Category Archives: For Attorneys and CPA’s

This category contains articles that are crucial to attorneys and CPA’s with international clients.
The articles focus on both inheritance tax issues and income tax issues. Each article is written by
Brian Dooley, CPA and MBT.

IRS Informants Wanted – aka the $104 million bounty

The plot in the  Perry Mason mystery TV show The Case of the Glamorous Ghost involves a tax informant.  Attorney Perry Mason says to  “private  Paul Drake:  “Well, a professional informer is usually interested in 20% reward but more than that they also interested in blackmail.”  

Then,  Lieutenant Tragg walks into the law office of Perry Mason. He replies by saying “which, as you know annoys a police department as much as shooting people in the back of the head.    Um, good evening, everyone”  the Lieutenant says greeting Perry, Della and Paul Drake.

My question to my readers is:   Are there Tax Bounty Hunters today?  Well,  here is a  $104 million tax bounty (on this link).  So, is bounty hunting a  viable business?  Senate Finance Committee member Chuck Grassley, (Republican from Iowa)  has upped the reward paid to Tax Bounty Hunters up to 30%.

As the 1960’s Perry Mason show demonstrates, the IRS has been paying a reward for more than half a century.    If you have an unreported tax issue, the IRS has  both domestic and international tax “voluntary disclosure” tax amnesty programs.

In the Perry Mason show, the bounty hunters worked on cruise ships.  Early last Century, cruise ships were for the very wealthy.   The wealthy would shop in Europe (where luxury goods cost less). They sneak the goods into the US.  The tax bounty hunter would travel to befriend wealthy Americans.  Then they would rat them out to the Customs Department.

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International Inheritance Estate Tax. Civil Law Trusts May not Be Trusts for U.S. Tax Law

I have received many calls from Americans asking about the  international inheritance estate tax foreign trusts law.  The issue is that some foreign trusts are not trusts for American tax law.    

A foundation or a trust in a non-common law country (such as Panama) is classified as a “civil law trust.”   The tax law assumes that the trust is a common law trust. 

A civil law trust may be either a foreign corporation or if you are lucky, an alter ego

The inheritance of a foreign corporation causes unexpected and undesired income taxes.  Yes, the problem is income tax.    Extremely different income tax laws apply to a distribution from a corporation versus a trust.  You can learn about saving taxes with a trust on this link.

Under international inheritance estate tax law, these civil trusts were not trusts for U.S. tax law.

Many Americans owned property along the beautiful Baja California, Mexico, Pacific Coast.   Mexico has an anti-immigrant law that prohibits foreigners from owning property near the ocean. Instead, a Mexican trust with a fixed period of 30 years owns the property.   

If the Mexican trusts was a trust, then Form 3520-A and  Form 3520 must be filed.  The penalty for late filing is five percent per year of the gross value of the trust’s assets. 

The IRS does great work.  It knows that just because an entity is called a “trust”, the name means nothing.   This 2013-14 revenue ruling is a great educational tool. Knowing the definitions is necessary for tax planning. The tax laws for trusts are unique.  

The IRS ruling is below in blue. The concept applies to all civil law trusts.  The U.S. has common law trusts (as well as the UK and its territories, Canada, Australia and  New Zealand).   You can learn about trust estate tax planning for common law countries on this link.

If you would like help with your tax planning, then please contact me,  Brian Dooley CPA,MBT,  at [email protected]  

At the end of this blog is the IRS warning that International Inheritance Estate Tax  Civil Law Trusts Are Not Trusts for U.S. Tax Law.Part I    Section 7701 — Definitions  26 CFR 301.7701-4: Trusts

ISSUE

Is the fideicomiso or Mexican Land Trust arrangement (“MLT”), described below, a trust under Treasury Regulation § 301.7701-4(a)?

