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Relief procedures for former U.S. citizens

The IRS recently released certain relief procedures for U.S. citizens who relinquished U.S. citizenship (‘an expatriation event”) after March 18, 2010 who are delinquent in their U.S. tax filings.

The purpose of  this relief is to allow eligible  individuals to escape the potential income tax implications of IRS Code 877A upon expatriation as well as interest/penalties and tax  payable for unfiled tax and information returns.  

Readers may refer to my 2017 blog on the expatriation rules at https://lnsca.com/u-s-expatriation/  for  further clarification.

Per the IRS announcement,

“Under the Relief Procedures for Certain Former Citizens (“these procedures”), the IRS is providing an alternative means for satisfying the tax compliance certification process for citizens who expatriate after March 18, 2010. These procedures are only available to U.S. citizens with a net worth of less than $2 million (at the time of expatriation and at the time of making their submission under these procedures), and an aggregate tax liability of $25,000 or less for the taxable year of expatriation and the five prior years.  If these individuals submit the information set forth below and meet the requirements of these procedures, they will not be “covered expatriates” under IRC 877A, nor will they be liable for any unpaid taxes and penalties for these years or any previous years.

These procedures may only be used by taxpayers whose failure to file required tax returns (including income tax returns, applicable gift tax returns, information returns (including Form 8938, Statement of Foreign Financial Assets), and Report of Foreign Bank and Financial Accounts (FinCEN Form 114, formerly Form TD F 90-22.1)) and pay taxes and penalties for the years at issue was due to non-willful conduct. Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”

Is this a viable program?

For  those who are currently delinquent filers and have relinquished citizenship, it appears a good deal for  them where their cumulative tax liability for the 5 years plus the 6th year is no more than $25K.

Under the streamlined foreign offshore procedure where one files 3 years of  past  due returns or goes back another 2 years or waits another 2 years to expatriate (to get to the 5 years of filings), income tax payable is not forgiven.

Under the IRC 877A provisions, the “covered expatriate” definition would include one whose average tax liability exceeded an average of $168,000 (2019 threshold) for the  prior 5 years.

IRS Form 8854 must be filed with the tax return for the year of expatriation. Late- filing this form carries a $2,500 penalty if one cannot demonstrate a “reasonable cause argument”. With this proposed relief procedure, this penalty is waived. It appears that by not  all filing the 8854, one could be deemed  a covered expatriate (regardless of being below the $2M net worth or 5 -year average tax liability thresholds) because one has not filed or met their IRS FILING OBLIGATIONS.

This relief program is not available to long-term residents, namely prior  green card holders who gave up (“an expatriation event”) their cards who held them for 8 out of the last 15 years (or part years). Those individuals should consider filing under the streamlined procedures,  at least  to eliminate penalties and interest costs.

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Cross Border Intercorporate Transactions

Several enquiries have been received by companies wishing to do business in the United States, some have already incorporated, and some are just in the investigative stage(s).

Annual professional fees can very much be a function of your annual or ongoing compliance costs such as corporate federal and state filings. The latter can increase fees significantly if one is doing business in various states, and whether income tax, franchise tax or sales tax, etc., are applicable or unforeseen state nexus issues.

Intercorporate cross border transactions may include management fees, interest & financing costs, loans/ advances and  receivables/payables from the sale of goods or services. The latter may create a transfer pricing issue which both Canada & the U.S. have their own specific legislation.Both countries also have certain foreign information returns or forms that carry significant penalties  for failure to file. Some reporting is looking for disclosure of  related party transactions by name, description and/or dollar amount. Other foreign information returns look to ownership such as “(controlled) foreign affiliate” or “controlled foreign corporation (“CFC”).

Both countries also have certain deemed income provisions such as imputed interest on intercompany loans or even deemed dividend income inclusions. There could be certain exceptions, exclusions or safe harbor provisions within the legislation. Both countries have withholding taxes on repatriation of profit to the other country in the form of dividends or branch profits, however the Canada/U.S. tax treaty may alleviate or reduce exposure.

Planning or investigating should be done before anyone ventures into a cross border business to avoid  unexpected surprises, say a year later when most  filings are due, and to ensure the plan or organizational structure will be tax effective from a corporate and personal perspective.

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IRS Form 8233

This form is used for a non-U.S. person to have the U.S. payor (considered a withholding agent) to reduce the amount of U.S. tax to be withheld on personal services provided in the United States. The individual providing the service could be an employee or an independent contractor, sole proprietor.

It is possible for a Canadian corporation to hire Canadian employees that travel to the U.S. to render personal services on its behalf. In this regard, the income derive therefrom would be subject to IRS Form 8233.

A non-U.S. person would be a Canadian not considered resident of the U.S. for U.S. income tax purposes, either under the Internal Revenue Code or under a tax treaty ( between the U.S. and country of residence of the income recipient). Depending on the days present in the U.S., the income from U.S. source may be entirely exempt from federal U.S. taxation. For state income taxation, some states follow the treaty and some do not.

