Tag Archives: international

How To Save U.S. Taxes For Nonresident Aliens

August 21, 2018 | By: Robert A. Green, CPA | Read it on

The U.S. stock markets have been stellar, and many non-U.S. persons have been accessing them from their home country. Other foreign individuals and entities prefer to open U.S.-based brokerage accounts for lower commissions, and better trading platforms.

In either case, the foreign individual or foreign company is subject to U.S. tax withholding on U.S. dividends and certain other U.S. passive income. The default withholding tax rate is 30%, and income tax treaties provide for lower rates, usually around 15% or less. U.S. brokers handle this tax withholding and pay those taxes to the Internal Revenue Service (IRS). The foreign investor does not have an obligation for U.S. tax compliance if withholding is done correctly.

The critical point is that capital gains are not taxable in the U.S. if the nonresident alien does not spend more than 183 days per year in the U.S. Most active traders don’t generate significant dividend income paid by U.S. companies, so tax withholding is not a problem. Many of them get a foreign tax credit for U.S. tax withholding in their resident country.

Some nonresident aliens establish a spousal-member LLC in the U.S. and file a U.S. partnership tax return. The LLC/partnership opens a U.S.-based brokerage account as a domestic entity. The LLC files a W-9 with a U.S. tax identification number. The broker treats the U.S. LLC/partnership as a U.S. account, which means the broker does not handle the tax withholding on dividends and other passive income for the foreign owners of the LLC.

Therefore, the nonresident alien owners must file a W-8BEN with the U.S. partnership. The U.S. partnership assumes responsibility for tax withholding on dividends and other portfolio income, and payment of those taxes to the IRS on a timely basis. It’s extra tax compliance work, but it’s not too complicated.

U.S. estate tax might come into play. Estate tax treaties may exempt brokerage accounts for nonresident aliens or provide higher exemptions from the tax. U.S. partnership interests are likely not includible in an estate for a nonresident alien. Brokers are not responsible for estate tax compliance, so it’s a tax matter for nonresident aliens and their tax advisors. Brokers require a conclusion of IRS estate proceedings before releasing assets from the account of the deceased.

Nonresident alien U.S. income tax treatment
In this scenario, nonresident aliens are subject to U.S. tax withholding on dividends paid by U.S. companies and on other “fixed or determinable, annual, or periodic” (FDAP) income. Per IRS Taxation of Nonresident Aliens: “FDAP income is passive income such as interest, dividends, rents or royalties. This income is taxed at a flat 30% rate unless a tax treaty specifies a lower rate.” Many countries have a tax treaty with the U.S. providing for 15% or lower withholding tax rate on FDAP income. Interest income on bonds and commercial paper issued by U.S. companies, by the U.S. Treasury, and by U.S. government agencies is generally exempt from U.S. tax withholding, although it’s reportable on Form 1042-S.

Nonresident alien individuals fill out W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting – Individuals) and furnish it to the broker. Don’t overlook Part II to claim tax treaty benefits. The broker then withholds taxes on U.S.-source dividends and other FDAP income at the appropriate tax treaty rates, or 30% if there is no tax treaty, and pays those taxes to the IRS directly. As a withholding agent, the broker is required to report all U.S.-source FDAP to the IRS and the client on Form 1042-S. There are other types of W-8 forms including W–8BEN–E (entities), W–8ECI (ECI from U.S. business), W–8EXP (foreign government or organization), and W–8IMY (foreign intermediary or branch).

Capital gains 183-day rule
If the nonresident alien spends more than 183 days in the U.S., he owes taxes on net U.S. source capital gains, even though he may not trigger U.S. residency under the substantial presence test. (U.S. residency is triggered with legal residence status or by meeting the substantial presence test. The IRS taxes U.S. residents on worldwide income.)

See IRS The Taxation of Capital Gains of Nonresident Alien Students, Scholars and Employees of Foreign Governments:

“Nonresident alien students and scholars and alien employees of foreign governments and international organizations who, at the time of their arrival in the United States, intend to reside in the United States for longer than 1 year are subject to the 30 percent taxation on their capital gains during any tax year (usually calendar year) in which they are present in the United States for 183 days or more, unless a tax treaty provides for a lesser rate of taxation. These capital gains would be reported on page 4 (not page 1) of Form 1040NR and would not be reported on a Schedule D because they are being taxed at a flat rate of 30 percent or at a reduced flat rate under a tax treaty.”

Income tax treaties
Per IRS Taxation of Nonresident Aliens:

“The United States has income tax treaties with a number of foreign countries. For nonresident aliens, these treaties can often reduce or eliminate U.S. tax on various types of personal services and other income, such as pensions, interest, dividends, royalties, and capital gains. Each individual treaty must be reviewed to determine whether specific types of income are exempt from U.S. tax or taxed at a reduced rate. More details can be found in IRS Publication 901, U.S. Tax Treaties.”

“Form 8833 does not apply to a reduced rate of withholding tax on noneffectively connected income, such as dividends, interest, rents or royalties.”

A nonresident alien may owe U.S. estate tax
U.S. estate tax considerations also may come into play in this situation. Nonresident aliens should learn how repatriation of funds work on death; they might have delays due to probate of the estate and getting IRS estate tax clearance. By opening a U.S.-based brokerage account, it lands the account in the U.S., which could potentially trigger U.S. estate taxes if over the estate exemption. While many types of funds like U.S. bonds are exempt from estate tax, U.S. equities are includible in an estate. (Nonresidents holding U.S. securities in a foreign brokerage account must count those U.S. securities in a U.S. estate.) The default estate exemption for nonresident aliens is $60,000; however, many estate tax treaties provide a significantly higher threshold. The estate tax rate starts at 18% and rises to 40%. An estate tax treaty beneficiary may be exempt from U.S. estate tax entirely on U.S. financial assets.  (Learn more about nonresident alien accounts income and estate taxation on Schwab’s Website and Schwab’s U.S. Tax, and Estate Disclosure to Non-U.S. Persons.)

Here is an IRS list of Estate & Gift Tax Treaties (International). The U.S.–Canada Income Tax Treaty includes estate tax issues. Canadians have a $2,000,000 estate exemption instead of the default $60,000 threshold.

Some nonresident aliens open a U.S. partnership account
Some U.S. brokers are not set up to accommodate nonresident aliens or other foreign persons including foreign corporations, partnerships, and trusts. They might recommend forming a U.S. LLC entity to open a U.S. entity account instead of a nonresident alien or foreign entity account. This U.S. entity account should be treated like other U.S. persons or entities, not subject to tax withholding on dividends by the broker. The U.S. LLC entity account should receive a Form 1099-B reporting dividends, interest, sale proceeds and cost basis, and other items of income or loss. The LLC files a W-9 with U.S. tax id number, not a W-8BEN-E for foreign entity status.

There are problems using a single-member LLC (SMLLC). Without classification as a partnership or C-Corp, an SMLLC is a disregarded entity. That would mean the SMLLC disregards to the nonresident alien individual, who should then file a W-8BEN-E. Nonresident aliens may not own an S-Corp. If the broker did treat the SMLLC disregarded entity as a domestic entity, the owner would have to file a complicated Form 1040NR in the event there is a U.S. tax liability (i.e., on U.S. dividends).

As stated above, it’s better to have a spousal-member LLC to file a partnership return. The U.S. partnership takes over the role as tax withholding agent from the broker, and the U.S. partnership must issue the Form 1042-S to the nonresident alien owners. Using a company does not avoid withholding taxes on U.S.-source FDAP income for nonresident owners.

“The Chapter 3 withholding regulations on U.S. source payments to foreign persons make clear that there is no U.S. withholding on payments to U.S. persons, which includes a partnership formed under U.S. law,” says tax attorney Roger D. Lorence. “The partnership is the withholding agent, and it is required to withhold on U.S. source dividends allocable to non-U.S. partners (nonresident aliens).” (See IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.)

The Form 1065 U.S. partnership tax return can be reasonably straightforward because all owners are non-resident aliens. The partnership can report zero capital gains and losses but reconcile to the 1099-B for IRS matching purposes. The partnership can omit expenses as they do not affect U.S. income taxes. In the tax return footnotes, the partnership should explain that the nonresident owners do not owe capital gains taxes, because they are in the U.S. under 183 days per year.

Usually, the partnership can allocate dividends and portfolio income to partners on the last day of the year, so tax deposits for withholding can wait until early January of the subsequent year. It’s one accounting period, which reduces the stress of making tax payments on a timely basis to avoid penalties.

There might be challenges to establishing an LLC bank account, and repatriating funds to a foreign country.

“The U.S. partnership is not engaged in a trade or business in the U.S. with effectively connected income (ECI). It’s an investor partnership with FDAP and a Section 864 exemption,” Lorence says. “Although not free from doubt, the better view is that it is not included in a U.S. estate of a nonresident alien owner. Intangible assets like partnership interests are situated where the owner resides and dies. Legal situs is where the owner is located on death.”

Four ways nonresidents trade U.S. financial markets

1. Some foreign-based brokers offer limited access to U.S. financial markets. Even on foreign-based brokerage accounts, there is U.S. tax withholding on dividends paid by U.S. companies and other FDAP income. Foreign brokerage accounts do not issue a Form 1042-S as a U.S.-based broker does for nonresident aliens. There are U.S. estate tax considerations for U.S. securities.

2. Leading U.S. brokers open affiliate brokerage firms in some countries. There may be affiliates in Canada and some European and Asian countries. It’s the same tax treatment as the previous: tax withholding on U.S.-source FDAP income, no 1042-S issuance, and potential U.S. estate tax on U.S. securities.

