I.R.S. Announces Major Changes to Amnesty Programs

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The I.R.S. announced major changes to its amnesty programs last month. These changes can be broken into two parts: changes to the 2012 Offshore Voluntary Disclosure Program (“O.V.D.P.”), which can be to referred to as the 2012 Modified O.V.D.P. or the 2014 O.V.D.P., and changes to the streamlined procedures (“Streamlined Procedures”). As the requirements for the latter are relaxed, the requirements for the former are tightened.

The changes in the amnesty programs reflect the new I.R.S. approach for addressing taxpayers with offshore tax issues. The new approach provides one path for willful taxpayers, with steeper penalties but certainty, and another path for taxpayers who believe their conduct was non-willful, with reduced penalties but uncertainty to the extent their conduct is subsequently proven willful.

CHANGES TO O.V.D.P.

The major changes to the 2012 O.V.D.P. include the following:

1. Changes to Preclearance Process

Under the 2012 O.V.D.P., all that was required was to submit a preclearance request was a fax to the I.R.S. O.V.D.P. department that contained the taxpayer’s name, social security number, date of birth, address, and if the taxpayer was represented by an authorized party, an executed power of attorney (P.O.A.).

Insights Vol. 1 No. 5: F.A.T.C.A. 24/7

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I.R.S. PUBLISHES 1ST F.F.I. LIST

On June 2, implementation of the Foreign Account Tax Compliance Act (“F.A.T.C.A.”) reached another milestone. On that date, the I.R.S. published its first list of foreign financial institutions (“F.F.I.’s”) that have registered with the I.R.S. to show intent to comply with F.A.T.C.A. and have received a Global Intermediary Information Number (“G.I.I.N.”) to document that compliance. The I.R.S. list is important since U.S. withholding agents who are being asked by F.F.I.’s not to remit the 30% withholding tax imposed under F.A.T.C.A. must first obtain a G.I.I.N. from the F.F.I. and then confirm on the I.R.S. published list that the G.I.I.N. is accurate and in full force.

More than 77,000 F.F.I.’s appear on this first list and include foreign affiliates of some of the U.S.'s largest financial institutions. Among those financial institutions are Bank of America, JPMorgan Chase, Merrill Lynch, and Franklin Templeton.

O.V.D.P. Update

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I.R.S. ANNOUNCES MAJOR CHANGES TO O.V.D.P. AND STREAMLINED PROCEDURES

After more than two weeks of speculation, 49 on June 18, 2014, the I.R.S. announced major changes to its current offshore voluntary disclosure programs earlier today. The programs affected are the 2012 Streamlined Filing Compliance Procedures for Non-Resident, Non-Filer U.S. Taxpayers (the “Streamlined Procedures”) and the 2012 O.V.D.P.

In general, as will be discussed in more detail below, the changes to the programs relax the rules for non-willful filers and at the same time potentially increase penalties for willful non-compliance.

The changes to the O.V.D.P., as announced today, include the following:

• Additional information will be required from taxpayers applying to the program;
• The existing reduced penalty percentage for non-willful taxpayers will be eliminated;
• All account statements, as well as payment of the offshore penalty, must be submitted at the time of the O.V.D.P. application;
• Taxpayers will be able to submit important amounts of records electronically; and
• The offshore penalty will be increased from 27.5% to 50% if, prior to the taxpayer’s pre-clearance submission, it becomes public that a financial institution where the taxpayer holds an account or another party facilitating the taxpayer’s offshore arrangement is under investigation by the I.R.S. or the Department of Justice.

F.B.A.R. Update: What You Need to Know

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NOTWITHSTANDING OFFICIAL COMMENTS, BITCOIN EXCHANGE ACCOUNTS SHOULD BE REPORTED ON F.B.A.R.’S

As noted in our previous issue, the I.R.S. clarified the tax treatment of Bitcoin, ruling that Bitcoin will not be treated as foreign currency but will be treated as property for U.S. Federal income tax purposes. As a result, the I.R.S. ruling may allow for capital gains treatment on the sale of Bitcoin. However, the ruling did not address whether Bitcoin is subject to Form 114 reporting.