FACTS

The Mexican Federal Constitution prohibits non-Mexican persons from directly holding title to residential real property in certain areas of Mexico (“restricted zones”). Non-Mexican persons, however, may hold residential real property located in the restricted zones through an MLT with a Mexican bank after obtaining a permit from the Mexican Ministry of Foreign Affairs.

Situation 1

A, a U.S. citizen, is the sole owner of X, a limited liability company organized under the laws of state Z in the United States. X is disregarded as an entity separate from its owner under § 301.7701-2(a) (a disregarded entity). A, through X, wanted to purchase Greenacre. Greenacre is Mexican residential real property located in a restricted zone. Neither A nor X may hold title directly to Greenacre under Mexican law.

X obtained a permit from the Mexican Ministry of Foreign Affairs and signed an MLT agreement with B, a Mexican bank. X negotiated the purchase of Greenacre directly with the seller of the property and paid the seller directly.

The seller had no interactions with B with respect to the sale. At settlement, legal title to Greenacre was transferred from the seller to B, subject to the MLT agreement, as of the date of sale. No property other than Greenacre is subject to the MLT agreement.

Under the terms of the MLT agreement, X has the right to sell Greenacre without permission from B. Further, B must grant a security interest in Greenacre to a third party, such as a mortgage lender, if X so requests. X is directly responsible for the payment of all liabilities relating to Greenacre. X must pay any taxes due in Mexico with respect to Greenacre directly to the Mexican taxing authority.

X has the exclusive right to possess Greenacre and to make any desired modifications, limited only by the need to obtain the proper licenses and permits in Mexico.

If Greenacre is occasionally leased, X directly receives the rental income and A, as the owner of X, reports the income on A’s U.S. federal income tax return.

Although B is identified as a fiduciary in the MLT agreement, it disclaims all responsibility for Greenacre, including obtaining clear title. B has no duty to defend or maintain Greenacre. B collects a nominal annual fee from X.

There is no other agreement or arrangement between or among A, X, B, or a third party that would cause the overall relationship to be classified as a partnership (or any other type of entity) for U.S. federal income tax purposes.

Situation 2

The facts are the same as in Situation 1 except that X is a corporation organized under the laws of State Z in the United States. X is treated as a corporation under § 301.7701-2(a). If Greenacre is occasionally leased, X directly receives the rental income and reports the income on its U.S. federal income tax return.

Situation 3

The facts are the same as in Situation 1 except that A deals directly with B without interposing X or any other entity. A obtained the permit from the Mexican Ministry of Foreign Affairs, signed the MLT agreement with B, and negotiated the purchase of Greenacre. Additionally, the provisions of the MLT agreement that apply to X in Situation 1 instead apply to A.

If Greenacre is occasionally leased, A directly receives the rental income and reports the income on A’s U.S. federal income tax return. B collects a nominal annual fee from A.

There is no other agreement or arrangement between or among A, B, or a third party that would cause the overall relationship to be classified as a partnership (or any other type of entity) for U.S. federal income tax purposes.

LAW AND ANALYSIS

Section 301.7701-1(a)(1) provides that whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.

Section 301.7701-2(a) defines a “business entity” as any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701-3) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Code.

If a business entity with only one owner is disregarded as separate from its owner, its activities generally are treated in the same manner as a sole proprietorship, branch, or division of the owner.

Section 301.7701-4(a) provides that the term “trust” refers to an arrangement created by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries.

Usually, the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement.

However, the beneficiaries of a trust may be the persons who create it, and it will be recognized as a trust if it was created for the purpose of protecting and conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them.

Generally, an arrangement is treated as a trust if it can be shown that the purpose of the arrangement is to vest in trustees the responsibility for the protection and conservation of the property for beneficiaries who cannot share in the discharge of this responsibility.

Rev. Rul. 92-105, 1992-2 C.B. 204, addresses the transfer of a taxpayer’s interest in an Illinois land trust under § 1031.

