from nonwillful conduct.

5. They are not under any IRS examination.

Practitioner NoteTimely Filing

Under the domestic program, even if a taxpayer’s failure to file was nonwillful, if he or she did not timely file original tax returns in the past 3 years, he or she is not eligible to use the streamlined procedures�

Filing ProceduresUS taxpayers who are eligible to use the stream-lined domestic offshore filing procedures must do the following:

1. File 3 years of amended tax returns report-ing all previously unreported income of any type. Include all missing international infor-mation returns. For this filing process only, Forms 3520 and 3520-A, if required, must be included with the amended tax returns and not filed separately.

2. Include at the top of the first page of each amended tax return, and at the top of each information return included as part of the amended tax return, the words (written in red) “Streamlined Domestic Offshore.”

3. Prepare and electronically file original or amended FBARs for the past 6 years to report previously undisclosed foreign financial accounts. For the reason for late filing, select the “Other” box and enter “Streamlined Fil-ing Compliance Procedures.”

Practitioner NoteRequired Returns

Required international reports may also include Form 8938, Statement of Specified Foreign Financial Assets; Form 5471, Information Return of U�S� Persons With Respect to Certain Foreign Corporations; or Form 5472, Information Return of a 25% Foreign-Owned U�S� Corporation or a Foreign Corporation Engaged in a U�S� Trade or Business�

Reasonable Cause StatementThe reasonable cause statement must contain facts and circumstances that establish the exis-tence of a reasonable cause for the failure to timely file the information returns. The taxpayer must also certify that any entity for which the infor-mation returns are being filed was not engaged in tax evasion. If the taxpayer does not attach a reasonable cause statement to each delinquent information return, the IRS will assess penalties according to its standard procedures.

Reasonable cause may be defined as the responsibility to exercise ordinary business care and prudence in determining a filing obligation and other requirements. It is not reasonable or prudent for taxpayers to have no knowledge of, or to solely rely on others for, the tax treatment of international transactions [I.R.M. § 20.1.9.1.1].

Streamlined Domestic Offshore Filing Procedures

The streamlined domestic offshore filing proce-dures are for nonforeign residents who want to comply with foreign income, financial asset, and account reporting. A taxpayer who is eligible to use the streamlined domestic offshore procedures and who complies with all of the requirements will be subject to only the Title 26 miscellaneous offshore penalty (discussed later) and will not be subject to accuracy-related penalties, information return penalties, or FBAR penalties.

Individual taxpayers, including estates of deceased individuals, qualify if they meet the fol-lowing five conditions:


Streamlined Domestic Offshore Filing Procedures 545

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Title 26 PenaltyThe Title 26 miscellaneous offshore penalty for US residents is 5% of the taxpayer’s highest aggregate value of undisclosed foreign assets in the covered tax return period and the covered FBAR period. Foreign financial assets are subject to this 5% penalty if one or more of the following applies:

1. The asset should have been, but was not, reported on an FBAR.

2. The asset should have been, but was not, reported on Form 8938.

3. The asset was reported, but the gross income from the asset was not properly reported.

Foreign financial assets that are subject to the penalty include the following:

■■ Financial accounts held at foreign financial institutions

■■ Financial accounts held at a foreign branch of a US institution

■■ Foreign stock or securities not held in a bro-kerage account

■■ Foreign mutual funds, hedge funds, and pri-vate equity funds

Canadian registered retirement savings plans are not subject to the penalty base because most US taxpayers are treated as having elected to defer US income tax on undistributed income earned in a Canadian retirement account. The penalty does not apply to foreign financial accounts in which the taxpayer has only signature authority.

Practitioner NoteCo-Owners

Co-owners are liable for the 5% penalty only on their individual portion of the highest aggregate balance in the account� However, the burden is on the taxpayer to demonstrate that he or she has less than full ownership�

4. Submit a comprehensive narrative statement that includes specific facts and explains why the taxpayer failed to report all income, pay all tax, and submit all required information returns, including FBARs.

5. Sign and submit Form 14654, Certifica-tion by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures, which certifies that the taxpayer is eligible for the streamlined domestic offshore procedures; all required FBARs have now been filed; the failure to report all income, pay all tax, and submit all required informa-tion returns, including FBARs, resulted from nonwillful conduct; and the miscellaneous offshore penalty amount is accurate.

