Tax Attorney California

Expatriation! Why and Why Not!!!

sandylaw — Sat, 12 May 2012 21:24:31 +0000

The headline news that a co-founder of Facebook has given up his U.S. citizenship to avoid income and estate tax may trigger a lot of interest in expatriation. Some people will read the news of the expatriation of Mr. Sevarin as validating expatriation for tax purposes. The process of giving up U.S. citizenship has several compelling and discouraging aspects, particularly for those taxpayers who have assets offshore.
To expatriate legally, a U.S. citizen must file Form 8854 with the IRS in which they certify that they are in compliance with federal tax law. This includes foreign asset disclosure and foreign income reporting. The soon to be expatriate must also pay an exit tax of 15% of the appreciated value of all their property subject to a statutory exclusion of $600,000 adjusted for inflation.
All of the technical issues are discussed in IRS Notice 2009-85. The key point for consideration is that the taxpayer must obtain or already have a second citizenship before surrendering their U.S. Passport at a U.S. Embassy and filing Form 8854, otherwise the expatriate will be a “stateless” person.
A reason for renouncing citizenship is to limit the income and estate taxes. The elimination of the “Bush Tax” when they expire December 31, 2012 will result in estate taxes being imposed on estates of $1.0M or more instead of $5.12M as they now. The estate tax rates will also go up from 35% to 55%. So, an individual who has assets of $5.12 M will have an estate tax of $2,266,000 January 1,2013 instead of zero now.
For an individual that has assets that are likely to appreciate the possible increase in capital gains tax when the “Bush” tax cuts expire may also a factor. The capital gains income tax rates will go up from 15% to 20%. That means every $1.0 M in gain costs an additional $50,000.
Both the income and estate and gift tax apply to worldwide income and worldwide assets.
The choice for some taxpayers, (about 1,800 per year) is to give up their U.S. citizenship and more to a jurisdiction which lacks the worldwide approach to taxation. Some will move back to their country of origin, others will take up citizenship in “tax havens”. Regardless, expatriation is for some a form of tax protest. It is not an answer, however, for those who currently have unreported foreign financial accounts, and have failed to file FBAR’s or otherwise make proper disclosures on. These people still run the risk of civil and criminal penalties and should consider the Offshore Voluntary Disclosure Program (OVDI) instead of expatriation. Other should consider immediate gifting programs, including charitable contributions as part of their tax planning strategies.

Why Asset Protection Trusts May Fail

sandylaw — Sun, 06 May 2012 16:35:11 +0000

In a recent federal income tax collection case, the trial court discusses the reasons why an asset protection trust failed to protect assets of a taxpayer from a tax levy. The court in Evseroff found that all the assets of an irrevocable trust were subject to collection by the IRS for the tax liability of the creator (settlor) of the trust. The court found that the transfer of assets by the taxpayer to an irrevocable trust was done with the actual intent to “avoid, hinder or delay” the collection of income tax. The court found that the critical element in the analysis was the degree of the taxpayer’s retained control over the assets of the trust.
The court look at whether the trust could be held responsible for the debts of the taxpayer under several theories. Was the trust the “alter ego” of the taxpayer or was it the “nominee” of the taxpayer. Under the “alter ego” theory the court would look at whether the taxpayer exercised control over the entity (the trust) and under the nominee theory the court looked at whether the taxpayer exercised control over the property transferred to the trust. Under both approaches the test ultimately comes down to whether the taxpayer exercised active or substantial control over the property.
One of the interesting features of Evseroff, is that the taxpayer appointed a series of family friends and business associates to serve as trustees, instaead of an institutional trustee. The court found the degree of influence and control retained by the taxpayer coupled with the lack of formalities was fatal to the purposes of trust and subjected the trust assets to the tax liabilities of Evseroff.
The Evseroff case is a good lesson to taxpayers who want to retain control of their assets and yet create a firewall from creditors. The more control the taxpayer has the more likely the IRS will be able to successfully attack the trust. Evseroff was not criminally charged as this was a only a civil action for collection.
Of particular note is the nature of the attack by the IRS could just as easily apply to offshore asset protection trusts. Here though there are now specific disclosure rules that could, if violated result in criminal charges being brought. Under IRC Section 6048D assets transferred to an offshore irrevocable trust are deemed to be the assets of the taxpayer and subject to disclosure on new Form 8938. Form 8938 is part of Form 1040 and the failure to disclose assets which are required to be disclosed could result in charges for subscribing to a false tax return ( a false statement crime). The taxpayer in these circumstance may also have to file a Report of Foreign Bank Account (FBAR). As many taxpayer’s now know, the failure to file an FBAR on a timely basis has severe civil and criminal penalties.
Whether the risk is civil or criminal the costs of defense alone should cause taxpayers to carefully consider true and accurate disclosure for offshore trusts and for all asset protection trust, the maintenance of rigorous formalities.

