The uncompensated use of foreign trust property by a U.S. Grantor, a U.S. Beneficiary, or a U.S. Person related to either of them is treated as a distribution by the trust for non-grantor trust income tax purposes (which also includes the loan of cash or marketable securities by a foreign trust or the use of any other property of the trust).
The distribution treatment of foreign trust transaction has been expanded to include the uncompensated use of property by certain U.S. Persons. The treatment of foreign trusts as having U.S. beneficiaries for grantor trust purposes has been expanded to include loans of cash or marketable securities or the use of any other trust property to or by a U.S. Person.
If a foreign trust permits the use of any trust property by a U.S. Grantor, a U.S. Beneficiary, or any U.S. Person related to either of them, the fair market value of the use of such property is treated as a distribution by the trust to the Grantor or Beneficiary (IRC §643(i)(1), as amended by the 2010 HIRE Act).
This treatment does not apply to the extent that the trust is paid the fair market value of such use within a reasonable time (IRC §643(i)(2)(E), as added the 2010 HIRE Act). If distribution treatment does apply to the use of trust property, the subsequent return of such property is disregarded for federal tax purposes (IRC §643(i)(3), as amended by the 2010 HIRE Act).
For purposes of treating a foreign trust as a grantor trust, there is a rebuttable presumption that the trust has a U.S. beneficiary if a U.S. Person transfers property to the trust. An amount is treated as accumulated for a U.S. Person even if that person has a contingent interest in the trust.
A foreign trust is treated as having a U.S. beneficiary if any person has discretion to make trust distributions, (unless none of the recipients are U.S. Persons). An amount will be treated as accumulated for the benefit of a U.S. Person even if that person’s interest in the trust is contingent on a future event (IRC §679(c)(1) as amended by the 2010 HIRE Act).
If any person has the discretion (by authority given in the trust agreement, by a power of appointment or otherwise, of making a distribution from the trust to or for the benefit of any person), the trust will be treated as having a beneficiary who is a U.S. Person, unless the trust terms specifically identify the class of person to whom such distribution may be made and none of those persons are U.S. Persons during the tax year (IRC §679(c)(4) as added by the 2010 HIRE Act).
If any U.S. Person who directly or indirectly transfers property to the trust is directly or indirectly involved in any agreement or understanding that may result in trust income or corpus being paid or accumulated to or for the benefit of a U.S. Person, that agreement or understanding will be treated as a term of the trust (IRC §679(c)(5) as added by the 2010 HIRE Act). The agreement or understanding may be written, oral or otherwise.
The provision creating a rebuttable presumption allowing the IRS to treat a foreign trust as having a U.S. beneficiary if a U.S. person directly or indirectly transfers property to the trust applies to transfers of property after March 18, 2010. (Act Section 532(b) 2010 HIRE Act.)
U.S. shareholders of passive foreign investment companies (PFICs) must file an annual information return containing information required by the IRS.
A U.S. Person who is a PFIC shareholder must file IRS Form 8621, Return by a Shareholder of a Passive Foreign Investment Company or Qualifying Electing Fund, for each tax year in which that person:
1. Recognizes gain on a direct or indirect disposition of PFIC stock.
2. Receives certain direct or indirect distributions from a PFIC.
3. Makes a reportable election.
Under IRC §1298, a U.S. Person who is a PFIC shareholder must file an annual report containing information required by the IRS. Since a PFIC shareholder only reports information required by the IRS, Code §1298(f) does not require any reporting until the IRS issues guidance (this provision is contingent upon IRS instructions).
In addition to the Code §1298(f) an individual who is a PFIC shareholder can also be required to disclose annual information under new Code §6038(D) (i.e., accounts in excess of $50,000).
IRC §1298(f) applies to all U.S. Persons. In contrast, only individuals are subject to IRC §6038(D) (unless the IRS issues guidance requiring annual information disclosure for domestic entities).
Under the new law, the statute of limitations is extended to six years if there is an omission of gross income in excess of $5,000 and the omitted gross income is attributable to a foreign financial asset.
Taxes are generally required to be assessed within three years after a Taxpayer’s return was filed, whether or not it was timely filed. A special rule extends the three year limitation period in the case where there is a substantial omission of income.
If a Taxpayer omits substantial income on a return, any tax with respect to that return may be assessed and collected within six years of the date on which the return was filed.
In the case of income taxes, there is a substantial omission of income if the Taxpayer omits from gross income an amount that was properly includible in gross income and that is in excess of 25% of the amount stated on the return.
