The Impact of the Foreign Account Tax Compliance Act (FATCA) of 2010
Breathes there the man with soul so dead, who never to himself hath said, “This is my own, my native land.” - Edward Everett Hale, “The Man Without a Country”
Poetic and patriotic words, but the reality of today is that many U.S. citizens don’t feel this way about their native land. In 2015, 4,279 U.S. persons relinquished or renounced their U.S. citizenship, a record-breaking amount. Many analysts project that the total number of renunciations or relinquishments in 2016 will exceed the 2015 mark. To put these numbers in perspective, less than 300 people renounced their U.S. citizenship in 2006.
Looking at statistics like these, you may ask yourself: “Why are so many people giving up U.S. citizenship?” And possibly, “Is this something I should consider?”
The Foreign Account Tax Compliance Act (FATCA) of 2010 and other U.S. tax reporting regulations may have something to do with why this is happening.
A simplified explanation of the FATCA legislation is as follows:
- It is primarily aimed at preventing tax evasion by U.S. taxpayers through the use of non-U.S. financial institutions and offshore investments.
- Foreign financial institutions are required to identify accounts held by U.S. persons and report account information to the IRS. Absent this information, they are required to withhold U.S. tax on U.S. source income paid and may decline account opening or terminate services.
Furthermore, the U.S. tax system is based on citizenship. A U.S. citizen pays tax on their worldwide income no matter what country they live in.
Beyond the tax compliance burden, the financial institution impact of the FATCA legislation has significantly impacted U.S. citizens living abroad. Rather than attempt to comply with FATCA reporting requirements, many foreign financial institutions are simply refusing to open or hold accounts for U.S. persons.
To alleviate the financial hardship and tax compliance burden, many U.S. citizens living abroad have decided not to maintain their U.S. citizenship. U.S. citizenship can be terminated through renunciation. A formal renunciation of U.S. citizenship must be made in a foreign state, generally at a U.S. consulate, and there are several State Department forms to file along with a processing fee.
In addition to the paperwork and fees, the exit tax under Internal Revenue Code Sec. 877A may apply. Generally speaking, in order to avoid the exit tax you must:
- be current with U.S. tax filings for the past 5 years,
- have had annual U.S. tax liabilities below $160,000 for those 5 years, and
- a net worth of less than $2,000,000.
If you find yourself in the situation where you are considering renunciation of your U.S. citizenship, there are planning opportunities and compliance requirements that must be considered. Contact Freed Maxick's International Expatriate Tax Services professionals to discuss your specific situation, or call to speak with an individual directly at 716.847.2651.View full article
If your company has a U.S. subsidiary, you will most likely have some transfer pricing considerations that need to be addressed. Transfer pricing can be one of the more complex tax issues affecting multi-national businesses. The goal for this post is to educate you about some of the transfer pricing related issues and terms and some of the documentation you’ll want to have on hand.
What is Transfer Pricing?
Transfer pricing principles apply to related company transactions that cross borders. These principles try to align the value and the income from operations within a jurisdiction where the relevant functions are performed and risks taken. Perhaps one of the clearest examples is to compare two companies that assemble, finish and sell wooden furniture.
Company 1 is located entirely in the U.S. and buys the wood that it will assemble and finish from unrelated companies. Company 2 is the U.S. subsidiary of a Canadian parent and it buys all of the wood that it assembles and finishes at its U.S. location from the parent company. Assuming that Canadian tax rates are lower than U.S. tax rates, Company 2 would seek to minimize its income in the U.S. to reduce its global tax burden.
This could be accomplished by having the Canadian parent supply the wood to them at a high cost, resulting in a high cost of goods sold in the U.S. that would reduce taxable income there.
Transfer pricing rules are designed to ensure that the price the Canadian parent charges its U.S. subsidiary is comparable to the price that its U.S. subsidiary would pay had it purchased wood from an unrelated party in an “arm’s-length” transaction.
Transfer pricing principles stipulate that the U.S. subsidiary would be required to have on hand contemporaneous documentation that the price it paid for the wood from its foreign parent was comparable to an arm’s-length price.
While this very basic example focused entirely on cost of goods sold, these same rules apply to all related party transactions such as charges for administrative support, royalties, interest and similar types of charges between a foreign parent and its U.S. subsidiary. Additionally, these rules work in alternate situations where the transactions are between a U.S. parent and a foreign related entity.
