Ch. 2

International

Tax Issues

PFICs

2-14 2-15

2011

U.S.A.

Foreign

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

14 Foreign Partnerships

U.S. Grantor Trust

The Romneys

PFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFIC 17

233 Pages (of 379) for PFICsNormally reporting numbers under $10 and often zeros.

What is a PFIC?

9

A PFIC is a foreign corporation that meets one of two tests:

1) 75% "passive" income, or

10

2) 50% of assets produce passive income or are held for the production of passive income.

11

Ex: A Foreign

Mutual Fund12

No Minimum Ownership Requirement

13

With Tiny Numbers Why

Comply?

14

If Form 8621 is willfully not filedthen the statute of limitations on Form 1040 or 1120 is suspended.

15

And For 2012

16

17

RequiredAnnual

Reporting

How arePFIC

shareholders taxed?

18

Three Regimes:1) IRC sec. 1291 Fund

2) Qualified Electing Fund (QEF)

3) Mark to Market19

Section 1291 Fund

(Default Regime)

2-2

Shareholder taxed on distributions

of earningsand

stock sale gains.

Definitions

22

(1) Distributions in current year that are at least 125% percent more than the average distributions over a three year period; and

(2) Sale Gain

“Excess Distribution”

Total Distributions

- Excess Distributions

= Nonexcess Distributions

“Nonexcess Distribution”

(Other than Sale Gain)

TaxTreatment

25

•Ordinary dividend income to the extent of E&P (Form 1040, line 9a).

•Excess, if any, over E&P:

–First recovers basis tax free

–Excess over basis is capital gain

Nonexcess Distributions

Allocate to each day in the shareholder's holding period of the

stock

Excess Distributions

Ignore E&P

Portion allocated to current year and pre-PFIC

years is ordinary income

(other income)

The balance is taxed at the

highest statutory rate for the year to which allocated

PLUS INTEREST on the tax

Romney IRC sec. 1291

Fund

30

2-10

2011

U.S.A.

Foreign

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

14 Foreign Partnerships

U.S. Grantor Trust

The Romneys

PFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFIC 17

No Election

Romney Form 8621 Part IV 2-10

Sale Gain = Excess Distribution…………$17

“Determine the taxation of the

excess distribution on a separate sheet and attach it to Form

8621”

Line 11a instructions The shares were acquired Dec. 14, 2010 and sold May 3, 2011.

Total Days Held: 141Total Days in 2011: 123 (87% = $15)Total Days in 2010: 18 (13% = $2)

Tax:35% x $2 = $1

Interest:4% X $1 = $0

Sale Gain = Excess Distribution…………$17

Excess Distribution Allocated to CY……$15

Tax on $2 at highest rate (35%)……………$1Interest on Tax (.04 x 2)……………$0

“For individuals, enter this amount on Form 1040 to the left of the line 44 entry space.

Enter ‘Sec. 1291’ next to the amount….”

Form 1040 Reportingof Tax

“For individuals, enter the interest at the bottom

right margin of Form 1040, page 1 and label it as ‘Sec. 1291 interest.’ Include this amount in

your check…”

Form 1040 Reporting of Interest

QEFRegime

(best option)

2-3

Include in income each year pro rata share of:

1)PFIC ordinary earnings, plus

2)PFIC net long-term capital gain.

Sale gain is capital gain.

Qualified Electing Fund (QEF)

2-3

Romney QEF Election

47

2-11

48

x

x

Romney Form 8621 Part II

The PFIC was purchased and liquidated by the foreign partnership in 2011

Romney Form 8621 Part II

Pro Rata Ordinary Earnings…………$1,051

Pro Rata Net Capital Gain…………$12,950

Distribution (all return of basis) $20,743

Without QEF, $14,001 of income would all be a non-excess distribution of E&P taxed as ordinary income.

Extended due date for filing shareholder’s return for “the first tax year to which the election will apply.”

When is the QEF Election Made? Retroactive

QEFElection?

Deemed Sale Election to convert

“unpedigreed” QEF

to pedigreed QEF

“Purge” Sec. 1291

fund taint.