Minimize Estate Tax on Foreign Assets

sandylaw — Sun, 29 Apr 2012 23:15:34 +0000

A recent U.S. Tax Court case provides a road map to minimize estate tax liability. In Wandry v. Commissioner the Tax Court held that a gift of an interest in a closely held business that was defined by dollar amount rather than percentage interest could successfully limit the tax consequences of the gift. The case allows a taxpayer to gift business interests, such a stock in a closely held business, (either on-shore or offshore) to be based upon a stated (defined) value which could be limited to the then prevailing estate and gift tax exemption. Example: Gifting $5,120,000 of stock in closely held corporation.
For U.S. taxpayers with interests in closely held businesses, including partnerships, limited liability companies and corporations that are located offshore (specified foreign financial assets) valuation of those businesses can be complex, take time and may be subject to differences of opinion among appraisers. Yet, these interests under pre-Wandry rules would have been gifted on a defined percentage interest basis. Example: gifting 5% of the stock of a closely held business. The risk of the defined percentage method is that if the IRS establishes that the gift was undervalued the donor may be subject to gift tax. Under Wandry, the donor can make a current gift of a business interest of a stated value, such as the current exemption of $5,120,000, and rest confidently in the knowledge that the percentage interest will be adjusted if there is a valuation adjustment later.
With the current Estate and Gift Tax exemption scheduled to role back from $5,120,000 at the end of 2012 to the 2009 levels of $1,000,000 now is an important moment to consider gifting using the defined value method. For holder of interests in foreign closely held businesses this is a particularly important opportunity to potentially limit U.S. taxation of their offshore holdings.

Estate and Gift Tax Trap for Owners of Foreign Assets

sandylaw — Mon, 23 Apr 2012 01:37:48 +0000

The Congressional Research Service (CRS) just published an analysis of the effect of extending the “Bush”tax cuts. Included in the expiring tax cuts are estate and gift tax rate cuts. If the tax cuts are allowed to expire then the estate tax will go from an exemption equivalent of $5,000,000 and a top bracket of 35% to an exemption equivalent of $1,000,000 and a top bracket of 55%. This change is likely to have an adverse effect on many U.S. taxpayer’s including those that are dual nationals or who otherwise have assets in foreign jurisdictions.

There are now in place numerous foreign asset disclosure requirements. Under the Bank Secrecy Act, U.S. taxpayers with foreign financial accounts that aggregate $10,000 or more in a calendar year must file a Report of Foreign Bank Account (FBAR) separate and apart from their income tax returns. As part of the HIRE Act, U.S. taxpayers must also file a Statement of Specified Foreign Financial Assets (Form 8938) if they own “specified foreign financial assets (not limited to bank account) that are $50,000 in value at year end or $75,000 at any point during the year. The Form 8938 is filed along with the taxpayer’s income tax return.
Form 8938 is something of a road-map for income, estate and gift tax purposes. It sets forth values and descriptions of foreign held assets, including interest in privately held businesses and partnerships. If the Bush tax cuts are allowed to expire U.S. taxpayers with what may very well be illiquid foreign assets may find themselves with insolvent estates because of the (a) reduction in exemption equivalent from $5,000,000 to $1,000,000 and (b) an inability to dispose of the foreign asset or otherwise raise the money to cover the estate or gift taxes.

