The U.S. Supreme Court’s June 2018 decision in South Dakota v. Wayfair has far-reaching impact on the state and local sales tax (SALT) obligations and previous competitive advantages of online and foreign businesses that sell products into the U.S.
The court’s ruling eliminates the prevailing physical presence test, which requires sellers to collect sales tax from customers who live in states where they own property or employ workers.
Instead, the court, under Wayfair, introduces an economic nexus test based on the sellers’ sales volume into each state. More specifically, U.S. states may now impose sales tax collection obligations on sellers, foreign or domestic, that conduct more than $100,000 in sales or more than 200 transactions in their jurisdictions in a given year regardless of whether the sellers has a physical presence in that locale. This economic nexus standard varies by state.
For example, if a foreign company that sells tangible goods from its headquarters in South America into the U.S. meets the sufficient dollar/transaction threshold in a particular U.S. state, the company would be required to collect sales and/or use tax on all orders received from customers in that state. This would apply even if the company does not have a permanent establishment (PE) in that state. When the company’s sales meet the test for establishing a meaningful and substantial presence in multiple states, it would need to collect and remit sales tax in each of those jurisdictions. With economic nexus laws, states will now be able to enact or enforce sales or transaction threshold and compel more companies outside of their borders to collect tax on sales made to in-state customers.
The Wayfair decision places a significant administrative burden on foreign businesses. International tax treaties generally apply solely to income taxes on the federal level. As a general rule, tax treaties do not apply to U.S. states, and bilateral tax treaties generally do not apply to non-income taxes at the state level. Therefore, foreign companies with U.S. customers may not escape sales and use tax obligations on the state and local levels. Instead, non-U.S. companies have a potential U.S. tax collection and filing responsibility when they meet the sufficient dollar/transaction threshold in a particular state regardless of whether or not they have a permanent establishment (PE) there.
It is important to note that while the U.S. Commerce Clause prohibits states from imposing excessive burdens on interstate commerce without Congressional approval, the Supreme Court has demonstrated its authority to “formulate rules to preserve the free flow of interstate commerce” when Congress fails to enact legislation. In its opinion in Wayfair, the court affirms that the dollar/transaction threshold satisfies South Dakota’s burden to establish economic nexus and impose tax on businesses that are “fairly related to the services provided by the state,” including “the benefits of a trained workforce and the advantages of a civilized society”. This final factor, which demonstrates a fair relationship between the tax imposed and the services provided by a state, can be easily applied to foreign companies that conduct business in U.S. states.
Foreign businesses must consider how the Wayfair decision will affect their sales and profits, and they must take steps to comply with state-level taxation going forward. This may involve assessing the volume of their transactions in each U.S. state, gaining an understanding of and a method for applying the SALT regimes in each U.S. state to their sales orders, and developing communication to let customers know that sales tax will be added onto future purchases.
About the Author: Karen A. Lake, CPA, is state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
The Tax Cuts and Jobs Act introduces a one-time “deemed repatriation tax” on the previously untaxed profits that U.S. individuals, businesses and foreign corporations owned by U.. shareholders earned and left overseas. Under the law, foreign earnings held overseas in the form of cash and cash equivalents are taxed at a rate of 15.5 percent rate, whereas foreign earnings invested in illiquid, fixed assets, such as plants and equipment, are subject to an 8 percent tax rate.
While the law allows taxpayers to make a timely election to pay the transition tax over an eight-year period, the IRS has clarified some of the initial questions that arose following the enactment of the hastily drafted new law. Following are three key points that taxpayers should plan for under the guidance of experienced tax advisors and accountants:
- Individuals who already filed a 2017 return without electing to pay the transition tax in eight annual installments can still make the election by filing an amended tax return by the extended filing deadline of Oct. 15, 2018.
- In some instances, the IRS will waive an estimated tax penalty for taxpayers subject to the transition tax who improperly attempted to apply a 2017 calculated overpayment to their 2018 estimated tax as long as they make all required estimated tax payments by June 15, 2018.
- Individuals with a transition tax liability of less than $1 million who missed the April 18, 2018, deadline for making the first of the eight annual installment payments may receive a waiver of the late-payment penalty if they pay the installment in full by April 15, 2019. A later deadlines applies to certain individuals who live and work outside the U.S. The language of the law previously led taxpayers to believe that if they missed the April 18, 2018, initial installment payment deadline, they would be required to pay the entire transition tax liability immediately, rather than over an eight-year period.