3. Some U.S. brokers open accounts for nonresident aliens. The nonresident alien files a W-8BEN claiming tax treaty benefits, if applicable. The U.S. broker is an income tax withholding agent on U.S.-source FDAP with a default tax rate of 30% unless overridden by a treaty rate of usually 15% or less. The U.S. broker issues Form 1042-S reporting U.S. source income and withholding tax. There are some U.S. estate tax considerations for the nonresident so check if there is an estate tax treaty with your country, perhaps providing a higher exemption amount or exclusion. Some nonresident aliens form a foreign corporation, partnership or trust to open the brokerage account with a U.S. broker, which helps avoid potential U.S. estate taxation.

4. Some U.S.-based brokers suggest the nonresident alien open a U.S. LLC to create an account and file as a partnership. The broker treats the account like a U.S. person or entity issuing an annual tax report Form 1099-B. The broker does not withhold taxes on dividends paid by U.S. companies or on other U.S.-source FDAP income. The U.S. partnership takes over that role as tax withholding agent and issues the 1042-S to the IRS and nonresident owner of the partnership. There is probably no U.S. estate tax on a U.S. partnership interest in an investment company. There are challenges to establishing an LLC bank account, and repatriating funds to a foreign country. Consult a tax advisor.

Roger D. Lorence, JD contributed to this blog post.

If You Trade Around The World, You Need To Know IRS Rules (Recording)

October 6, 2016 | By: Robert A. Green, CPA

U.S. traders move abroad; others make international investments and non-resident aliens invest in the U.S. How are their taxes handled?

Join GNMTraderTax international tax experts Robert A. Green CPA, tax attorneys Mark Feldman and Roger Lorence, and Deborah King CPA as we discuss:

  • U.S. resident traders living abroad.
  • U.S. resident traders with international brokerage accounts.
  • Report of foreign bank and financial accounts.
  • IRS Offshore Voluntary Disclosure Program.
  • Foreign retirement plan elections and reporting.
  • Foreign assets reported on Form 8938.
  • U.S. traders move to Puerto Rico to escape capital gains taxes.
  • Renouncing U.S. citizenship or surrendering a green card.
  • Non-resident aliens are opening U.S. brokerage accounts.
  • Foreign partners in a U.S. trading partnership can be tax-free.
  • International tax forms.

Read our recent blog post: If You Trade Around The World, You Need To Know IRS Rules.

If You Trade Around The World, You Need To Know IRS Rules

October 5, 2016 | By: Robert A. Green, CPA

ForbesSmall

Green’s blog post in Forbes.com

 

U.S. traders move abroad; others make international investments and non-resident aliens invest in the U.S. How are their taxes handled?

When it comes to international tax matters for traders, focus on the following:
  • U.S. resident traders living abroad
  • U.S. resident traders with international brokerage accounts
  • Report of foreign bank and financial accounts
  • IRS Offshore Voluntary Disclosure Program
  • Foreign retirement plan elections and reporting
  • Foreign assets reported on Form 8938
  • U.S. traders move to Puerto Rico to escape capital gains taxes
  • Renouncing U.S. citizenship or surrendering a green card
  • Non-resident aliens are opening U.S. brokerage accounts, and
  • Foreign partners in a U.S. trading partnership can be tax-free

U.S. resident traders living abroad
U.S. tax residents are liable for federal tax on worldwide income whether they live in the U.S. or a foreign country. If you qualify for “bonafide” or “physical residence” abroad, which is living abroad for an entire tax year, try to arrange Section 911 “foreign earned income” benefits on Form 2555. Avoid double taxation by paying tax in both a foreign country and the U.S. by availing yourself of foreign tax credits reported on Form 1116. If you live in a country which charges higher taxes than the U.S., sometimes it makes sense to skip the Section 911 exclusion and use just the foreign tax credit.

The Section 911 exclusion on foreign earned income is $101,300 for 2016, an amount the IRS raises each year. There is also a housing allowance along with maximum amount (cap) per location. The problem for traders is that capital gains and trading gains are not “foreign earned income” so they are unable to utilize Section 911 benefits. There is a solution: Traders with trader tax status (TTS) can form a Delaware S-Corp to pay officer compensation, and that compensation is foreign earned income. U.S.-based traders with TTS use an S-Corp to create “earned income” to unlock health insurance and retirement plan deductions. Add the foreign earned income exclusion and housing allowance to that list. Before committing to the S-Corp solution, compare expected net income tax savings, minus payroll tax costs vs. using a foreign tax credit.

The U.S. has tax treaties with many countries, and these agreements specify which country is entitled to collect tax on different types of items, like retirement plan distributions. Cite a tax treaty provision to override a regular tax on Form 8833. Its important to note that tax treaty provisions are used to reduce tax liability; the IRS may not use them to increase a tax.

U.S. resident traders with international brokerage accounts
Many traders living in the U.S. have a foreign brokerage account. It’s complicated when traders open these accounts held in a foreign currency. Counterparties outside the U.S. do not issue Form 1099-B, and accounting is a challenge. Traders should separate capital gains and losses, including currency appreciation or depreciation, from changes in currency values on cash balances, which are Section 988 ordinary gain or loss.

Some foreign brokers encourage traders to form foreign entities as a requirement to get access or to set up an account. Look before you leap: Tax compliance for an international entity is significant, and there are few to no tax advantages for traders. International tax compliance is very complex, and theres a risk of messing up tax reporting. Its very rare to achieve material deferral on foreign income, and there are plenty of tax penalties for non-compliance. But all this being said, there are plenty of good reasons to trade foreign markets. Just get the right advice beforehand and make sure the reason to do so is compelling.

Report of foreign bank and financial accounts
U.S. residents with a foreign bank, brokerage, investment and another type of account (including retirement and insurance in some cases) who meet reporting requirements must e-file FinCEN Form 114, Report of Foreign Bank and Financial Account (known previously as Foreign Bank Account Reports or “FBAR”). If your foreign bank and financial institution accounts combined are under $10,000 for the entire tax year, you fall under the threshold for filing FinCEN Form 114.

Filing due date changed: A new law enacted on July 31, 2015, changed the due date from June 30 to April 15 starting with 2016 filings in 2017. Congress added an automatic extension for six months to Oct. 15 to coordinate FinCEN Form 114 with individual income tax returns.

In recent years, we have learned that many taxpayers omitted foreign bank account reports when they should have filed them. Many taxpayers just didnt realize it. Some had financial interests in family accounts offshore if they were foreign nationals before moving to the U.S. Or some taxpayers married a foreign person gaining that financial interest. Others may have international retirement or insurance accounts that they never realized were subject to FBAR reporting.

The FBAR rule states “a financial interest in, signature authority or other authority over foreign financial accounts.” Traders and executives of hedge funds and other financial institutions and trustees typically have signature authority or other authority over foreign financial accounts triggering FBAR filings for them.

Most taxpayers owning foreign accounts reported their foreign income and were not trying to cheat the IRS by hiding it offshore. Because they reported foreign income correctly, many are allowed to file a late FBAR and avoid penalties. Otherwise, there is a highly complex and nuanced penalty regime in connection with late or incorrect FBAR filings.

IRS Offshore Voluntary Disclosure Program
Consider entering the IRS Offshore Voluntary Disclosure Program (OVDP), which has been extended to encourage taxpayers to come clean before getting busted by the IRS. The OVDP penalties are high (though there are exceptions). Its not amnesty by any means and its an expensive undertaking with tax attorneys and accountants. But if you wait to get busted by the IRS, your foreign bank or anyone else, the penalties are far higher. Criminal penalties may apply too unless you join the program first. The current OVDP program has no end date, but the IRS has explicitly stated it may revoke it at any time. On July 1, 2014, the IRS created a “streamlined” program for those taxpayers who were negligent in not filing FBARs (but did not do so on purpose). U.S. resident taxpayers pay just a 5% penalty with this streamlined program.

While OVDP is a good plan for some (such as tax cheats in serious potential trouble), its often not appropriate for those discussed earlier who reported their income but just missed an FBAR filing.

Its wise for American taxpayers to turn themselves in before getting busted. It can make a significant difference in treatment and penalties.

Foreign retirement plan elections and reporting
Dont assume international retirement plans are like U.S. pension plans with tax deferral on income until you take taxable distributions. For U.S. tax purposes, the IRS considers many international retirement plans taxable investment accounts because they aren’t structured as qualified plans under Section 401 unless they qualify under Section 402(b) as an employeestrust established by an employer. While that seems unfair and counterintuitive to many, it’s the rule, and it catches many unsuspecting taxpayers and accountants off guard. To the extent that Section 402(b) does not apply, you may have to pay a high Passive Foreign Investment Company (PFIC) tax. Include these retirement plans on the annual FinCEN Form 114 each year, whether or not the plan has deferral.

In October 2014, the IRS acknowledged the tax-deferral problem on Canadian retirement plans and provided assistance. In Revenue Procedure 2014-55, the IRS repealed the need for filing a tax election, which means Canadian retirement plans automatically qualify for tax deferral. These rules are retroactive, so it abates back taxes, interest, and penalties. It’s no longer needed to file Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans). This relief does not apply to international retirement plans outside of Canada.

Foreign assets reported on Form 8938
Tax Form 8938 is more about giving the IRS a heads up regarding your international assets. Its not about reporting income and loss — there are other tax forms for that. The filing threshold for Form 8938 is materially higher than the FBAR threshold, and its even higher for Americans living out of the country. (See Form 8938 instructions.)

U.S. traders move to Puerto Rico to escape capital gains taxes
Puerto Rico (PR) is not a state or foreign country; its a “possession” with a government and tax system (Hacienda). Residents of PR report particular types of income to Hacienda and other forms of revenue to the IRS. Trading gains are capital gains on “personal property” taxed where the sellers tax home is.