6. Attach a copy of the completed Form 14654 behind page 2 of each of the amended tax returns.

7. Send, in paper form, the Form 14654, full payment of all tax due and the penalty, and all amended returns and supporting sched-ules to:

Internal Revenue Service 3651 South I-H 35, Stop 6063 AUSC Attn: Streamlined Domestic Offshore Austin, TX 78741

Practitioner NoteForm 2848

The tax practitioner should also submit Form 2848, Power of Attorney and Declaration of Rep-resentative� The tax forms listed on Form 2848 should include all the submitted forms�

NonwillfulGenerally, nonwillful conduct is conduct that is due to negligence, inadvertence, or mistake; or conduct that is the result of a good-faith misun-derstanding of the requirements of the law. A taxpayer who understands that there are foreign filing requirements, but deliberately avoids learn-ing about or inquiring about them, may have acted willfully. The streamlined procedures are not designed to protect deliberate ignorance or conscious avoidance.



Nonresidency RequirementUS citizens or lawful permanent residents meet the nonresidency requirements if in any one or more of the most recent 3 years for which the US tax return due date, including extensions, has passed; the individual did not have a US abode; and the individual was physically outside the United States for at least 330 full days. A taxpayer can have a temporary presence in the United States and maintain a dwelling in the United States without having a US abode. For joint fil-ers, both spouses must meet the nonresidency requirements.

Taxpayers who are not US citizens or per-manent residents meet the nonresidency require-ments if in any one or more of the most recent 3 years for which the US tax return due date, including extensions, has passed, the individual did not meet the substantial presence test [see I.R.C. § 7701(b)(3)].

Filing ProceduresThe filing procedures are like the domestic filing procedures. Taxpayers who are eligible to use the streamlined foreign offshore filing procedures must file Form 14653, Certification by US Person Residing Outside of the United States for Stream-lined Foreign Offshore Procedures.

Streamlined Foreign Offshore Filing Procedures

The streamlined foreign offshore filing proce-dures allow nonresident US taxpayers to comply with their US tax filing obligations. A taxpayer who is eligible to use the streamlined foreign off-shore procedures and who complies with all the program requirements will not be subject to fail-ure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties.

The procedures are like the domestic proce-dures (discussed earlier), with the following main differences:

1. The procedures are for nonresidents.2. There is no Title 26 penalty.3. A taxpayer can use the procedures even if he

or she has not filed US tax returns.

Individual taxpayers, including estates of deceased individuals, qualify if they meet the fol-lowing four conditions:

1. They meet the nonresidency requirements (discussed later).

2. They have failed to report gross income from a foreign financial asset and pay tax as required by US law and may have failed to file FBARs and/or one or more international information returns.

3. The filing and disclosure failures were from nonwillful conduct.

4. They are not under any IRS examination.


Filing Procedures 547

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related to that nonresident alien individual or foreign estate

2. Gifts valued at more than $16,076 for 2018 and $16,388 for 2019 (adjusted annually for inflation) from foreign corporations or for-eign partnerships, including from foreign persons related to the foreign corporations or foreign partnerships

Aggregation RulesIf a US person receives multiple gifts or multiple payments of a bequest during any one calendar year from the same nonresident alien individ-ual or same foreign estate, the US person must combine the gifts and bequests to determine if the reporting threshold has been met. Gifts from related foreign parties in the same calendar year must be aggregated for reporting purposes.

Related Foreign PartiesRelated foreign parties include, but are not lim-ited to, members of the same family (brothers, sisters, half-brothers, half-sisters, spouses, ances-tors, lineal descendants, and the spouses of any of these) or corporations in which the family owns, directly or indirectly, more than 50% in value of the outstanding stock. Also, if the US recipi-ent person knows, or has reason to know, that a donor is acting as a nominee or intermediary for another donor, then those gifts must be aggre-gated for purposes of the disclosure threshold.

Filing Procedures

US persons report gifts and bequests from a for-eign person by completing the identifying infor-mation on page 1 of Form 3520 and Part IV on page 6 of Form 3520. The US person must report the date of each gift or bequest, an adequate description of the property received, and the FMV of each gift or bequest.

