Identifying and Reporting the Proper Taxpayer in International Structures

One of the main issues in U.S. tax law is figuring out who is responsible for paying taxes on certain income. It can be tricky when dealing with non-U.S. entities, as their classification for tax purposes is really important. Sometimes, the person or company getting the income isn’t actually the one responsible for paying taxes on it. The IRS and U.S. courts have looked at complicated income and planning structures to figure out who should really be paying the taxes. Because the IRS pays close attention to transactions and tax planning involving other countries, tax experts need to be very careful when giving advice about U.S. tax responsibilities. Offshore companies can choose how they want to be taxed in the U.S. by filling out a form. If a foreign company chooses to be taxed as a disregarded entity or a partnership, its shareholders will have to pay U.S. taxes on the company’s income, even if they don’t get any of that income. But they can get a credit for any taxes the company paid to its local government. This is important for shareholders in high-tax countries because it helps them avoid being taxed twice. And if the company loses money, its U.S. shareholders can use those losses to lower their own taxes. Choosing pass-through treatment for a foreign business entity can be a smart tax decision for U.S. owners. It can help avoid certain taxes, limit taxes to one level, and potentially qualify for lower capital gains tax rates. For foreign partnerships with multiple owners, it may make sense to default to partnership status for U.S. tax purposes, unless it’s more beneficial to be classified as a corporation. One way the IRS might “pierce” the ownership of a partnership is if one person or company effectively controls the partnership and the other owners have very little or no real ownership. This could affect how the partnership is taxed and could also impact estate taxes. However, it could be hard for the IRS to prove this if the other owners have at least a one percent stake that they bought with their own money. Basically, foreign trusts don’t have a specific option to choose their tax status on a form, like other types of entities do. They have to show that they are a trust through their paperwork, how they operate, and their tax filings. In some cases, a foreign trust might want to choose to be taxed like a corporation to avoid certain taxes. This could be helpful if the trust owns property in the U.S. and the person who set up the trust isn’t a U.S. resident or citizen. They might be able to make this choice even after they die, to save on taxes. In some countries, there are civil law foundations that act like trusts in common law countries. They are managed by a board instead of trustees, and are recorded in public records. The debate on whether trusts or foundations are better for tax and estate planning in the US has no clear answer. Depending on certain factors, a civil law foundation can be treated as either a trust or a corporation for tax purposes, which can affect estate planning. If the founder or anyone involved with the foundation is a US citizen or resident, they must report the foundation’s assets and income to the US government. A limitada is like a limited liability company, and for U.S. tax purposes, it can be treated as a single-owner company, a corporation, or a partnership. A comandita is a type of partnership in certain countries, and for U.S. tax purposes, it can be treated as a corporation or a partnership with the right election. A fideicomiso is a way for U.S. people to invest in property in Mexico. It’s like a mix between a trust and a custodial agreement. At first, the IRS said you had to treat it like a foreign trust for tax purposes, but then they changed their mind and said you don’t have to. It’s important to be careful and make sure you understand the rules before deciding how to report it for taxes. The IRS can treat a company as a sham if they believe it’s being used to avoid taxes. They’ve done this with international companies and individuals with offshore income. It’s harder for a company to do this on their own. If a foreign company is acting on behalf of someone else, that person is considered the real owner for tax purposes. US courts have ruled that a company can be considered a nominee for the true owner of assets under certain conditions. In National Carbide Corp. v Commissioner, the U.S. Supreme Court laid out six factors to determine if a corporation is acting as an agent for a principal for tax purposes. These factors include the name and account the corporation operates under, if the principal is bound by the corporation’s actions, and if the corporation transmits money to the principal. It’s important to have written documentation to prove the existence of a corporate agency agreement, but it’s not always necessary. In another case, written agreements specifying the corporation’s role as an agent were upheld by the Supreme Court. However, a purported agency relationship was considered a sham when the written document was ineffective, and the actions of the parties were inconsistent. It’s better to have a written agreement to confirm the nominee/agency relationship, but an oral agreement may also suffice under certain circumstances. Some people try to use foreign companies to avoid paying taxes in the US, but the IRS is cracking down on this. Even if they use a foreign company as a “blocker” to hide their assets, they are still required to report everything to the US government. The IRS is catching on and prosecuting these people. It’s important to follow the rules and pay taxes on all your income. Under certain IRS programs, taxpayers can disregard their own foreign entities as long as they report all their assets and income from these entities and dissolve them before finalizing their agreements with the IRS. The IRS allows taxpayers to admit to using their foreign entities as a cover for their own assets, and in return, the IRS will waive the requirement to file late information returns for these entities. The taxpayers must also confirm that they will dissolve these entities before finalizing their agreements with the IRS. It is likely that the IRS will treat these foreign entities as disregarded for all other tax purposes. Classifying foreign entities for U.S. tax purposes can be complicated. The rules provide flexibility, but there are many tax and estate planning considerations to think about before creating or changing a foreign investment or business involving U.S. persons. It’s important to understand the potential tax consequences and seek professional advice. This passage discusses legal cases and provides examples of how shares or assets are owned and controlled by specific individuals or entities. It also mentions the professional background of a lawyer named Leslie A. Share. This information is provided on behalf of the Tax Law Section. The Florida Bar is also mentioned, along with its mission statement.

Source: https://www.floridabar.org/the-florida-bar-journal/identifying-and-reporting-the-proper-taxpayer-in-international-structures/