PR enacted tax incentive acts that are tailor-made for traders/investors, investment managers, and financial institutions. Passed in 2012, PR Act 22 allows investors and traders with bona fide residence in Puerto Rico to exclude from PR and U.S. taxes under Section 933 100% of all short-term and long-term capital gains from the sale of personal property accrued after moving there. Personal property includes stocks, bonds, and other financial products. Act 22 does not require investment in Puerto Rican stocks and bonds; trades can be made with a U.S. broker or on any exchange around the world. This capital gain tax break applies to professional traders using the default realization method, or Section 475 MTM.

There is a different PR tax incentive act for investment managers, who charge advisory fees. They sell their services to investors outside of PR and hence they can qualify for PR Act 20 tax incentives for “export service businesses.” The Act 20 tax incentive is a 4% flat tax rate on net business income. The owner also receives Act 22 100% exclusion on dividends received from the PR business entity, and exclusion from U.S. tax, since Section 933 excludes PR-sourced dividends.

On Nov. 30, 2015, PR enacted Act 187-2015 amending Acts 22 and 20 to stiffen the requirements. For Act 22 incentives, PR requires new applicants after Dec. 1, 2015, to purchase residential property in PR within two years and open a deposit account. For Act 20 incentives, PR requires gradually hiring five full-time employees in PR.

These PR tax benefits are not easy to arrange. Moreover, the political and economic conditions are uncertain, to say the least.  Traders and investment managers need to move their family and operations to PR to get these tax breaks while they retain the benefit of U.S. citizenship with a passport.

Renouncing U.S. citizenship or surrendering a green card
Some countries have much lower tax rates than the U.S. and a few countries exempt capital gains from tax. Increasingly, traders, investment managers, and other taxpayers are surrendering their U.S. resident status (citizenship or green card), which requires potentially paying a Section 877A expatriation tax. The expatriation tax only applies to “covered expatriates” who have a net worth of $2 million or 5-year average income tax liability exceeding $139,000. The IRS assesses the expatriation tax on unrealized capital gains on all assets — fair market value less cost-basis including debt — on the expatriation date. Only the net amount over $600,000 is taxable. Deferred compensation and IRAs are included and taxable, too.

While the expatriation tax is likely to take a big tax bite out of the wealthy, it wont apply to the majority of online traders who may not have significant unrealized net gains and who are not covered expatriates. There are other tax issues to consider including U.S. real property and estate planning in connection with beneficiaries residing in the U.S. Learn more about the expatriation tax on IRS Form 8854. Theres an election to defer tax, and regular income tax rates apply.

Non-resident aliens are opening U.S. brokerage accounts
Non-resident aliens are subject to tax withholding on dividends, certain interest income and sales of master limited partnerships like energy companies. They have U.S. source income — effectively connected income (ECI) — on real property and regular business operations located in the U.S.

A non-resident alien living abroad can open a U.S.-based forex or futures trading account and not owe any capital gains taxes in the U.S. U.S. tax law has long encouraged foreign taxpayers to invest and trade in U.S. financial markets. Caveat: the exclusion does not benefit dealers. A non-resident alien living abroad can also open a U.S.-based securities account, but there could be some dividend tax withholding. If the non-resident spends more than 183 days in the U.S., he owes taxes on net U.S. source capital gains, even though he may not trigger U.S. residency under the substantial presence test. (U.S. residency is triggered with legal residence status or by meeting the substantial presence test.) There are exemptions from the 183-day capital gains tax rules for employees of foreign governments living in the U.S. and special rules for students temporarily in a school in the U.S. The non-resident alien doesnt need a U.S. tax identification number and isn’t required to file a U.S. non-resident tax return, Form 1040NR. As a non-resident alien individual, fill out W-8BEN and furnish it to the broker.

Some U.S. brokerage firms ask non-resident aliens to establish a U.S. entity for opening a U.S.-based brokerage account. Often, the non-resident alien chooses a single-member LLC (SMLLC) formed in Delaware, and it files a W-8BEN-E with the broker. As a disregarded entity, the SMLLC activity is part of the individuals activity, which is not U.S.-source income on trading income. Many non-resident aliens run into obstacles when trying to repatriate money to their home country, as the broker may not permit international payments. These non-resident aliens also have trouble establishing U.S. bank accounts for the entity without a U.S. presence or address.

Foreign partners in a U.S. trading partnership can be tax-free
If the non-resident is a member of a U.S.-based “pass through” taxable entity — such as a hedge fund or proprietary trading firm — that person is still exempt from effectively connected income. Typically, foreign partners in U.S. partnerships are considered to have U.S. ECI on their Schedule K-1 income. But if the partnership is a trading company — in financial markets, not goods — the income is considered portfolio income, including the partners share. Typically, U.S. partnerships withhold taxes on foreign partners, but that is not required if the foreign partner only has portfolio income not subject to U.S. tax. It gets more complicated with dividends in the partnership since dividends tax isnt withheld for the share owned by the foreign partner.

International tax matters are complicated and often involve tax planning between the U.S. and one or more foreign countries or possessions. There are significant international opportunities for income and tax savings, but many pitfalls and compliance rules, too. Dont try to cheat on your taxes by hiding assets and income offshore; the IRS has extensive operations around the world to bust tax cheats. Engage tax attorneys and CPAs with extensive international experience, so it works out well.

GNMTraderTax attorneys Mark Feldman and Roger Lorence, and CPA Deborah King contributed to this content.

This content is an updated version of International Tax Matters in “Green’s 2016 Trader Tax Guide.”

Webinar/Recording: If You Trade Around The World, You Need To Know IRS Rules.

 

Puerto Rico’s Tax Haven Status Is Tailor Made For Investors, Traders And Investment Managers (Recording)

September 6, 2014 | By: Robert A. Green, CPA

Presented by Robert A. Green, CPA. Guest Panelists: NYC tax attorney Mark Leeds of Mayer Brown and PR tax accountant Gabriel Hernandez of BDO (both quoted in the blog).

Traders can move to Puerto Rico to take advantage of U.S. possession tax law. Couple with special PR tax incentives, including Act 22 for 100%-exclusion of trading gains and Act 20 4% tax rates on export service businesses like investment management.

Click here for our related blog.

International Tax Matters

September 1, 2014 | By: Robert A. Green, CPA

When it comes to international tax matters for traders, focus on the following:
  • U.S. resident traders living abroad
  • U.S. resident traders with international brokerage accounts
  • Report of foreign bank and financial accounts
  • IRS Offshore Voluntary Disclosure Program
  • Foreign retirement plan elections and reporting
  • Foreign assets reported on Form 8938
  • U.S. traders move to Puerto Rico to escape capital gains taxes
  • Renouncing U.S. citizenship or surrendering a green card
  • Non-resident aliens are opening U.S. brokerage accounts, and
  • Foreign partners in a U.S. trading partnership can be tax-free

U.S. resident traders living abroad

U.S. tax residents are liable for federal tax on worldwide income whether they live in the U.S. or a foreign country. If you qualify for “bonafide” or “physical residence” abroad, which is living abroad for an entire tax year, try to arrange Section 911 “foreign earned income” benefits on Form 2555. Avoid double taxation by paying tax in both a foreign country and the U.S. by availing yourself of foreign tax credits reported on Form 1116. If you live in a country which charges higher taxes than the U.S., sometimes it makes sense to skip the Section 911 exclusion and use just the foreign tax credit.

U.S. resident traders with international brokerage accounts

Many traders living in the U.S. have a foreign brokerage account. It’s complicated when traders open these accounts held in a foreign currency. Counterparties outside the U.S. do not issue Form 1099-B, and accounting is a challenge. Traders should separate capital gains and losses, including currency appreciation or depreciation, from changes in currency values on cash balances, which are Section 988 ordinary gain or loss.

Report of foreign bank and financial accounts

U.S. residents with a foreign bank, brokerage, investment and another type of account (including retirement and insurance in some cases) who meet reporting requirements must e-file FinCEN Form 114, Report of Foreign Bank and Financial Account (known previously as Foreign Bank Account Reports or “FBAR”). If your foreign bank and financial institution accounts combined are under $10,000 for the entire tax year, you fall under the threshold for filing FinCEN Form 114.

IRS Offshore Voluntary Disclosure Program

Consider entering the IRS Offshore Voluntary Disclosure Program (OVDP), which has been extended to encourage taxpayers to come clean before getting busted by the IRS. The OVDP penalties are high (though there are exceptions). Its not amnesty by any means and its an expensive undertaking with tax attorneys and accountants. But if you wait to get busted by the IRS, your foreign bank or anyone else, the penalties are far higher. Criminal penalties may apply too unless you join the program first. The current OVDP program has no end date, but the IRS has explicitly stated it may revoke it at any time. On July 1, 2014, the IRS created a “streamlined” program for those taxpayers who were negligent in not filing FBARs (but did not do so on purpose). U.S. resident taxpayers pay just a 5% penalty with this streamlined program.

Foreign retirement plan elections and reporting

Dont assume international retirement plans are like U.S. pension plans with tax deferral on income until you take taxable distributions. For U.S. tax purposes, the IRS considers many international retirement plans taxable investment accounts because they aren’t structured as qualified plans under Section 401 unless they qualify under Section 402(b) as an employees’ trust established by an employer. While that seems unfair and counterintuitive to many, it’s the rule, and it catches many unsuspecting taxpayers and accountants off guard. To the extent that Section 402(b) does not apply, you may have to pay a high Passive Foreign Investment Company (PFIC) tax. Include these retirement plans on the annual FinCEN Form 114 each year, whether or not the plan has deferral.

In October 2014, the IRS acknowledged the tax-deferral problem on Canadian retirement plans and provided assistance. In Revenue Procedure 2014-55, the IRS repealed the need for filing a tax election, which means Canadian retirement plans automatically qualify for tax deferral. These rules are retroactive, so it abates back taxes, interest, and penalties. It’s no longer needed to file Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans). This relief does not apply to international retirement plans outside of Canada.

