The Hiring Incentives to Restore Employment (HIRE) Act which recently was passed by Congress was signed by the President on March 18, 2010. This Summary explains how the "HIRE Act" encourages companies to hire (and retain) unemployed workers by creating an employer “payroll tax holiday” of sorts for hiring unemployed workers in 2010 and an employer tax credit if these new hires are retained for at least one year. It also explains how the Act boosts expensing for 2010 and permits certain bond issues to elect to receive a payment in lieu of providing a tax credit to the bondholders. It also includes a summary of the Act's new anti-offshore tax abuse measures and other revenue raising provisions.
Payroll Tax Holiday in 2010 for Hiring Unemployed Workers. The Federal Insurance Contributions Act (FICA) imposes two taxes, the Old Age, Survivors and Disability Insurance (OASDI) tax and the Medicare Hospital Insurance (HI) tax. These taxes are imposed on employers for wages paid with respect to employment and on employees for wages received with respect to employment. The OASDI tax rate is 6.2% on wages up to an annually-adjusted “wage base” ($106,800 for 2010). The HI tax rate is 1.45% on all wages, regardless of amount. Under pre-Act law, the Social Security payroll tax wasn't forgiven for employers who hired the unemployed.
Employers who hire members of certain targeted groups before Sept. 2011 may claim a work opportunity credit (WOTC) equal to a percentage of up to $6,000 of first-year wages per employee, $12,000 for qualified veterans, and $3,000 for qualified summer youth employees. If the employee is a long-term family assistance recipient, the credit is a percentage of first- and second-year wages, up to $10,000 per employee.
New law. The Act provides relief from the employer share of OASDI taxes for employers that hire unemployed workers. The relief applies to wages paid beginning on the day after the enactment date and ending on Dec. 31, 2010. ( Code Sec. 3111(d) , as amended by Act Sec. 101(a)) More specifically, the OASDI tax on employers doesn't apply to wages paid by a qualified employer with respect to employment during the period beginning on the day after the enactment date and ending on Dec. 31, 2010, of any qualified individual for services performed:
- in a trade or business of the qualified employer; or
- for a qualified employer that is tax-exempt under Code Sec. 501(a) , in furtherance of the activities related to the purpose or function on which the employer's exemption is based. (Code Sec. 3111(d)(1) , as amended by Act Sec. 101(a))
Observation: The payroll tax holiday applies only to the 6.2% OASDI portion of the employer's tax. It doesn't apply to the 1.45% Medicare (HI) portion of the employer's tax, nor to any part of the employee's tax. It also doesn't affect the self-employment tax paid by self-employed individuals.
Observation: The amount of tax forgiven per employee can't exceed $6,621.60, because the OASDI tax applies to only the first $106,800 of wages paid in 2010 ($106,800 × 6.2% = $6,621.60).
Observation: An employee need not work for a minimum number of hours in order for the employer to qualify for the payroll tax holiday.
Qualified employer defined. A qualified employer is any employer other than the U.S., a state, or a political subdivision of a state (i.e., a local government, or an instrumentality). (Code Sec. 3111(d)(2)(A) ) However, a public institution of higher education is a qualified employer even though it is a government instrumentality. ( Code Sec. 3111(d)(2)(B) )
Qualified individuals defined. A qualified individual is anyone who:
(1) Begins employment with a qualified employer after Feb. 3, 2010, and before Jan. 1, 2011.
Observation: Although a qualified employee who begins work after Feb. 3, 2010 can be eligible for the payroll tax holiday, only the employer's portion of OASDI on his wages paid with respect to employment after the enactment date will be forgiven.
(2) Certifies by signed affidavit, under penalties of perjury, that he hasn't been employed for more than 40 hours during the 60-day period ending on the date the individual begins employment with the qualified employer.
(3) Isn't employed to replace another employee of the qualified employer unless that other employee separated from employment voluntarily or for cause.
