International Estate Planning Pt. 4

This is the fourth and last in a series of blogs about the tax aspects of international estate tax planning.

Ownership & Titling Thoughts

Corporations:  Many people choose to hold real property in the name of a corporation rather than using their own names.  This allows for non-disclosure of beneficial ownership in public records.  There is no registry of ownership of corporation shares published in the US; however, for real estate, the ownership is a matter of public record and available in courthouse documents throughout the US.  Thus, corporations may provide better protection against legal liability for the owner with respect to the investment.

The IRS, however, is notified of the share ownership of a US corporation.  This is a reason why foreign holding corporations are often layered on top, to own the shares of the US corporations.

This corporate structure also is useful if you need to ask for a refund of taxes withheld on sale of the property, perhaps withholdings by state tax authorities or perhaps due to withholding done in error.  To request a refund, the owner of the property needs to have a US tax identification number.  If the property owner is a corporation, getting a tax identification is easier.  If the owner is a foreign individual, obtaining a tax identification number may require furnishing the IRS with all kinds of personal information, including passports, birth certificates, and foreign residence addresses.

Foreign vs. domestic trusts:  The distinction between a “foreign trust” and “domestic trust” is extremely important.  The tax and reporting implications of this distinction are significant both for trusts that you set up as well as for trusts that you are beneficiary of.

Taxable income of a nongrantor foreign trust is generally computed in the same manner as if the assets were held by a NRA, i.e., taxed on US source income.  Compare this to a nongrantor domestic trust, where the trust is generally taxed on worldwide income.  The desirability of having a foreign trust vs a domestic trust varies, depending on the applicable facts of a given situation.

Things get complicated if a foreign trust has US beneficiaries and the foreign trust makes distributions to those beneficiaries in any year following the year in which the income was earned.  In other words, a distribution of trust income that has been accumulated from prior years.

There are complex forms and disclosures to be filed as well as interest charges for throwback taxes on the accumulation distribution.  Thus, if you have a foreign trust in the mix, try to simply the situation as much as possible, which usually means making sure all income is distributed currently, if possible.

More Ownership & Titling Thoughts

Controlled Foreign Corporations:  If a foreign corporation is controlled directly or indirectly by a US person or entity, then such US shareholder must provide the IRS with full financial details of that corporation.  A foreign corporation is considered to be a CFC if the US shareholders, each owning 10% or more of the shares, collectively own more than 50% of the corporate stock [by voting power or value].

Certain types of income, often referred to as tainted or Subpart F [including GILTI, beyond the scope of this writing] income, that are earned by the corporation, even if undistributed, will be taxable to 10% US shareholders as if it had been distributed [phantom distributions].

US persons who own 10% of a CFC need to file the information required on Form 5471 or face increasingly severe penalties.  A penalty of $10K may be incurred for failure to comply with these filing requirements.  There is a maximum fine of $50K for continuing non-compliance.  If you fail to report all Form 5471 information when prescribed, you may also be subjected to a reduction in your claiming of credits for foreign taxes paid.

Thus, divesture of CFC’s prior to becoming a US person should be considered.

Passive foreign investment companies:  Foreign corporations are classified as PFICs when they meet either of two tests:

1.      At least 75% of the corporation’s gross income is characterized as passive income

2.      At least 50% of its assets produce or are held for the production of passive income

For example, a foreign mutual fund that produces entirely investment income would be considered a PFIC.  On the other hand, a foreign corporation which, for example consists primarily of an active business and fails the 75% or 50% thresholds would not be considered a PFIC [though it might still be considered a CFC].

Unless a US shareholder of a PFIC chooses to be taxed currently on his share of PFIC earnings, which is usually a good idea, he will be taxed as ordinary income rates on distributions received.  If the distributions include amounts that are considered earned in previous years but not distributed until now, which is almost always the case, he will also have to pay interest charges on those “phantom” distributions.

Thus, divesture of PFICs should be considered to simplify your life and save you from headaches and high interest charges.

Thank you for reading.  If you have questions about US taxation relating to international transactions, either business or personal, please contact us.

For questions, please connect with Daniel Won at [email protected]