These changes may move some taxpayer’s to consider the source of their foreign assets. Were those assets acquired with after tax income, or by gift or bequest? If by gift or bequest was a Form 3520 required to be filed and was it filed? If not, is there a “reasonable cause” for not filing timely? Substantial penalties may apply if Form 3520 was required and there is no “reasonable cause” for not filing.

The value of such gifts or bequests may also be the subject of considerable debate in dealing with valuation for U.S. estate and gift tax purposes. If the interest acquired is a minority interest in a closely held business a competent appraisal may be needed. The use of such an appraisal may be of great importance in establishing that a Form 3520, Report of Foreign Gift or Bequest was not needed.

Given the dramatic changes in the estate and gift tax rates that may occur by January 2013, it is important for all U.S. taxpayer’s including those with foreign assets to consider whether they (a) need to clean up their asset reporting by either a voluntary disclosure or late filing of required returns, (b) implement a gifting strategy or both.

How will foreign assets affect your U.S. Estate and Gift Tax Obligations?

sandylaw — Tue, 10 Apr 2012 01:06:04 +0000

The U.S. taxes income worldwide and it also imposes estate and gift taxes on assets held worldwide. Many other countries operate on a “territorial” system where only income earned or assets located within the country are subject to taxation. Throughout the last several years I have had many clients who were unaware of the global nature of the U.S. taxation system and therefore, found themselves facing penalties for failing to report foreign income, interest and dividends and failing to report accounts in foreign financial institution. Some clients failed to file a Report of Foreign Bank Account (FBAR) or failed to report foreign gifts, bequests or trust transfers (Report of Foreign Gift, Bequest or Trust Transfer). Some failed to file reports of controlled foreign corporations (CFC) or controlled foreign partnerships (CFP) or file other required information returns. Many of these clients are U.S. citizens living abroad. Some have lived abroad decades and have raised families in other countries. For these clients an explanation of the specific facts and circumstance of their non-compliance may provide a “reasonable cause” defense to penalties. But some of the clients are immigrants to the U.S. and have green cards or are naturalized citizens who fact disclosure requirements as well. A third class of client is the U.S. citizen who has business interests abroad who may have failed to properly report foreign held investments or active trade or business interest. Regardless of the client group, all will likely be subject to significant issues as a result of two factors.

First, for 2011 income tax returns a new Form 8938 (Report of Specified Foreign Financial Assets) is required for taxpayer’s with investment (intangible) assets held abroad the exceed specified valuation thresholds of $50,000 at year end for resident individuals $100,000 for resident couples who are married filing jointly. Higher limits apply for U.S. taxpayers living abroad. If the year end values are less than the threshold, there is also an alternative value of $75,000 during the year for u.S. resident individual taxpayers and $150,000 for couples who are married filing jointly. The disclosure or non-disclosure of specified foreign financial assets for 2011 may ultimately be used by the IRS to accept or reject claims of reasonable cause for past non-compliance, but may also provide a road map to assets for estate and gift tax purposes. All tax practitioner’s must be careful to advise clients about the client’s disclosure obligations and take special notice of IRS Circular 230 rules of practice. Deliberately aiding clients in non-disclosure can result in criminal charges against the practitioner and the client(s) under the Omnibus Clause of the IRC Sec 7206(2).