(4)
Isn't related to the qualified employer in a way that would disqualify him for the WOTC under Code Sec. 51(i)(1) . ( Code Sec. 3111(d)(3) )
The Committee Report says an employer may qualify for the payroll tax holiday when it hires an otherwise qualified individual to replace one who was terminated for cause or due to other facts and circumstances, such as where a factory is closed due to lack of demand. When the factory reopens, the payroll tax holiday can be claimed both for rehiring old workers and hiring new workers. However, an employer who terminates an employee without cause in order to claim the payroll tax holiday for hiring the same or another employee doesn't qualify.
Oservation: Under item (4), above, there's no payroll tax holiday for hiring a relative such as the qualified employer's child or descendant of a child; a stepchild; sibling, stepbrother, or stepsister; parent or stepparent; niece, nephew, uncle or aunt; or in-laws.
If the qualified employer is:
- a corporation, an individual standing in any of the above relationships to anyone who owns, directly or indirectly, more than 50% in value of its outstanding stock, after applying the Code Sec. 267(c) attribution rules, won't qualify.
- a noncorporate entity, an individual standing in any of the above relationships to anyone who owns, directly or indirectly, more than 50% of the capital and profits interests in the entity attribution rules, won't qualify.
- an estate or trust, a grantor, beneficiary, or fiduciary of the estate or trust, or an individual having any of the familial relationships described above to a grantor, beneficiary, or fiduciary of the estate or trust, won't qualify.
- An individual unrelated to the qualified employer who is the employer's dependent because he has the same principal place of abode and is a member of the employer's household won't qualify. If the qualified employer is a corporation, an individual who is a dependent of anyone who owns, directly or indirectly, more than 50% in value of the outstanding stock, won't qualify. A dependent of a grantor, beneficiary, or fiduciary of an estate or trust that is a qualified employer won't qualify.
Special rule for first calendar quarter of 2010. The payroll tax holiday doesn't apply for wages paid during the first calendar quarter of 2010. Instead, the amount by which the qualified employer's OASDI tax for wages paid during the first calendar quarter of 2010 would have been reduced if the payroll tax holiday had been in effect for that quarter is treated as a payment against the qualified employer's OASDI tax for the second calendar quarter of 2010. ( Code Sec. 3111(d)(5)(B) ) The payment is treated as made on the date when the employer's second-quarter OASDI tax is due.
Observation: Most employers report employment taxes quarterly on Form 941 (Employer's Quarterly Federal Tax Return). The rule providing that the payroll tax holiday doesn't apply for wages paid during the first quarter will give IRS time to issue guidance about the payroll tax holiday and will give employers time to adjust their payroll systems accordingly. Employers won't lose out, because the amount of first-quarter wages that would have been forgiven will be allowed as a credit for the second quarter.
Election out; coordination of payroll holiday with WOTC. A qualified employer may elect, in the manner that IRS requires, not to have the payroll tax holiday apply. ( Code Sec. 3111(d)(4) ) Unless the employer elects out of the payroll holiday, wages paid or incurred to a qualified individual won't qualify for the WOTC during the one-year period beginning on the date that the qualified employer hired the individual. ( Code Sec. 51(c)(5) ) The Committee Report indicates that the election can be made on an employee-by-employee basis.
Observation: The WOTC is in many cases more valuable than the payroll tax holiday, especially for low-wage employees, because it is generally 40% of “qualified first-year wages” of up to $6,000, for maximum credit of $2,400 per worker. The payroll tax holiday is equal to 6.2% of wages, and applies only to wages paid through Dec. 31, 2010. However, the WOTC is harder to qualify for, because the employee must be certified by an agency as belonging to a targeted group. The main qualification for payroll tax holiday is that the employee have been unemployed for 60 days, and the employee's affidavit is sufficient for this purpose.
