IRS updates list of treaties qualifying foreign dividends for preferential rates

Notice 2011-64, 2011-37 IRB

A new notice updates the list of U.S. tax treaties that meet requirements for dividends from foreign corporations to qualify for preferential rates. The notice also clarifies the requirements for treatment as a qualified foreign corporation.

Background. A noncorporate taxpayer's adjusted net capital gain is taxed at a maximum rate of 15% or, to the extent it would have been taxed at a rate below 25% if it had been ordinary income, at a maximum rate of 0%. (Code Sec. 1(h))

Adjusted net capital gain is net capital gain for the tax year (i.e., the excess of net long-term capital gains over net short-term capital losses for a tax year):

• less the sum of specified types of long-term capital gain that are taxed at a maximum rate of 28% (gain on the sale of most collectibles and gain on the unexcluded part of Code Sec. 1202 small business stock) or 25% (unrecaptured section 1250 gain, i.e., gain attributable to real estate depreciation),
• plus qualified dividend income.

Qualified dividend income—generally, dividends received during the tax year from domestic corporations and “qualified foreign corporations,” subject to holding period requirements and specified exceptions—is effectively treated as adjusted net capital gain, and therefore taxed at the same rates that apply to adjusted net capital gain. (Code Sec. 1(h)(11))

Subject to certain exceptions, a qualified foreign corporation is any foreign corporation that is either (i) incorporated in a U.S. possession (Code Sec. 1(h)(11)(C)(i)(I)), or (ii) eligible for benefits of a comprehensive income tax treaty with the U.S. that IRS determines is satisfactory for purposes of this provision and that includes an exchange of information program (the “treaty test”). (Code Sec. 1(h)(11)(C)(i)(II)) A foreign corporation that does not satisfy either of these two tests is treated as a qualified foreign corporation with respect to any dividend paid by it if the stock on which the dividend is paid is readily tradable on an established securities market in the U.S. (Code Sec. 1(h)(11)(C)(ii))

A qualified foreign corporation does not include any foreign corporation that for its tax year in which the dividend was paid, or the preceding tax year, is a Code Sec. 1297 passive foreign investment company. (Code Sec. 1(h)(11)(C)(iii)) A dividend from a qualified foreign corporation is also subject to the other limitations in Code Sec. 1(h)(11). For example, a shareholder receiving a dividend from a qualified foreign corporation must satisfy the Code Sec. 1(h)(11)(B)(iii) holding period requirements.

Updated list. Notice 2011-64 updates the list to add two U.S. income tax treaties that entered into force after the publication of Notice 2006-101: the U.S. income tax treaties with Bulgaria (which entered into force on Dec. 15, 2008) and Malta (which entered into force on Nov. 23, 2010). (Notice 2011-64, Sec. 2)

Other requirements. Notice 2011-64 also clarifies that a foreign corporation must be eligible for benefits of one of the U.S. income tax treaties listed in the Appendix in order to be treated as a qualified foreign corporation under Code Sec. 1(h)(11)(C)(i) 's treaty test. Accordingly, the foreign corporation must be a resident under the relevant treaty and satisfy any other requirements of that treaty, including the requirements under any applicable limitation on benefits provision. For purposes of determining whether it satisfies these requirements, a foreign corporation is treated as though it were claiming treaty benefits, even if it does not derive income from sources within the U.S. (Notice 2011-64, Sec. 3)

Effective date. Notice 2011-64 is effective with respect to: (1) Bulgaria for dividends paid on or after Dec. 15, 2008; (2) Malta for dividends paid on or after Nov. 23, 2010; (3) Bangladesh for dividends paid on or after Aug. 7, 2006; (4) Barbados for dividends paid after Dec. 19, 2004; (5) Sri Lanka for dividends paid on or after July 12, 2004; and (6) all other U.S. income tax treaties listed in the appendix for tax years beginning after Dec. 31, 2002. (Notice 2011-64, Sec. 4)

Tax Havens in Zug Switzerland and Ireland

The popular news show 60 MINUTES has done an excellent piece on the tax havens being used by large US Corporations to shelter untold amounts of income from US high tax rates. The two places mentioned are Zug, Switzerland and Ireland.  Read the article here.