About the Author: Andre Benayoun, JD, is an associate director of International Tax Services with Berkowitz Pollack Brant, where he works with inbound and outbound multinational businesses and nonresident aliens on a variety of matters, including structuring for mergers, acquisitions and liquidations; planning for profit repatriation; treaty analysis; tax-efficient debt financing; and pre-immigration tax planning. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
A common planning challenge faced by multinational families is the U.S. taxation of gifts from foreign, non-U.S. family members to their relatives who are U.S. citizens and U.S. tax residents. For example, if a husband is a non-U.S. citizen who lives and works in foreign country X, what is the best way for him to transfer money to his wife and family living in the U.S.? What does U.S. tax law require the wife to report to the IRS on an annual basis to prevent those cash gifts from becoming subject to U.S. income tax and/or penalties? What are the reporting requirements and how can a U.S. family member avoid penalties when he or she receives a large inheritance from a relative who was a non-U.S. person at the time of passing?
The IRS requires U.S. taxpayers to file Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, to report receipts of large gifts and inheritances that meet the following thresholds:
Gifts or bequests valued at more than $100,000 received from non-US individuals or foreign estates, including non-US persons related to the non-US individual or foreign estate,
- Gifts valued at more than $16,111 in 2018 from foreign corporations or foreign partnerships, including foreign persons related to those foreign entities,
- Gifts in the form of distributions of loans from a foreign trust, regardless of the amount.
The $100,000 threshold is based on the aggregate value of all gifts a U.S. taxpayer receives in a given year from a foreign estate or from a non-U.S. person and his or her family members. Therefore, if a U.S. citizen receives $50,000 from her non-U.S. mother and $60,000 from her non-U.S. father, she will have a requirement to file Form 3520 and report to the IRS the aggregate value ($110,000) of both gifts.
Form 3520 is due by April 15th following the year of the gift and can be extended to October 15th if additional time is needed. Failure to timely file and report a gift or inheritance from a foreign person will result in a penalty as high as 25 percent of the amount of the foreign gift or bequest. This penalty may also apply when the information contained on a taxpayer’s Form 3520 is inaccurate or incomplete. The IRS will waive penalties for late filing if there is reasonable cause.
Avoiding Penalties and Tax Traps
U.S. citizens who expect to receive gifts from foreign sources have an opportunity to minimize their U.S. tax liabilities when they take the time to plan under the guidance of experienced tax accountants and advisors. With some advance planning preparation, it is possible for U.S. persons to receive gifts or inheritance free of U.S. taxes.
For example, foreign family members should not make “gifts” to their U.S. family members from a foreign corporation, since the IRS will consider such transfers to be taxable corporate dividends that cannot qualify as tax-free gifts. There is a similar concern with distributions received from foreign partnerships, which the IRS would also presume to be taxable distributions.
Another potential tax trap can occur when U.S. persons receive as “gifts” shares in a foreign corporation that owns assets that produce passive income. This may include an offshore company that owns a portfolio of stocks and bonds or passively managed rental real estate. The primary tax concern is that these gifts of corporate shares could ultimately trigger a U.S. tax liability to the new U.S. owner, even if no actual cash was distributed. U.S. persons are also susceptible to taxation in connection with distributions or loans they receive from certain foreign trusts. For example, a U.S. beneficiary who receives a distribution from a foreign non-grantor trust could be subject to U.S. income tax and an interest charge on the distribution amount. While beneficiaries of foreign trust distributions and loans cannot avoid the IRS’s reporting requirement (also on Form 3520) they may be able to minimize their income tax exposure on these transfers when they plan ahead and properly structure the trust and the distributions.
In each of these situations, multinational families have the opportunity, with advance planning, to restructure their holdings and/or develop appropriate gifting strategies to maximize tax efficiency for U.S. family members.
Similarly, U.S. persons should be careful of their susceptible to taxation in connection with distributions or loans they receive from certain foreign trusts. For example, a U.S. beneficiary of a foreign non-grantor trust who receives a distribution or loan from the trust could be subject to income tax and an interest charge on the distributed amount. While the U.S. beneficiary cannot avoid his or her IRS reporting requirement on Form 3520, he or she may minimize his or her income tax exposure on these transfers when the trust and distributions are properly structured far in advance.
Some Tax Relief for Married Couples
Under U.S. tax laws, special rules apply to gifts between U.S. citizens and their non-U.S. spouses. In general, married couples who are both U.S. citizens may make unlimited tax-free gifts to each other during life and at death. This is known as the marital deduction. Similarly, a U.S. citizen may receive from a non-U.S. spouse an unlimited amount of tax-free gifts.
However, the unlimited marital deduction does not apply when the spouse receiving a gift is not a U.S. citizen. Under these circumstances, a U.S. tax citizen spouse must report to the IRS any gift exceed $152,000 in 2018 that he or she makes to a nonresident alien spouse.
