Tax 101: Form 5471 - How to Complete the Form in Light of Recent Changes

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INTRODUCTION

As part of the obligation to file income tax returns, U.S. persons owning 10% or more of the stock of a foreign corporation – measured by voting power or value of the stock that is owned – are obligated to provide information on the foreign corporation. Ownership is determined by reference to stock directly held, indirectly held through foreign entities, and deemed held through attribution from others. The scope and detail of the information to be reported is dependent on the percentage of ownership maintained by the U.S. taxpayer. As the degree of ownership increases, the amount of information increases. The reporting vehicle is Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations). For returns that report on tax year 2013, this form also reports on the net investment income tax (“N.I.I.T.”) arising through a controlled foreign corporation (“C.F.C.”).

Great emphasis is put on international tax compliance, and from 2009, the I.R.S. systematically assesses penalties for late filing of Form 5471. In addition, the 2010 Foreign Account Tax Compliance Act (“F.A.T.C.A.”) extended the statute of limitations for the I.R.S. to examine a tax return if certain information returns, including Forms 5471, were not timely or properly filed. The statute of limitations will remain open on the entire tax return and not only on Form 5471 if Form 5471 is not timely filed. Once the form is filed the statute of limitation will begin to run. To assist the I.R.S. to spot inconsistencies, beginning in tax year 2012, the I.R.S. assigned a unique reference identification number to each foreign entity, which allows the I.R.S. to compare forms filed with respect to a certain company over several years.

In the Matter of John Gaied - New York State's Highest Court Pushes Back New York Taxing Authorities

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New York State will tax as a “resident” of New York: a domiciliary of the State and a person treated as a “statutory resident.” A domiciliary is generally a person whose permanent and primary home is located in New York. A statutory resident is a person who is not a domiciliary, but maintains a permanent place of abode in this state and spends in the aggregate more than 183 days of the taxable year in New York. In other words, to be a statutory resident for New York tax purposes, the person must be present in New York for more than 183 days (in the aggregate) AND maintain a permanent place of abode in New York.

New York’s highest court was asked to determine what it means to “maintain” a permanent place of abode in New York. The New York State taxing authority’s position is that a person can have a permanent place of abode, which he or she does not necessarily have to own or lease, if the person can stay there whenever he or she wants, even if he or she stays there occasionally or not at all. Special rules apply to corporate apartments, college students, and the military.

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.

New York Enacts New Legislation For New York Nonprofits

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New York’s Governor Andrew Cuomo has signed the Nonprofit Revitalization Act of 2013 into law, effective July 1, 2014, making a number of key reforms to New York law that have long been sought by the charitable sector and legal practitioners. Nonprofit organizations will now be able to incorporate, dissolve and merge more easily; communicate and hold meetings using modern technology like Skype and videoconference; and effect various transactions without the need to seek Court approval. The new law has added new governance provisions to provide crucial oversight and governance reforms. Nonprofit boards will have to perform stricter oversight of insider deals, and the Attorney General will be better able to hold insiders accountable for abuse. The new law requires the adoption of more robust financial oversight requirements, conflict of interest policies, and, for certain charities, whistleblower policies to protect nonprofit employees from retaliation when they identify wrongdoing.

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 →

Dividend Equivalents: Past, Present and Future

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Code §871(m) of the Code was enacted as part of the H.I.R.E. Act on March 18, 2010 and treats “dividend equivalents” as U.S. source dividends for withholding tax purposes. On January 23, 2012, Temporary Regulations (the “2012 Temporary Regulations”) and a notice of proposed rulemaking (the “2012 Proposed Regulations”) were published. The 2012 Proposed Regulations and Temporary Regulations provided guidance relating to U.S. source dividend equivalent payments made to nonresident individuals and foreign corporations. They also provided guidance to withholding agents. Correcting amendments to the 2012 Temporary Regulations were published on February 6, 2012, on March 8, 2012 and on August 31, 2012. On December 5, 2013 new proposed regulations (the “2013 Proposed Regulations”) withdrew the 2012 Proposed Regulations. In addition and at the same date, final regulations (“2013 Final Regulations”) were published that essentially adopted the 2012 Temporary Regulations.

BACKGROUND

Code §871(m) defines a dividend equivalent as one of the following:

• Any substitute dividend made pursuant to a securities lending or a salerepurchase transaction that (directly or indirectly) is contingent upon, or determined by reference to, the payment of a dividend from sources within the United States;
• Any payment made pursuant to a specified notional principal contract (“N.P.C.”) that (directly or indirectly) is contingent upon, or determined by reference to, the payment of a dividend from sources within the United States; and
• Any other payment determined by the Secretary to be substantially similar to a payment described in the two previous categories (a substantially similar dividend).

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.