Tag Archives: avoiding the branch profits tax

International Tax CPA Prepares Form 1120F and Avoid the Branch Profits Tax

The International Tax CPA know that the branch profits tax is a sneaky beast.   It has three prongs.  One is your interest expense. Next, the amount of equity in your U.S. business,  Lastly, the reason you have equity in your U.S. business.  This tax is reported on Form 1120F.

If you kept equity in your U.S. business to avoid the branch profits tax, then you owe the branch profits tax.   Form 1120F’s balance sheet is where you study this topic.

The branch profits tax is designed after the domestic corporate tax law known as the “accumulated earnings and profits tax”.  This law is found in tax code section 531.  This key factor is the accumulation of profits to avoid paying a dividend (and thus the income tax on the dividend).

International Tax CPA and the Form 1120F

My course to the California Society of CPA’s on international tax planning included the branch profits tax.  Below is part of the course.   If you need help with your international tax planning, then contact me at [email protected]

This course was for the international tax CPA. So, you may find the video too complicated. I suggested that you forward this blog to your CPA  (if he is not an international tax CPA).

Here (this link) is more information on the branch profits tax.  The tax is tricky.

If you have paid the tax, then let us see if we can get the IRS to refund branch profits tax to you.  I can tell you one way to know if your CPA has messed up.

If your business does not have a double entry set of accounting books (called a general ledger), then the branch profits tax calculation may be wrong.

CPA International Tax – How They Avoid Small Business Taxes

The topic “CPA International Tax – How They Avoid Small Business Taxes” seemed to obvious to me.  Yet, yesterday Ian called and question why this foreign corporation should have a general ledger.

Now, here is the problem.  Most of my readers (now almost a 100,000)  would ask me the same question.  Worse, most of them do not know what a general ledger is.

14% is the average tax rate of Big Business (on this link).  44% is the tax rate of small business.  Big Businesses always have a general ledger.  

CPA International Tax – How They Avoid Small Business Taxes by Using the General Ledger

It is process of creating the general ledger.  Back in the days when “Columbus sailed the Ocean Blue), a smart business owner was tired of being cheated by his staff.  He needed “internal control” to prevent theft.    He and his accountant came up with a new bookkeeping theory.

Please remember, this was new theory in 1490.  So, if you are not using it, you are about 500 years behind the times.

The process is posting each transaction twice. Once as  a positive number and again as a negative number.  This is called “being balance”

When I add up all of the postings, the sum is zero.

A good CPA (by that I mean if yours is not doing this, fire them) does a “workpaper” for each account in your balance sheet.    By doing this he tracks the changes in your net worth.

The change in your net worth is alway your net income minus your draws.  This is the only way to determine that you have the correct amount if net income.

As your CPA prepares the workpaper, he will see tax saving opportunities.  Without these workpapers, it is doubtful that he will see them.

Back to Ian and his query of  a CPA International Tax Specialists

A foreign corporation pays income taxes and also another tax, the branch profits tax (learn how to avoid this tax on this link). 

This tax is the corporation’s net worth reduced by draws.    Remember what I wrote above about “net worth”.   

Ian’s CPA took a shortcut. It cost a quarter of a million dollars.  The foreign corporation paid branch profits tax that it did not owe.   All that to save the cost of preparing a general ledger.

A general ledger will find other tax savings.  Remember (on this link) that Big Businesses average tax rate is 14%, 

If you need help saving taxes, then contact me, Brian Dooley, CPA, MBT at [email protected]

 

Avoiding the Form 1120F- Foreign Corporation Branch Profits Tax Trap

Preparing the Branch Profits Tax section of the IRS form 1120F  has trapped many foreign investors in U.S. real estate and with US business operations.

 In addition to paying income tax on your profit, the foreign corporation pays tax again on the change in the value of its U.S. business. 

The branch profits tax is based upon a law from the 1950’s. The section 531, tax on accumulated earnings, was deadly to a small business.  However, now most small businesses operate in S-corporations or limited liability company. Since entities of this type are pass through, avoid section 531 does not apply.   Because of this many tax professionals are unaware of this law.

The branch profits tax is just as deadly to the foreign business.  This tax applies if the foreign corporation has income effectively connected with a U.S. business. The applies if the corporation has either a permanent establishment of a fixed place of business.

 If you want help preparing your Form 1120F, then call me Brian Dooley, CPA, MBT at 949-939-3414.

Some CPA’s are advising their clients that keeping assets on the American branch office balance sheet avoids the branch profits tax.    Just holding assets on the books,  does prevent the branch profits tax.  The assets must be continued to be used in an active corporate business.

Section 531 (a tax on accumulated distribution) is the concept used when the branch profit tax was enacted.  Under this section, the corporation must prove the business reason for keeping liquid assets.   The point of section 531 is to cause the second tax.  This is a tax on a dividend that the corporation has refused to distribute.

Likewise, the IRS can impose the branch profits tax when a foreign corporation with a US branch merely retains liquid assets just to avoid the tax.   

Upon a distribution of property to the shareholder of a foreign corporation, the 30 percent branch profits tax apply.  Similar to section 531, corporation needs to maintain ongoing director minutes, shareholder minutes and business plans explaining why assets are not distributed to the shareholder or the home office.