The tax rates they are paying in these two locations are about 16-18 percent.

Individual entrepreneurs  may be able to do the same (assuming they structure their business correctly) if they have an operating business that sells goods or services and those sales are to international customers. It will not work with respect to some types of income if the foreign corporation put in place has certain types of income call Subpart F income.

FBAR filing rules and Chart of Potential Civil and Criminal Penalties for non filing or late filing

Possible Civil and Criminal Penalties that can be imposed by the IRS for failure to file FBAR (TDF 90-22.1) forms or filing those forms late as well as other rules concerning that form are can read at the link to the following IRS webpage:  FBAR Rules, Civil and Criminal Penalties

The penalties may be reduced if you enter the 2011 IRS Offshore Voluntary Disclosure Program prior to its deadline of 8/31/11. 

1,470 Millionaires Didn’t Pay Income Taxes in 2009

The IRS data showed there were 235,413 taxpayers making $1 million or more in 2009, of whom 1,470 paid no federal income taxes. Among the possible reasons, according to ABC News, could be write-offs for charitable deductions, investments in tax-exempt state and municipal bonds, or foreign tax credits.

In contrast, the average income for taxpayers fell that year in the wake of the financial crisis by $3,516 to $54,283, a drop of approximately 6.1 percent, according to the Huffington Post.

IRS Reminds Taxpayers that the Aug. 31 Deadline Is Fast Approaching for the Second Special Voluntary Disclosure Initiative of Offshore Accounts

WASHINGTON — U.S. taxpayers hiding income in undisclosed offshore accounts are running out of time to take advantage of a soon-to-expire opportunity to come forward and get their taxes current with the Internal Revenue Service.

The IRS today reminded taxpayers that the 2011 Offshore Voluntary Disclosure Initiative (OVDI) will expire on Aug. 31, 2011. Taxpayers who come forward voluntarily get a better deal than those who wait for the IRS to find their undisclosed accounts and income. New foreign account reporting requirements are being phased in over the next few years, making it ever tougher to hide income offshore. As importantly, the IRS continues its focus on banks and bankers worldwide that assist U.S. taxpayers with hiding assets overseas. 

“The time has come to get back into compliance with the U.S. tax system, because the risks of hiding money offshore keeps going up,” said IRS Commissioner Doug Shulman. “Our goal is to get people back into the system. The second voluntary initiative gives people a fair way to resolve their tax problems.”

The 2011 OVDI was announced on Feb. 8, 2011, and follows the 2009 Offshore Disclosure Program (OVDP).  The 2011 initiative offers clear benefits to encourage taxpayers to come forward rather than risk detection by the IRS. Taxpayers hiding assets offshore who do not come forward will face far higher penalties along with potential criminal charges.

For the 2011 initiative, there is a new penalty framework that requires individuals to pay a penalty of 25 percent of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period. Some taxpayers will be eligible for 5 or 12.5 percent penalties in certain narrow circumstances.

Participants also must pay back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties. All original and amended tax returns must be filed by the deadline.

The IRS has made available the 2011 OVDI information in eight foreign languages for those taxpayers with undisclosed offshore accounts. The agency took this step to reach taxpayers whose primary language may not be English. These translations include the following languages: Chinese (Traditional andSimplified), Farsi, German, Hindi, Korean, Russian, Spanish and Vietnamese. 

The IRS decision to open a second special disclosure initiative was based on the success of the first program and many more taxpayers coming forward after the program closed on Oct. 15, 2009. The first special disclosure initiative program closed with about 15,000 voluntary disclosures regarding accounts at banks in more than 60 countries. Many taxpayers came in after the first program closed.  These taxpayers were deemed eligible to take advantage of the special provisions of the second initiative.

Further details about this initiative are provided in a series of questions and answers.

Tax Frauds You Should Be Wary About

Here are five year-round scams every taxpayer should know about.