Personal services provided must be in the U.S., services provided from your home-office in Canada is considered Canadian source or foreign source from a U.S. perspective, and is not subject to the application of this form. Usually individuals paid by a U.S. payor would receive a W-2 ( as an employee), or a 1099 information slip, as independent contractor.

If the U.S. payor also pays for services provided in Canada, they may request IRS Form W8- BEN or IRS Forms W8-Ben-E. The latter form is for non-individual income recipients. This form is usually requested by the payor to ensure there is no withholding requirement with respect to the cross- border payment for services provided outside the United States.

The form is signed by the withholding agent and by the recipient of the income. One copy is sent to the Internal Revenue Service.

The form requires the individual recipient to have an ITIN or what is called, individual taxpayer identification number. In this regard, the individual would note ‘applied for” on the form in this box and attach a signed copy of the form with his/her IRS Form W-7 (application for an ITIN).

The payor should understand that an individual cannot obtain an ITIN prior to filing a tax return without attaching the 8833 to the W-7 application. If the payor resists signing this form until an ITIN is obtained, it may end up withholding 30% federal tax and the individual will have to file a 1040NR with a treaty-based disclosure IRS Form 8288 to obtain a refund. The withholding agent should examine the instructions and the appendix to the W-7 to learn on how this works.

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Revised GILTI provisions offer reprieve to U.S. individual investors

Commencing in 2017, the December 2017 Tax Cuts and Jobs Act required  U.S. persons to be taxed on accumulated profits, generally derived from active business income of controlled-foreign corporations (“CFC”s) under section 965 of the IRS Code. This was also known as the transition or repatriation tax. Currently and prior to 2017, specific types of income earned by the CFC, primarily investment income, had to be accrued annually and taxable to the CFC shareholder if certain exclusions and exemptions were not available.

For subsequent taxation years, annual active business income as defined as global intangible low-tax income (“GILTI”) under section 951A of the IRS Code must be included in income. This is the continuation of the repatriation tax but in a different form.

U.S. corporate investors of CFC

Where the U.S. person is a U.S. C corporation, the GILTI provisions provided for a flat 50% deduction of the GILTI under  Section 250 of the IRS Code bringing the tax rate to 10.5% from  the 21% U.S. corporate rate.

An election is available under section 960  of   the IRS Code for the C corporation to take an indirect foreign tax credit up to 80% of  the foreign tax incurred by the CFC. Where the effective CFC tax rate was at least 13.12%, this election resulted in no tax to the C corporation on GILTI.

U.S. individual investors of CFC

For individual U.S. investors, GILTI is included in  their reported adjusted gross income reported on the U.S. 1040  tax return, taxed at their marginal tax rate that could be as high as 37%. However, a similar indirect foreign tax credit as outlined in section 960 available to the C corporation investor is available under section 962 of the IRS Code to the individual.

With an annual section 962 election, the IRS Code pretends that the individual is  a corporation and in lieu of including GILTI in adjusted gross income taxed at the marginal tax rate of the individual,  one could compute separately the tax on GILTI by applying the 21% corporate rate  with a foreign tax credit up to 80% of the foreign corporate tax. This section 962 tax payable is reported on a separate  line of the U.S. 1040.

Prior to the recent released proposed regulations, it was perceived that in computing the section 962 tax, this “notional” corporation could not take the 50% section 250 deduction. Therefore, only where the CFC’s effective  tax rate was at least 26.25%, the section 962 election resulted in no tax on GILTI to the U.S. individual. When the effective rate to the Canadian corporation was lower than 26.25%, the section 962 election still resulted in tax payable.

For 2018,  the annual tax rate on active business income on the first $500K could be in the 13% range (depending on the province) due to the  federal & provincial Canadian  small business deduction. Income above this $500K threshold is a taxed at around 26.5%.

With a low effective Canadian corporate rate, the section 962 election without an available section 250 deduction could result in about a 10.6% incidence of U.S. tax on GILTI, still better than 37%  without the election, but not as generous as with a C corporation shareholder of the CFC. 

This is the double tax issue for U.S. individual investors of the CFC,- U.S. taxation on undistributed profits in one year and Canadian individual taxation in a subsequent year when the distribution occurs

New rules for U.S. individual investors

Recently issued  proposed regulations to sections 250 and 962 of the IRS Code clarify to allow U.S. individuals to claim this section 250 50% deduction. This means with an effective  CFC tax rate of at least 13.12%, there would be no tax on GILTI, same as if the actual owner of  the CFC was a C corporation.