Learn about winning the IRS audit of the branch profits tax on this link.   On this link, find out more innovative methods to eliminate both the branch profits tax and foreign corporation income tax on this link.   If you need help with an international tax audit, then contact me at [email protected]

tax planning, international tax strategies, foreign tax strategies, foreign tax plan, international tax plan, offshore tax,

Learn how to save taxes with “International Taxation in America for the Entrepreneur” using tried and true methods.

If you would like to us to prepare your Form 1120F,  then please call me, Brian Dooley CPA, at 949-939-3414.  

Learn move about international tax planning with my easy to read book, International Taxation in America for the Entrepreneur available at Amazon on this link.  The book takes about two hours to read.

 

 

International Tax CPA Accountant for Preparation of Form 1120F

Email Template Header

Get an international tax expert and pay the least in taxes with your Form 1120F.

Brian Dooley, CPA, MBT is an expert in international tax.  Your foreign corporate income tax return has three parts.  Each part is independent and has its own international tax laws.

Brian is the leading specialist in the branch profits tax and effectively connected income tax accounting.  His book, International Taxation in America is a textbook on issues such as permanent establishments in the United States by a foreign corporation.

Give Brian a call at 949-939-3414 and discuss your tax concerns. Brian is located in Orange County, California.

He truly is an expert, He testifies at the Department of U.S.Treasury, the Congress and the U.S. Senate.   He is an instructor for the California Society of CPAS and the Graduate tax  Program for the California State University System.

 

Minimizing or Eliminating the Branch Profits Tax and Reducing U.S. Taxable Income for the Foreign Corporation

This blog is a subpage  “Avoiding the Form 1120F- Foreign Corporation Branch Profits Tax Trap”  on this link.

At thirty percent, the branch profits tax worth avoiding.  There are some options foreign corporations use for minimizing or eliminating the branch profits tax and U.S. corporate income taxes.  They are:

(1) Increase salaries and bonuses within the reasonable compensation rule limit to the shareholders/employee.  To the extent they work outside the U.S., the salary is exempt from U.S. taxation.

(2) Provide more fringe benefits (e.g., a qualified pension plan). The plan can be a domestic plan or a foreign plan.  Certain tax savings are available if the plan is funded with assets in a foreign trust.

(3) Have the corporation pay a “stewardship fee” to the home office. A “stewardship fee” is a payment for the benefit provided by the home office[1].

(5) Pay dividends, including, perhaps, a consent dividend.

(6) Redeem stock, using a deferred payment obligation as consideration. Accumulating money to pay for a redemption is not considered a valid purpose for accumulating earnings but redeeming now and paying off the debt later is permissible.[2]

(7) Establish a qualified pension plan. A resulting unfunded pension liability should reduce unreasonable accumulations.  The plan can be within the U.S. or outside the U.S. If many of the  U.S. branch employees are not U.S. citizen, the foreign pension plan will have an advantage in the long run.

(8) Recapitalize the corporation to shift dividends to selected shareholders such as those residing in a treaty partner country.

(9) Buy business assets instead of leasing them.

If you want to increase the quality of your tax planning, then email me, Brian Dooley, CPA, MBT, at brian@intltaxcounselors.com.

Footnotes:

[1] The following is from an IRS web page: Foreign Corporations (FC) may operate in and earn taxable income in multiple jurisdictions including the U.S. In the case of an FC operating in the U.S. through a formal or de facto branch, the FC is required to file a Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, and may have a U.S. tax liability.

The FC is required to calculate its taxable income and report the earnings of the U.S. branch (USB) that are effectively connected with the conduct of a Trade or Business within the U.S (Effectively Connected Income, or ECI). As part of this calculation of ECI, the U.S. branch is allowed to deduct expenses associated with the earning of such income. The amount of expenses related to the ECI is generally deductible in the calculation of ECI based on normal domestic principles such as “reasonable” and “ordinary and necessary.”

Taxpayers should report total expenses that are related to ECI on line 11, Part I, and line 39(a), Part IV, of Schedule H (Form 1120-F). Indirect expenses, such as those expenses incurred by the foreign headquarters, or a brother-sister branch, on behalf of the U.S. branch, and related to the trade or business of the U.S. branch in earning its ECI, may also be deductible in part, or possibly, in whole. It is necessary that the FC make an allocation and apportionment to the U.S. branch of these types of expenses to clearly reflect ECI.

The methods and principles of Treas. Reg. Secs.1.861-8 through 1.861-17, 1.861-8 through 1.861-14T, and 1.882-5 ( the 861 and 882-5 regulations), as well as the general rules for deductibility as stated above, apply. In general, the regulations require that deductions be allocated to gross income based on a reasonably close factual relationship. Taxpayers should report total indirect expenses apportioned to ECI on line 16, Part II, and line 40(a), Part IV of Schedule H (Form 1120-F).

This means that in earning gross income of a particular type or class, certain expenses may be necessary. The deductions resulting from such expenditures are allocated and apportioned to such gross income to the extent that a reasonably close factual relationship exists. As always, the resulting taxable income must be clearly reflected.

[2] 6/ Mountain State Steel Foundries, Inc. v. Commissioner, 284 F.2d  737 (4th Cir. 1960); C.E. Hooper, Inc. v. Commissioner, 539 F.2d 1276  (Ct. Cl. 1976).