Final Regulations in Regard to Source of Income from Sale of Personal Property
The IRS has published final regulations on source of income from sales of inventory produced in the US and sold outside the United States and vice versa.
The final regulations [§§ 1.863-1(f), 1.863-2(c), 1.863-3(g), 1.863-8(h), 1.864-5(e), 1.864-6(c)(4), and 1.865-3(g)], which apart from a few changes preserve the principal premise upon which the Treasury had constructed the proposed regulations of December 30, 2019, also contain new rules for determining the source of income from sales of personal property (including inventory) by nonresidents that are attributable to an office or other fixed place of business that the nonresident maintains in the US.
Moreover, the new regulations modify rules for determining whether foreign source income is effectively connected with the conduct of a trade or business within the United States.
The final regulations became effective on December 11, 2020.
Final Regulations in Regard to GILTI
On July 23, 2020, the Federal Register published final IRS regulations under the GILTI (global intangible low- taxed income) and subpart F income provisions of the Internal Revenue Code [§§1.951A-7(b) and 1.954-1(h)(1) and (3)] in regard to the treatment of income that is subject to a high rate of foreign tax. The regulations permit the taxpayers to exclude highly taxed income of certain CFCs (controlled foreign corporations) from their GILTI calculations. The exclusion is on an elective basis.
The regulations will take effect on September 21, 2020.
IRS Guidance on Extension of Tax Deadlines
On March 20, 2020, the IRS issued Notice 2020-18 and therein provided guidance on the extension of tax (and information) return filing and tax payment deadlines. This notice coincides with the announcements made by the Secretary of the Treasury. Due to the extraordinary circumstances (the pandemic), the 2019 tax year filing and payment deadlines are extended to July 15, 2020. Estimated tax payments (including payments on self-employment income) that would normally be due on April 15 are also extended to July 15, 2020. These extensions are not limited by any dollar threshold. The period beginning on April 15 and ending on July 15, 2020, will be disregarded for the purpose of calculation of any interest and penalties associated with a failure to file a federal income tax return or to pay federal income tax postponed by the notice. The notice did not provide for any extension for the filing of information returns.
In a subsequently issued Notice 2020-23, the IRS provided an additional relief to the taxpayers - to include an additional time for certain time-sensitive actions - and suggested that generally the relief extends to expatriates and nonresidents.
IRS Notices 2020-18 and 2020-23
Adjustments to Foreign Housing Expense Limitations
The IRS provided adjustments to the limitation on housing expenses for purposes of IRC §911. These adjustments correspond to geographic differences in housing costs relative to housing costs in the United States. When the limitation on housing expenses is higher for tax year 2020 than the adjusted limitations on housing expenses provided in Notice 2019-24, qualified taxpayer may apply the adjusted limitations for tax year 2020 to his or her 2019 tax year.
IRS Notice 2020-13
Rights to a Property Held in a Bahamian Trust
A district court held that, with respect to an interpretation of the trust instrument that governs a trust created in the Bahamas, the court would first look to Bahamian law to determine the taxpayer’s rights to a property that is being pursued by the United States government.
Nineveh Investments Limited v. U.S., 2019 PTC 312 (E.D. Pa. 2019)
IRS Issues Proposed Regulations in Regard to FATCA
The IRS has issued proposed regulations under IRC §§1471 through1474 (Foreign Account Tax Compliance Act), and under IRC §§1441 and 1461. If adopted and implemented, the regulations would (1) eliminate withholding on payments of gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States, (2) defer withholding on certain foreign pass-thru payments, (3) eliminate withholding on certain insurance premiums, and (4) clarify the definition of an "investment entity."
Proposed Regulations -132881-17
Offspring Now Liable for FBAR-related Penalties Assessed Against His Father
A district court held that the government's assessment of penalties related to failure to report foreign bank accounts (FBAR) did not abate upon the decedent's death. The court ruled that the government could pursue its claim against the decedent's son because the son who was a distributee of the decedent's estate.
U.S. v. Estate of Schoenfeld, 2018 PTC 331 (M.D. Fla. 2018)
“Qualified dividends” From Cyprus and Hong-Kong Corporations Reclassified as Ordinary Income. Application of “Act of State” Doctrine Challenged.
Barry and Rochelle Smith indirectly owned controlled foreign corporations in Hong-Kong and Cyprus. The United States Tax Court determined that a Cypriot corporation that paid the Smiths a $57.1 million dividend was not a qualified foreign corporation and therefore, the payment was not eligible for the reduced tax rate under IRC §1(h)(11)(C). The Court reclassified the entire amount as ordinary income. In doing so, the Court rejected the plaintiff’s assertion that the bona fide status of the corporation as a Cypriot entity stemmed from an application of the “act of state” doctrine. In essence this international law doctrine postulates that every sovereign state is bound to respect the independence of every other sovereign state, and the courts of one country will not sit in judgment on the acts of the government of another done within its own territory.