2-4

x

xEnter Gain or Loss

In Part IVas

Excess Distribution

Mark to Market Regime

2-4

• PFIC stock must be “marketable stock’’

• FMV > A.B. = Gross income

• A.B. > FMV = Ordinary loss to the extend of unreversed inclusions

• Gain on stock sale is also ordinary.

Mark To Market Election

2-4 RomneyMark to Market

Election

60

2-13

61

x

x

Romney Form 8621 Part III

<$269> loss but <$14> allowed because only $14 of unreversedinclusions

Who Must FileForm 8621

65

U.S. Persons who are direct or indirect shareholders of PFIC:

•U.S. citizens and residents

•U.S. C Corporations

•U.S. S Corporations

•U.S. Partnerships

•U.S. Estates

•U.S. Trusts (other than grantor)

U.S. Citizen

United States

Foreign Country

PFIC.006%

Direct Ownership: 2011

U.S.A.

Foreign

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

14 Foreign Partnerships

U.S. Grantor Trust

The Romneys

PFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFIC 17

What ifa U.S.

Family PartnershipOwned the Foreign

Partnerships?70

2011

U.S.A.

Foreign

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

14 Foreign Partnerships

U.S. Grantor Trust

The Romneys

U.S. Family

Partnership

PFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFICPFIC 17

The U.S. Partnership would file the PFIC Form 8621s.

The Romneys, as partners, would file Form 8621 if:

1) The partnership does not file Form 8621

2) Income from an IRC sec. 1291 fund (the default).

3) The partnership makes a QEF election and the Romneys wish to defer payment of the tax.

x

x

Wanda Chan Example

In January 2011, Wanda invested about $10,000 (.000264%) in a foreign partnership that owns 12 PFICs.

Each PFIC reports $0, income, distributions, etc.

2-14

Filing Strategy•File 12 separate Form 8621s.

•Make a QEF election for each.

•Report zeros in Form 8621 Part II.

xIf no prior

QEF election, then make a deemed sale election

xEnter Gain or Loss

In Part IVas

Excess Distribution82

2012 RequiredAnnual

Reporting

83 84

Excess DistributionInclusion

Inclusion or ded .

Return to the Romneys

Is this 100% owned foreign corporation a PFIC?

2-20

The Romneys

Foreign Investments$13,000

United States

Foreign Country

U.S. Grantor Trust

Foreign Corporation(Bermuda)

100%

Dividends……………...$16Interest……………….$125Net Capital Gain…..$2,261Other Income………. $320Total Income……….$2,722

Form 5471 Income Statement

At least 87% of gross income is passive

Other Investments……………………..$13,154

Form 5471 Balance Sheet

100% of assets are passive

Isn’t Sankaty a PFIC?

Form 5471 Sch I

Subpart F Income……….$2,722

CFC ReportingTrumps PFIC Reporting

No Form 8621 is Required

Other LessonsFrom the Romneys

Background Form 8938And

Instructions

94

FFA value:> $50,000 at year end

or

> $75,000 at any time during the year

96

Filing ThresholdFor Individuals (unless MFJ)

MFJ Filing Threshold

Value of SFFAs:

(1)> $100,000 at Year End

OR

(2) $150,000 at any time during the year.

$10,000 Minimum

$50,000 Maximum

Penalty for Failure to File Form 8938

98

Specified ForeignFinancial Assets(SFFAs)

99

1) financial accounts maintained by a foreign financial institution.

100

Any

Foreign Mutual Funds (PFICs)are

Foreign Financial Institutions

101 102

Other Foreign Financial Assets

2) Assets not held at a (U.S. or Foreign) financial institution:a) stocks or securities

issued by a foreign person;

b) other investment financial instrument or contract issued by foreign person;

103

Any

Any

c) interest in a foreign entity

104

any

105

RomneyForm 8938

2-18 2011 8938

Willard M. Romney and Ann D. Romneyx

x

See Attached Statement

Attachment to Form 8938 Spreadsheet footnote:

The highest capital account balance during the tax year was used as a reasonable estimate of maximum value based on readily accessible information

Reg sec. 1.6038D -5T(a):

Except as provided [otherwise] the value of a specified foreign financial asset …is the asset's fair market value.