Under the facts of the ruling, an individual taxpayer created an Illinois land trust and named a domestic corporation as trustee. Under the deed of trust, the taxpayer transferred legal and equitable title to the real property to the trust, subject to the provisions of an accompanying land trust agreement.

The land trust agreement provided that the taxpayer retained exclusive control of the management, operation, renting and selling of the real property, together with an exclusive right to the earnings and proceeds from the real property. Under the agreement, the taxpayer was required to file all tax returns, pay all taxes, and satisfy any other liabilities on the real property.

Rev. Rul. 92-105 concludes that, because the trustee’s only responsibility was to hold and transfer title at the direction of the taxpayer, a trust, as defined in § 301.7701-4(a), was not established. The ruling holds that, on the facts described in the ruling, the trustee was a mere agent for the holding and transfer of title to the real property, and the taxpayer retained direct ownership of the real property for federal income tax purposes.

Situation 1

Because B’s only duties under the MLT agreement are to hold the legal title to Greenacre and transfer title at the direction of X, the MLT is not a trust. X retains the right to manage and control Greenacre. X has the right to collect any rent on Greenacre.

 Also, X has the obligation to pay directly any taxes and other liabilities due on Greenacre. Accordingly, because X is treated as a disregarded entity under § 301.7701-2, A is treated as the owner of Greenacre.

Situation 2

The MLT is not a trust, and the analysis is the same as in Situation 1 except that because X is treated as a corporation under § 301.7701-2(a), X is treated as the owner of Greenacre.

Situation 3

Because B’s only duties under the MLT agreement are to hold the legal title to Greenacre and transfer title at the direction of A, the MLT is not a trust. A retains the right to manage and control Greenacre. A has the right to collect any rent on Greenacre. In addition, A has an obligation to pay directly any taxes and other liabilities due with respect to Greenacre. Accordingly, A is treated as the owner of Greenacre.

HOLDING(S)

In all three situations described above, the MLT is not a trust within the meaning of § 301.7701-4(a).

If, under the MLT agreement, B holds legal title to any assets other than Greenacre or is permitted or required to engage in any activity beyond holding legal title to Greenacre, the holding of this revenue ruling does not apply and the rules of §§ 301.7701-1 through 301.7701-4 will determine the federal tax classification of the MLT.

The IRS’ Warning: International Inheritance Estate Tax. Civil Law Trusts Are Not Trusts for U.S. Tax Law

Note that a fideicomiso (Mexican Land Trust) that is described in Rev. Rul. 2013-14, 2013-26 I.R.B. 1267, is not a trust for U.S. tax purposes, Thus, the U.S. owner of the fideicomiso is not required to file a Form 3520 or a Form 3520A.   In this case, it helped the taxpayer because  it was an alter ego. 

The IRS warning that International Inheritance Estate Tax. Civil Law Trusts Are Not Trusts for U.S. Tax Law has a more deadly result if the entity is a corporation.   Distributions from corporations are usually taxed as a “non-qualified dividend”.    These dividends are taxable at the highest rate.  

French U.S. Estate Tax Treaty Gives French Citizens a Preferred Inheritance Tax Strategy

The French U.S. Tax Treaty gives French citizens  preferred inheritance tax strategy. 

France is on the United States’ favorite country list.   Recently, France and the U.S. changed their tax treaty.   Under the new treaty,  the U.S. estate tax does not apply if the spouse inherits the property.   And it gets better with the new $11,000,000 exemption.

French U.S.  Estate Tax Treaty Gives French Citizens part of the $11,000,000 Exemption.

This is how it works.  François owns $14,000,000 in assets.   $5,000,000 is invested in the U.S. stock market.  $9,000,000 is property and other assets in France.   His U.S. estate tax exemption is 5/14th of $11,000,000 (which is $3,928,571). 

If François should die, his U.S. taxable estate is $1,071,428 ($5,000,000 in stocks minus $3,928,571).  The U.S. estate taxes will be approximately $400,000.