This month, pursuant to a recent I.R.S. webinar, an I.R.S. official stated that Bitcoins are not required to be reported on this year’s Form 114. However, the official noted that the issue is under scrutiny, and caveated that the view could be changed in the future.

Notwithstanding the official’s comments, whether Bitcoin is a reportable asset will depend on the nature and manner it is held.

F.B.A.R. Assessment and Collections Processes: A Primer

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With the June 30^th deadline fast approaching and the recent cases addressing F.B.A.R. penalties, we thought it would be useful to provide a primer on F.B.A.R. assessment and collections processes.

BACKGROUND

In general, a U.S. person having a financial interest in, or signature authority over, foreign financial accounts must file an F.B.A.R. if the value of the foreign financial accounts, taken in the aggregate and at any time during the calendar year, exceeds $10,000.

The F.B.A.R. must be filed electronically by June 30 of the calendar year following the year to be reported. No extension of time to file is available for F.B.A.R. purposes.

Failure to file this form, or filing a delinquent form, may result in significant civil and/or criminal penalties:

• A non-willful violation of the F.B.A.R. filing obligation can lead to a maximum penalty of $10,000. If reasonable cause can be shown and the balance in the account is properly reported, the penalty can be waived.
• In the case of a willful violation of the filing obligation, the maximum penalty imposed is the greater of $100,000 or 50% of the balance in the account in the year of the violation.

F.B.A.R. Penalty: Recent Cases

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U.S. v. ZWERNER: WILLFUL NON-FILINGS RESULT IN MONSTROUS CIVIL PENALTIES

United States v. Zwerner illustrates the potential for monstrous civil penalties resulting from willful failure to file F.B.A.R.’s. It further confirms the point that, if evidence of willfulness exists even in a sympathetic case, the I.R.S. may assert willful penalties in the case of “silent” or “quiet” disclosures, which the I.R.S. and its officials have consistently warned in official and non-official statements.

The facts of the case in brief are as follows:

From 2004 through 2007, Carl Zwerner, currently an 87-year-old Florida resident, was the beneficial owner of an unreported financial interest in a Swiss bank account that he owned indirectly through two successive entities. He did not report the income on the accounts for the period of 2004 through 2007, according to the complaint filed by the United States, but in his answer to the complaint, Zwerner, while admitting that he filed a delinquent F.B.A.R. for 2007, denied filing an amended return for that year, stating that his financial interest in the foreign account was reported on his timely-filed 1040 for that year. The complaint also alleged that, for 2006 and 2007, he represented to his accountant that he had no interest or signature authority over a financial account in a foreign country. Zwerner denied those allegations.

Insights Vol. 1 No. 4: Updates & Other Tidbits

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PASSIVE FOREIGN INVESTMENT COMPANY: RELAXATION OF RULES APPLICABLE TO TAX-EXEMPT SHAREHOLDERS

The passive foreign investment company (“P.F.I.C.”) rules can have an adverse impact on any U.S. person that may invest in a foreign company classified as a P.F.I.C. A P.F.I.C. can include an investment in an offshore investment company that owns investment assets such as stocks and securities. While ownership by a taxable U.S. investor can produce adverse tax results, ownership by a U.S. taxexempt entity, such as a retirement plan or an individual retirement account (“I.R.A.”), usually will not result in adverse tax results. This situation is helpful since many tax-exempt entities invest in offshore investment companies. The one exception is if the U.S. tax-exempt investor borrows money to make its investment in the P.F.I.C. then the U.S. tax exempt may recognize unrelated business taxable income (“U.B.T.I.”) from this investment. Despite its tax-exempt status, U.B.T.I. is taxable to a U.S. tax-exempt investor under Code §511.

The P.F.I.C. rules, as do many tax rules, include extensive constructive ownership rules whose purpose is to make sure that the statutory purpose behind the rules are not undercut by use of intermediate holding companies or other means. One lurking issue was whether these constructive ownership rules could possibly apply where a beneficiary of a retirement plan or I.R.A. or a shareholder of a tax-exempt entity gets a distribution from the entity that is attributed to its investment in a P.F.I.C. The I.R.S. recently issued Notice 2014-28 that alleviated this concern. As a result, a shareholder of a tax-exempt organization or a beneficiary of a tax exempt retirement plan or I.R.A. is not subject to the P.F.I.C. rules. This notice alleviates not only possible adverse tax results, but also the need to file any relevant P.F.I.C. tax forms such as Form 8621, Information Return for a shareholder of a P.F.I.C.

