NEW LAW ENACTED ENFORCING AND BROADENING REPORTING OF FOREIGN ENTITIES, ASSETS, ETC

The President recently signed into law the “Hiring Incentives to Restore Employment Act of 2010” (the HIRE Act, P.L. 111-47 ). The HIRE Act includes a comprehensive set of measures to reduce offshore noncompliance by giving IRS new administrative tools to detect, deter and discourage offshore tax abuses, as well as a three-year delay (through 2020) of implementation of worldwide allocation of interest—the liberalized rule for allocating interest expense between U.S. sources and foreign sources for purposes of determining a taxpayer's foreign tax credit limitation. An overview of these provisions follows.


Increased disclosure of beneficial owners


Reporting on certain foreign bank accounts. The Act imposes a 30% withholding tax on certain income from U.S. financial assets held by a foreign institution unless the foreign financial institution agrees to disclose the identity of any U.S. individual with an account at the institution (or the institution's affiliates) and to annually report on the account balance, gross receipts and gross withdrawals/payments from such account. Foreign financial institutions would also be required to agree to disclose and report on foreign entities that have substantial U.S. owners. Congress expects that foreign financial institutions will comply with these disclosure and reporting requirements in order to avoid paying this withholding tax. These provisions are effective generally for payments made after 2012.
Reporting on owners of foreign corporations, foreign partnerships and foreign trusts. The Act requires foreign entities to provide withholding agents with the name, address and tax identification number of any U.S. individual that is a substantial owner of the foreign entity. Withholding agents are to report this information to the U.S. Treasury Department. The Act exempts publicly-held and certain other foreign corporations from these reporting requirements and provides the Treasury Department with the regulatory authority to exclude other recipients that pose a low risk of tax evasion. Any withholding agent making a withholdable payment to a foreign entity that does not comply with these disclosure and reporting requirements is required to withhold tax at a rate of 30%. These provisions are effective generally for payments made after 2012.


Extending bearer bond tax sanction to bearer bonds designed for foreign markets. Bearer bonds (i.e., bonds that do not have an official record of ownership) allow individuals seeking to evade taxes with the ability to invest anonymously. Recognizing the potential for U.S. individuals to take advantage of bearer bonds to avoid U.S. taxes, Congress took a number of steps in the 1980's to eliminate bearer bonds in the U.S. First, they prevented the U.S. government from issuing bearer bonds that would be marketed to U.S. investors. Second, they imposed sanctions on issuers of bearer bonds that could be purchased by U.S. investors. The Act extends many of these sanctions to bearer bonds that are marketed to foreign investors and prevents the U.S. government from issuing any bearer bonds. These provisions apply to debt obligations issued after Mar. 18, 2012.


Foreign financial asset reporting


Disclosure of information with respect to foreign financial assets. The new law requires individuals to report offshore accounts and other foreign financial assets with values of $50,000 or more on their tax returns. Individuals who fail to make the required disclosures are subject to a penalty of $10,000 for the tax year; an additional penalty can apply if Treasury notifies an individual by mail of the failure to disclose and the failure to disclose continues. These provisions apply for tax years beginning after Mar. 18, 2010. The act give the IRS a lot of discretion to define what exactly a "financial asset" might be. It is very possible their definition may be very broad and includes many assets not previously thought of as financial assets.


Penalties for underpayments attributable to undisclosed foreign financial assets. For tax years beginning after Mar. 18, 2010, the Act imposes a penalty equal to 40% of the amount of any understatement that is attributable to an undisclosed foreign financial asset (i.e., any foreign financial asset that a taxpayer is required to disclose and fails to disclose on an information return).


New 6-year limitations period. For returns filed after Mar. 18, 2010, as well as for any other return for which the assessment period has not yet expired as of Mar. 18, 2010, the Act imposes a new six-year limitations period for omissions of items from a tax return that exceed $5,000 and are attributable to one or more reportable foreign assets. The Act also clarifies that the statute of limitations does not begin to run until the taxpayer files the information return disclosing the taxpayer's reportable foreign assets.