The state of limitations period will be suspended if the Taxpayer failed to timely provide information with respect to foreign financial assets required to be reported. The limitation period will not begin to run until the information required has been furnished to the IRS.
The new six-year statute of limitations applies not only to returns filed after March 18, 2010 on which the Taxpayer fails to report income in excess of $5,000 attributable to foreign financial assets, but also to returns filed on or before the date for which the statute of limitations is still open on March 18, 2010 (Act §513(d) of the HIRE Act [PL 111-147]).
For example, a 2006 tax return (filed in 2007), on which the Taxpayer failed to report more than $5,000 of income attributable to a foreign financial asset and which is otherwise subject to the three-year limitations period, will be subject to the new six-year statute of limitations.
The HIRE Act gives the IRS assessment and collection remedies unavailable with respect to the FBAR penalty.
A 40% accuracy-related penalty is imposed for underpayment of tax attributable to transactions involving undisclosed foreign financial assets. Undisclosed foreign financial assets include foreign financial assets that are subject to information reporting but the required information was not provided by the Taxpayer.
The 40% accuracy-related penalty is imposed for underpayment of tax that is attributable to an undisclosed foreign financial asset understatement (IRC §6662(b)(7) and (j) as added by the HIRE Act 2010). An undisclosed foreign financial asset understatement for any tax year is the portion of the understatement for the year that is attributable to any transaction involving an undisclosed foreign financial asset.
In contrast to the FBAR penalty which is limited to collection through the U.S. Financial Management System (which collects non-tax debts for the government), the HIRE Act penalties give the IRS the ability to assess and collect these new penalties through its administrative powers (including tax levy and tax lien).
The new penalties under the HIRE Act are for the understatement of tax and impose a lesser burden of proof and threshold for imposition of the penalty than the willful FBAR penalty.
WASHINGTON (June 8, 2010) – Sen. Carl Levin, D-Mich., made the following statement today regarding the Swiss rejection of the UBS settlement:
“The U.S.-Swiss treaty that was rejected today by the Swiss lower house would have allowed UBS to provide the names and account information for U.S. clients suspected of opening Swiss accounts to evade U.S. taxes. Rejection of the treaty is an international embarrassment that can be laid at the feet of Swiss legislators who are willing to continue to allow their banks to facilitate U.S. tax evasion.
“It was two years ago, in July 2008, that the United States first issued a summons to UBS to get the names of an estimated 52,000 U.S. clients with hidden Swiss accounts that had not been reported to the IRS. The Swiss government intervened to block the summons and prevent disclosure of the names. After a year of delay, in August 2009, a settlement was reached in which the United States agreed to give up its right to all 52,000 names in exchange for getting prompt access to information on key accounts, estimated at 4,450 or less than ten percent of the total. Now the Swiss, despite multiple U.S. concessions and having strung out the UBS case for two years, have failed to live up to their end of the bargain.
“The United States should reject any further attempts by the Swiss to delay the UBS case. It is time to move forward with the summons in court and force UBS to provide the names and account information for all 52,000 suspected U.S. tax cheats.
“This travesty underscores the need for legislation that I’ve introduced which, among other measures, would empower the U.S. Treasury Secretary to take action against any foreign bank or jurisdiction that impedes U.S. tax enforcement by, for example, prohibiting U.S. banks from accepting wire transfers or honoring credit cards from the foreign bank facilitating U.S. tax evasion.”
U.S. Taxpayers who hold any interests in specified foreign financial assets during the tax year must attach their tax returns for the year certain information with respect to each asset if the aggregate value of all assets exceeds $50,000. An individual who fails to furnish the required information is subject to a penalty of $10,000. An additional penalty may apply if the failure continues for more than 90 days after a notification by the IRS to a maximum of $50,000. The penalty may be avoided if the Taxpayer shows a reasonable cause for the failure to comply.
The Joint Committee on Taxation, Technical Explanation of the Hiring Incentives to Restore Employment Act (JCX-4-10) clarifies that although the nature of the information required to be disclosed is similar to the information disclosed on an FBAR, it is not identical.
For example, a beneficiary of a foreign trust who is not within the scope of the FBAR reporting requirements because his interest in the trust is less than 50%, may still be required to disclose the interest with his tax return if the $50,000 value threshold is met. In addition, this provision is not intended as a substitute for compliance with the FBAR reporting requirements which remain unchanged.