Transfer Pricing: Theory and Practice
In theory, transfer pricing is about making sure that income and value are recorded in the country and localities where the corresponding operations of the business are performed.
In practice, the U.S. and foreign governments audit transfer pricing with an eye toward making sure that multi-national businesses have apportioned profits related to operations in a manner that ensures these businesses pay the full amount required in their respective countries. Businesses, on the other hand, focus on managing international operations to minimize the amount of profits generated in higher tax countries.
The critical point for businesses is not that you should try to contort your numbers in order to minimize your U.S. tax burden when you file a return. More than anything else, you need to consider the possibility of cross-border commerce from the start of your business. Plan growth in a manner that provides optimal support for operations in other countries while minimizing income that could be apportioned to high tax jurisdictions. If transfer pricing is not considered until your tax preparer is working on your U.S. tax return, you won’t be able to do much to manage the impact in the current year.
The U.S. rules require that the rationale for your related party transaction pricing be documented thoroughly at the time the return is filed. That documentation is not sent with the return, but it must be made available to the IRS in the event of an audit.
What’s at Stake If a Transfer Price Is Revised?
In addition to owing additional income tax related to the adjustment from the transfer price, U.S. law also provides for penalties in this area. Penalties for inaccurate transfer pricing can range from 20% to 40% of the tax related to the understatement of the income that resulted from the transfer prices used by the taxpayer. In addition, depending on tax treaties or the tax policy in the parent company’s home country, the changes could result in double taxation of certain income. If the U.S. determines that more income should be subject to tax in America, the parent company’s home country may not accept a corresponding decrease in taxable income calculated there.
The analysis, calculations and documentation required to accurately set and support transfer pricing policies within a company should always be performed or supervised by a professional with considerable experience in the field. Given the significant penalties that can be assessed if transfer prices are determined to be inaccurate, few businesses can afford to run the risk of miscalculating these numbers.
Documenting a Transfer Price
U.S. tax regulations provide a specific list of the documentation needed to support a transfer price calculation. The rules do not require that all of this information be filed along with the tax return, but they do require that the calculation of the transfer price and the creation of the related documents occur during the process of preparing the tax return. If your return is selected for audit, the IRS will ask for these documents and the rules require that you provide them within 30 days of the request.
Proper documentation for a transfer price calculation on a U.S. tax return includes:
- An overview of the taxpayer’s business.
- A description of the taxpayer’s organizational structure covering all related parties engaged in transactions that may include transfer pricing.
- Any documents specifically required by regulations.
- A description of the transfer pricing method selected and an explanation of why it was selected.
- A description of alternative transfer pricing methods that were considered and an explanation of why they were not selected.
- A description of the transactions between the parent and controlled parties.
- A description of how the transfer price was compared to relevant alternatives.
- An explanation of the economic analysis and projections used to develop the transfer pricing method.
- A description or summary of any relevant data obtained by the taxpayer after the end of the tax year and before the filing of the return that would help determine if the taxpayer selected and applied the transfer pricing method in a reasonable manner. And,
- A general index of the principal and background documents and a description of the recordkeeping system used for cataloging and accessing those documents.
What you have to report and what you have to pay all depends on if and when you take the plunge.
International tax issues can sometimes be categorized by how differently people frolic at the beach. Here are some examples:“Treaty Filing:” Just the toes.
Lots of the folks at the beach never go in any deeper than getting their feet wet. Could be a kid who sticks a toe in and gets freaked out by the waves, or a more mature person who wanders to the water’s edge to cool off just a bit then heads back to the comfort of a beach chair.
These folks are like businesses that may ship products or sell services into another country without ever establishing a more permanent presence. The obligations of the business in the country where the products or services are used will be governed by a tax treaty, if one exists, between its home government and the destination country. For businesses selling into the U.S., these activities typically will generate an information-reporting obligation at the federal level. Those businesses also need to be aware of potential state tax obligations that may be triggered by their activities, if sales cross certain thresholds.
“Branch Filer:” Wading in a bit deeper.
Other people will wade in about waist- or chest-deep and go no farther. Maybe they don’t want to get their hair wet, or they don’t want water in their ears. It could be that salt water stings their eyes too much. Whatever the reason, they know their limits and stay within them.