Second, there is a distinct possibility that the current estate and gift tax exemptions will not be extended. These were part of the “Bush” era tax cuts. If the current estate and gift tax exemptions of $5,000,000 per person (adjusted for inflation) are not extended then the law reverts to the 2009 limits of $3,500,000 for estate taxes and $1,000,00 for gifts. Because of the political environment and likelihood of no-action by Congress this year, U.S. taxpayers with estates greater than $3,500,000 or who would like to make gifts greater than $1,000,000 to reduce potential estate taxes, now is the time to consider taking action. Actions can include fractional gifting of interests in offshore investment assets (Specified Foreign Financial Assets) while the opportunity exists. If the Bush Era tax cuts are allowed to expire, then the gift tax exemption drops from the current (unified estate and gift tax credit equivalent) of $5,000,000 to $1,000,000. That means a lost opportunity to reduce potential estate tax. In addition to the difference in the size of the taxable estate, (going from $5,000,000 exemption to $3,500,000) the maximum estate tax rate increases to 45% from 35%. So on a current taxable estate of $5,000,000 the estate tax goes from zero to $675,000 (45% X 1,500,000). By delaying, assuming no gifting is done the cost is at least $675,000.

Valuation strategies and approaches are critical in dealing with foreign assets. In making a gift of an interest in an offshore asset, whether it is an interest in a closely held business or real property, competent appraisal reports should be prepared, particularly if fractional interests are gifted. The valuation should be reasonably close in value to the valuation reported on the Form 8938, (presuming that the asset is reportable). Gifting strategies can include gifts to irrevocable trusts, charitable foundations, or other gifting devices, depending on the needs and desires of clients.

The ultimate conclusion is that because the U.S. has a worldwide income tax and estate and gift tax system, care and attention needs to be paid to all reporting obligations and tax liabilities. The penalties for non-disclosure of foreign assets can be severe including FBAR penalties which range up to 50% to annual account balances to tax penalties and prosecution. The other problem with non-disclosure is that the failure to disclose may prevent proper estate and gift tax planning. For those taxpayers who recognize the importance of proper and timely estate planning, now is the time to consider coming forward. A well constructed reasonable cause argument and a proper gifting strategy may be of great value in the long run when put forth in the proper form. For some clients the form will be an Offshore Voluntary Disclosure, for other clients filing of unfiled information returns with a reasonable cause explanation my be adequate. Careful analysis of each client situation and client’s plans are the key to a proper recommendation.

Finally, I am introducing my video blog http://www.youtube.com/watch?v=9RYcHiAAwoY

Income Tax follows Actual Ownership of Foreign Account

sandylaw — Sun, 08 Apr 2012 00:32:12 +0000

I have seen the following scenarios quite often in working with clients to determine whether a voluntary disclosure (OVDI) is appropriate and how they should report foreign account.

First, a parent or grandparent entrusts a younger generation family member with management of family assets. Often these assets are set aside by persons who are foreign nationals who are living outside the U.S. and not subject to U.S. taxation. The funds are often not reported to or in many cases are hidden from their native government. The persons engaging in this conduct are often oppressed minorities or expect to be political or religious refugees and the funds are flight capital.

Second, the account is often opened in the sole name of a member of the younger generation charged with fund management on the condition that he or she use the funds only as directed by the family elder. In cases that I see, the account holder is now a U.S. taxpayer.
The second circumstance I often see is where the elder family members deposit funds into an account and have members of the younger generation sign on as powers of attorney or beneficiaries. Often the funds are intended as either current or future gifts. The younger generation beneficiaries are U.S. taxpayers while the elder may not be or was not at the time the account was opened.