Insights Vol. 1 No. 4: F.A.T.C.A. 24/7

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I.R.S. RELEASES “GOOD FAITH” NOTICE

I.R.S. Notice 2014-33, issued on May 2, 2014, established a major relaxation of the F.A.T.C.A. withholding regime that will begin on July 1, 2014. While not providing for a delayed implementation, the Notice says that all affected persons may treat 2014 and 2015 as a transition period in which such parties must show a good faith effort to comply with F.A.T.C.A. As long as they act in good faith, there will be no liability for any withholding agent who did not properly withhold for F.A.T.C.A. or for any Foreign Financial Institution (“F.F.I.”) that failed to properly register or fill out the appropriate forms. While the scope of actions that comprise good faith is somewhat unclear, this notice eliminates the need for withholding agents to seek perfection in F.A.T.C.A. compliance, which may have driven them to over-withhold.

The I.R.S. also said that the definition of a pre-existing account will be delayed from July 1, 2014, to January 1, 2015. As a result, new on-boarding procedures can be delayed until January 1, 2015, and U.S. withholding agents do not have to get the new forms such as the Form W-8BEN-E until the end of the year. Likewise, F.F.I.’s do not have to get those forms from their own account holders until the end of the year.

I.R.S. RELEASES VARIOUS FORMS, INSTRUCTIONS

The I.R.S. released the much anticipated Form W-8IMY on April 30. The Form W-8IMY will need to be used by qualified or non-qualified intermediaries, foreign partnerships and foreign simple or grantor trusts. The I.R.S. has still not released instructions that will supplement the newly published F.A.T.C.A. compliant forms. I.R.S. officials said that the agency is working diligently to complete instructions for the series of W-8 forms covering W-8BEN-E, W-8IMY and W-8EXP.

Tax 101: Transactions in FX - A Primer for Individuals

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In our last issue, we discussed the recent I.R.S. guidance on bitcoins which, in general, stated that transactions in bitcoins should be treated as transactions in property under the general rules of the Internal Revenue Code (the “Code”) rather than the special rules applicable to foreign currency. We therefore thought it would be useful to provide a primer on common transactions involving foreign currency (sometimes hereinafter referred to as “FX”) with respect to U.S. individuals.

IN GENERAL

The first thing to note about engaging in transactions involving foreign currency is that foreign currency is treated as any other asset. Think stocks, bonds, or real estate. When an individual buys foreign currency, that individual has a basis in the FX (e.g., Euro) similar to any other investment. When the individual sells that foreign currency, that individual will have a realization event, in which case gain or loss may have to be recognized. Whether the character of that gain or loss is ordinary will depend on the specific transaction and the applicability of Code §988, as will be discussed in more detail below.

Example 1

Mr. FX Guy, a U.S. citizen individual, buys real property located in the U.K. for 100,000 British pounds (£) on January 1, 2014. In order to effectuate the purchase, Mr. FX Guy uses £100,000 that he purchased for $150,000 on January 1, 2012 when the exchange rate was $1.5 to £1. Assume on January 1, 2014, the exchange rate was $2: £1 as the British pound appreciated against the U.S. dollar. The £100,000 has a basis of $150,000. It was acquired on January 1, 2012 and disposed of on January 1, 2014. The disposition is a sale of an asset (in this case, the FX). The amount realized is the fair market value of the consideration received, or $200,000. Accordingly, the taxpayer has a gain of $50,000 attributable to the foreign currency that must be recognized. The character of the gain, and the applicability of §988, will depend on whether the transaction was a “personal transaction.”

Insights Vol. 1 No. 2: Updates & Other Tidbits

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UPDATE TO STREAMLINED PROCEDURES: DIFFERENT STROKES FOR THE SAME FOLKS

In our prior issue, Insights Vol. 1, No. 1, we noted that, for a U.S. taxpayer entering into the Streamlined Procedures (i.e., fast-track program) in 2013, an I.R.S. agent informally advised filing tax returns for the years 2009, 2010, and 2011. Upon further discussions with the I.R.S., the agent revisited the issue, advising that a taxpayer entering into the program today would need to file the last three years of tax returns (i.e., 2010, 2011, and 2012). In the event the taxpayer does not file a timely 2013 return prior to the submission, the applicable look-back period is 2011, 2012, and 2013.

