Real estate holding structures for nonresidents – tax law changes coming
This is a distant early warning to nonresidents with U.S. real estate investments. The warning applies to multi-national corporations as well (businesses that operate in the United States and elsewhere in the world) but I am going to focus on real estate investors here.
An proposed change in U.S. tax law may double the tax you pay when you sell the real estate.
WHO MAY BE AT RISK
Anyone owning U.S. real estate through a holding structure that contains a corporation for which an election has been made to treat it as a disregarded entity.
Examine your holding structures (that wedding cake of trusts, corporations, partnerships, and limited liability companies that you pay for every year) and plan to change those structures before the end of 2010.
You may be using corporations as part of a holding structure for your U.S. real estate. If so, it is likely that one or more of these corporations made an election to be disregarded for U.S. income tax purposes. (You would do this because the income tax rate on capital gains earned by regular corporations is much higher than the capital gains tax rate for other holding structures. You’d pay less in tax when you sell the real estate.)
When you elect to treat a corporation as a disregarded entity (use Form 8832 [PDF] to do this), the company continues to exist and operate in every normal way, except that it doesn’t exist for U.S. income tax purposes. You ignore the corporation and the shareholder of that corporation will pay the tax instead.
NEW TAX LAW
President Obama’s team has proposed changes that will (I expect) largely eliminate this strategy. The ability to make a simple election and treat a corporation as a disregarded entity will likely be eliminated for most people.
We don’t know the details of the proposal yet. Like all tax laws, this will have rules, exceptions to the rules, and exceptions to the exceptions.
I think it is likely that the new tax law will be enacted. It is aimed at stopping certain tax-saving strategies for multi-national corporations. The U.S. government needs money. Enough said.
The new tax law may well be clumsy enough to affect nonresidents with U.S. real estate investments who are not using the tax-saving strategies that are targeted by the U.S. government. And that’s why I am saying you should be prepared.
THE FEDERAL TAX IMPACT IF THE LAW IS CHANGED
If it is made, you will pay a much higher tax on your capital gain when you sell your real estate. Looking at today’s tax rates, this will change your tax rate from a Federal tax at 15% (if you owned the property for more than a year) to a Federal tax somewhere in the 34% or 35% range. That means your Federal tax on profit when you sell the real estate will more than double.
NEXT ACTION @ YOU
Here’s what to do:
- Identify holding structures that contain corporations that are treated as disregarded entities.
- Create a plan for what you will do if the law changes.
- (Maybe there is a reason other than the threatened tax law to make a change to your holding structure. If so, do it.)
- Watch the tax law proposals as they work through Congress.
- Take action when you feel the time is right.
(Shameless plug. International tax work is what we at Hodgen Law Group do. All day, every day. I can help you solve these problems. Call me. Mobile +1-626-437-2500.)
FBAR requirements apply to nonresidents too
The U.S. government requires “U.S. persons” to file Form TD F 90-22.1 (PDF) to report ownership or control of financial accounts located outside the United States.
Nonresidents of the United States will be pleased to know that stealth changes to this Form now may also impose this filing requirement on them. A “U.S. person” is now includes “a person in and doing business in the United States.” (See the instructions for Form TD F 90-22.1).
So who might be included?
- A U.S. company has a director who is a nonresident of the United States. The director comes to the United States every now and then on company business. “Doing business in the United States?” Maybe.
- A non-U.S. company has a full time employee in the United States. That non-U.S. company is probably doing business in the United States and therefore must file Form TD F 90-22.1
There are endless variations on this theme.
What should you do?
The new form has gone from a relatively straightforward application (it is easy to figure out whether you are a U.S. resident or a U.S. citizen) to a fuzzy application (the question of “am I engaged in business in the United States?” is exceedingly problematic).
A cynic would think that the Federal government is trying to govern by FUD. FUD works in the short term, but over the long term is fails. Over the long term this is going to push business activities away from the United States. Why would a nonresident of the U.S. deliberately put his head in the bear’s mouth?
Suggestions for nonresidents with business interests in the U.S.:
- Direct business activity in the United States by a foreign company is no longer advisable. In the tax trade, the jargon we use is “branch operations.” This exposes you to the “5 years in prison and $250,000 penalty” rules that apply to Form TD F 90-22.1.