Payment of dividends by the CFC

It is generally understood that under Subpart F of  the IRS Code, any inclusion of corporate earnings prior to a distribution thereof would increase the basis of the CFC’s shares for U.S. tax purposes. Likewise, receipt of previous taxed income (“PTI”) would not be taxable and would reduce basis. These rules are complex with specific ordering provisions and accounting.

When a section 962 election is made, its related regulations have defined taxable S962 earnings and profits (“E&P”) and excludable S962 E&P for the purpose of determining what portion of the actual distribution relating to S962 E&P is taxable.

Excludable S962 E&P is the amount of tax paid by the taxpayer with respect to the S962 election in the prior year. Taxable S962 E&P is the excess of S962 E&P over excludable S962 E&P.

The  portion of  the distribution that is considered a taxable dividend may be classified as a “qualified dividend” attracting a maximum federal tax rate of 20%,  eligible for a full foreign tax credit for the higher Canadian tax rate levied on the dividend. If the CFC operates in a non-treaty country, the taxable dividend is not a qualified dividend, subject to the taxpayer’s individual marginal tax U.S. tax rate.

With the  proposed regulations, a valid timely-filed  section 962 election and a low effective Canadian tax rate, the U.S. individual shareholder of the CFC residing in Canada should not be presented with a double tax issue where undistributed earnings of the CFC are taxable in a year prior to the year of distribution

IRS Reporting requirements

As one can perceive, the annual compliance costs for U.S. investors of a CFC will rise as a result of the changes in the tax law. Where there are a series of foreign corporations such as investment holding corporations and/or sister corporations, the foregoing computations, ordering provisions and accounting are more complex and time consuming. This complexity under Subpart F of the IRS Code was present before the passing of sections 965 and  951A. Now it is more complex!

IRS Form 5471 (the annually filed U.S. information return by a U.S. shareholder of the CFC)  has been significantly revised, requiring additional schedules and revisions to earlier schedules. New IRS  Form 8992 reporting the computation of GILTI and IRS Form 8993 for the computation of the section 250 deduction  must be completed and filed with the timely-filed (including allowable extensions) U.S. person’s income tax return. The 5471 information return for each CFC carries a minimum $10KU.S. penalty for failure to timely file or failure to file a complete information return.

Currently there is no prescribed form for the section 962 election. Per its regulations, the election has certain information that must be presented and attached to the  timely-filed income tax return for the election to be considered valid.

U.S. filing extensions should be filed if  the  June 15th  automatic due date for U.S. individual filers residing outside of  the United States cannot be met. Any tax payable by  the individual U.S. investor is due still due by April 15th

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Revised U.S. Estate/Gift Tax Exclusions

The December 2017 Tax Cuts and Jobs Act doubled the lifetime exclusion to $11.18M effective for 2018 to 2025, subject to inflation adjustments for subsequent years. The unified tax credit relating to the 2018 exclusion is $4,417,800. For 2019, the exclusion amount is expected to be $11.4M with a unified credit of $4,505,800.

After 2025, the foregoing may or may not be approved by Congress to be of a permanent nature. If it is not approved, the thresholds will revert to the pre-existing inflation-adjusted amount. 

Taxable gifts made during one’s lifetime are subject to the same graduated tax rates as estate tax. The 2018 $11.18M (2019-$11.4M) lifetime gift tax exclusion/estate tax exclusion is available to U.S. citizens, U.S. domiciliaries and green card holders. Post-1976 taxable gifts are included in the gross estate and credit is given for gift tax previously paid.

For years 2015 to 2017, the first $14,000 of gifts of a present interest annually made by a donor to each non-spouse donee, are not included as taxable gifts. For 2018 and 2019, this annual exclusion rises to $15,000. If the recipient spouse is not a U.S. citizen, the annual exclusion is $152,000 for 2018, expected to rise to $155,000  for 2019. Where the recipient spouse is a U.S. citizen, the entire gift is non-taxable.

If the value of the gift is above for foregoing noted annual exclusion, then one has to compute the gift tax using the estate/gift tax rate table, that rises to a 40% tax rate at the $1M mark. As the unified tax credit is for both the incidence of estate and gift tax,  the present $11.18M (2018) lifetime exclusion may apply to  U.S. citizen donors.

Although for U.S. purposes, this lifetime exclusion, say to gift significant amounts is very attractive, at least to 2025, for those U.S. citizen donors  that reside in Canada, the gifting of appreciable assets will create immediate  income taxation here if the transfer is not to their spouse because a gift in Canada is a disposition for income tax purposes. In Canada, proceeds of disposition for spousal gifts are deemed to be the donor’s tax basis in the asset transferred, unless an election is made for the proceeds to be at fair market value. Canada will not give a foreign tax credit for U.S. gift tax because it is not an income tax.

One should review transfers to non-spouse recipients before any transfer is contemplated if the U.S. citizen is not residing in the United States to avoid potential tax exposure in their country of residence. The appropriate Tax Treaty should be examined for any relief.

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