Railroad retirement tax holiday. Effective for compensation paid after the enactment date, the Act provides a railroad retirement tax holiday that is similar in many respects to the FICA tax holiday. ( Code Sec. 3221(c) , as amended by Act Sec. 101(d))
New Up-to-$1,000 Credit for Each “Retained Worker”. For any tax year ending after the enactment date, the Act provides an up-to-$1,000 credit for “retained workers.” (Act Sec. 102) A retained worker is defined as any qualified individual, as defined for purposes of the payroll tax holiday (see above):
(1) who was employed by the taxpayer on any date during the tax year,
(2) who was so employed by the taxpayer for a period of not less than 52 consecutive weeks, and
(3) whose wages (as defined in Code Sec. 3401(a) ) for that employment during the last 26 weeks of the period (described in item (2) above) equaled at least 80% of the wages for the first 26 weeks of that period. (Act Sec. 102(b))
Observation: The definition of wages for withholding purposes in Code Sec. 3401(a) generally includes all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash. Thus, compensation that isn't subject to withholding, such as certain fringe benefits, wouldn't be included as wages for purposes of the up-to-$1,000 credit for retained workers. Also, wages paid to certain types of employees that are exempt from income tax withholding under Code Sec. 3401(a) wouldn't qualify as wages for purposes of the up-to-$1,000 credit. The exemptions from withholding provided in Code Sec. 3401(a) include wages paid to certain agricultural labor, domestics working in private homes, certain employees working in foreign countries (if the employer is required to withhold on the wages under foreign law), etc.
Amount of the credit. Under Act Sec. 102(a), for any tax year ending after the enactment date, the current year business credit determined under Code Sec. 38(b) for the tax year is increased , for each retained worker (as defined above) with respect to which the 52-consecutive-week requirement in (2), above, is first satisfied during the tax year, by the lesser of:
- $1,000; or |
- 6.2% of the wages (as defined for income tax withholding in Code Sec. 3401(a) ) paid by the taxpayer to the retained worker during the 52-consecutive-week-period. (Act Sec. 102(a))
Observation: If a retained worker's wages during the 52-consecutive-week-period exceed $16,129.03, the increase to the current year business credit for that retained worker will be $1,000.
Observation: Since the increase to the current year business credit under the above rules applies in the tax year in which the 52-consecutive-week test is first satisfied, the increase to the current year business credit with respect to each retained employee only occurs in one tax year (i.e., the tax year in which the 52-consecutive-week test is first satisfied by a particular employee).
Observation: For an employer using the calendar year as its tax year, the increase to the current year business credit will be claimed on the employer's 2011 tax return.
Illustration 1: ABC Corp., a taxpayer using the calendar year as its tax year, hires Earl, a retained worker, on Feb. 15, 2010. The 52-consecutive-week requirement is first satisfied in the 2011 tax year if Earl works for ABC until Feb. 14, 2011. His wages for the 52-consecutive-week period are $30,000. In that case, on its 2011 tax return, ABC's current year business credit will be increased by $1,000 for Earl.
Observation: Certain fiscal year taxpayers may have to claim the increase to the current year business credit on tax returns for two tax years on an employee-by-employee basis.
Illustration 2: The facts are the same as in illustration (1) except that ABC Corp. uses a fiscal year beginning on Dec. 1 and ending on Nov. 30 as its tax year. ABC Corp. also hires Carol on Dec. 31, 2010, and she is still working for ABC on Dec. 30, 2011. Carol's wages for the 52-consecutive-week-period are $52,000.
The 52-consecutive-week requirement is first satisfied with respect to Earl on Feb. 14, 2011 and with respect to Carol on Dec. 30, 2011. Thus, ABC can claim the $1,000 increase to the current year business credit for Earl on its tax return for the fiscal year ending on Nov. 30, 2011 and the $1,000 increase for Carol on its tax return for the fiscal year ending on Nov. 30, 2012.