The reporting obligations follow the beneficial use of the funds in both cases. The U.S. taxes income and estates and gifts on a worldwide basis. So, if a U.S. person has actual dominion or control over the use and enjoyment of funds in foreign accounts, then the accounts are reporting laws and income from the accounts is includable in the U.S. persons tax returns. If the funds were acquired by gift or bequest a Report of Foreign Gift or Bequest(Form 3520) may also need to be filed.
Whether the U.S person has dominion or control over the account is determined by subjective and objective factors. Objective factors include (1) whether there is a written agreement between the parties and its terms, and (2) how the funds were actually used. Subjective factors are cultural backgrounds of the parties (what is the custom and practice for the specific community). In some cultures the parents open accounts in the names of their children and do not tell their children about the existence of the accounts for years.
I am often asked whether a voluntary disclosure (OVDI) should be filed by U.S persons who are in one of these scenarios. The answer is often, it depends. It depends on the facts. Most foreign financial institutions are or soon will begin to require proof of compliance with U.S. income tax laws in order to keep accounts in good standing if the account is in the name of a U.S. person. If a U.S. person has the ability to make independent decisions and use the funds and not previously filed FBAR’s or reported the income an OVDI filing may be warranted. In all cases where there is a purported claim of a gift of foreign account funds or an inheritance of such funds, an explanation must be provided to establish “reasonable cause” for not filing the proper information returns (Report of Foreign Gift or Bequest) on a timely basis to avoid severe penalties.
As the IRS focuses more and more resources on international tax evasion techniques and tax evasion careful reporting is a must to avoid penalties, including penalties for tax evasion, tax fraud and FBAR penalties.

An Ostrich is a large bird not an foreign account strategy

sandylaw — Sat, 31 Mar 2012 17:29:45 +0000

In my video blog, http://www.youtube.com/embed/9RYcHiAAwoY?rel=0, I briefly discuss what not to do when considering foreign asset disclosure options. Ducking for cover or pretending that your undeclared foreign accounts will not be discovered is analogous to an Ostrich who hides it head. Information Exchange Agreements between the U.S. and other governments are the rule not the exception today.
Foreign financial institutions are screening their account records for customers who have a U.S. connection and then requesting evidence of compliance with U.S. laws. Even after receipt of requested documents, many foreign financial institutions are asking customers with U.S. residence to find another institution. New IRS Form 8938 give the IRS greater information and enforcement powers. Now, unless taxpayers and (in some cases) their tax return preparers are willing to commit multiple acts of non-compliance the IRS will have a road map to not only foreign financial accounts, but to all sorts of foreign held assets (specified foreign financial assets). The new disclosure will and does have important income, and estate and gift tax ramifications.
Ostrich like actions will require greater and greater risk taking on the part of taxpayers and when and if such hiding fails, the results will likely be catastrophic, meaning possible criminal charges, civil fraud and evasion claims, 40% unreported income penalties, and a potential 50% per year willfulness penalty for failure to file a Report of Foreign Bank Account (FBAR). A better approach is to come forward under the Offshore Voluntary Disclosure Initiative (2012) and deal with unfiled FBAR’s and to truthfull disclose specified foreign financial assets on Form 8938. Then it would be wise to consider estate and gift planning alternative for foreign held assets. Compliance may be the best option and only sensible strategy. Remember, Ostrich is a bird, not a life style.

If you hide assets offshore from a spouse be sure to file an FBAR

sandylaw — Sun, 18 Mar 2012 17:48:51 +0000

A recent Forfeiture Case was brought against a taxpayer who was hiding financial assets (almost $4.6 M) from his soon to be ex-spouse. The case, US v. $4,656,085 (http://goo.gl/7b64A) illustrates how bad divorce planning (asset protection)can lead to worst case outcomes. The taxpayer husband made an effort to hide substantial sums of money in offshore accounts through a variety of structures, including nominee corporations.

The taxpayer’s intermediary, (the person who arranged the structures) is alleged to have been a confidential informant working for the U.S. government.
The taxpayer was repeatedly advised or reminded of his obligation to file a Report of Foreign Bank Account (FBAR) by the confidential informant but refused to do so. He was apparentntly more concerned about the potential discovery of the funds by his soon to be ex-spouse than he was about the civil and criminal consequences of his actions. The result of his seemingly deliberate conduct was the seizure of the funds, and the filing of a Forfeiture complaint by the U.S. What is most ironic, is that the ex-wife has an opportunity to file a claim to the funds in the Forfeiture action. She could end up with the money after all and the taxpayer left without funds, and facing civil and criminal penalties, including charges of tax evasion, money laundering and conspiracy.