The surviving French spouse can sell the property located in the U.S income tax-free.

This is  how it works.   When the spouse inherits the property, she or he has a new cost for tax purposes.   The cost is the market value at the time of the death.  For example, French couple acquired a home in Los Angeles in 2009 for U.S.$500,000.

The husband dies in 2017.   The house is now worth $1,500,000.   The wife inherits the homet.  The U.S. death tax does not apply because of the U.S. – French Tax Treaty.

Next, U.S income tax law increases the tax cost of inherited property to the market value as of the day of death.    When the spouse sells the property for $1,500,000 she will have no gain or loss.

This new tax law is found in a “protocol” to the original French-U.S. income tax treaty and not to the estate tax treaty.  Here is a link to the protocol.

If you need help with your U.S. – French tax planning, then please email me at [email protected]  Also, here is a link in French explaining the U.S. estate tax laws.

By the way, U.S. tax laws allow a unique type of trust that will avoid inheritance tax for the children of French citizens.  The  trust is called a “marital deduction trust”.  This trust created at the time of the death of the first spouse.   For French tax law, this trust is a U.S. person which provides interesting tax savings.  

New French U.S. Tax Treaty Gives French Citizens Preferred Inheritance Tax Strategy with a Nevada Trust

If you find that you owe U.S. estate taxes, consider a Nevada Self-Directing Trust.  The IRS has issued very favorable rulings on these trusts.   Just as the name sounds, you direct the trust investments and also distributions to your family. 

If you would like to discuss  how the new french – U.S. tax treaty  gives french citizens preferred inheritance tax strategy, then contact me at [email protected]  

You can learn more on how the  French U.S. Estate Tax Treaty Gives French Citizens a Preferred Inheritance Tax Strategy  on this link.  This page has the IRS international estate tax treaty explanation.  This IRS page applies to all estate tax treaties. 

Why You Will Always Pay too Much in Taxes

Nothing is more complex than income tax. Yet, most small business owners meet with their CPA at year end with the fantasy that this will save taxes. At best, it reduces this year's taxes by increasing next year's taxes.

Einstein stated that “The hardest thing to understand in the World is the income tax.”  Yet, most small business owners meet with their CPA at year end with the fantasy that this will save taxes. At best, it reduces this year’s taxes by increasing next year’s taxes.

  Think of 1,000,000 pages written over 100 years by different people with different agendas.  Big Business exploits this complexity by hiring the best international tax accountants. 

However, small business sees the international  tax accountant as an unwanted expense. 

The complexity is caused by the process. Great Depression tax laws apply to international businesses.  World War II tax laws apply to small (and big) business.

Starting  50 years ago (1967), our Government began using  “patches” to get the Tax Code to make social changes (this is known as socialism).  The current tax reform is more than 400 pages of patches. 

Now, don’t blame anyone party.  Both sides jumped on patch bandwagon.  The result is 1,000,000 of pages of conflicting laws.

Most small business owners budget an hour or so of their CPA’s time for “year-end” tax planning.   Meanwhile, the news reports that firms like General Electric have 2.3% tax rate over the last decade.     GE’s tax department is larger than all of the IRS’s international tax department.

Great firms invest in their tax structure.   Business tax planning fees are tax deductible. Here, in my lovely state of California, $10,000 in tax planning fees is only $4,700 of after-tax dollars (our marginal highest tax rate is  53%).

While the conflicting laws are very complex, they create 1,000s of international tax accounting strategies.   Here are a few:
1.  Cash advance payments can be tax-free for decades (more on this link).
2.  Small business owners over age 57 have huge tax savings with private pension plans
3.  Importers can use the Bush administration contract manufacturing laws to avoid taxes (more on this link) legitimately.
4. The IRS has designed a new type of trust to help you avoid state income taxes and protect your assets (more on this link).
5.  President Reagan’s privately owned insurance company tax law allow you to have your insurance company.  You can self-insure and pay your domestic insurance corporation up to $1.2 million a year tax-free.  This is known as a captive insurance company (more on this link).
6.  Defer taxes (like Disneyland) with gift cards and other private money (more on this link).  Use an offshore corporation as the “maker” of the gift cards. 