Furthermore, the Court ruled that the cancellation of the outstanding accounting receivables balance of $21.1 million, i.e. monies owed to the aforementioned Cypriot entity – a fact not challenged by the Smiths – constituted a constructive dividend to the Smiths.
Further still, the Court ruled that $12.3 million received by the Smiths from a Hong-Kong entity were to be treated as ordinary dividend and not as a qualified dividend eligible for a reduced tax rate.
Smith v. Commissioner, 151 T.C. No. 5 (2018).
The Why, the Who and the How of the New Reporting Requirements for Foreign-Owned Domestic Disregarded Entities
The so-called ‘check-the-box’ entity classification regulations (§§ 301.7701-1 through 301.7701-3) will cause a classification of a single owner business entity as a “disregarded entity” for federal tax purposes unless that entity elects to be treated as a corporation. This is a common scenario in regard to single member domestic limited liability companies (LLCs), whereby in absence of a timely made entity classification election, the LLC becomes disregardedas separate from its owner and henceforth reports its items of income and expense on Schedule C (an integral part of a personal tax return). Note that a nonresident who reports his or her effectively connected income and expenses from business or practiced profession on Form 1040NR would also use Schedule C to give a detailed report in that regard.
The recent regulations (T.D. 9796) – implemented as of January 1, 2017 – introduce a profound change for one class of disregarded entities.
Why the new regulations?The U.S. Treasury has long viewed the opportunity for foreign nationals to form U.S. based single member LLCs, while not electing the corporate status for tax purposes, as a fertile ground for shell games. In the more recent years, the Treasury has become far more keen to enter into additional, bilateral Tax Information Exchange Agreements (TIEAs) – the last notable effort in that filed being evidenced by the December 2016 agreement with Argentina – and, as a consequence, has become more attuned to the needs of its counterparts. At the same time, many a sovereign player and some international organizations have not hesitated to put a lantern on the weaknesses of the U.S. financial and tax system when it comes to making it more difficult for non-U.S. persons to evade taxes in their home jurisdictions.
Considering that a disregarded entity that does not have U.S. based employees or Form 1099 filing requirements (reporting of payments rendered to an independent contractor) is typically not required to obtain an Employee Identification Number (EIN), the visibility on the LLC’s asset holding activities is substantially reduced. The asset holding activities of such LLCs, in their substance, more often than not, may be indistinguishable from the asset holding activities of their respective owners. With an eye toward reciprocity, the Treasury constructed the new regulations primarily in order to enhance its ability to harvest information that would be useful to treaty and/or TIEA counterparts.
Who will be affected?Any foreign person that owns, directly or indirectly, a domestic disregarded entity in its entirety. The indirect ownership encompasses ownership via other disregarded entity, as well as ownership via a grantor trust. The definition of a foreign person extends to any foreign corporation, company, partnership or association, as well as to any foreign estate or trust described in §7701(a)(31).
How will the regulations affect this particular class of entities?In essence, the new regulations throw the foreign-owned disregarded entities into the existing realm of reporting for foreign corporations engaged in U.S. trade or business and domestic corporations with at least 25% foreign ownership interest. This area is governed by §§6038C and 6038A of the U.S. tax code. For the limited purpose of complying with section 6038A of the code and the derived therefrom regulations, a foreign-owned disregarded entity will be treated as a domestic corporation. In practical terms this policy shift will mean the following:
Foreign-owned disregarded entities will be required to obtain an EIN. The very process of obtaining an EIN will give the IRS a glimpse of what is at the core of that entity’s activities.
Foreign-owned disregarded entities will be obligated to file, on annual basis, Form 5472 and therein report on a whole host of transactions with foreign related parties. The reportable transactions, whether monetary or for other consideration, include but are not limited to: sales, purchases, commissions (paid and received), rents, royalties, cost sharing payments and receipts, and – more crucially – all contributions, distributions, and amounts loaned or borrowed. The term related partyfor the purpose of Form 5472 reporting includes all thirteen categories under §267(b), which among other classes of relationship covers spouses and most types of relationship by blood, as well as certain controlled partnerships, as stipulated under §707(b)(1). Lastly, the relationship may be established by operation of §482, which relates to allocation of income and expenses among taxpayers – a somewhat more esoteric concept and perhaps a less likely way to be pulled into the new reporting requirements.
Foreign-owned disregarded entities will have to adhere to the record keeping requirements of §6001. That will certainly benefit a foreign government’s efforts when seeking information in the U.S. via letters rogatory or other recognized protocol.
Barring one’s ability to show a reasonable cause, noncompliance can be castigated rather harshly by the IRS. This is also the case here.
The presented here information is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.