Exceptions are provided for

• Trusts• Estates• Pension plans• Deferred comp. plans.

But not foreign phps

113

General FMV Relief inTemp. Reg. Preamble

Even if there is no information from reliable financial information sources regarding the fair market value the regulations do not require a filers to obtain an appraisal by a third party in order to reasonably estimate the asset's fair market value.

$1,850,84016,324 1040 Ln8A

$4,517,93511,612

1,838721

1040 Ln9A

1040 Ln8A1040 Ln131040 Ln171040 Ln30

B…B…

B…D…E…

xx

21

No Check in the Box for Form 8621?

Include in value for filing threshold

Foreign Mutual Funds (PFICs)

are Specified Foreign Financial Assets for purposes of Form

8938.

117

All of the Romney’s PFICs are owned through foreign

partnerships and such SFFAs are not reported on Form 8938 by the

U.S. partner 118

Each and every foreign partnership is an SFFA that is reported by the U.S. Partner on Form

8938

119

What ifa U.S.

Family PartnershipOwned the

Romney Foreign Partnerships?

120

2011

U.S.A.

Foreign

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

Foreign Partnership

14 Foreign Partnerships

U.S. Grantor Trust

The Romneys

U.S. Family

Partnership

In 2011, this structure eliminates Form 8938 Reporting

In 2012, the U.S. family partnership must file Form 8938 124

RomneyForm 8865s

2-19

Two 8865s Foreign Phps

To report cash transfers to foreign partnerships:

$111,081 for a 3.3366 % Int.

$296,471 for a .38280% Int.

126

RomneyForm 926

2-20

Form 926To report the Romneys’$114,009 share of a partnership’s cash transfer to a foreign corporation.

128

RomneyFBARs

FBAR

Did the Romney’s file an FBARFor 2011 ?

X

X

NO FBAR’s Filed. Error?

Foreign Mutual Funds (PFICs)are Foreign Financial

Institutions for FBAR reporting

131

All of the Romney’s PFICs are owned through foreign partnerships and they do not own more than 50% of any foreign php.

132

They do own 100% of a foreign corporation

(Sankaty), but it must NOT own an FFA over $10,000

133

What reporting would be required if

the Romney’s directly owned

.00001% of a foreign mutual fund worth

$10,500? 134

Specified Person

United States

Foreign Country

Foreign Mutual Fund$10,500

.00001%

Direct Ownership:

•Form 8621 -- PFIC

•Form 8938 with the box checked for Form 8621.

•TD F 90-22.1 -- FBAR

IRS Website Q&As on Form 8938

IRS Guidance On Reporting Of Specified Foreign Financial Assets

-- Full Text

2-20

Foreign real estate is not a specified foreign financial asset required to be reported on Form 8938.

If the real estate is held through a foreign entity, such as a corporation, partnership, [nongrantor] trust or estate, then the interest in the entity is an SFFA.

Directly held tangible assets, such as art, antiques, jewelry, cars and other collectibles, are not SFFAs.

Directly held precious metals, such as gold, are not specified foreign financial assets.

Gold certificates issued by a foreign person are SFFAs.

Question: This tax year I sold precious metals that I held for investment to a foreign person. Do I have to report the sales contract on Form 8938?

Form 8938 SFFAs include:

Any financial instrument or contract that has an issuer or counterparty that is other than a U.S. person.

Answer:The contract with the foreign person to sell assets held for investment is an SFFA.

Report if the reporting threshold is exceeded.

A safe deposit box is not a financial account.

Question: How do I value my interest in a foreign pension or deferred compensation plan for purposes of reporting this on Form 8938?

Answer:

(1) Use FMV

(2) IF FMV is unknown, then use amount of cash or property distributed.

3) If no distributions and FMV is unknown, then value at zero.

Lets hope they allow something similar with PFICs

Comparison of Form 8938 and TD F 90-22.1 (FBAR) Requirements

IRS Website

2-25

FBAR

FinCEN Notice 2012-1 (Feb. 14, 2012)

FBAR Filing Extension To June 30, 2013 For Certain Individuals

2-29

Narrow relief for public companies where the executive of the parent company has signature authority over accounts of a subsidiary or vice versa.