These swimmers are similar to businesses that might lease or build some type of warehouse or other permanent structure in the U.S. or have some other type of significant presence in the states (such as an office or employees), but not create a separate legal entity in the country. They would treat the operations in the U.S. as a “branch” for tax purposes. Branch treatment typically isn’t the ideal situation for most businesses. When it does make sense, the key is to plan from the outset to treat U.S. operations as a branch and operate accordingly going forward. This operation will usually face tax obligations at the federal and state level in the U.S.
“U.S. Legal Entity:” Taking the plunge.
Most folks who head for the water eventually get comfortable enough to take the plunge and dive in. For many who enjoy the beach, the plunge is the whole reason for going.
Top 100 CPA firm Freed Maxick assists international businesses as they expand into the U.S. Contact us to learn about how we can help you avoid the pitfalls and realize the benefits of doing business in the U.S.Most businesses that are growing across borders are best served by planning for the plunge from the start and executing on that strategy as operations ramp up. For a non-U.S. business establishing a presence in the U.S., there are 3 main reasons why forming a U.S. entity beats operating a U.S. branch. First, a U.S. entity is better positioned to handle U.S. employment issues. Second, a U.S. entity can often manage legal liability more effectively than a branch. And lastly, the tax rules for U.S. entities are somewhat less complicated than those that apply to branch operations.
3 Questions that Define Reporting and Withholding Obligations
Most U.S. businesses understand that payments to U.S. contractors trigger reporting obligations at the end of the year. Once the amount paid to a contractor crosses certain thresholds, a Form 1099 is prepared and sent both to the business that performed the services and to the IRS. As the economy has become more global and work can easily be performed virtually from around the world, some U.S. businesses have been slow to realize that payments to foreign contractors may trigger similar reporting obligations.
It’s important to note that payments to foreign contractors may trigger reporting and withholding obligations on the part of the U.S. payor—but not in all cases. The reporting and withholding requirements on the U.S. payor depend on the answers to 3 questions.1. Is the payee a U.S. person or business?
It’s never safe to assume that a contractor is or is not a U.S. person. The Internet makes it easy for a business to create a virtual presence almost anywhere. The only safe way to determine whether or not the contractor is a U.S. person is to ask. If the contractor replies that the business is a U.S. business, most payors know to have that contractor fill out a Form W-9 to provide the information that will be used to report payments to the IRS.
If the contractor is not a U.S. business, the payor should require a Form W-8BEN-E (for entities) or Form W-8BEN (for individuals). Once the U.S. business receives this form, it does NOT forward it to the IRS. The U.S. payor simply maintains the form in its records. In the event of an audit, the form will substantiate why payments were not reported.2. Where did the payee perform the services?
If the U.S. payor has one of the Forms W-8BEN on file and the contractor performed all services outside of the U.S., it is likely that no reporting or withholding obligations exist regarding the payments made by the U.S. payor to the foreign contractor.
If the foreign contractor performed some or all of the work related to the contract in the U.S., the payor may have a reporting and withholding requirement related to those payments.3. If the payee performed services in U.S., what does the payor do?
If the foreign contractor did some or all of the work related to the contract in the U.S., the payor has additional obligations under IRS rules. Typically, the U.S. payor will have to report the payments related to the U.S.-sourced work to the IRS on a Form 1042. The payor is expected to not only report the amounts paid to non-U.S. contractors for work done in the U.S. but also to withhold U.S. taxes (typically 30%) from those payments. Note, the 30% rate could potentially be reduced if the payments are made to a country with which the U.S. has a treaty. Like other withholding requirements, failure to comply with them can subject the U.S. payor to penalties and interest. Failure to withhold also could entitle the IRS to go after the payor for the amount of tax that should have been withheld. Depending on the amount of U.S.-sourced work a company pays foreign contractors to perform, failure to properly withhold can quickly snowball into a significant tax obligation.
We’ve provided a quick overview here of the rules that apply when U.S.-based businesses make payments to foreign contractors. If your business engages contractors who may be based outside of the United States, it’s important to consult with a professional who is familiar with the details of the reporting and withholding rules. Contact us for help navigating complex U.S. and international tax rules.
Are you a Canadian “snowbird” spending winters in the United States? You may not realize it, but you could be considered a U.S. tax resident. If this is the case, the basis on which tax residency is determined is through the IRS “Substantial Presence Test.”