The advisors and accountants with Berkowitz Pollack Brant work with multinational families to comply with complex international tax laws and maximize tax efficiency across borders.
About the Author: Lewis Kevelson, CPA, is a director with Berkowitz Pollack Brant’s International Tax practice, where he assists cross-border families and their advisors with personal financial planning and wealth management decisions. He can be reached at the firm’s West Palm Beach, Fla., office at (561) 361-2050 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
The IRS announced it will end the Offshore Voluntary Disclosure Program (OVDP) on Sept. 28, 2018. This move will leave taxpayers with one less option for avoiding penalties and criminal prosecution when they did not previously report all of their non-U.S. income, or when they did not comply with all of the U.S.’s various reporting requirements applicable to non-U.S. income and assets.
The good news is that taxpayers who need the OVDP still have time to participate in the program, but they will have to hurry. The better news is that the IRS will continue to provide reticent taxpayers with other amnesty programs offering penalty relief and/or protection against criminal prosecution. Most of these programs, however, do not offer relief from income tax liabilities or interest on non-reported amounts.
It is common for non-compliant taxpayers to ask, “Which program is best for me?” While there is no on-size-fits-all solution, the answer will depend on the unique facts and circumstance of each individual’s specific case.
What are my Options to Become Tax Compliant?
Offshore Voluntary Disclosure Program (OVDP)
According to the IRS, more than 56,000 taxpayers have participated in the OVDP, and the government has collected more than $11.1 billion in taxes, penalties and interest since introducing the program in 2009. With the IRS’s plan to end the program on Sept. 28, 2018, taxpayers have a limited amount of time to apply to participate, receive clearance from the agency’s Criminal Investigation division and make their OVDP submission.
The OVDP requires taxpayers to file eight years of amended or original income tax returns (including all required information returns) and eight years of foreign bank account reports using FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Taxpayers will be subject to income tax, interest and penalties for lack of accuracy, late filing and/or late payment. In addition, they will be required to pay a one-time OVDP penalty equal to 27.5 percent of the value of their foreign accounts and certain other foreign assets for the year during the eight-year period where the aggregate value of such assets was the highest. This penalty increases to 50 percent when a taxpayer has accounts at certain financial institutions or when they received advice from certain individuals determined to be facilitators. The IRS has published a list of 146 facilitators and financial institutions that it considers “bad” and for which the 50 percent penalty will apply.
One of the key advantages of the OVDP is that cooperative taxpayers will be unlikely to face criminal prosecution. In addition, the program provides taxpayers with peace of mind in the form of a closing agreement concluding the matter and more certainty with respect to penalties, which may be less than what they would have faced under the Tax Code.
In addition to burdening taxpayers with a requirement to file eight years of income tax returns and FBARs, the OVDP is very rigid, and IRS agents have little flexibility regarding abatement of penalties. Moreover, taxpayers are required to track down and provide the IRS with account statements covering eight years of all of their foreign accounts, which can be a very challenging, expensive and time-consuming process.
Streamlined Filing Compliance Procedures
The streamlined procedure is available to both U.S. residents and non-resident taxpayers whose failure to report foreign financial assets and pay all tax due on their offshore income was the result of “non-willful conduct.” This means that their reticence resulted from negligence, inadvertence or mistake, or a good-faith misunderstanding of the requirements of the law.
A main advantage of streamlined procedures is that they require taxpayers to prepare fewer tax returns than required by other programs. Taxpayers must submit only three years of income tax returns (with all applicable information returns), six years of foreign bank account reports using FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), and a certification statement indicating that they meet the streamlined eligibility requirements.
In addition, while taxpayers using streamlined procedures will be subject to income tax and interest on delinquencies, the IRS will not impose penalties for a taxpayer’s late filing and/or late payment, inaccuracy, or failure to file information returns. Taxpayers who qualify for the non-resident program will not be subject to any penalties, whereas taxpayers who qualify for the resident program will pay a 5 percent penalty based on the highest aggregate balance/value of their foreign financial assets during the years included in the penalty period.
The disadvantages to streamlined procedures include a lack of protection from criminal prosecution and exposure to IRS audit of submitted returns covering the delinquency period. In addition, once a taxpayer applies this procedure, he or she no longer has the option to participate in a voluntary disclosure. Finally, because the IRS typically does not acknowledge receipt of a streamlined submission, participating taxpayers will not have the certainty provided by an OVDP closing agreement. In other words, no news is the best news.