Illustration 3: The facts are the same as in illustration (2) except that Earl quits working for ABC on Jan. 30, 2011. Since he only worked for ABC for 50 consecutive weeks, the 52-consecutive-week requirement isn't satisfied for Earl, and ABC can't claim the up-to-$1,000 credit for him.
Observation: Presumably, IRS will soon issue a form for claiming the $1,000 increase to the current year business credit for the retention of certain newly hired employees as it has for other employee retention credits such as the Midwestern Disaster Area employee retention credit that is claimed on Form 5884-A and on Form 3800.
CAUTION: An employer will need to keep careful records with respect to each employee hired after Feb. 3, 2010 and before Jan. 1, 2011 so that it can prove that each employee for which it claims the up-to-$1,000 increase to the current year business credit meets the definition of a retained worker.
Observation: Presumably, the increase to the current year business credit under Act Sec. 102 occurs before the application of any of the limitations under Code Sec. 38(c) that apply to the general business credit as determined under Code Sec. 38(a)(2) . Thus, the up to $1,000 increase to the current year business credit is subject to the rules that, under Code Sec. 38 , can prevent some taxpayers from enjoying full use of the credit to reduce their tax liabilities in the tax year that the credit is claimed. For example, the increase to the current year business credit under Act Sec. 102 won't be allowed to offset any of a taxpayer's alternative minimum tax (AMT), and will be limited in its offset of a taxpayer's regular income tax.
Carryback limit on the $1,000 increase per retained worker. No portion of the unused business credit under Code Sec. 38 for any tax year that is attributable to the up-to-$1,000 increase in the current year business credit under Act Sec. 102 can be carried to a tax year beginning before the enactment date. (Act Sec. 102(c))
Observation: A one-year carryback generally applies to unused business credits under Code Sec. 39(a)(1) . However, Act Sec. 102(c) prevents a taxpayer from carrying back any portion of an unused business credit that is attributable to the up-to-$1,000 increase of the current year business credit to a tax year beginning before the enactment date. Since a taxpayer using the calendar year as its tax year is only entitled to the up-to-$1,000 increase to the current year business credit in 2011 (see above), the effect of the rule in Act Sec. 102(c) is that a calendar year taxpayer can't carry back any portion of the unused business credit that is attributable to the up-to-$1,000 increase to 2010 (a tax year that began before the enactment date). Thus, a calendar year taxpayer isn't allowed the one-year carryback (that would be allowed under Code Sec. 39(a)(1)(A) but for the rule in Act Sec. 102(c)) of any portion of any unused business credit that is attributable to the up-to-$1,000 increase to the current year business credit under Act Sec. 102. However, a calendar year taxpayer can carry forward for 20 years that portion of any unused business credit that is attributable to the $1,000 increase.
Observation: The transitional rule in Act Sec. 102(c) was necessary because the transitional rule in Code Sec. 39(d) (generally providing that no part of any unused current business credit attributable to a component credit can be carried back to any tax year before the first tax year that the component credit was allowable) is limited to the credits listed under Code Sec. 38(b) ), and the increase to the current year business credit under Act Sec. 102 isn't listed in Code Sec. 38(b) .
Observation: There are no special carryforward provisions that apply to the up to $1,000 increase to the current year business credit for retained workers. Thus, presumably, any portion of the general business credit that is attributable to the increase to the current year business credit will be subject to the 20-year carryforward limitations applicable to current year unused business credits.
U.S. possessions. The Act provides comparable rules relating to the application of the up to $1,000 increase to the current year business credit to employers in U.S. possessions. For this purpose, a U.S. possession includes Puerto Rico and the Northern Mariana Islands. (Act Sec. 102(d)(3)(A))
Asset Expensing Limits Boosted For 2010. Generally, taxpayers can elect to treat the cost of any Code Sec. 179 property placed in service during the tax year as an expense which is not chargeable to capital account, and any cost so treated is allowed as a deduction for the tax year in which the section 179 property is placed in service.