FinCEN Announcement Feb 24, 2012

Mandatory E-Filing For FBARS Delayed until

July 1, 2013

2-29

Internal Revenue Manual Provisions Addressing FBAR

Penalties

IRM on FBAR Civil Penalties and

Mitigation Guidelines

2-30

“FBAR civil penalties have

varying upper limits, but no floor.

The examiner has discretion in

determining the amount of the

penalty, if any. Examiner

discretion is necessary because

the total amount of penalties

that can be applied under the

statute can greatly exceed an

amount that would be

appropriate in view of the

violation.”

“Penalties should be asserted only

to promote compliance with the

FBAR reporting and recordkeeping

requirements. In exercising their

discretion, examiners should

consider whether the issuance of

a warning letter and the securing

of delinquent FBARs, rather than

the assertion of a penalty, will

achieve the desired result of

improving compliance in the

future.”

Mitigation Guideline Examples

Nonwillful violation with maximum balance under $50K

Penalty: $500 per violation/max. $5,000

Willful violation with maximum balance over $1 million

Penalty: the greater of (a) $100,000 or (b) 50% of the balance in the account at year end.

U.S. v. Williams (Fourth Cir. 07/20/2012)

Failure To File FBARs on Foreign Accounts is

Willful

2-34

CCA 201208028

Estate Liable For Decedent's Foreign Trust Reporting

Penalties

2-36

PLR 201245003(11/9/12)

Mexican Land Trust (fideicomiso) is Not a Trust for U.S. Tax

Purposes

The sole purpose of the Mexican Landholding Trust is to satisfy the Mexican Federal

Constitution by vesting legal title to the

property in the name of the trustee

Rev. Rul. 92-105 applied similar logic to an Illinois Land

Trust

IR 2012-64 (6/26/2012)

2012 Offshore Voluntary Disclosure Program

(OVDP) Announcement

2-37

2009 and 2011 OVDPs:• $5 billion in back taxes,

interest and penalties

• 33,000 voluntary disclosures

1,500 voluntary disclosures already in the 2012 program

Offshore Voluntary Disclosure Program Frequently Asked

Questions and Answers –IRS Website

(Posted 06/26/2012)

Selected FAQs

2-39

Unlike the 2009 and 2011 OVDPs:• No set deadline for taxpayers

to apply.

• Offshore penalty 27.5% (up from 25% in 2011 program) of the value of foreign assets for the disclosure period.

Q&A 7- Program Requirements• File amended returns and pay

delinquent tax and interest.• Extend S of L-- Title 26 and 31• Pay 20% accuracy penalty• Failure to File Penalties• Failure to Pay Penalties• 27.5% Penalty on value

foreign assets.

Q&A 8 Example:$1,000,000 in a foreign bank account in 2003.

$50,000 of omitted income from 2003 through 2010.

OVDP: $518,000 plus interest

Without OVDP:

• About $4,543,000 ($3,825,000 FBAR penalties)

• Plus possible criminal prosecution

Q&A 23 --- How do I request pre-clearance before I submit my offshore voluntary disclosure?

Submit certain information and IRS Criminal Investigation will notify the taxpayer whether or not they are cleared to make an offshore voluntary disclosure.

Q&A 9 --- Disclosure PeriodFor calendar year taxpayers the voluntary disclosure period is the most recent eight tax years for which the due date has already passed.(Ex: 2004 through 2011)

Q&A 42 --- What about the Statute of Limitations?

• The taxpayer agrees to waive the statute in order to get the deal (27.5% penalty).

• “…, the statute of limitations for asserting FBAR penalties is six years from the date of the violation, which would be the date that an unfiled FBAR was due to have been filed. 31 U.S.C. § 5321(b)(1).”

Q&A 17 --- Delinquent FBARs Only“The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities and you have not previously been contacted regarding an income tax examination or a request for delinquent returns.”