1. Hiding Income Offshore The IRS aggressively pursues taxpayers involved in abusive offshore transactions and the promoters who facilitate or enable these schemes. Taxpayers have tried to avoid or evade U.S. income tax by hiding income in offshore banks and brokerage accounts, or by using offshore debit cards, credit cards, wire transfers, foreign trusts, employee-leasing schemes, private annuities or life insurance plans.

In February, the IRS announced a second voluntary disclosure initiative to bring offshore money back into the U.S. tax system. The new voluntary disclosure initiative will be available through Aug. 31, 2011.
2. Phishing Scam artists use phishing to trick unsuspecting victims into revealing personal or financial information. Scams take the form of e-mails, phony websites or phone calls that offer a fictitious refund or threaten an audit or investigation to lure victims into revealing personal information. The IRS never initiates unsolicited e-mail contact with taxpayers about their tax issues. Phishers use the information to steal the victim’s identity, access their bank accounts and credit cards or apply for loans. Please forward suspicious scams to the IRS at phishing@irs.gov. You can also visitwww.irs.gov, keyword phishing, for additional information.
3. Return Preparer Fraud Dishonest tax return preparers cause trouble for taxpayers by skimming a portion of the client’s refund or charging inflated fees for tax preparation. They attract new clients by promising refunds that are too good to be true. To increase confidence in the tax system, the IRS now requires all paid return preparers to register with the IRS, pass competency tests and attend continuing education. Taxpayers can report suspected return preparer fraud to the IRS on Form 3949-A, Information Referral.
4. Filing False or Misleading Forms The IRS continues to see false or fraudulent tax returns filed to obtain improper tax refunds.
Scammers often use information from family or friends to file false or fraudulent returns, so beware of requests for such data. Don’t claim deductions or credits you are not entitled to and never willingly allow others to use your information to file false returns. If you participate in such schemes, you could be liable for financial penalties or even face criminal prosecution. The IRS takes refund fraud seriously, has programs to aggressively combat it and stops the vast majority of incorrect refunds.
5. Frivolous Arguments Promoters of frivolous schemes encourage people to make unreasonable and outlandish claims to avoid paying the taxes they owe. If a scheme seems too good to be true, it probably is. The IRS has a list of frivolous legal positions that taxpayers should avoid on www.irs.gov. These arguments are false and have been thrown out of court repeatedly.

For the full list of 2011 Dirty Dozen tax scams or to find out how to report suspected tax fraud, visit www.irs.gov.

California's New Voluntary Compliance Initiative Includes Unreported Foreign Income

California's Voluntary Compliance Initiative 2 will run from August 1, 2011 through October 31, 2011. It provides (for those who file amended returns and participate) for reduced penalties and can avoid criminal action by California for those who have participated in abusive tax avoidance transactions or offshore financial arrangements.

What is an offshore financial arrangement? 

An offshore financial arrangement (OFA) is any transaction designed to avoid or evade California income or  franchise tax through the use of: (a) offshore payment cards, including credit, debit, or charge cards issued  by banks in foreign jurisdictions, or (b) foreign banks, financial institutions, corporations, partnerships, trusts, or other entity.  This would include interest, dividends, capital gains, rental income, etc. that were not reported on your California tax return solely because those items were located or occurred in a offshore countries.

What is an abusive tax avoidance transaction?

Abusive tax avoidance transaction (ATAT) means a:  

• Tax shelter as defined under Internal Revenue Code (IRC) Section 6662(d)(2)(C)

• Reportable transaction as defined under IRC Section 6707A(c)(1) that is not adequately disclosed in

accordance with IRC Section 6664(d)(2)(A),

• Listed transaction as defined under IRC Section 6707A(c)(2),

• Gross misstatement within the meaning of IRC Section 6404(g)(2)(D), or

• Transaction to which the noneconomic substance transaction (NEST) penalty applies under Revenue and

Taxation Code (RTC) Section 19774.

Read More Here.  Let us help you amend your current and past returns and enter the program while there is still time to take advantage of its benefits.  