ISSUE 3: GIFTS OR BEQUESTS FROM A FOREIGN PERSON A taxpayer may have to report foreign gifts or bequests�

US persons use Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, to disclose own-ership in a foreign trust and to report transactions with a foreign trust. Form 3520 is also used to report the receipt of certain large gifts or bequests from foreign persons. Form 3520 is an informa-tion return only, not a tax return. The receipt of a gift from a foreign person or a bequest from a foreign decedent is not subject to US income tax. However, there are large penalties for failure to timely file Form 3520.

Foreign Gift or Bequest

A US resident or citizen, including a US citi-zen residing abroad, must report certain large gifts and bequests from a foreign person [I.R.C. § 6039F]. The taxpayer must file Form 3520 if he or she received (directly or indirectly) a foreign gift or bequest in excess of a threshold amount (discussed later). A foreign gift or bequest is

■■ money or other property that a US person receives from a foreign person or decedent, and

■■ treated as a gift or bequest and is excluded from gross income.

A foreign person is a nonresident alien indi-vidual, or a foreign corporation, partnership, or estate. Gifts from foreign trusts are subject to dif-ferent rules than gifts from foreign persons and must be reported as foreign trust distributions in Part III of Form 3520.

A gift to a US person does not include amounts paid for qualified tuition or medical pay-ments made on behalf of a US person.

Reporting ThresholdA US person must file Form 3520 if, during any tax year, he or she receives the following:

1. Gifts or bequests valued at more than $100,000 from a nonresident alien individual or foreign estate, including all foreign persons


548 ISSUE 3: GIFTS OR BEQUESTS FROM A FOREIGN PERSON

Penalties

A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect. Generally, the initial penalty is $10,000 (or cer-tain other amounts for trust reporting). For failure to report foreign gifts, a penalty equal to 5% of the amount of such foreign gifts applies for each month for which the failure to report continues (not to exceed a total of 25%). No penalty will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect.

Practitioner NoteAdditional Information

A tax practitioner completing Form 3520 may also want to include the name of the donor or decedent, the relationship of the donor to the donee, and the city and country in which the donor resides�

If the total of all gifts and bequests exceeds $100,000 USD, but no one gift or bequest exceeds $5,000, then the filer does not complete line 54 columns (a) through (c) for each gift or bequest. Instead, he or she must write on the first line of column (b) “no gifts or bequests exceed $5,000” and report the total of all gifts and bequests in column (c).

A US person reports gifts from foreign corpo-rations or foreign partnerships on line 55 of Form 3520. The US person must include the name, address, and US taxpayer identification number (if any) of each donor and the date, description, and FMV of the gift.

Generally, Form 3520 is due on April 15 of the year following the year in which the report-able gifts or bequests were received. For individu-als residing outside of the United States or Puerto Rico on April 15, or for individuals in active mili-tary or naval service outside of the US or Puerto Rico on April 15, the due date for Form 3520 is June 15. If the US person is granted an extension of time to file an income tax return, then the due date for Form 3520 is October 15.


Transition Tax 549

13In general, section 965 requires that, for the

last tax year beginning before January 1, 2018, any US shareholder of a specified foreign corpo-ration must include in income its pro rata share of the corporation’s accumulated post-1986 deferred foreign income.

Practitioner NoteEffective Date

The transition tax became effective for share-holders of foreign corporations as of the last tax year of specified foreign corporations beginning before January 1, 2018� Thus, a US shareholder in a calendar-year foreign corporation should have included the tax on a 2017 US income tax return� A shareholder in a fiscal-year foreign corpora-tion should have included the tax on a 2018 tax return�

Specified Foreign CorporationA specified foreign corporation is a CFC (any foreign corporation where more than 50% of the total combined voting power of all classes of stock is owned, or considered to be owned, by US shareholders on any day within a tax year). In addition, it includes any foreign corporation (other than a passive foreign investment com-pany) that has a shareholder that is a domestic US corporation.

US individuals and corporations are poten-tially subject to the transition tax if they own at least 10% of the stock in a specified foreign cor-poration. Generally, US shareholders who pre-viously filed Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, must pay tax under section 965. However, many shareholders who have not regu-larly filed Form 5471 may now be subject to the tax.

ISSUE 4: US SHAREHOLDERS OF FOREIGN CORPORATIONS New tax laws apply to US shareholders in foreign corporations�

The filing and disclosure obligations for US shareholders in foreign corporations depend on the shareholder’s ownership and the operations of the foreign corporation. This section provides a broad overview of requirements under the tran-sition tax and the global intangible low-taxed income (GILTI) tax.