Foreign assets reported on Form 8938

Tax Form 8938 is more about giving the IRS a heads up regarding your international assets. Its not about reporting income and loss — there are other tax forms for that. The filing threshold for Form 8938 is materially higher than the FBAR threshold, and its even higher for Americans living out of the country. (See Form 8938 instructions.)

U.S. traders move to Puerto Rico to escape capital gains taxes

Puerto Rico (PR) is not a state or foreign country; its a “possession” with a government and tax system (Hacienda). Residents of PR report particular types of income to Hacienda and other forms of revenue to the IRS. Trading gains are capital gains on “personal property” taxed where the sellers tax home is.

PR enacted tax incentive acts that are tailor-made for traders/investors, investment managers, and financial institutions. Passed in 2012, PR Act 22 allows investors and traders with bona fide residence in Puerto Rico to exclude from PR and U.S. taxes under Section 933 100% of all short-term and long-term capital gains from the sale of personal property accrued after moving there. Personal property includes stocks, bonds, and other financial products. Act 22 does not require investment in Puerto Rican stocks and bonds; trades can be made with a U.S. broker or on any exchange around the world. This capital gain tax break applies to professional traders using the default realization method, or Section 475 MTM.

There is a different PR tax incentive act for investment managers, who charge advisory fees. They sell their services to investors outside of PR and hence they can qualify for PR Act 20 tax incentives for “export service businesses.” The Act 20 tax incentive is a 4% flat tax rate on net business income. The owner also receives Act 22 100% exclusion on dividends received from the PR business entity, and exclusion from U.S. tax, since Section 933 excludes PR-sourced dividends.

On Nov. 30, 2015, PR enacted Act 187-2015 amending Acts 22 and 20 to stiffen the requirements. For Act 22 incentives, PR requires new applicants after Dec. 1, 2015, to purchase residential property in PR within two years and open a deposit account. For Act 20 incentives, PR requires gradually hiring five full-time employees in PR.

A new $5,000 annual PR charity requirement was added to Act 22 in 2017 as well. (For more on these 2017 changes, see BDO PR Newsletter: Act 43 & 45 – Amendments To Incentive Acts 20 & 22.)

When Hurricanes Irma and Maria severely damaged PR in September 2017, many newly established residents had to evacuate the island. These former U.S. residents are concerned they will not meet the required day count in PR due to hurricane damage, subjecting them to U.S. taxation on capital gains. There is some relief from the IRS. (See How To Protect Puerto Rico Tax Incentives In The Wake Of Hurricanes Irma And Maria.) Consult a PR tax expert.

These PR tax benefits are not easy to arrange. Moreover, the political and economic conditions are uncertain, to say the least.  Traders and investment managers need to move their family and operations to PR to get these tax breaks while they retain the benefit of U.S. citizenship with a passport.

Renouncing U.S. citizenship or surrendering a green card

Some countries have much lower tax rates than the U.S. and a few countries exempt capital gains from tax. Increasingly, traders, investment managers, and other taxpayers are surrendering their U.S. resident status (citizenship or green card), which requires potentially paying a Section 877A expatriation tax. The expatriation tax only applies to “covered expatriates” who have a net worth of $2 million or 5-year average income tax liability exceeding $139,000. The IRS assesses the expatriation tax on unrealized capital gains on all assets — fair market value less cost-basis including debt — on the expatriation date. Only the net amount over $600,000 is taxable. Deferred compensation and IRAs are included and taxable, too.

While the expatriation tax is likely to take a big tax bite out of the wealthy, it wont apply to the majority of online traders who may not have significant unrealized net gains and who are not covered expatriates. There are other tax issues to consider including U.S. real property and estate planning in connection with beneficiaries residing in the U.S. Learn more about the expatriation tax on IRS Form 8854. Theres an election to defer tax, and regular income tax rates apply.

Non-resident aliens are opening U.S. brokerage accounts

The U.S. stock markets have been stellar, and many non-U.S. persons have been accessing them from their home country. Other foreign individuals and entities prefer to open U.S.-based brokerage accounts for lower commissions, and better trading platforms.

In either case, the foreign individual or foreign company is subject to U.S. tax withholding on U.S. dividends and certain other U.S. passive income. The default withholding tax rate is 30%, and income tax treaties provide for lower rates, usually around 15% or less. U.S. brokers handle this tax withholding and pay those taxes to the Internal Revenue Service (IRS). The foreign investor does not have an obligation for U.S. tax compliance if withholding is done correctly.

The critical point is that capital gains are not taxable in the U.S. if the nonresident alien does not spend more than 183 days per year in the U.S. Most active traders don’t generate significant dividend income paid by U.S. companies, so tax withholding is not a problem. Many of them get a foreign tax credit for U.S. tax withholding in their resident country.

Some nonresident aliens establish a spousal-member LLC in the U.S. and file a U.S. partnership tax return. The LLC/partnership opens a U.S.-based brokerage account as a domestic entity. The LLC files a W-9 with a U.S. tax identification number. The broker treats the U.S. LLC/partnership as a U.S. account, which means the broker does not handle the tax withholding on dividends and other passive income for the foreign owners of the LLC.

Therefore, the nonresident alien owners must file a W-8BEN with the U.S. partnership. The U.S. partnership assumes responsibility for tax withholding on dividends and other portfolio income, and payment of those taxes to the IRS on a timely basis. It’s extra tax compliance work, but it’s not too complicated.

U.S. estate tax might come into play. Estate tax treaties may exempt brokerage accounts for nonresident aliens or provide higher exemptions from the tax. U.S. partnership interests are likely not includible in an estate for a nonresident alien. Brokers are not responsible for estate tax compliance, so it’s a tax matter for nonresident aliens and their tax advisors. Brokers require a conclusion of IRS estate proceedings before releasing assets from the account of the deceased. (Learn more on my blog post How To Save U.S. Taxes For Nonresident Aliens.)

Foreign partners in a U.S. trading partnership can be tax-free

If the non-resident is a member of a U.S.-based “pass-through” taxable entity — such as a hedge fund or proprietary trading firm — that person is still exempt from effectively connected income. Typically, foreign partners in U.S. partnerships are considered to have U.S. ECI on their Schedule K-1 income. But if the partnership is a trading company — in financial markets, not goods — the income is considered portfolio income, including the partners share. Typically, U.S. partnerships withhold taxes on foreign partners, but that is not required if the foreign partner only has portfolio income not subject to U.S. tax. It gets more complicated with dividends in the partnership since dividends tax isnt withheld for the share owned by the foreign partner.

International tax matters are complicated and often involve tax planning between the U.S. and one or more foreign countries or possessions. There are significant international opportunities for income and tax savings, but many pitfalls and compliance rules, too. Dont try to cheat on your taxes by hiding assets and income offshore; the IRS has extensive operations around the world to bust tax cheats. Engage tax attorneys and CPAs with extensive international experience, so it works out well.

For more in-depth information on international tax matters, read Green’s 2018 Trader Tax Guide. The above content is a short excerpt from the guide.

Foreign Partners In A U.S. Trading Partnership Can Be Tax Free

August 19, 2014 | By: Robert A. Green, CPA

Non-resident alien traders often ask us these two tax questions:

• “If I open an individual brokerage account in the U.S. to trade securities, futures and forex, will I be liable for U.S. taxes on my trading gains?”

• “If I become a partner in a U.S. proprietary trading firm filing a partnership tax return, do I owe U.S. taxes on my Schedule K-1 income?”

The answer to the first question is no. Trading gains are considered portfolio income which is not effectively connected income (ECI) in the U.S. Generally, non-resident aliens are liable for U.S. tax on income from business and real property in the U.S. There is tax withholding on dividend payments and sales of master limited partnerships (MLPs). There is no withholding in connection with futures or forex trading.

The answer to the second question is more complex. Typically, foreign partners in U.S. partnerships are considered to have U.S. ECI on their Schedule K-1 income. But if the partnership is a trading company — in financial markets, not goods — the income is considered portfolio income, including the partner’s share. Typically, U.S. partnerships withhold taxes on foreign partners, but that is not required if the foreign partner only has portfolio income not subject to U.S. tax. It gets more complicated with dividends in the partnership, since there was no withholding of dividends tax for the share owned by the foreign partner.

864(b) Trading Safe Harbor
According to research by tax attorney Mark Feldman, if the partnership is doing just forex trading (or other types of trading in stock, securities or futures), then it is probable that a foreign partner will not be subject to U.S. tax based on the following:

Generally, under Section 875(1), if a partnership is engaged in a trade or business in the U.S. (“ETB”), a nonresident alien partner of the partnership is automatically ETB. However, Section 864(b)(2)(A)(ii)&(B)(ii), provides an exception to ETB if a nonresident alien trades for his own account—even if through a principal office located in the US. It seems that this exception overrides the general rule of Section 875(1); after all, a deemed presence under 875(1) should be no worse than an actual presence in a principal office.

See FSA 199909004: Section 1.864-2(c)(2)(iii) provides rules for determining whether the taxpayer’s principal office is in the United States. . . . However, we note that the Taxpayer Relief Act of 1997, P.L. 105-34, section 1162(a), removed the requirement that the partnership have its principal office outside the United States. Therefore, for taxable years beginning after December 31, 1997, even if it was determined that USP [US partnership, with its principal office in the US] was a trader rather than investor in stocks and securities, FC [foreign corp, which was a partner in USP] nevertheless would not be subject to tax on its distributive share of USP’s capital gains due to the section 864(b)(2)(A)(ii) safe harbor. After December 31, 1997, FC would fail the trading safe harbor in section 864(b)(2)(A)(ii) only if either FC or USP was also a dealer in stocks or securities.