Other disclosure provisions


New reporting rule for PFICs. Effective on Mar. 18, 2010, activities with respect to passive foreign investment companies (PFICs) are subject to a new reporting rule. Unless otherwise provided by IRS, each U.S. person who is a shareholder of a PFIC must file an annual information return containing such information as IRS may require. A person that meets this new reporting requirement could, however, also have to meet the new reporting rule requiring disclosure of information with respect to foreign financial assets (see above). It is anticipated that IRS will exercise its regulatory authority to avoid duplicative reporting. 

More on IRS Commissioners Position on Offshore Disclosure and International Enforcement

The Journal of Accountancy has just interviewed the IRS Commissioner. The following two questions addressed the IRS on the recent Offhsore Voluntary Disclosure Program and US tax enforcement abroad:

JofA: What can you tell us about processing the estimated 14,700 voluntary disclosures last fall under the reduced-penalty program for foreign financial transaction reporting?

Shulman: For several years, we have been very focused on offshore compliance. When he was a senator, President Obama emphasized offshore compliance and then came in and immediately gave us tremendous new resources for it. [Treasury] Secretary [Timothy] Geithner made this an agenda item at the G8 [Group of Eight summit].

The U.S. government is getting very serious about rooting out offshore tax evasion. And while we’re increasing the risk that you’re going to get caught if you’re hiding assets overseas, we made an offer where people could come in and pay their taxes and interest and a stiff penalty but avoid going to jail. The response was overwhelming. We would have never imagined that 14,700 people would come in.

We are still in the early stages, wading through those returns, looking at information, at patterns of institutions or advisers who help people park money overseas and not pay taxes. Where we don’t have enough information from a taxpayer, we’re digging deeper with further questions and potential audits. This will be a treasure trove of information for us to look for and pursue other wrongdoing.

JofA: Can you say anything about what the government’s next move might be in the UBS case or other foreign financial transaction reporting initiatives?

Shulman: Our offshore compliance effort is a multifaceted and multiyear effort. Probably, the next big thing, I hope, will be passage of FATCA, the Foreign Account Tax Compliance Act. A blueprint was put forward by President Obama in his 2010 budget, and legislation has been introduced by Senate Finance Committee Chairman Max Baucus, [Former] House Ways and Means Committee Chairman Charles Rangel and others. It will require financial institutions doing business as qualified intermediaries to report more information and do more due diligence, so it will give us a lot more and better information. If people don’t sign up to be a QI, there will be withholding at the source.

The president last year gave us funding to hire 800 new people in our international operations. In the 2011 budget that was just put forward, he added funding for another 800 people, so we’re building up expertise. I’m spending a lot of time with my counterparts in foreign governments, comparing notes and sharing information, so international cooperation is being stepped up. We started a high-wealth unit recently, which will look at the web of finances of high-wealth American taxpayers, and that will include their foreign accounts and resources. We are moving on multiple fronts.

Five Facts about the Foreign Earned Income Exclusion

If you are living and working abroad you may be entitled to the Foreign Earned Income Exclusion.  Here are five important facts from the IRS about the exclusion:

1. The Foreign Earned Income Exclusion United States Citizens and resident aliens who live and work abroad may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs.
2. The General Rules To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country, otherwise known as foreign earned income. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.
3. The Exclusion Amount The foreign earned income exclusion is adjusted annually for inflation. For 2009, the maximum exclusion is up to $91,400 per qualifying person.
4. Claiming the Exclusion The foreign earned income exclusion and the foreign housing exclusion or deductions are claimed using Form 2555, Foreign Earned Income, which should be attached to the taxpayer’s Form 1040. A shorter Form 2555-EZ, Foreign Earned Income Exclusion, is available to certain taxpayers claiming only the foreign income exclusion.
5. Taking Other Credits or Deductions Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered revoked.