Attorney-Client Privilege - CPAs, Enrolled Agents, and Tax Preparers Do Not Have It

When you are discussing your personal tax situation (and problems) with your CPA, Enrolled Agent or tax preparer, everything you say to them and all of their files and notes on your conversations with them, must be revealed to the IRS if subpoenaed or requested in a legal action.  They can also be forced to testify on everything you said during meetings with the preparer or on the phone.

When you consult with a licensed attorney, everything you tell them, including notes in their files, and in most situations the tax research and their advice and recommendations to you is privileged and private. The attorney cannot be forced to reveal any of those items if subpoenaed or questioned by the IRS or in a legal matter.

You need to keep this Attorney-client privilege in mind when consulting a tax professional concerning entering any of the IRS Voluntary Disclosure Programs and seeking counsel on past unfiled tax returns or tax problems (both civil and criminal). Discussing the situation with anyone other than an attorney could later be used against you.

It is often best when their are potential tax problems or possible criminal consequences to have an Attorney actually hire the accountant to prepare any required returns in order to keep as much as information as legally possible from being subject to discovery.  Documents that are connected with the actual preparation or information which is on your tax return (or information which should be on your return)  cannot be kept confidential.

IRS Issues another draft version of Form 8938 for foreign financial asset holders

 Form 8938, “Statement of Specified Foreign Financial Assets”

The IRS has issued another new draft Form 8938, “Statement of Specified Foreign Financial Assets,” which is available on IRS's website. Form 8938 will be used by individuals to report an interest in one or more specified foreign financial assets.

Background. For tax years beginning after Mar. 18, 2010, taxpayers with an interest in a “specified foreign financial asset” during the tax year must attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000. 

“Specified foreign financial assets” are: (1) depository or custodial accounts at foreign financial institutions, and (2) to the extent not held in an account at a financial institution, (a) stocks or securities issued by foreign persons, (b) any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and (c) any interest in a foreign entity. 

For most taxpayers on a Calendar year basis, this form will be due with their 2011 tax return.

The draft Form 8938 was released on June 22nd without instructions. However, the draft form references the instructions throughout, which indicates that they will likely be issued soon.

Part I of the draft form requires information about foreign deposit and custodial accounts, including the maximum value of any such account during the tax year. Part II has similar entries for “other foreign assets,” but notes that specified foreign financial assets that have been otherwise reported on Forms 3520, 3520-A, 5471, 8621, or 8865, do not have to be included on Form 8938. Part III asks for a summary of tax items attributable to the accounts and assets reported in Parts I and II, including associated items such as interest, dividends, and royalties. Part IV requires disclosure of the number of the filed forms referenced in Part II on which any foreign financial assets that were excepted from Part II were reported.

You  can be view the new draft  form on the IRS website at http://www.irs.gov/pub/irs-dft/f8938--dft.pdf. 

Foreign Bank and Financial Account Report (FBAR)(TDF 90-22.1) is due 6/30/11 and cannot be extended.

Form TDF 90-22.1 to report your foreign financial and bank accounts is due 6/30/11 and cannot be extended. There is a penalty of $10,000 or more for not filing this form or filing it late.  It is filed separately from your US tax return.

• The FBAR form and instructions can be downloaded here.
• The FBAR must be filed if the combined highest balances in your foreign bank accounts, pension accounts, stock brokerage accounts, etc. equal or exceed $10,000 at any time during 2010.
• If you have not filed this form in past years but are required to, the IRS can busject you to much greater penalties and criminal prosecution unless you enter the 2011 IRS Voluntary Offshore Disclosure Program which may reduce your penalties and stop possible criminal prosecution by its deadline 8/31/11.
• The IRS is currently securing lists of US depositors from foreign banks and financial institutions and will be checking in the future and imposing penalties if they discover you should have filed this form and did not do so.
• Failing to file this form has much more serious monetary and criminal consequences in most situations than failing to file your personal tax returns late.

Please contact us for a mini consultation if you wish a consultation protected by Attorney client privilege on your personal situation.  We have helped hundreds of expatriates catch up with their past unfiled returns and FBAR forms.