The FSA is presumably basing itself on this language in Treas. Reg. 1.864-2(c)(2)(ii) (which was not yet amended to reflect the repeal of the principal office requirement, otherwise known as the Ten Commandments, in 1997):

Partnerships. A nonresident alien individual, foreign partnership, foreign estate, foreign trust, or foreign corporation shall not be considered to be engaged in trade or business within the United States solely because such person is a member of a partnership (whether domestic or foreign) which, pursuant to discretionary authority granted to such partnership by such person, effects transactions in the United States in stocks or securities for the partnership’s own account or solely because an employee of such partnership, or a broker, commission agent, custodian, or other agent, pursuant to discretionary authority granted by such partnership, effects transactions in the United States in stocks or securities for the account of such partnership. This subdivision shall not apply, however, to any member of (a) a partnership which is a dealer in stocks or securities or (b) a partnership (other than a partnership in which, at any time during the last half of its taxable year, more than 50 percent of either the capital interest or the profits interest is owned, directly or indirectly, by five or fewer partners who are individuals) the principal business of which is trading in stocks or securities for its own account, if the principal office of such partnership is in the United States at any time during the taxable year.

Presumably, after the regulation is amended, part (b) of the last quoted sentence will be removed. Also, PLR 8850041 (not reliable for precedent) says that Section 864(b)(2)(B) “commodities” include forex.

Bottom line
“It’s my understanding that a non-U.S. person that is a member of a prop trading firm is subject to the exemption in 864 for trading for your own account provided that the prop trading firm is not a dealer,” tax attorney Roger Lorence says. “In some cases, a prop trading firm is a member of a commodities exchange or a securities exchange, but this is as a customer member. The prop trader receives better fees and commissions, but is not actually making a market or otherwise trading. So long as the prop trading firm is a customer member, then there’s no ETB issue. However, there can be state issues where the state diverges from the federal rules of 864.”

Tax treatment for foreign futures

June 2, 2014 | By: Robert A. Green, CPA

EY Global Tax Alerts: (My list below of foreign futures exchanges granted Section 1256 treatment by the IRS is the same as the EY list, which is unchanged on foreign exchanges since 2013.)
- Updated 2018 US Section 1256 qualified board or exchange list
- Updated 2017 US Section 1256 qualified board or exchange list
- Updated 2016 US Section 1256 qualified board or exchange list

A leading global broker Newedge promised Section 1256 treatment for foreign futures traded on Euronext Paris and Euronext Amsterdam exchanges. Our blog helped them retract that promise and agree those exchanges don’t have Section 1256 treatment.

Section 1256 offers up to 12% lower capital gains tax rates on short-term trading with its attractive 60/40 tax rates. It includes regulated futures contracts (RFCs), broad-based stock indices, options on those indices, options on futures, nonequity options, certain off-exchange foreign currency contracts and a few other items. But it can be a hard club to get into. Among Section 1256 contracts, regulated futures contracts, nonequity options and securities futures contracts must be traded on or subject to the rules of a “qualified board or exchange” (QBE). U.S. exchanges make the list pretty easily, but foreign exchanges don’t. Let’s look at the QBE requirement in more detail.

QBE
Section 1256 includes a list of those exchanges that are considered QBEs. Imagine Section 1256 being a popular club with a bouncer at the door holding a VIP guest list. If the exchange or board of trade you trade on is not on the QBE list, then the contracts you trade are excluded from Section 1256 tax treatment — even if they are regulated futures contracts.

QBEs include national securities exchanges registered with the SEC (category 1), domestic boards of trade designated as a “contract market” by the CFTC (category 2) or any other exchange or board of trade or other market (worldwide) that the CFTC and Treasury determines has rules adequate to carry out the purposes of Section 1256 (category 3).

According to Section 1256, contracts on category 1 and 2 exchanges are deemed RFCs if the contract “(A) with respect to which the amount required to be deposited and the amount which may be withdrawn depends on a system of marking to market, and (B) is traded on or subject to the rules of a qualified board or exchange.” (This doesn’t include securities futures contracts.)

The first step in finding out if a product qualifies for Section 1256 is to see if its exchange is on the QBE list. Don’t jump to that conclusion just because you received a 1099B reporting Section 1256 treatment. E&Y’s “Updated 2013 US IRC Section 1256 qualified board or exchange list” is a handy reference.

Notice the North American Derivatives Exchange (Nadex) — a domestic board of trade — is a category 2 because it’s a CFTC-regulated “Designated Contract Market” (DCM). In part two of this blog series, I discuss whether Nadex binary and variable payout options meet the definition of Section 1256 contracts, as either a regulated futures contract, or nonequity option.

Foreign exchanges with QBE status
These category 3 foreign QBEs received a CFTC exemption (“no action letter”) and Treasury/IRS determination granting them QBE status published in a required revenue ruling:

• International Futures Exchanges (Bermuda) Ltd.(inactive)
• Mercantile Division of the Montreal Exchange (inactive)
• Mutual Offset System (Rev. Rul. 87-43). A partnership between Chicago Mercantile Exchange and Singapore International Monetary Exchange Limited
ICE Futures Rev Rul 2007-26

o Per RIA, “a United Kingdom Recognized Investment Exchange that was (1) a wholly-owned subsidiary of a U.S. parent corporation, and (2) overseen by the U.K.’s Financial Services Authority, provided that the exchange continued to comply with all CFTC conditions necessary to retain its no-action relief permitting it to make its electronic trading and matching system available in the U.S.”

Dubai Mercantile Rev. Rul. 2009-4
ICE Futures Canada Rev. Rul. 2009-24
London International Financial Futures and Options Exchange (LIFFE) Rev. Rul. 2010-3

o Per RIA, “Is a regulated exchange of the United Kingdom … Exchange offered electronic trading of commodity futures contracts and other futures and options contracts. Contracts were cleared and settled by Clearing House, a CFTC-regulated Derivatives Clearing Organization. The CFTC had granted Exchange no-action relief permitting it to make its electronic trading and matching system available in the U.S.”

Eurex Deutschland Rev. Rul. 2013-5

o Per RIA, “Is a regulated exchange of Germany, as long as: either CFTC continues to allow Eurex to provide direct access to its electronic trading and order matching system from U.S. under existing no action letter, pending CFTC approval of Order of Registration, or Eurex holds valid Order of Registration as foreign boards of trade (FBOT). IRS grants consent to taxpayers to change to Section 1256 mark to market method for 1st taxable year during which taxpayer holds Eurex Deutschland Contract that was entered on or after 3/1/2013.”

CFTC looks abroad
The CFTC’s reach is global — protecting customers located in the U.S. trading on foreign exchanges.

The CFTC website (international foreign products) says “These regulations are designed to carry out Congress’s intent that foreign futures and foreign options products offered or sold in the U.S. be subject to regulatory safeguards comparable to those applicable to domestic transactions. As set forth in CFTC Regulation 30.4, any domestic or foreign person engaged in activities like those of a futures commission merchant (FCM), introducing broker (IB), commodity pool operator (CPO), or commodity trading advisor (CTA) must register in the appropriate capacity or seek an exemption from registration under CFTC Regulation 30.5 or CFTC Regulation 30.10.”

The first step in finding out if Section 1256 applies is to look up the CFTC no action letter with 30.5 or 30.10 exemption. The CFTC publishes current and pending no action letters at “Foreign Government Agencies and SROs that have Received CFTC Orders under CFTC Regulation 30.10” and “Pending Requests for CFTC Regulation 30.10 Exemption.”

Treasury’s determination is published
The second step is to look up the IRS revenue ruling. The IRS has a two-step process for these determinations.

1. The foreign exchange must submit a private letter ruling requesting QBE status. If the IRS is satisfied that the exchange has sufficient rules for application of Section 1256, it publishes a revenue ruling. The revenue ruling applies to the commodity futures contracts and futures contract options only entered on the named exchange, and not any affiliated exchanges (Note 1). For example, Section 1256 applies for futures traded on Eurex Deutschland, but not for futures traded on an affiliate of Eurex Deutschland.

2. The IRS looks to see if the exchange obtained a CFTC exemption (no action letter). Section 738 of the Dodd-Frank Act gives the CFTC authority to adopt rules and regulations that require registration of a foreign board of trade that provides U.S. participants direct access to the board of trade’s electronic trading system. This proposed registration system is supposed to replace the no-action letter process.

Mergers, partnerships and cooperation lead to questions about QBE status
There have been several cross-border mergers and acquisitions, partnerships and other cooperation agreements between U.S., EU and Asian exchanges and foreign boards of trade. These mergers and affiliations are confusing brokers, who are then confusing their clients. Keep things simple and clear: make sure you see an IRS revenue ruling in the exact name of the exchange you trade on.

When a U.S. QBE has a “mutual offset agreement” with a non-QBE foreign exchange, the IRS treats trades executed on the foreign exchange that are assumed by the U.S. QBE as Section 1256. But trades executed on the U.S. QBE that are assumed by the foreign exchange are not considered Section 1256. This was the case with the CME/SIMEX Mutual Offset System (Rev. Rul. 87-43).

If a U.S. QBE acquires a foreign non-QBE, generally the foreign regulator oversees the foreign non-QBE. The foreign non-QBE does not inherit the U.S. exchange’s QBE status. The foreign exchange must have it’s own CFTC exemption (no-action letter) and request a formal determination by Treasury for foreign QBE status. The ICE Futures 2009 revenue ruling listed above is a similar case. (Note 2 confirmation from IRS)

Dodd Frank rules for swaps
As of 2011, the Dodd-Frank Act requires privately negotiated derivatives contracts to clear on derivatives exchanges or boards of trade. The CFTC is trying to coordinate these rules with similar ones enacted in the EU. Among other things, the CFTC wants EU swaps exchanges to report on trading activities by Americans. Dodd-Frank law and IRS proposed regulations exclude swap contracts from Section 1256.