For purposes of IRC Code §6038(D) as added by the HIRE Act, a specified foreign financial asset includes:
1. Any depository, custodial, or other financial account maintained by a foreign financial institution, and
2. Any of the following assets that are not held in an account maintained by a financial institution:
a. Any stock or security issued by a person other than a U.S. Person
b. Any financial instrument or contract held for investment that has an issuer or counterparty other than a U.S. Person, and
c. Any interest in a foreign entity (IRC §6038(D)(b) as added by the 2010 HIRE Act).
The information required to be disclosed with respect to any asset must include the maximum value of the asset during the tax year (IRC §6038(D)(c) as added by the 2010 HIRE Act).
For a financial account, the Taxpayer must disclose the name and address of the financial institution in which the account is maintained and the number of the account.
In the case of any stock or security, the disclosed information must include the name and address of the issuer and such other information as is necessary to identify the class or issue of which the stock or security is a part.
In the case of any instrument, contract, or interest, a Taxpayer must provide any information necessary to identify the instrument, contract, or interest along with the names and addresses of all issuers and counterparties with respect to the instrument, contract, or interest.
Under these rules, a U.S. Taxpayer is not required to disclose interests held in a custodial account with a U.S. financial institution. In addition, the U.S. Taxpayer is not required to identify separately any stock, security instrument, contract, or interest in a disclosed foreign financial account.
An individual who fails to furnish the required information with respect to any tax year at the prescribed time and in the prescribed manner is subject to a penalty of $10,000 (IRC §6038(D)(d) as added by the 2010 HIRE Act). If the failure to disclose the required information continues for more than 90 days after the day on which the notice was mailed (from the Secretary of Treasury), the individual is subject to an additional penalty of $10,000 for each 30-day period (or a fraction thereof) with the maximum penalty not to exceed $50,000.
In addition to the $10,000 penalty (up to $50,000) under IRC §6038(D) a 40% accuracy-related penalty is imposed on any understatement of tax attributable to a transaction involving an undisclosed foreign financial asset.
The statute of limitations for omission of gross income attributable to foreign financial assets (omission of gross income in excess of $5,000 attributable to a foreign financial asset), is extended to six years.
The IRC §6038(D) penalties are not imposed on any individual who can show that the failure is due to reasonable cause and not willful neglect. (IRC §6038D(g), as added by the 2010 HIRE Act.)
The information disclosure with respect to foreign financial assets supplements the FBAR reporting regime. The HIRE Act broadens reporting requirements and extends the rules to ownership of foreign assets such as foreign stocks, securities, interests in foreign companies not covered by the FBAR reporting. The threshold reporting requirement amount for FBARs ($10,000) is increased to $50,000. While the FBAR reporting covers those having signatory or other authority, the new reporting regime focuses on ownership.
The Foreign Account Tax Compliance Act (The “Act”) expands withholding rules and additional reporting requirements for foreign financial institutions and non-financial foreign entities.
Under U.S. tax law, a withholding agent must deduct or withhold a tax equal to 30% on any withholdable payment (e.g., interest, dividends, rents, salaries, wages, premiums, annuities, compensations, and other fixed or determinable annual or periodical gains, profits and income from sources within the United States) made to a foreign financial institution or to a non-financial foreign entity (unless specific reporting requirements are met).
For each U.S. account maintained by the foreign financial institution, the institution must provide identifying information for each account holder that is a specified U.S. Person or substantial U.S. owner, the account number, the account balance, and gross receipts and withdrawals from the account.
A non-financial foreign entity that is a beneficial owner of a withholdable payment must certify that it has no substantial U.S. owners or provide identifying information for each substantial U.S. owner.
Every person required to deduct or withhold any tax to enforce reporting on certain foreign accounts is liable for the tax and is indemnified against claims and demands of anyone for the amount of the payments. (IRC §1474(a), as added by the 2010 HIRE Act.)
In March 2010, the IRS suspended TD F 90-22.1 (FBAR) filing requirements for persons other than U.S. Citizens and domestic entities (including those “in and doing business in the U.S.”). (IRS Announcement: 2010-16)
On 8/7/09, IRS Notice 2009-62, extended the deadline for filing FBAR’s for 2008 (and prior years) for persons with signature authority (but no financial interest) in foreign financial accounts until June 30, 2010.
In March 2010, the IRS extended the 2008 FBAR filings due June 30, 2010 until June 30, 2011 (for FBAR filings due for 2010 and prior years) for “persons with signature authority” (but no financial interest) in foreign financial accounts, defined as including: “Those in which the assets are held in a commingled fund and the account owner holds an equity interest in the fund (including mutual funds). (IRS Announcement: 2010-23)
On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment (“HIRE”) Act (P.L. 111-147) (The “Act”) which included the Foreign Account Tax Compliance Act containing new foreign account tax compliance rules.