Old law. For tax years beginning in 2008 and 2009, the maximum amount that could be expensed under Code Sec. 179 was $250,000, and the maximum deductible expense was reduced (i.e., phased out, but not below zero) by the amount by which the cost of Code Sec. 179 property placed in service during tax year 2008 or 2009 exceeded $800,000. The $250,000 and $800,000 amounts were not adjusted for inflation.
Under pre-Act law, for tax years beginning in 2010, the maximum amount that could be expensed under Code Sec. 179 , was $134,000, and the maximum deductible expense had to be reduced (i.e., phased out, but not below zero) by the amount by which the cost of Code Sec. 179 property placed in service during the 2010 tax year exceeded $530,000 (i.e., the beginning-of-phaseout amount). The 2010 amounts reflected statutory inflation adjustments.
For tax years beginning after 2010, the maximum expensing amount under Code Sec. 179 is $25,000, the beginning-of-phaseout amount is $200,000, and neither amount is adjusted for inflation.
Qualifying property for purposes of the Code Sec. 179 expensing election is depreciable tangible personal property purchased for use in the active conduct of a trade or business, including “off-the-shelf” computer software placed in service in tax years beginning before 2011.
New law. For tax years beginning after 2007 and before 2011, the Act provides that:
- the dollar limitation on the Code Sec. 179 expensing deduction is $250,000,
- the reduction in the dollar limitation (beginning-of-phaseout amount) starts to take effect when property placed in service in a tax year exceeds $800,000, and
- neither the dollar limitation nor the beginning-of-phaseout amount is adjusted for inflation. ( Code Sec. 179(b) , as amended by Act Sec. 201(a)).
Additionally, the increase in dollar limitation amounts and no-inflation-adjustment rule for 2008 and 2009 are removed. (Act Sec. 201(a)(3))
Observation. Thus, the Act increases for one year (2010) the amount a taxpayer can expense under Code Sec. 179 . The maximum amount a taxpayer can expense for a tax year beginning in 2010 is $250,000 of the cost of qualifying property placed in service for that tax year. The $250,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during 2010 exceeds $800,000.
Observation: Since the $250,000 and $800,000 limitation amounts and no-inflation-adjustment rule applied under pre-Act law for tax years beginning in 2008 and 2009, the Act both extends those limitation and phaseout amounts to tax years beginning in 2010 and eliminates the inflation-adjustment rule which applied for tax years beginning in 2010 under pre-Act law.
Ilustration : In 2010, Midcorp, a calendar-year taxpayer, places into service Code Sec. 179 property with a cost of $660,000. It can elect to expense $250,000 of the cost (there's no phaseout because the cost of Code Sec. 179 property placed in service during the year does not exceed $800,000, the beginning-of-phaseout amount for 2010).
Observation: For property placed in service in tax years beginning in 2010, the Code Sec. 179 expensing deduction phases out completely only when the cost of the property exceeds $1,050,000 ($800,000 (beginning-of-phaseout amount) + $250,000 (dollar limitation)). This is the same limit that applied under pre-Act law for property placed in service in 2008 or 2009.
Issuers of Certain Tax Credit Bonds Can Elect to Receive Direct Payment In Lieu of a Tax Credit to the Bondholder. As an alternative to traditional tax-exempt bonds, state and local governments may issue qualified tax credit bonds. Qualified tax credit bonds allow the bondholder (i.e., investor) to claim a nonrefundable tax credit in lieu of receiving interest. Qualified tax credit bonds include:
- new clean renewable energy bonds (New CREBs)—i.e., certain bonds issued to finance capital expenditures for qualified renewable energy facilities;
- qualified energy conservation bonds (QECBs)—i.e., certain bonds issued for a “qualified energy conservation purpose” such as initiatives for reducing greenhouse emissions;
- qualified zone academy bonds (QZABs)—i.e., certain bonds issued to finance certain academic programs operated by public schools in cooperation with businesses in economically disadvantaged areas; and
- qualified school construction bonds (QSCBs)—i.e., certain bonds issued to finance the construction, rehabilitation, or repair of, or the acquisition of land for, public school facilities.