Many foreign exchanges don’t want U.S. filings
NYC tax attorney Roger Lorence heard from Treasury and IRS officials that several foreign exchanges and boards of trade fear getting involved with the U.S. Treasury and IRS — perhaps due to controversial U.S. FATCA and FBAR reporting — so they don’t want a CFTC exemption and Treasury determination granting them QBE status. But perhaps they will change their minds if Americans demanding QBE status become a major part of their business activity.

Note 1: Preamble to Proposed Regulation § 1.1256(g)-1 

(Part D, 9/16/2011)
D. Qualified Board or Exchange
Section 1256(g)(7)(C) provides that a qualified board or exchange includes any other exchange, board of trade, or other market which the Secretary determines has rules adequate to carry out the purposes of section 1256. Section 1.1256(g)-1(a) of the proposed regulations specifies that such determinations are only made through published guidance in the Federal Register or in the Internal Revenue Bulletin. 

Robert Green observation: The proposed reg requires publishing in the Federal Register or Internal Revenue Bulletin, whereas the current 1.1256 regulation requires publishing in an IRS Revenue Ruling. Either way, qualification for Section 1256 requires Treasury/IRS to make a formal determination and publish it for public consumption. Notice the IRS published some of the above Revenue Rulings in the IR Bulletin, whereas others we published as pdf files only. More consistency in publishing would be better.

Since section 1256(g)(7) was adopted, the Treasury Department and the IRS have issued determinations for six* entities, all of them foreign futures exchanges. See Rev. Rul. 2010-3 (2010-1 CB 272 (London International Financial Futures and Options Exchange)), Rev. Rul. 2009-24 (2009-2 CB 306 (ICE Futures Canada)), Rev. Rul. 2009-4 (2009-1 CB 408 (Dubai Mercantile Exchange)), Rev. Rul. 2007-26 (2007-1 CB 970 (ICE Futures)), Rev. Rul. 86-7 (1986-1 CB 295 (The Mercantile Division of the Montreal Exchange)), and Rev. Rul. 85-72 (1985-1 CB 286 (International Futures Exchange (Bermuda))). The IRS has followed a two step process for making each of the six qualified board or exchange determinations under section 1256(g)(7). See § 601.601(d)(2)(ii)(b).

*Robert Green observation: Eurex Deutschland (Rev. Rul. 2013-5) was published after this preamble date of 9/16/2011.

In the first step, the exchange submitted a private letter ruling to the IRS requesting a determination that the exchange is a qualified board or exchange within the meaning of section 1256(g)(7)(C). Once the IRS determined that the exchange had rules sufficient to carry out the purposes of section 1256, the Treasury Department and the IRS published a revenue ruling announcing that the named exchange was a qualified board or exchange. The revenue rulings apply to commodity futures contracts and futures contract options of the type described under the CEA that are entered into on the named exchange. The revenue ruling does not apply to contracts that are entered into on another exchange that is affiliated with the named exchange.

Robert Green observation: The above important sentences in bold are current law, they are not something new in Proposed Regulation § 1.1256(g)-1.

In determining whether a foreign exchange is a qualified board or exchange under section 1256(g)(7)(C), the Treasury Department and the IRS have looked to whether the exchange received a CFTC “direct access” no-action relief letter permitting the exchange to make its electronic trading and matching system available in the United States, notwithstanding that the exchange was not designated as a contract market pursuant to section 5 of the CEA. Section 738 of the Dodd-Frank Act, however, provides the CFTC with authority to adopt rules and regulations that require registration of a foreign board of trade that provides United States participants direct access to the foreign board of trade’s electronic trading system. In formulating these rules and regulations, the CFTC is directed to consider whether comparable supervision and regulation exists in the foreign board of trade’s home country. Pursuant to section 738, the CFTC has proposed a registration system to replace the direct access no-action letter process. Under the proposed registration system, a foreign board of trade operating pursuant to an existing direct access no-action relief letter must apply through a limited application process for an “Order of Registration” which will replace the foreign board of trade’s existing direct access no-action letter. Many of the proposed requirements for and conditions applied to a foreign board of trade’s registration will be based upon those applicable to the foreign board of trade’s currently granted direct access no-action relief letter.

The IRS has conditioned a foreign exchange’s qualified board or exchange status under section 1256(g)(7)(C) on the exchange continuing to satisfy all CFTC conditions necessary to retain its direct access no-action relief letter. Consequently, if the CFTC adopts the proposed registration system, an exchange that has previously received a qualified board or exchange determination under section 1256(g)(7)(C) must obtain a CFTC Order of Registration in order to maintain its qualified board or exchange status. The IRS will continue to evaluate the CFTC’s rules in this regard to determine if any changes to the IRS’s section 1256(g)(7)(C) guidance process are warranted.

Note 2: Confirmation with IRS
Our tax attorney Roger Lorence spoke with an IRS official responsible for Section 1256 issues, and he confirmed that: “A foreign board or exchange must get a revenue ruling if they have a CFTC 30.10 ruling to receive 1256 treatment for their qualifying contracts. A foreign board that receives a revenue ruling is covered on 1256 but related foreign exchanges are not covered – the revenue ruling only applies to the exchange covered in that ruling. Affiliated foreign exchanges must get their own revenue ruling to qualify under 1256.”

Thank you to our tax attorneys Mark Feldman and Roger Lorence and my co-managing member Darren Neuschwander, CPA for their help with this blog.

Puerto Rico’s Tax Haven Status Is Made For Traders

May 13, 2014 | By: Robert A. Green, CPA

Postscript Aug. 2017: On July 11, 2017, the Governor of Puerto Rico signed into law House Bill 878 as Act 43 amending Act 20 of 2012, and Senate Bill No. 369 as Act 45 amending Act 22 of 2012. Act 43 eliminates the minimum employment requirement of five employees from Act 20. Act 45 adds a new $5,000 annual PR charity requirement in Act 22.(See BDO PR Newsletter: Act 43 & 45 – Amendments To Incentive Acts 20 & 22.)

Postscript June 12, 2017: On June 11, 2017, Puerto Ricans voted to change their status from U.S. territory to statehood in a non-binding referendum. Statehood would render PR’s territorial tax incentives invalid, including Act 22 and 20 for traders and investment managers. Statehood requires U.S. Congressional approval, which is doubtful in this Republican Congress, considering that PR has mostly Democratic representatives.

Postscript Mar. 22, 2016: On Nov. 30, 2015, PR enacted Act 187-2015 amending Acts 22 and 20 to stiffen the requirements. For Act 22 incentives, PR now requires new applicants after Dec. 1, 2015, to purchase residential property in PR within two years and open a deposit account. For Act 20 incentives, PR requires gradually hiring five full-time employees in PR. Read more about the changes on a PR attorney’s blog, Puerto Rico Expands Tax Haven Deal For Americans To Its Own EmigrantsPuerto Rico Act 22 – The Individual Investors Act and Puerto Rico Act 20 – The Export Services Act.

Postscript Oct. 1, 2014: I recommend this excellent article from The Tax Adviser, Tax Advantages for U.S. Traders of Securities and Commodities Relocating to Puerto Rico.

Watch our related Webinar recording “Puerto Rico’s tax haven status is tailor made for investors, traders and investment managers.”


 

Forbes-logo

Puerto Rico Pours On Tax Incentives For Investors

Puerto Rico’s new tax incentive acts are tailor made for traders/investors, investment managers and financial institutions. In the past, Puerto Rico offered tax incentives to manufacturers. Puerto Rican officials now believe investors, investment managers and financial institutions can more easily move virtual businesses there. The officials figure these groups will bring an influx of new money and key investments to the island to help it rise above its current state of financial distress.

“Puerto Rico is one of only a few places in the world where a U.S. citizen or permanent resident can live, without giving up their U.S. citizenship and passport, while legitimately avoiding payment of tax to the IRS on PR source income,” NYC tax attorney William Blum says. “Those who would like to legally reduce their tax burden, and who are ready for an exciting lifestyle change, should seriously consider it.”

Act 22 for traders and investors
Enacted in 2012, PR Act 22 allows investors and traders with bona fide residence in Puerto Rico to exclude 100% of all short-term and long-term capital gains from the sale of personal property accrued after moving to PR. Act 22 does not require investment in Puerto Rican stocks and bonds; trades can be made with a U.S. broker or on any exchange around the world. This applies to day traders. While trader tax status and Section 475 MTM elections are important tax strategies for residents of the U.S., they are irrelevant when applying PR Act 22 exclusions.

U.S. tax law Section 933 “Income from sources within Puerto Rico” is synchronized with PR tax law, including Acts 22 and 20. Americans with residence in PR split their income, reporting “non-PR source” income (income in the U.S. and elsewhere other than in PR) on U.S. Form 1040, and PR-source income on a PR income tax return filed with Hacienda (PR’s tax authority).

IRS Pub 1321 “Special Instructions For Bona Fide Residents Of Puerto Rico Who Must File A U.S. Individual Income Tax Return (Form 1040 or 1040A)” shows how to treat different types of income (see page 2, “Source of Income Rules”). Other than the “sale of personal property” which is sourced in the “seller’s tax home” (presumably in Puerto Rico), other types of income are sourced from: the location of payer for interest and dividend income; where the service is performed for wages and compensation; where services were performed that earned the pension income; where the property is used for royalties paid on patents, copyrights and IP; and the location of property for the sale or real property like residential, rental and commercial real estate.

Can you see the tax loophole? Worldwide capital gains (other than gains on real property) are sourced in PR and they are 100% excluded from both U.S. and PR tax, resulting in a trader’s tax nirvana. There’s one exception: trades made from an office outside of PR do not qualify as PR source capital gains subject to the exclusion.