Thousands of International Tax Strategies used by the best International Tax Accountants

International tax accountants do not have a book of these.  Your CPA must spend time with you and learn the details of your business.  Your tax loophole maybe your inventory method, your e-commerce website, your multi-state transactions, your business insurance (or the items that you are not insuring) and the list goes on.

Domestic Tax Planning collaborates International Tax Planning

For example, Bob has a successful web based business.   He has a few part-time employees and independent contractors assisting him.   He wants to be a tax haven. Yes, Bob, himself wants to be a tax haven.  He learned about the new solo 401-K tax law.  Bob can be the sole trustee, sign on the bank account, buy real estate that is financed, buy stocks, bonds, and stock funds.   Like former Presidential candidate Mitt Romney, he uses the solo 401K plan to own tax haven offshore corporations (more on this link). 

He started the fund in November.  By January he placed more than $100,000 tax deductible dollars into the plan.  This saved him $50,000 in taxes.  Of course, the investment profits will be tax-free.  He hired a law firm to establish the plan and maintain the plan.  The cost over two years is $10,000 deductible dollars (so after tax $5,000).    $5,000  saves $50,000.

Bob also used a 1954 tax law on medical reimbursement plan.   He paid $15,000 to his attorney to draft the plan.  This plan does not have to file a tax return, so there is no annual cost.  The plan pays for all the supplements required by his doctor, his co-pay, and therapies not covered by insurance.   He saves $10,000 a year in taxes for a $5,000 one-time deductible ($2,500 after-tax) cost.  $2,500 saves $10,000 year after year.

If you would like to discuss your tax concerns, ,then email me, Brian Dooley, CPA, MBT, at [email protected].

Foreign Passive Investment Funds (PFIC) Tax Plan with a Controlled Foreign Corporation

The foreign passive investment funds (PFIC) controlled foreign corporation uses a little known law.  It is called the “overlap rule”.

Seems almost impossible when two anti-taxpayers international tax laws can save you taxes. This is what happens with the Congress does not understand basic accounting.    For every debit (which in accounting is a plus “+”) there is a credit (which is minus “-“),

This axiom is the foundation of all income tax loopholes because this tax is a tax on accounting income.

When a holding company owns investment funds,  U.S. tax law collapses.  A few years ago, Congress could leave well enough alone.  Instead, they enacted a vague law requiring the income under the passive foreign investment company (“PFIC”) tax law to be reported by the U.S. shareholder of a foreign holding company.

The most popular foreign investment funds have been the Vanguard Investment funds managed from Dublin, Ireland.   These funds fit the definition of a PFIC.

From “reporting” the tax law vaguely implies that the shareholder pays tax on the PFIC’s income (if any and this if any has it’s on tax planning on this link).

The U.S. shareholder has to IRS Forms to file.  They are Form 5471 and Form 8621.  These two forms don’t integrate with each other.

I talked to the IRS International attorney in charge of form 8621 and PFIC taxation regarding this.  He knew of the problem but had no plans to fix this.   And why?  My guess is that it can’t be fixed because the two tax laws do not integrate.

Thus, your international tax accountant has many options in your tax planning when he prepares your Form 5471 and Form 8621.  Too many for me to fit them all into a blog.  One option allows you to convert ordinary income (called Subpart F income) into long term capital gain income.

However, a video will help your the tax preparer of your Form 8621.  I used this video for my international tax class for the California Society of CPAs.  This means that unless you are an international tax  CPA, you will find it boring and while debit and credits are boring. they are the focal point of tax loopholes.

If you need help in preparing your Form 5471 or Form 8621, then contact  me Brian Dooley, CPA, MBT at [email protected]