Q&A 18 --- Delinquent Forms such as Forms 5471, 3520:

“The IRS will not impose a penalty for the failure to file the delinquent Forms 5471 and 3520 [presumably also Forms 8865 and 926] if there are no underreported tax liabilities and you have not previously been contacted…”

Q&A 38 --- Accounts with mere signature authority

No need to include in foreign assets subject to 27.5% penalty.

“The taxpayer may cure the FBAR delinquency for the account the taxpayer does not own by filing the FBAR with an explanatory statement before being contacted…”

Q&A 47 I have a client who may be eligible to make a voluntary disclosure.

What are my responsibilities to my client under Circular 230?

2-48

The IRS anticipates that taxpayers will seek qualified tax and legal advice and representation in connection with considering and making a voluntary disclosure.

If a taxpayer seeks the advice of a tax practitioner, the practitioner must exercise due diligence in determining the correctness of any oral or written representations made to the client about the program and the implications for that taxpayer of going forward.

If the taxpayer decides to proceed with the disclosure, the practitioner must exercise due diligence….

If the taxpayer decides not to make the voluntary disclosure despite the taxpayer’s noncompliance with United States tax laws, Circular 230 requires the practitioner to advise the client of the fact of the client’s noncompliance and the consequences of the client’s noncompliance.

A practitioner whose client declines to make full disclosure of the existence of, or any taxable income from, a foreign financial account during a taxable year, may not prepare the client's income tax return for that year without being in violation of Circular 230.

Q&A 50 Will examiners have any discretion to settle offshore voluntary disclosure cases?

NO

Examiners will compare the

OVDP penalty regime with...

The tax, interest, and applicable penalties at their maximum levels for all open years in the absence of the OVDP penalty regime.

The taxpayer will pay the

lesser amount.

The taxpayer may “opt out”

Q&A 51

2-49

Q-51 Under what circumstances might a taxpayer consider opting out of the civil settlement structure of the OVDP?

“An opt out is an election made by a taxpayer to have his or her case handled under the standard audit process.”

See Q51.1 Example 2

• $200,000 FFA Balance• Nonwillful FBAR

violation• $2,000 unreported

interest income

2-51

2-52

CivilSettlement

StructureIncome Tax Due $700

20% Accuracy penalty

$140

27.5% Offshore Penalty

$55,000

Civil Fraud Penalty

0

FBAR Penalty 0Total $55,840

2-52

CivilSettlement

Structure

Opt outand 1 yearnonwillful

FBAR penalty

Income Tax Due $700 $700

20% Accuracy penalty

$140 $140

27.5% Offshore Penalty

$55,000 0

Civil Fraud Penalty

0 0

FBAR Penalty 0 $10,000Total $55,840 $10,840

IRM Mitigation

guidelines say

$5,000 max. FBAR penalty

2-52

OVDP Q&A 54

I have a Canadian registered retirement savings plan (RRSP), registered retirement income fund (RRIF), or other similar Canadian

plan.

2-60

I did not make a timely election pursuant to Article XVIII(7) of the

U.S. – Canada income tax treaty to defer U.S.

income tax on income earned by the RRSP or

RRIF…

Cannot

Elect Treaty

Relief

Retroactively

The Form 8891 also eliminates Forms 3520 and 3520-A filing

With OVDP:

Q & A 54 provides a path to possiblygetting a retroactiveelection for filing Form 8891 with zero income tax and zero OVDP penalty.

If the election is granted, then the RRSP or RRIF

balance is

NOT included in the offshore penalty base.

IRS Instructions and Questionnaire for Streamlined Filing

Compliance Procedures for Non-Filer U.S. Taxpayers residing

outside U.S. (6/26/2012)

2-61

Aimed primarily at nonresidentnonfilers of

Forms 1040 and FBARs.

Secondarily, relief for U.S. citizens

residing in Canada, seeking late Form 8891 elections

T.D. 9584, Reg. § 1.6049-4, -5, -6 , -8; 31.3406(g)-1

(4/17/2012)Rev Proc 2012-24

(4/17/12)

Bank Deposit Interest Reporting For

Nonresident Aliens

2-64

The identification of a country as having an information exchange agreement with the U.S. does not automatically mean that the information collected will be reported to the foreign jurisdiction.

So far, the exchange is

automatic only for Canada.