Pub 1321 includes these instructions: “Caution: There are special rules for gains from dispositions of certain investment property (for example, stocks, bonds, debt instruments, diamonds, and gold) owned by a U.S. citizen or resident alien prior to becoming a bona fide resident of a possession. You are subject to these special rules if you meet both of the following conditions: For the tax year for which the source of gain must be determined, you are a bona fide resident of Puerto Rico; for any of the 10 years preceding that year, you were a citizen or resident alien of the United States (other than a bona fide resident of Puerto Rico); if you meet these conditions, gains from the disposition of this property will not be treated as income from sources within the relevant possession for purposes of the Internal Revenue Code. Accordingly, bona fide residents of American Samoa and Puerto Rico, for example, may not exclude the gain on their U.S. tax return. However, there is a special election that you can make to allocate gain/losses between the U.S. and Puerto Rico from disposition of certain property. For additional details see Publication 570.”

It’s a bit deceptive in marketing materials from PR sites for Act 22. Many promise 100% exclusion on all interest and dividend income, but the U.S. will keep taxing non-PR source interest and dividend income, even if PR does not. Act 22 also provides a 10% PR tax rate on the sale of real property located in PR if held under 10 years since establishing PR residence, and a 5% tax rate if held more than 10 years.

Act 20 for investment managers
Investment managers charge advisory fees, which are service business revenues. They export their services to investors outside of Puerto Rico and hence they can qualify for Act 20 tax incentives for “export service businesses.”

To receive these incentives, they need to move their operations to PR and they should have a minimum of three employees there who are paid reasonable wages. The employees are bona fide residents and they pay PR taxes on their individual tax returns on this compensation. PR is part of FICA and Medicare, so the employer needs to charge payroll taxes in a similar manner to the U.S.

The Act 20 tax incentive is a 4% flat tax rate on net business income. The owner receives Act 22 100% exclusion on dividends received from the PR business entity. PR-sourced dividends are excluded from U.S. taxes under Section 933.

Companies retaining some operations in the U.S. will have “effectively connected” trade or business income subject to U.S. tax.

Many owners and employees of investment management operations have significant capital gains income generated from their own investment portfolios, including investments in their own funds and profit allocations of capital gains in their managed hedge funds. These capital gains can be excluded under Act 22, except for the trades that originate from an office outside of PR. A CEO of an investment management firm can not be the only one that moves to PR, he also needs to bring along much of his investment management operations and employees, too.

Bona fide residence has stringent tests
You must pass all three different tests — the presence test, tax home test and closer connection test – for individual bona fide residence and all three are not easy to pass. Many taxpayers and advisors are aggressive about state residency tests for domicile and they lose when audited by tough tax examiners. PR’s Act 22 and 20 are new and only 2012 and 2013 tax returns have been filed, not giving state and PR auditors much time to check yet.

It’s difficult to move an investment management business to PR. You have to change documents with investors, hedge funds and counterparties to reflect the PR company name and address and carry on your business from Puerto Rico.

Everyone There Will Have Moved Here! An Overview of the US Federal and Puerto Rican Tax Incentives for Bona Fide Residents of Puerto Rico” is an excellent article by NYC tax attorney Mark Leeds and PR tax accountant Gabriel Hernandez. (The article includes in-depth information about the three residency tests and an example of an investment manager.)

When someone calls with questions about Puerto Rican tax benefits, Leeds says offspring are an important factor. “The first thing I ask is do you have kids and what are their ages? The sweet spot of the PR tax strategy is for people in their 20s without kids and older people whose children have moved on,” he says. “If children are embedded in communities, it’s hard to make the change of residence work because it’s hard to meet the bona fide residence tests. If kids and spouses will stay in the U.S., it’s unlikely that the trader will satisfy the closer connection test. The strategy works well for young traders and older guys in private equity and hedge funds.”

The article says “(Act 22) has a 100% tax exemption from Puerto Rico income taxes on all long-term capital gains accrued after the individual becomes a bona fide resident of Puerto Rico.” I asked Mr. Hernandez if this should say all capital gains (including short term). Hernandez confirmed all capital gains now receive the exemption.

“Originally, PR Act 22 had only the long-term capital gains exclusion and after a short while they corrected it to include all capital gains (on the sale of personal property),” he says. Afterwards, I asked Mr. Hernandez for a legal citation on this correction and he emailed me Law 138 in Spanish and wrote “Article 3 of Law 138 amends Article 5 of Act 22 to provide exemption to the “totalidad” (which means 100%) of the capital gains.”

Some tax professionals feel the Hacienda might consider a day trader, scalper or high-frequency trading market-maker to be a business, and disqualify their trading gains from Act 22 exclusions. But Hernandez and Leeds disagree.

“Puerto Rico follows federal precedents on trade or business, and trading is a capital gains activity in the U.S.,” Hernandez says.

Moving to a foreign country instead
If an American citizen or legal resident (greencard holder) becomes a bona fide resident of a foreign country, as opposed to a U.S. territory or possession like Puerto Rico, their taxes are handled as follows: If they retain U.S. citizenship or legal residence status, they may use Section 911’s Foreign Earned Income Exclusion ($99,200 for 2014). If they surrender U.S. citizenship or legal residence status, they are subject to Section 877’s Expatriation Tax rules. (Both are beyond the scope of this article.)

Bottom line
For traders and investment managers who are ready, willing and able to meet the stringent bona fide residency tests, PR Act 22 and Act 20 tax incentives are probably a great deal.

For such a drastic move and change of lifestyle, you will want to be conservative in assessing your passing of the residency tests. It’s wise to discuss the ins and outs of these tax programs with experts in these matters, and run pro-forma U.S. and PR tax returns based on your facts and circumstances over a few years of projected stay. Carefully assess the pros and cons. One con is there’s no Section 475 NOL tax loss insurance for business traders.

If you’re young and single or an empty nester, this type of move may work well for you. Saving up to 50% or more on federal and state income tax rates on your trading gains can beef up your retirement income in a significant way. Plus, in PR you already found your retirement home in the sun!

For more information
Moving to Puerto Rico

Hedge Funds Take Muni Bond Market by Storm

FBAR deadline & foreign financial asset reporting update

June 12, 2012 | By: Robert A. Green, CPA

The IRS provides additional guidance on FBAR versus new form 8938. See these helpful links.

Basic Questions and Answers on Form 8938

U.S. tax residents, don’t miss the FBAR (TDF 90-22.1) filing deadline of June 29, 2012 for 2011 FBAR reports TDF90-22.1. Otherwise, you may be subject to very large penalties. Non-resident aliens are not subject to these filing requirements if they do not have a green card.

There’s also another foreign tax form for 2011 tax returns, Form 8938 Statement of Foreign Financial Assets.

In prior years, many taxpayers overlooked or conveniently did not report their foreign financial accounts. Unfortunately, the IRS lumps all taxpayers into the category of tax cheat, assuming they are hiding money in offshore bank accounts. The IRS famously busted several Swiss banks and extended the busts to banking by Americans in India, Israel, Asia, and many tax havens throughout the world. In our opinion, IRS penalties should be designed for penalizing blatant tax cheats and not taxpayers who inadvertently overlooked quirky filings and did report their foreign income. The law differentiates between negligence and reasonable cause. Inadvertent overlooking is unfortunately usually subject to negligence penalties.

That’s where our top tax attorney Mark Feldman provides value. He can try to qualify you for a lower or full penalty abatement. The worst thing to do is to ignore this matter and wait for the IRS to bust you and then lower the boom with full penalties and perhaps even criminal charges.

Speak with us soon and you can work with our tax attorney with attorney-client privilege. Our CPAs can handle all your tax filings in association with your tax attorney, thereby preserving attorney-client privilege on our CPA services, too.

Side note. Per the IRS website, “If you are a U.S. citizen or resident alien residing overseas, or are in the military on duty outside the U.S., on the regular due date of your return, you are allowed an automatic two-month extension to file your return and pay any amount due without requesting an extension. For a calendar year return, the automatic two-month extension is to June 15.” Like other taxpayers, you can request an automatic extension until October 15 (see our Mar 29 blog).

An email message from the AICPA to it’s members:

The U.S. government has become increasingly concerned about, and focused on, offshore tax evasion. One tool the government has to combat such tax evasion is the Report of Foreign Bank Accounts (TDF 90-22.1) or FBAR.

The FBAR is required to be filed by two categories of U.S. filers:

1. Owners of foreign accounts

2. Those with signature of authority over foreign accounts, but no financial interest in the accounts.
The threshold for filing an FBAR is only $10,000 in aggregate for all foreign accounts. The amount per account is measured at the highest point during the year. The $10,000 threshold has not been indexed for inflation by Treasury since the early 1970s.

Note that the potential civil and criminal penalties for failure to timely file an FBAR are severe. The FBAR is required by the US Bank Secrecy Act of 1970 (“BSA”). The BSA is a law enforcement statute and is not part of the tax code. Instead, the BSA is part of the general Treasury Department Regulations. Because of this, the Departments of Treasury and Justice have the ability to impose both monetary civil as well as criminal penalties for the failure to timely file an FBAR.

The FBAR rules are highly complex. Accordingly, if there is any chance you own a foreign account or have signature of authority over a foreign account please contact your assigned CPA with Green NFH immediately.

If you have any questions about FBAR and Form 8938, as well as any foreign tax matters, contact us for help. We have CPAs and tax attorneys highly experienced in international tax matters for Americans abroad and non-resident aliens conducting investing or business in the U.S.

Cost-Basis Reporting on IRS Form 8949 Is a Nightmare and FATCA Makes the IRS a FATCAT (plus Form 8938 for foreign assets)

February 2, 2012 | By: Robert A. Green, CPA

See our Cost-Basis Reporting area in our Trader Tax Center for more content, blogs, Webinars, Video and our Petition to Congress.

