INCREASED TAX COMPLIANCE audits and notices from the U.S. Treasury with more frequency in the last three years:
(1) New IRS Form 8938, "Statement of Specified Foreign Financial Assets", is required to be attached to a "specified" individual's tax return Form 1040 or 1040NR for 2011. The form requires information on foreign financial assets in which the taxpayer has an interest.
"Specified Foreign Financial Assets" (SFFA) include: (1) depository or custodial accounts at foreign financial institutions, and if held in an account at a foreign 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. (IRC Sec. 6038D(b))
Potential Penalties for failure to report such information include a $10,000 penalty, increasing to $50,000, if failure continues after IRS notification of such failure, unless due to 'reasonable cause' and not willful neglect. (IRC Sec. 6038D(g))
The statute of limitations (SOL) will not begin to run until Form 8938 is filed. A 6 year SOL exists if $5,000 of income associated with a SFFA is omitted on the tax return. A 40% deficiency penalty can be assessed with such foreign unreported income.
New tax trends and developments on a global scale demonstrate how tax treaty countries are sharing tax information regarding taxpayers residing in their borders. The recently enacted HIRE Act in the U.S. in March 2010 significantly increases penalty exposure for undisclosed or unreported foreign institution accounts or assets, as well as requires foreign financial institutions to withhold U.S. taxes on such accounts, under certain circumstances after 2012.
Increased tax compliance pressure is also being demonstrated in Australia and in European countries during the past year.
U.S. Tax Legislation Passed in 2010
The 2010 HIRE ACT was enacted on 3-18-2010.
It includes a comprehensive set of measures to reduce offshore noncompliance by giving IRS officials new administrative tools to detect, deter and discourage offshore tax abuses. Practitioners and taxpayers need to be informed of these significant new laws in today's global and mobile society. An overview of the new offshore anti-abuse law provisions are illustrated and discussed below.
Increased Disclosure of Beneficial Owners
Reporting on Certain Foreign Financial Accounts Offshore
The New Act imposes a 30% 'federal withholding tax' on certain income payments from U.S. financial assets held by a foreign financial institution, unless the foreign financial institution agrees to disclose the identity of the U.S. individual with the account(s) at the institution (or the institution's affiliates). In addition to disclosing the owner's identity, the institution must annually report to IRS the account balance(s), gross receipts and gross withdrawals or payments from the account(s). This new procedure would also apply to investments in Hedge Funds and Private Equity Funds. Foreign financial institutions would also be required to disclose and report on foreign entities (trusts, partnerships, and corporations) that have substantial U.S. owners, or be required to withhold the 30% tax on payments. These provisions are EFFECTIVE generally for payments made after 2012.
COMMON FIDUCIARY CONCERNS & QUESTIONS
Case Study #1:U.S. Estate With U.S. & Foreign Beneficiaries
Mary Smith, a surviving spouse, is a U.S. citizen and Oregon resident. She has a son, Richard, who lives in France, a daughter, Linda, who lives in Australia, and two U.S. citizen/resident sons, William and Paul. Mary is the income beneficiary of her husband's by-pass trust, the Smith Family Trust. Mary believes that she has a good estate plan which is incorporated in her recently drafted revocable trust and pour-over will. Her concerns include the following issues: a) She had difficulty deciding who to designate as her executor/successor trustee in the event of her death. Richard is the best choice and most qualified of the persons or institutions that she feels comfortable in designating such responsibility. b) What is the most efficient administrative plan to distribute the most net assets to her beneficiaries, resulting in the least professional cost and the least tax liabilities owed by the beneficiaries ? c) Should her estate plan documents be amended before her death to incorporate the most effective planning and estate and trust administrative details ?
SUMMARY OF THE FACTS
Mary Smith's revocable trust has a current value of $11 mil, consisting of primarily of marketable securities, her primary residence in Oregon and a second home in Canada. The Smith Family Trust has a current value of $9.5 mil, consisting of primarily marketable securities.
Based upon the facts indicated, the best plan of action for Mary would begin with seeking professional advice from professionals knowledgeable with international trust laws, inheritance tax issues and estate and income tax laws. She could develop a good strategic plan by understanding the legal and tax issues, formalize a plan accordingly, and amending her estate plan documents while she is alive and competent to do so.
For example, designating Richard as her successor trustee and executor will qualify both trusts as 'Foreign Trusts' for U.S. purposes under IRC Sec. 7701(a)(30). Both trusts, by having a foreign fiduciary with the primary supervision of the trust administration duties, rather than a U.S. person, would fail the 'control test' under IRC Sec. 7701(a)(30)(E). Thus, both trusts would not be treated as 'domestic trusts'.
If a 'foreign' person can control or veto any substantial trust decisions, the trust will have a 'foreign status' (for U.S. tax purposes). This would be the result, even if the trust is governed by the laws of a U.S. state (as its court jurisdiction), and even if all assets are located in the U.S.