This advice is consistent with the 2012 O.V.D.P. F.A.Q. # 9, which answers the question “What years are included in the OVDP disclosure period?” as follows:

For calendar year taxpayers the voluntary disclosure period is the most recent eight tax years for which the due date has already passed. The eight-year period does not include current years for which there has not yet been non-compliance. Thus, for taxpayers who submit a voluntary disclosure prior to April 15, 2012 (or other 2011 due date under extension), the disclosure must include each of the years 2003 through 2010 in which they have undisclosed foreign accounts and/or undisclosed foreign entities. Fiscal year taxpayers must include fiscal years ending in calendar years 2003 through 2010. For taxpayers who disclose after the due date (or extended due date) for 2011, the disclosure must include 2004 through 2011. For disclosures made in successive years, any additional years for which the due date has passed must be included, but a corresponding number of years at the beginning of the period will be excluded, so that each disclosure includes an eight year period.

The I.R.S. Extends the Time for Estate Tax Portability Election for Small Estates

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On January 27, 2014, the I.R.S. released Rev. Proc. 2014-18. This revenue procedure provides an automatic extension of time to file a late portability election for estates of the first to die of a married couple provided that certain requirements are met. “Portability” refers to the option of the surviving spouse to make use of any gift and estate tax exemption that was not used by the deceased spouse. Thus, if the executor missed the opportunity to elect portability, now is the time to take advantage of this election, as this opportunity will end on December 31, 2014.

BACKGROUND

In 2010, Congress amended §2010(c) of the Code to allow the estate of a decedent who is survived by a spouse to make a portability election, which allows the surviving spouse to apply the decedent’s unused exclusion (“D.S.U.E.”) amount toward the surviving spouse’s own transfers during life and at death.

Notice 2011-82, issued on October 17, 2011, provided preliminary guidance regarding the requirements to elect portability of the decedent’s D.S.U.E. amount. Notice 2012-12, issued on March 3, 2012, provided temporary (and limited) relief by, in general, extending the deadline to file an estate tax return (Form 706, Unified States Estate (and Generation-Skipping Transfer) Tax Return) for portability election purposes by six months if certain requirements were met. In June 2012, temporary regulations were issued that provided more detailed guidance on portability.

F.A.T.C.A. and Trusts: A Primer

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The Foreign Account Tax Compliant Act (“F.A.T.C.A”) requires that “foreign financial institutions” (“F.F.I.’s”) and “non-financial foreign entities” (“N.F.F.E.’s”) identify and disclose their U.S. accounts and substantial U.S. holders or be subject to a 30% withholding on certain U.S. source payments (including gross proceeds) made to a foreign entity.

F.A.T.C.A. affects both:

• U.S. tax residents owning assets outside the U.S.; and
• Non-U.S. tax residents holding assets inside the U.S. provided they are tax residents of a country subject to a Model Intergovernmental Agreement (“I.G.A.”) that provides for reciprocity (i.e., U.S. financial institutions reporting information on non-U.S. tax residents to their non-U.S. home country).

More notably, F.A.T.C.A. withholding may apply to all foreign entities including foreign trusts. However, F.A.T.C.A. withholding will not apply if the entity qualifies for an exemption or complies with specified reporting requirements.

The O.E.C.D. Announces Global Standard for Automatic Exchange of Information

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As we noted in our prior issue, the Leaders of the G-20 Summit endorsed automatic exchange of information reporting to combat tax evasion in September 2013. In particular, they stated:

We commend the progress recently achieved in the area of tax transparency and we fully endorse the OECD proposal for a truly global model for multilateral and bilateral automatic exchange of information. Calling on all other jurisdictions to join us by the earliest possible date, we are committed to automatic exchange of information as the new global standard, which must ensure confidentiality and the proper use of information exchanged, and we fully support the OECD work with G20 countries aimed at presenting such a new single global standard for automatic exchange of information by February 2014 and to finalizing technical modalities of effective automatic exchange by mid-2014. In parallel, we expect to begin to exchange information automatically on tax matters among G20 members by the end of 2015.