Green’s Forbes blog version: Beware The Long (Global) Arm Of The IRS.

In an attempt to balance the budget and close the “tax gap,” Congress, the Obama administration and the IRS are on a mission to intimidate Americans into reporting all of their income, onshore and offshore. What’s new on 2011 tax returns? Beefed-up reporting for securities traders with a problematic new tax form 8949, which deals with the IRS’s new cost-basis 1099-B reporting rules. And, reporting of foreign assets over certain thresholds with new tax form 8938.

Before Congress and the President upset their political bases when they try to balance the budget by cutting entitlement or defense spending or passing new tax hikes, they want to close the tax gap (busting tax cheats), close special-interest tax loopholes, broaden the tax base and maybe lower tax rates, too (as suggested by the Bowles Simpson Deficit Commission).

The world is now the IRS’s oyster, and by using new sophisticated technology and productivity – just like the rest of us – the IRS is on a mission to catch tax cheats and taxpayers who conveniently overlook income and asset reporting.

Big changes on 2011 tax returns.
There are two new bombshells for our trader clients to deal with on their 2011 tax returns – the all new forms 8949 (Sales and Other Dispositions of Capital Assets) and 8938 (Statement of Foreign Financial Assets).

Securities traders will be shocked by the new tax-filing compliance headaches, red flags and problems caused by the IRS’s new Cost-Basis Reporting rules, which are all a part of its new tax form 8949.

Futures traders can count their lucky stars — they are free from this mess. With mark-to-market (economic reporting) in Section 1256, futures traders receive a one-page Form 1099 with their realized and unrealized gains and losses for the year. Simply enter that one simple number for “aggregate profit and loss” to Form 6781 and you also benefit from lower tax rates with 60/40 tax treatment. It may not be as easy if you trade instruments like ETF options. Brokers may treat those as securities, but you will want to treat them as Section 1256 contracts instead per our content.

Active securities traders and their accountants face a nightmare in filling out Form 8949 and reconciling their own trade accounting records — like TradeLog — with beefed-up broker-provided Form 1099-Bs.

First, these 1099-Bs are coming very late this year, as brokerage firms are struggling with the new rules. We expect most brokers will revise their 1099-Bs several times. This makes it almost impossible to file a full tax return by the April 17 deadline. You should get a good handle on your securities trade accounting with TradeLog and send that information to your tax preparer as soon as possible. Plan to file an extension, and be sure it’s valid by paying at least 90% of your tax liability by April 17 with the extension filing. Handle the difficult Form 8949 reconciliations and explanations required on your tax return after the extension and before the final due date of Oct. 15. Brokers may send revised 1099-Bs after April 15, too.

What’s the fuss with Form 8949?
You can’t enter information directly to Schedule D anymore, as you must use Form 8949 for all line-by-line reporting, received from the brokerage firm. This form has three types of situations (Parts A, B and C) for each short-term and long-term holding period (12 months) — potentially six different Form 8949s to deal with.

Part A — the good part — is used for cost basis that matches your 1099-B. As the instructions say “transactions reported on Form 1099-B with basis reported to the IRS.” For the 2011 tax return, this includes corporate stock purchased and sold in 2011.

These rules are being phased in, so many cost-basis items are not covered on 1099-Bs until 2012 and 2013. That’s where column B is used, as the instructions say for “transactions reported on Form 1099-B but basis not reported to the IRS.” This could include stock purchased prior to 2011 and other non-covered securities in 2011 like options, mutual funds and bonds. Form 8949 instructions also state, “If there are wash sales for items, reported on Part I-A, then you enter that adjustment in column (g) and with W code in (b).”

Caution: Taxpayers often disagree with brokers on reporting wash sales, and this can be a challenge to report on Form 8949. Tax software often only allows wash sales reported in this new column if there is a taxable loss. That can be a problem when summary reporting refers to a separate TradeLog report showing a net gain. Expect wash sale adjustments in situations where one broker doesn’t recognize a wash sale, which TradeLog may correctly recognize between a second brokerage account and an IRA.

Finally, Part C is for transactions where no Form 1099-B has been issued. This could be the case for a sale of personal assets or a home. We also may use this part for our transfers to Schedule C to allow home-office deductions.

Prior to this tax season, you could just leave the heavy lifting to TradeLog, and simply enter the 1099-B amount to Schedule D to satisfy the IRS. It’s a whole different ball game this year — you must do the heavy lifting. TradeLog is working feverishly to issue an update that makes it easier for you, too. Good trade accounting software continues to be a must for active securities traders.

Is it easier for Section 475 MTM traders?
GreenTraderTax has always recommended Section 475 MTM for securities business traders so they could be exempt from wash sales – which represent many of these difficult adjustments to be reported. Some traders have always incorrectly assumed that with Section 475 MTM, they could use summary reporting on Form 4797, stating “details available on request.” They are very wrong — Form 4797 requires line-by-line reporting too.

Plus, leading tax publisher RIA and PPC recommend that Section 475 MTM traders report total proceeds on Form 8949, and then back it out with an adjustment in Part C. While Section 475 MTM traders may be free from the mess of reconciliations on Form 8949, they still should fill out the form to avoid trouble. Its likely IRS computers will work in overdrive to match every individual’s Form 1099-B with their individual tax return and a Form 8949. We expect a huge increase in computer tax notices and headache and cost for taxpayers to deal with those notices. Get it right the first time to avoid getting a tax notice.

For more information and examples of dealing with Form 8949, watch our Webinar recording from Feb. 2, 2012.

Form a trading entity for 2012 to skip these problems.
After facing this nightmare once for tax year 2011, you will want to form an entity for your trading business in 2012 to skip these tax problems and unlock plenty of other tax savings. Entities currently aren’t required to file a form 8949; hopefully that continues to be the case for 2012 and subsequent tax years. Like with an individual Schedule C, the IRS turns up the heat on individual taxpayers, thinking they are less sophisticated and more prone to errors, whether inadvertent or purposeful.

Our important transfer strategy for sole proprietor business traders of moving some Schedule D trading gains to Schedule C to unlock home-office deductions and 100% Section 179 depreciation is even more of a red flag in 2011. It must be in that dreaded “Other” column on Form 8949. That’s okay, since we explained this transfer in our footnotes in the past anyway — but this year the IRS computers may choke on that more and send a tax notice.

This is not a problem with an entity return. The IRS is also beefing up audits of Schedule Cs and asked many traders to document and justify their trading expenses, too. The IRS audits entities much less. Our entity formation service is excellent and the price is right, so check with us soon.

In the past, we suggested entities for business traders only, since the AGI-deductions (retirement plan and health-insurance premiums) are beneficial with trader tax status. This year, investors may want to consider an entity as well, just to avoid the dreaded Form 8949 accounting and reconciliation mess that individuals face.

The IRS insists on knowing about material foreign accounts and transactions.
Over the past decade, it’s become increasingly easy for traders and investors to tap into foreign markets including emerging markets, tax havens and offshore funds. Plus, Americans move around the world for business or personal opportunities and they wind up with foreign accounts and transactions. Plenty of non-resident aliens marry Americans, or move to America becoming greencard holders and U.S. residents, too. Now, the IRS considers this all their business, too!

The Foreign Account Taxpayer Compliance Act (FATCA) is not just about tax reporting by Americans. It’s also to pressure foreign banks into divulging their American client information so the IRS can bust both the taxpayer and these foreign banks. Congress has gone on a similar extra-territorial path with Dodd-Frank and new CFTC restrictions for retail American forex trading accounts. The EU is reciprocating and also complaining about FATCA; perhaps a new Congress in 2013 will backtrack, or even this Congress in 2012. Stay tuned.

Oddly, another way to avoid Form 8949 headaches is to use a foreign broker, as they are not subject to these new complex cost-basis reporting rules for U.S. brokers only. But, then you trade in one set of tax compliance headaches for another, the foreign reporting ones which can be more onerous.

More details on FATCA, FBAR and the new Form 8938.
We wrote several blogs last year about Report of Foreign Bank and Financial Accounts (FBAR) on Form TD F 90-22.1. We also wrote about the IRS OVDI and OVDP programs, which the IRS recently reopened again (see details below). I blogged about Gov. Romney’s tax return — almost half of his 500+ tax forms had to do with foreign reporting. It must have cost him a fortune in tax preparation fees.

Another blogger did a nice job on this topic — see his blog here. He covers Form 8938 in full.

Update: The IRS issued new guidance saying “a personal residence or a rental property does not have to be reported” on Form 8938, unless it’s held by a partnership, LLC, corporation or trust. See the IRS’ “Basic Questions and Answers on Form 8938 (posted 2-29-12)” athttp://www.irs.gov/businesses/corporations/article/0,,id=255061,00.html

IRS announces third offshore voluntary disclosure program.
The IRS recently reopened an offshore voluntary disclosure program (OVDP) to allow taxpayers with offshore financial accounts (including brokerage accounts, mutual funds, pension plans and life insurance) or assets to comply with their U.S. federal income tax obligations and foreign account reporting requirements. Because the FATCA will force foreign banks to divulge information regarding their U.S. clients, U.S. taxpayers have a strong incentive to enter the OVDP rather than risk detection by the IRS. Once the IRS has begun an audit of a taxpayer, the taxpayer is no longer eligible to participate in the OVDP.

The new OVDP will be open for an indefinite period, but the IRS could choose to end it at any time.

The new program has no deadline to apply. However, the IRS emphasized that the terms of the new program could change in the future. The IRS stated that, for example, at any time the penalties under the program could be increased.

Bottom line
If you are going to be snagged with Form 8949 adjustments, and or reporting of foreign tax matters, make sure to get a handle on your tax preparation plan sooner rather than later. Don’t spring this on your tax preparer at the last minute and it’s a huge mistake to hide anything foreign.