International cross border management consulting fees deducted on a U.S. tax return are traced by the IRS. This expense can place you in jail if you can not prove why the fee was paid.
The IRS is hunting for management fees or consulting fees paid to or from a foreign business. The United States is the only country that puts you in jail for ignoring the economic substance of a transaction.
Mr. Albert S.N. Hee was sentenced to 46 months in prison. He was a successful businessman in Hawaii. To get money out of his U.S. corporation, he paid his wife and children about $750,000. He deducted the expense on his corporate tax return claiming that they were providing services to his business.
When the IRS found out the truth, he was arrested on various criminal charges. The easiest one for the IRS to prove was filing a false tax return. All the IRS has to prove is the Mr. Hee placed an item on his return (the expense) that was not true. The IRS does not need to prove that taxes were avoided.
Take Mike as an example. He is Canadian and lives in Vancouver. He has invested in a U.S. business. He has provided the startup money to an e-commerce business and owns 25% of the business (operating as a limited liability company). Mike does not want the complexity (and therefore accounting fees) of filing a U.S and state tax return.
Mike is taking his share of the profits as a management fee. He spends time getting an update report from the other owners but he is not managing the business.
He is paying Canadian taxes on the income but no American taxes. The criminals are the LLC, its managing members, and Mike. Often the IRS will add the criminal charge of “conspiracy to defraud” and mail fraud.
What should have Mike have done?
For a Canadian, an American LLC is not the best choice. Since Mike is not involved with management, a limited partnership is a good option. Under the Canadian-United States Tax Treaty, Canada will offset his Canadian income taxes by the U.S. income tax.
The limited partnership will make the estimated tax payments for Mike. Mike will get one or two-page report (call a Form K-1) from the partnership telling Mike the amount of his taxable income and the amount of estimated taxes. Mike will file a U.S. and state income tax returns.
Yes, it is a hassle. But other international businesses see this a part of the cost of being an international business. Usually the CPA fees for the returns are less than $5,000. By the way, the fees are a tax deduction.
Judges are harsh on non-U.S. citizens saying to the defendant that they came to America to make money. Unlike citizens who have no choice but to pay taxes, the nonresident alien came here by their own choosing.
If you need help in organizing your international business transactions, the email me, Brian Dooley, CPA, MBT at [email protected]