Build America Bonds (BABs), which are otherwise tax-exempt bonds issued to finance capital projects for which the issuer (i.e., a state or local government) irrevocably elects to treat as taxable bonds, entitle the holder to a nonrefundable tax credit. For BABs that are “qualified bonds”—certain BABs issued before 2011 for which the issuer irrevocably elects, on or before the issue date of the bonds, to have the refundable tax credit rules of Code Sec. 3461 apply—the issuer may elect to claim a refundable tax credit (the so-called “direct payment” option) in lieu of the tax credit to the bondholder.
New law. For bonds originally issued after the enactment date, the Act allows an issuer of New CREBS, QECs, QZABs, or QSCBs to make an irrevocable election on or before the issue date of the bonds to receive a payment in lieu of providing a tax credit to the holder of the bonds. Thus, these “specified tax credit bonds” are treated as “qualified bonds” under Code Sec. 6431 , and the issuer is entitled to receive a direct payment from IRS. ( Code Sec. 6431(f) , as amended by Act Sec. 301(a))
Interest paid to the holder of the bond is includible in the holder's gross income. ( Code Sec. 6431(f)(1)(D) ) The issuer's direct payment option for qualified tax credit bonds is in lieu of the credit for the holder, and the bondholder can't claim the tax credit that otherwise would be available under the qualified tax credit bond rules. ( Code Sec. 6431(f)(1)(E) )
For specified tax credit bonds, the amount that IRS will pay to the issuer (or to any person making interest payments on the issuer's behalf) for any interest payment due under the bond is equal to the lesser of:
(1) the amount of interest payable under the bond on that date ( Code Sec. 6431(f)(1)(C)(i) ), or
(2) the amount of interest that would have been payable under the bond on that date if the interest were determined at the applicable credit rate determined under Code Sec. 54A(b)(3) . ( Code Sec. 6431(f)(1)(C)(ii) )
Thus, the amount of the payment to the issuer of a specified tax credit bond that is a New CREB, QECB, QZAB, or QSCB is a function of the market-determined interest rate on the bond and not a rate set by IRS. (Committee Report)
Under a special rule, for any New CREB or QECB, the amount of the credit determined under Code Sec. 6431(f)(1)(C)(ii) is 70% of the amount otherwise determined, without regard to this rule, Code Sec. 54C(b) (new CREB annual credit is 70% of the amount otherwise allowed), and Code Sec. 54D(b) (QECB annual credit is 70% of the amount otherwise allowed). ( Code Sec. 6431(f)(2) )
The income tax deduction otherwise allowed to the issuer of a qualified bond that is a New CREB, QECB, QZAB, or QSCB for interest paid on the bond is reduced by the amount of the payment made under Code Sec. 6431 for the interest. ( Code Sec. 6431(f)(1)(G) )
Observation: The issuer of a New CREB, QECB, QZAB, or QSCB that elects the direct payment option for the bond must make regular interest payments to the bond holders. The deduction otherwise allowed to the issuer for these interest payments must be reduced by the amounts the issuer receives from IRS.
New CREBs, QECBs, QZABs, and QSCBs for which the election is made count against the national limitation for such bonds in the same way that they would if no election were made. (Committee Report)
An issuer can elect the direct payment option for qualified bonds that are New CREBs, QECBs, QZABs, or QSCBs even if the bonds aren't issued before 2011. ( Code Sec. 6431(f)(1)(B) )
Observation: However, due to a “zero” national bond volume limitation that is prescribed for both QZABs and QSCBs for years after 2010, they can be issued after 2010 only if unused national bond volume limitations for pre-2011 years can be carried forward. For carryforward for QSCBs, see below.