For this purpose, you will be considered a U.S. tax resident if you meet the following requirements:
Physically present in the United States at least 31 days in the current year, and
183 days during the 3 year period that includes the current year and the 2 years immediately before that.
If you fall into this category, don’t panic! There is potential relief available to Canadian citizens that are caught by this Substantial Presence Test:
You are present in the U.S. for fewer than 183 days in the current year.
You maintain a “tax home” in a foreign country during the year.
You have a “closer connection” to the foreign country where your “tax home” is than to the U.S.
Are there exceptions to the rule?
There are exceptions to the substantial presence test. The following are a few examples:
Days you are in the United States for less than 24 hours- when you are in transit between two places outside the United States.
Days you are in the United States as a crew member of a foreign vessel.
Days you can classify “exempt individual.”
The term “exempt individual” does not refer to someone exempt from U.S. taxes, but to anyone that claims exemption from counting days of presence in the United States. For example- a teacher or trainee temporarily in the United States under a “J” or “Q” visa, who substantially complies with the requirements of the visa. For a full list of exemptions and exceptions, please refer to the IRS substantial presence test.
What should you do next?
If you exclude days of presence in the United States because you fall under a special category, you must file Form 8840 (Closer Connection Statement) or Form 8843 (Statement of exempt individuals and individuals with a medical condition).
Freed Maxick International tax practice professionals can help you determine if you qualify as a U.S. tax resident, and assist you with Substantial Presence Test filings. We can navigate the IRS guidelines and minimize potential penalties. Contact us to connect with our experts.
It’s always a benefit to business and real estate owners to uncover ways to save money. Did you know that the tax depreciation records of golf course owners likely contain a tax deduction that can be claimed for the 2012 tax year?
The tax deduction is claimed by adopting specific sections of the temporary repair regulations that were issued in December 2011. The IRS is allowing taxpayers to adopt specific sections of these regulations for their 2012 tax year and to defer other sections that may result in income until the 2014 tax year. Specific sections of these regulations allow taxpayers to claim a deduction for assets that are now reclassified as repairs, routine maintenance, or were disposed of before 2012.
It’s a lot of information to wade through, but CSP 360 and their affiliate Freed Maxick CPAs can help country clubs and golf course owners navigate through the complex regulations.
Get the Tangible Property Q&A now to learn more!
Check out a few examples of how we can help:
1) Tax Deductions: Golf course owners that capitalized improvements to buildings and the course since 1987, likely removed or abandoned assets as a result. The remaining tax basis in these assets and perhaps, the costs of removal, can be claimed as a tax deduction for 2012 tax year.
For another example, let’s assume during 2008 that $1 Million of structural improvements were made to a club house facility and $1 Million of land improvements were made to the golf course bringing the total investment to $8 Million. A cost segregation specialist identifies $1 Million of tax basis remaining in the real and personal property disposed of in conjunction with the improvements.
Result? The golf club owner is entitled to claim a $1 Million tax deduction for the 2012 tax year.
2) Regulation Changes: All golf course owners should prepare for other changes under these regulations which may affect current accounting policies and procedures. For example, a golf course owner that has historically expensed assets for tax purposes based on their book capitalization policy may need to act before 2014 to be able to continue to deduct assets under this policy beginning in 2014. In addition, all golf course owners will be required to review their treatment of materials and supplies and repairs in order to comply with the new repair regulations.
3) Uncovering Cash Flow: For example, let’s assume a club house was constructed and placed in service during 2004 with an original cost of $2 Million and the golf course was constructed with an original cost of $4 Million for a total capitalized cost of $6 Million. A cost segregation study reclassified $2.4 Million of the capitalized cost as land improvements and tangible personal property.
Result? This reclassification results in a $1.5 Million tax deduction for 2012 providing additional cash flow from the federal and state income tax savings.
CSP 360 is affiliated with Freed Maxick CPAs and is one of the nation's leading providers of cost segregation and consulting services to real estate owners. CSP 360 is the national leader in providing cost segregation services to the golf and hospitality industries. Our experienced team of Construction Engineers and CPAs work in the cost segregation service niche with no outsourcing.
Allow us to show you how our Cost Segregation and CapX services could result in a substantial income tax savings for the 2012 tax year. Contact Us today to learn more about how we can assist.