On February 13, 2014, the Organisation for Economic Co-Operation and Development (“O.E.C.D.”) announced a global standard for automatic exchange of financial account information. Over 40 countries made a joint statement an committed to an early adoption of this standard. On February 23, 2014, the G-20 finance ministers and central bank governors endorsed the proposal.

Corporate Matters: Oral Agreement Can Be Unilaterally Terminated If There Is No Definite Term or a Particular Undertaking

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Under New York partnership law (“Partnership Law”), a partnership can be formed orally. Additionally, a partnership may be dissolved unilaterally if “no definite term or particular undertaking is specified” in the underlying agreement.

In Gelman v. Buehler 2013 NY Slip OP 01991 (March 26, 2013, plaintiff (P) and defendant (D) were recent business school graduates who decided to form a partnership in 2007. D had proposed a plan to P aimed at acquiring $600,000 from investors for the purpose of establishing a "search fund" to research and identify and raise any additional funding needed to pay the purchase price of the targeted business. P and D were to manage the business with the goal of increasing its value until it could be sold at a profit (referred to as a "liquidity event") and the investors would share in the profits realized from the sale. P accepted D's proposal and the partnership was formed by oral agreement. P and D expected that the business plan would reach its objective in four to seven years. The partners apparently pursued prospective investors for several months. D withdrew from the venture after P refused his demand for majority ownership of the partnership.

Tax 101: Undisclosed Offshore Accounts, Are You Eligible for Streamlined Procedures?

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By Stanley C. Ruchelman and Armin Gray

For persons having undisclosed offshore accounts and contemplating participation in the I.R.S. voluntary disclosure program, one frequently asked question is eligibility for the streamlined procedures (“Streamlined Procedures”) announced by the I.R.S. O.V.D.I. The Streamlined Procedures are effective as of September 1, 2012 and should be considered if there are offshore tax-noncompliance issues. If an individual qualifies, the benefits are substantial: he or she will be eligible for fast-track resolution of the case, the look-back period is limited to three years of delinquent tax returns and six years of F.B.A.R.'s, and he or she will avoid penalties. However, most taxpayers will not qualify as eligibility is limited to a narrow class of taxpayers where intentional tax non-compliance is unlikely to exist.   See more →

I.R.S. Issues Regulations Regarding P.F.I.C. Reporting Requirements

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On December 30, 2013, the I.R.S. released temporary and final regulations regarding P.F.I.C. reporting requirements. In T.D. 9650, the I.R.S. reaffirmed that it would not require any U.S. persons that owned any interest in a P.F.I.C. during 2010, 2011 or 2012 to file an information return on Form 8621 under the new rules unless they sold the stock, received a distribution or needed to make a P.F.I.C. election. However, Form 8621 will be required to be filed by any U.S. person that owned at any time during 2013 an interest in a P.F.I.C. Thus the form will filed with the 2013 income tax return that must be filed later this year.

The regulations adopted rules addressing constructive or indirect ownership. The constructive ownership or attribution rules can cause a person to become an owner of an interest in a P.F.I.C. even though no stock is directly owned in the P.F.I.C. As a result, ownership of P.F.I.C stock by a corporation, partnership, trust or estate can be attributed to the entity’s shareholders, partners or beneficiaries, who then can become subject to the P.F.I.C. rules.

BACKGROUND

U.S. investors must determine if any foreign corporation owned may be classified as a P.F.I.C. A foreign corporation will be classified as a P.F.I.C. if either (i) 75% or more of the corporation's gross income is passive income (such as from interest, dividends or capital gains) or (ii) 50% or more of the corporation's assets are held for the production of passive income (such as stocks, bonds or cash). A typical P.F.I.C. is an offshore investment company or mutual fund although P.F.I.C. status can be a potential issue for any foreign corporation, especially if the corporation has large cash reserves or is in the services business outside the U.S.