Ownership

A US shareholder who owns, directly or indi-rectly, 10% or more of the voting stock in a foreign corporation will likely have a US filing requirement. US shareholders who own less than 10% of a foreign corporation generally do not have a filing requirement, but they still must include in gross income dividends received from any foreign corporations and gain from the sale of foreign corporate stock. If a US shareholder is required to pay foreign taxes, he or she may claim a foreign tax credit to offset US taxes levied on that same income.

If US-shareholder ownership in a foreign cor-poration exceeds 50%, then the foreign corpora-tion is a controlled foreign corporation (CFC). The US shareholders may have to pay US tax on the annual profit from passive income, even if it is not distributed.

Transition Tax

Newly revised I.R.C. § 965 significantly expands the scope of US taxation of earnings from foreign corporations. Previously, US shareholders could defer US taxes on net income by keeping the money in the foreign corporation. Section 965 requires US shareholders to pay a transition tax on untaxed foreign earnings of specified foreign corporations as if those earnings had been repa-triated to the US.


550 ISSUE 4: US SHAREHOLDERS OF FOREIGN CORPORATIONS

Corporate ShareholdersA US corporation (but not an individual or pass-through entity) can generally deduct 50% of the GILTI. Thus, its GILTI tax is 10.5%, or one-half the 21% corporate tax rate. In addition, the US corporate shareholder can claim a foreign tax credit for 80% of foreign taxes paid or accrued on GILTI. In general, if the foreign tax rate is zero, the effective US tax rate on GILTI will be 10.5%, but if the foreign tax rate is 13.125% or higher, there will not be any GILTI tax after application of the foreign tax credit.

Noncorporate ShareholdersUS individual and noncorporate shareholders of a CFC must include GILTI in their income, but they are not entitled to the 50% deduction. Indi-viduals pay tax at a maximum 40.8% (inclusive of net investment income tax). Also, an individual taxpayer cannot claim a foreign tax credit for taxes paid at the corporate level.

Section 962 ElectionAs discussed earlier, a US individual shareholder of a CFC can make a section 962 election to be treated as a corporate taxpayer. The shareholder who makes the section 962 election may benefit from the lower corporate tax rates and the foreign tax credit.

However, when the CFC pays a dividend to the individual shareholder, the dividend is likely taxable income. If the foreign country and the United States have a comprehensive tax treaty, the individual shareholder taxpayer should be able to treat the dividend as a qualified dividend.

Planning PointerTransfer to C Corporation

If instead of making the section 962 election, a US individual taxpayer holds his or her CFC stock in a US C corporation, the taxpayer will be eli-gible for the 50% deduction� Thus, a better long-term strategy may be to own the CFC through a US C corporation�

Transition Tax RatesCorporations are subject to a 15.5% transition tax on accumulated earnings and profits (E&P) related to cash assets and an 8% tax on E&P related to other assets. Individuals in the highest tax bracket are subject to a 17.5% transition tax on E&P related to cash assets and a 9.1% tax on E&P related to noncash assets. These tax rates exclude any applicable net investment income tax.

Shareholders who are required to pay the transition tax can elect to pay the tax in eight annual installments, as follows:

■■ 8% of the tax in each of the first 5 years■■ 15% of the tax in year 6■■ 20% of the tax in year 7 ■■ 25% of the tax in year 8

For most individual taxpayers who missed the April 18, 2018, deadline for making the first of the eight annual installment payments, the IRS will waive the late-payment penalty if the install-ment was paid in full by April 15, 2019.

Section 962 ElectionAn individual taxpayer who is subject to the tran-sition tax may elect to be treated as a corporate shareholder for the purposes of paying the tax. The election may make the taxpayer eligible for a lower tax rate, especially for individual share-holders in a fiscal-year foreign corporation who benefit from the lower 2018 corporate tax rates. In addition, the shareholder may receive an offset for corporate foreign taxes paid.

GILTI Tax

The I.R.C. § 951A global intangible low-taxed income (GILTI) tax is generally an annual exten-sion of the one-time transition tax. It is intended to discourage taxpayers from shifting income from intangible assets to low- or no-tax jurisdic-tions. GILTI is the total active income earned by a CFC that exceeds 10% of the CFC’s depreciable tangible property. Like the transaction tax, the GILTI tax applies even if the corporation makes no distributions.


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