- You would be well advised to look exceedingly carefully at the travel of non-U.S. employees to the United States, and what they do when they are here. You could inadvertently cause the foreign business to be accused of “doing business” in the United States.
- Pay attention to the definition of “engaged in trade or business in the United States” when it comes to hiring independent contractors and agents. This is a perennial favorite of the U.S. government. You think you hired an outside agent to do business for you. The U.S. government begs to differ, and says that the outside agent is really just an extension of your business.
I’m just saying that now a foreign taxpayer is at the mercy of an eager bureaucrat who looks to build a reputation and career, or an eager politician who aspires to higher office. Before, the downside of getting things wrong meant you paid some tax. Now the downside is that you may get a threat of criminal tax prosecution.
Over the long term, this will cause a significant change in the U.S. economy. These regulatory changes are hidden trade barriers. Slowly, our Federal government is closing the door to shut out the rest of the world. The rest of the world will not suffer. We will.
Latest from the government
In the May 8, 2009 American Bar Association Section of Taxation meeting in Washington, DC , Steven Musher, IRS associate chief counsel (international) was asked about this. Tax Notes Today, at 2009 TNT 88-16, reported he was asked:
whether an FBAR must be filed for a company’s foreign directors who come to the U.S. four or five times a year to sit in on board meetings and who have signatory authority from the foreign entities over the foreign entities’ bank accounts.
Musher said an alert added to the IRS Web site in February provides some guidance on what it means to do business in the United States. He acknowledged, however, that the headliner probably does not answer all questions.
“We are giving serious considerations to these issues,” he said, adding that practitioners have raised several “fair” questions, such as what to do if a company has a U.S. branch but also has foreign accounts that have nothing to do with the U.S. branch, or what to do when there’s a U.S. partnership and the parent company has nothing to do with the partnership.
Tax Notes Today is behind a paywall otherwise I would give you a hyperlink to the article.
Guidance for real estate brokers with foreign clients
I made my first post at Bloodhoundblog.com. It is “keep yourself sane” advice for real estate brokers handling sales with foreign buyers or sellers.
Sign of the times
Got off the phone with an unnamed Swiss gentleman who is in the banking and trust company business. Flat out refuses to touch any business involving a U.S. citizen. Reports he gets several calls a week about this.
Current political and tax trends in the United States can only be described as isolationist and protectionist in result. I am not speaking of anything overtly political. I’m just saying that capital flows are being and will continue to be hindered, to the detriment of the U.S. economy.
Late FBAR filing and penalties
Undeclared foreign bank accounts.
It’s a common question. “I have this foreign bank account, but I haven’t been declaring it by filing Form TD F 90-22.1.? [PDF] What should I do?”
The short answer is clean it up. All of it.
First things first. Form TD F 90-22.1 is commonly known as an FBAR, for Foreign Bank Account Report.
The Treasury Department [warning: video] is announcing that it is ready to pounce. You’d be a damned fool to delay cleaning up your wreckage.
The next question is “But what about the penalties?”
Yep, the penalties are massive. And for extra spice and excitement, they can throw you in jail, too.
Up to now my experience has been that people who voluntarily file the required forms–even if they are years late–haven’t had penalties imposed.
Tax Notes Today (Lexis cite is 2008 TNT 219-3) has another report from last weekend’s California Tax Bar and California Tax Policy Conference session in San Francisco. Luis Tejeda, an IRS fraud technical supervisor, spoke and confirmed what many of us have suspected. The article says:
FBAR filings have surged to nearly 400,000 a year, Tejeda said, in part because of increased voluntary compliance with publicity about the government’s interest in the UBS and Lichtenstein cases. “We want taxpayers to come forward voluntarily, first of all,” he said. In most cases, IRS review in Detroit of filed FBARs does not lead to further investigation by compliance employees, he said. “What we’re really concentrating on is those that do not come forward,” Tejeda said. An increasing number of taxpayers are coming forward with information as a result of the IRS’s efforts at “turning the tide around” in international enforcement, he said, because U.S. taxpayers realize the IRS can get that information from many more sources now. [Emphasis added].
No guarantees. But coming forward and cleaning things up is the best indicated strategy and gives you the best chance at no penalties or at least reduced penalties. It’s either that or live with stress. Or, I guess, you can run away to Panama.
Life’s too short. (That is secret code for “You are going to die someday so don’t be dumb. It’s just money.”)