Non-Resident Alien Interest Reporting Rules Upheld

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On January 13, 2014, the District Court for the District of Columbia dismissed the Florida Bankers Association and the Texas Bankers Association (collectively, the “Plaintiffs”) lawsuit that challenged the 2012 regulations requiring U.S. banks (including U.S. offices of non-U.S. financial institutions) to report to the I.R.S. the amount of interest paid to certain non-residents.

Pursuant to the United States’ relentless fight against offshore tax evasion, the I.R.S. finalized regulations requiring U.S. banks to report certain information on non-U.S. account holders. These regulations are necessary, in part, for countries that request reciprocal information on their resident account holders who have U.S. financial accounts as a precondition to signing an I.G.A. with the U.S. In particular, the regulations require reporting of deposit interest aggregating $10 or more paid to N.R.A.s on Form 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding) for the calendar year in which interest is paid. Interest is reportable even if there is no withholding requirement. The regulations apply to all payments of interest made after January 1, 2013, and the first Form 1042-S must be filed with the I.R.S. by March 15, 2014. The reporting will be made with respect to an N.R.A. who is a resident of a country that is identified as a country with which the U.S. has in effect an income tax agreement relating to the exchange of tax information.

Year-End Review: I.R.S. O.V.D.P.

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The I.R.S. and the Department of Justice (“D.O.J.”) continued their tenacious efforts against offshore tax evasion. Three major events took place in 2013: (i) a shift in the methodology to detect quiet disclosures; (ii) the bank voluntary disclosure program (“B.V.D.P.”) announced by the United States and Switzerland on August 29, 2013, and (iii) certain notable convictions, plea deals, and civil penalties.

We expect the I.R.S. and D.O.J.’s unwavering focus on offshore tax evasion to continue in 2014 as F.A.T.C.A begins to be implemented. Some practitioners fear that when F.A.T.C.A. information reporting begins, the O.V.D.P. may end, as the I.R.S. will have received information automatically on foreign accounts. If a U.S. taxpayer remains uncertain about declaring foreign financial accounts, now is the time to take remedial action. There is no Plan B, if time runs out.

QUIET DISCLOSURES

While the I.R.S. officially has discouraged quiet disclosures, a Government Accountability Office (“G.A.O”) report, released on April 26, 2013, identified shortcomings in the I.R.S.’s ability to detect quiet disclosures. According to the G.A.O. report:

[The] G.A.O. analyzed amended returns filed for tax year 2003 through tax year 2008, matched them to other information available to IRS about taxpayers' possible offshore activities, and found many more potential quiet disclosures than IRS detected. Moreover, IRS has not researched whether sharp increases in taxpayers reporting offshore accounts for the first time is due to efforts to circumvent monies owed, thereby missing opportunities to help ensure compliance . . . Taxpayer attempts to circumvent taxes, interest, and penalties by not participating in an offshore program, but instead simply amending past returns or reporting on current returns previously unreported offshore accounts, result in lost revenues and undermine the programs' effectiveness.

Year-End Review: F.A.T.C.A.

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Implementation of F.A.T.C.A., first enacted in 2010, took great strides in 2013.

On January 17, 2013, the I.R.S. issued the final F.A.T.C.A. regulations. In more than 500 pages, the I.R.S. laid out a roadmap for determining who is covered by F.A.T.C.A., who is exempt, and the burdens imposed on foreign financial institutions (“F.F.I.'s"), other foreign investors, and U.S. withholding agents to comply with its rules.

On July 12, 2013, the I.R.S. released Notice 2013-43, which revised the timelines included in the final F.A.T.C.A. regulations for withholding agents and F.F.I.'s to begin their due diligence, withholding, and information reporting requirements. Specifically, it delayed implementation of F.A.T.C.A. withholding on investment income (but not gross proceeds from sale) by six months so that withholding will first start on July 1, 2014. It also adopted a six-month extension for the F.A.T.C.A. registration portal (the “Portal”). Also deferred were rules applicable to grandfathered obligations, new account opening procedures, new qualified intermediaries (“Q.I.'s"), withholding foreign partnerships (“W.P.'s"), and withholding foreign trusts (“W.T.'s") agreements. Withholding on gross proceeds from sales of stocks and securities is still scheduled to come into effect on January 1, 2017.