Delinquent FBAR, Delinquent International Information Return Submission Procedures
Taxpayers may avoid FBAR penalties and file delinquent FBARs directly to the U.S. Treasury Department with an explanation for their late filing, only when they satisfy all of the following requirements:
- they have unfiled FBARs,
- they are not required to use the OVDP or streamlined procedure to file delinquent or amended tax returns to report and pay additional tax,
- they are not already under IRS investigation, and
- they have not been contacted previously by the IRS regarding delinquent FBARs.
Under certain circumstances, taxpayers may qualify to file directly with the appropriate service center delinquent information returns and amended income tax returns, if required, along with a reasonable cause statement explaining the facts related to their failure to file. The IRS may impose penalties based on whether the agency agrees with the taxpayer’s reasonable cause position.
Returns submitted through these procedures will not automatically be subject to audit. Yet, they may be selected through the existing audit selection processes that are in place for any tax or information returns.
Service Center Filings
Some taxpayers who do not meet the eligibility requirements of the streamlined procedures, but who feel they do not have enough substantial offshore income and/or assets to justify an OVDP submission, may wish to simply file original and/or amended income tax returns with information returns and a reasonable-cause statement and hope for the best. This option also works for taxpayers who feel that there were extenuating circumstances that justified their failure to file properly. This is a very risky strategy, but it may be appropriate in certain cases. Taxpayers deciding to pursue this route should do so very carefully and only after consulting with an attorney with knowledge about offshore reporting matters and all of the available programs.
In the current regulatory environment, it is much more difficult for U.S. taxpayers to avoid reporting and paying taxes on foreign assets. To avoid exposure to criminal prosecution and significant penalties, it makes sense for taxpayers to come forward and disclose their offshore interests through one of the IRS’s amnesty programs. In addition to speaking with an experienced tax advisor, it is always a good idea for taxpayers to discuss their situations with an attorney.
The advisors and accountants with Berkowitz Pollack Brant work with domestic and foreign individuals and businesses to comply with international tax laws, maximize tax efficiency and reduce unnecessary compliance costs.
About the Author: Arthur Dichter, JD, is a director of International Tax Services with Berkowitz Pollack Brant, where he works with multi-national businesses and high-net worth foreign individuals to structure their assets and build wealth in compliance with U.S. and foreign income, estate and gift tax laws. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at email@example.com.
Behind the fairytale nuptials of British Prince Harry to American actress Meghan Markle is a dose of reality that the recently betrothed couple will need to pay their share of U.S. taxes during their marriage.
Under U.S. tax laws, U.S. citizens must report and pay taxes on their worldwide income, including assets held in overseas bank accounts, regardless of whether or not they reside in the U.S. By law, Markle must maintain her U.S. citizenship and pay U.S. taxes even if she applies for residency status in the U.K., which can be a three-year process. Any money that she earns in Britain or elsewhere will be subject to U.S. taxes.
Moreover, if Markle and the Prince have joint financial accounts with a balance of more than $10,000 at any point during the year, the bank or financial institution holding those accounts would be required to share the royal couple’s personal financial information with Uncle Sam, thanks to the U.S.’s Foreign Account Tax Compliance Act (FATCA). This includes all of the royal family’s trusts and offshore accounts in which Prince Harry holds ownership interest or for which he is a named beneficiary. Finally should the royal couple bear children while Markle is a U.S. citizen, those offspring will be considered U.S. citizens subject to U.S. tax laws.
If Markle becomes a dual citizen of the U.S. and the U.K, she may still have to meet her annual U.S. tax reporting requirements and disclose sensitive information about trusts and other financial accounts held by the royal family. However, as a U.S. citizen or dual citizen, she may qualify for either a foreign earned income exclusion or a foreign tax credit for taxes she paid in the U.K. on U.K.-source income. Should she take the deduction, she would be able to waive U.S. taxes on the first $104,000 of non-investment income she earns in the U.K. If she takes the credit, she may be able to use the taxes she paid in the U.K. to reduce her U.S. tax liabilities.
One option to keep the IRS’s prying eyes and hands away from the royal couple’s finances is for Markle to renounce her U.S. citizenship after the requisite three-to-five year waiting period.
While this may appear to be the simplest option, it would subject Markle to a significant exit tax and make it difficult for her to regain U.S. citizenship in the future.
U.S. citizens living abroad should meet with experienced tax advisors to understand their U.S. and foreign tax reporting responsibilities based upon such things as the type of income they receive.
About the Author: Rick D. Bazzani, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where he provides individuals with a broad range of tax-efficient estate-, trust- and gift-planning services. He can be reached in the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or at firstname.lastname@example.org.