Under the Act, new reporting and disclosure requirements for foreign assets will be phased in between 2010 – 2013:
1. Foreign Institutional Reporting: Foreign Institutions have new reporting and withholding obligations for accounts held by U.S. Persons (generally effective after 12/31/12, commencing 1/1/13).
2. Foreign Financial Assets ($50,000): Individuals with an interest in a “Foreign Financial Asset” have new disclosure requirements. If foreign financial assets are valued in excess of $50,000, the U.S.
Taxpayer must attach certain information to their income tax returns for tax years beginning after March 18, 2010. (U.S. Taxpayers are not required to disclose interests that are held in a custodial account with a U.S. financial institution).
The penalty is substantial ($10,000, plus additional amounts for continued failures, up to a maximum of $50,000 for each applicable tax period). The penalty may be waived if the individual can establish that the failure was due to reasonable cause and not willful neglect.
3. 40% Penalty: A 40% accuracy-related penalty is imposed for underpayment of tax that is attributable to an undisclosed foreign financial asset understatement. Applicable assets are those subject to mandatory information reporting when the disclosure requirements were not met. The penalties are effective for tax years beginning after March 18, 2010.
4. 6 Year Statute of Limitations: Statute of limitations re: omission of income in connection with foreign assets: The statute of limitations for assessments of tax is extended to six (6) years if there is an omission of gross income in excess of $5,000 attributable to the foreign financial asset. The six year statute of limitations is effective for tax returns filed after March 18, 2010, as well as for any other tax return for which the assessment period has not yet expired as of March 18, 2010.
5. Passive Foreign Investment Companies: The Act imposes an information disclosure requirement on U.S. Persons who are PFIC shareholders.
A PFIC is any foreign corporation if:
a. 75% or more of the gross income of the corporation for the taxable year is passive income; or
b. The average percentage of assets held by such corporation during a taxable year which produce passive income or which are held for the production of passive income are at least 50%.
6. Foreign Trusts with U.S. Beneficiaries: The Act clarifies if a foreign trust is treated as having a U.S. Beneficiary, an amount accumulated is treated as accumulated for the U.S. Person’s benefit even if that Person’s trust interest is contingent. The Act clarifies that the discretion to identify beneficiaries may cause the trust to be treated as having a U.S. Beneficiary. This provision is effective after March 18, 2010.
7. Rebuttable Presumption/Foreign Trust – U.S. Beneficiary: The Act creates a rebuttable presumption that a foreign trust has a U.S. Beneficiary if a U.S. Person directly or indirectly transfers property to a foreign trust (unless the transferor provides satisfactory information to the contrary to the IRS). This provision is effective for property transfers after March 18, 2010.
8. Uncompensated Use of the Foreign Trust Property: The Act provides that the uncompensated use of the foreign trust property by a U.S. Grantor, a U.S. Beneficiary (or a U.S. Person, related to either of them), is treated as a distribution by the trust.
The use of the trust property is treated as a distribution to the extent of the fair market value of the property’s use to the U.S. Grantor/U.S. Beneficiary, unless the fair market value of that use is paid to the trust.
The loan of cash or marketable securities by a foreign trust, or the use of any other property of the trust, to or by any U.S. Person is also treated as paid or accumulated for the benefit of the U.S. Person. This provision applies to loans made and uses of property after March 18, 2010.
9. Reporting Requirements, U.S. Owners of Foreign Trusts: This provision requires any U.S. Person treated as the owner of any portion of a foreign trust to submit IRS-required information and insure that the trust files a return on its activities and provides such information to its owners and distributees.
This new requirement imposed on U.S. Persons treated as owners is in addition to the current requirement that such U.S. Persons are responsible for insuring that the foreign trust complies with its own reporting obligations. This provision is effective for taxable years beginning after March 18, 2010.
10. Minimum Penalty re: Failure to Report Certain Foreign Trusts: This provision increases the minimum penalty for failure to provide timely and complete disclosure on foreign trusts to the greater of $10,000 or 35% of the amount that should have been reported.
In the case of failure to properly disclose by the U.S. Owner of a foreign trust of the year-end value, the minimum penalty would be the greater of $10,000 or 5% of the amount that should have been reported.
This provision is effective for notices and returns required to be filed after December 31, 2009.