How could this all have been avoided? First, (and most obviously) the taxpayer could have come clean about the funds and made a proper disclosure in the divorce proceedings. Second, he should have filed an FBAR for each year each of the offshore accounts was open and had $10,000 or more. For the nominees corporations, other returns may also have been needed as well. For year 2011 he would have to file a Statement of Specified Foreign Financial Assets (Form 8938) with his income tax return if the accounts had $50,000 at year end or $100,000 at any point during the calendar year 2011. Third, his advisers (including his lawyer) may wish that the did a more comprehensive interview and determined a disclosure strategy, including whether he should have made a Voluntary Disclosure. It is unclear whether the taxpayer had U.S. based professional advise in establishing the offshore strategy. Fourth, his statements and documents delivered to his tax preparer will be subject to discovery by the US in the civil and criminal cases (there is no tax preparer privilege in the criminal case).

The lesson for other divorcing taxpayers, is that hiding assets offshore or through offshore structures, in anticipation or as a result of a divorce is a highly risky bet and the odds are overwhelmingly in favor of the house (the IRS).

Delinquent Taxpayer’s May Lose Passports

sandylaw — Tue, 13 Mar 2012 15:45:32 +0000

The Senate passed the surface transportation bill with an amendment that would give the State Dept the right to deny, limit or revoke passports of “seriously delinquent” U.S. taxpayer’s. The passport provision is part of the Fight Offshore Tax Abuses, amendment offered by Senator Carl Levin. The Bill now moves to the House.
The Bill defines “seriously delinquent” as taxpayers who owe a federal tax debt for which a lien or levy may be filed. This would apply to a variety of taxpayer’s including those who default on installment agreements, including those who may default on payments under the Offshore Voluntary Disclosure Initiative (OVDI or OVDP). The timing of the Bill is also of interest, in that offshore banks are beginning to advise U.S. account holders of their obligations to report the accounts by filing Reports of Foreign Bank Accounts (FBAR’s) and report income earned on the accounts for income tax purposes. Most foreign banks will ultimately report U.S. depositor account information to IRS. The IRS will then be able to assess tax, interest and penalties on the unreported income and begin lien and levy action. The Bill if passed by the House and signed by the President would also enable the IRS to request revocation of or limitations on a U.S. taxpayer’s passport.
While the future of the Bill is in the hands of the House, the pressure against offshore tax avoidance continues to mount. For most taxpayer’s that meet the criteria, coming forward now is still a better choice than waiting for the IRS to come knocking. For some, this move will evoke thoughts of expatriation. In either case the “tax man cometh”

Statment of Specified Foreign Financial Assets is a Valuation MInefield

sandylaw — Sun, 11 Mar 2012 01:29:47 +0000

Form 8938 “Statement of Specified Foreign Financial Assets” is required as part of the 2011 individual income tax returns. Taxpayer’s must estimate values of certain assets, including equity interests in foreign corporations and partnerships. For those assets that are traded on an established exchange traditional valuation methods can be used to determine value. But for privately held investment interests valuation is more complex and disclosure issues become important.

Three basic approaches to discounting privately held investment interests can be used for taxpayer’s holding investments in privately held investments, including foreign investments. These methods are the Discount for Lack of Marketability, (DLOM) Discount for Lack of Liquidity (DLOL) and Discount for Lack of Control (DLOC). These discounts need to be carefully considered when taxpayers or their advisers consider the range of value disclosure for the foreign investment interest. The IRS will, upon subsequent examination look at filed Forms 8938 along with the Form 1040 to determine the value of the disclosed interest. The value statement may have adverse affects on estate and gift tax audits if rights to later submit an discount argument through proper appraisal. The result could be a long an expensive process to determine value of the interest if there IRS estate and gift tax auditor and taxpayer disagree on valuation. Proper efforts to reserve the right to submit evidence that a discount to valuation should be made with the filing of the Form 8938.