In a technical correction, t he Act also provides that for bonds issued after Feb. 17, 2009—i.e., as if it were originally included in American Recovery and Reinvestment Act §1521—the Code Sec. 54F(e) rule allowing the carryover of unused QSCB limitation by a State or Indian tribal government applies to the 40% of QSCB limitation that is allocated among the largest school districts. It also provides that the limitation amount allocated to a State is to be allocated to QSCBs issuers within the State by the State education agency (or such other agency as is authorized under State law to make the allocation). ( Code Sec. 54F , as amended by Act Sec. 301(b))
Foreign Compliance and Other Revenue Raising Provisions in the HIRE Act of 2010
The Hiring Incentives to Restore Employment (HIRE) Act creates a host of new anti-abuse measures designed to deter U.S. individuals from attempting to hide assets overseas, further delays the effective date of the worldwide allocation of interest provision, and accelerates certain estimated tax payments for very large corporations.
Withholdable Payments to Foreign Financial Institutions and Other Foreign Entities. Payments made to foreign persons of fixed or determinable annual or periodical (“FDAP”) income from U.S. sources are subject to a 30% U.S. withholding tax, unless the beneficial owner qualifies for an exemption or a reduced withholding rate under an income tax treaty. FDAP income includes interest and dividends but not gains on sales of property.
Statutory exemptions from withholding apply to interest on bank deposits; portfolio interest; and capital gains.
Most U.S. income tax treaties provide for zero withholding on fixed interest payments and reduce the withholding rate on dividends to 15% (for portfolio dividends) and 5% (for direct investment dividends paid to a 10% or greater shareholder).
A withholding agent that makes payments of U.S.-source amounts to a foreign person must report those payments, including any amounts of U.S. tax withheld, to IRS on Forms 1042 and 1042-S by March 15 of the calendar year following the year in which the payment is made.
The U.S. withholding tax rules are administered through a system of self-certification. Thus, a nonresident investor seeking to obtain withholding tax relief for U.S.-source investment income typically must provide a certification on Form W-8 to the withholding agent to establish foreign status and eligibility for an exemption or reduced rate. Provision of the Form W-8 also establishes an exemption from the rules that apply to many U.S. persons governing information reporting on Form 1099 and backup withholding.
New law . The Act adds a new chapter 4 to the Code. ( Code Sec. 1471 through Code Sec. 1474 , as added by Act Sec. 501) It provides for withholding taxes to enforce new reporting requirements on specified foreign accounts owned by specified U.S. persons or by U.S. owned foreign entities. The Act establishes rules for withholdable payments to foreign financial institutions and for withholdable payments to other foreign entities. These rules are generally effective for payments made after Dec. 31, 2012. However, they don't apply to any obligation outstanding on the date that is two years after the enactment date, or from the gross proceeds from any disposition of the obligation. (Act Sec. 501(d))
Payment to foreign financial institutions. Generally for payments made after Dec. 31, 2012, a withholding agent must deduct and withhold a tax equal to 30% of any withholdable payment made to a foreign financial institution that does not meet certain requirements. ( Code Sec. 1471(a) ) A “withholdable payment” is non-effectively connected (1) U.S. source FDAP income (as to which nonresident withholding currently applies (see above)), (2) gross proceeds from the sale of property that produces interest and dividend income (which have not previously been subject to nonresident withholding) and (3) interest on deposits with foreign branches of a domestic commercial bank (which is otherwise non-U.S. source income). ( Code Sec. 1473(1) ) To avoid this 30% withholding requirement, a “foreign financial institution” must either enter into a Code Sec. 1471(b) agreement with IRS and satisfy the requirements listed below, or satisfy one of several alternatives. ( Code Sec. 1471(a) )
Code Sec. 1471(b) agreement. Withholding on withholdable payments is not required if a Code Sec. 1471(b) agreement is in effect between the foreign financial institution and IRS in which the institution agrees to:
(1) Obtain information regarding each holder of an account maintained by the institution to determine which accounts are U.S. accounts (see below);
(2) Comply with verification and due diligence procedures prescribed by IRS to identify U.S. accounts;
(3) Report annually for any U.S. account, identifying information as to the specified account holder (i.e., any U.S. person other than a corporation whose stock is regularly traded on an established market, or certain affiliates, or certain exempt or special corporations or entities) and any substantial owner of a U.S. owned foreign entity;
(4) Deduct and withhold 30% from certain pass-through payment made to “a recalcitrant account holder” or certain other foreign financial institutions;
(5) Comply with IRS requests for additional information for any U.S. account maintained by the institution; and
(6) Attempt to obtain a waiver where a foreign law would (but for a waiver) prevent the reporting of information required by these rules for any U.S. account maintained by the institution, and, if a waiver is not obtained, to close the account. ( Code Sec. 1471(b) )
Annual reporting is also required as to account balances and gross receipts and withdrawals from the account. ( Code Sec. 1471(c)(1) )
U.S. accounts. A U.S. account is any financial account which is held by one or more “specified U.S. persons” or a “U.S. owned foreign entity” (with an exception where all accounts held by a natural person do not exceed $50,000). ( Code Sec. 1471(d)(1) ) A specified U.S. person is any U.S. person other than (i) a corporation whose stock is regularly traded on an established securities market or members of its “expanded affiliated group” and (ii) certain entities that are exempt or have a special status and government bodies. ( Code Sec. 1473(3) ) A “U.S. owned foreign entity” is a foreign entity with one or more substantial U.S. owners, applying a more than 10% ownership of stock by vote or value test to a corporation; a more than 10% of capital or profits interests to a partnership; any interest in a grantor trust; and under regs, any specified U.S. person with more than a 10% interest in a trust. ( Code Sec. 1471(d)(1) , Code Sec. 1473(5) )
Payments to other foreign entities. Generally for payments made after Dec. 31, 2012, a withholding agent must deduct and withhold a tax equal to 30% of any withholdable payment made to a nonfinancial foreign entity if the beneficial owner of the payment is a nonfinancial foreign entity that does not meet specified requirements. ( Code Sec. 1472(a) ) Withholding is not required if the payee or the beneficial owner of the payment provides the withholding agent with either a certification that the foreign entity does not have a substantial U.S. owner, or provides the withholding agent with the name, address and TIN of each substantial U.S. owner. ( Code Sec. 1472(b) )
Withholding does not apply to any payment beneficially owned by a publicly traded corporation or a member of an expanded affiliated group of a publicly traded corporation. Nor does it apply to any payment beneficially owned by any: (1) entity organized under the laws of a U.S. possession, which is wholly owned by one or more bona fide residents of that possession; (2) foreign government, political subdivision thereof, or wholly owned agency or instrumentality of any foreign government or political subdivision thereof; (3) international organization or any wholly owned agency or instrumentality thereof; (4) foreign central bank of issue; (5) any other class of persons identified by IRS for these purposes; or (6) payments identified by IRS as posing a low risk of U.S. tax evasion. ( Code Sec. 1472(c) )
Grace period during which IRS does not have to pay interest extended for certain overpayments. The Act provides that the grace period during which the government isn't required to pay interest on overpayments is increased from 45 days to 180 days for overpayments resulting from excess amounts deducted and withheld under chapter 3 ( Code Sec. 1441 through Code Sec. 1464 (withholding on nonresident aliens and foreign corporations)) or new chapter 4 ( Code Sec. 1471 through Code Sec. 1474 ). ( Code Sec. 6611(e) ) The increased grace period applies to refunds of withheld taxes for: (1) returns due after the enactment date, (2) claims for refund filed after the enactment date, and (3) IRS initiated adjustments if the refunds are paid after the enactment date. (Act Sec. 501(d)(3))
Repeal of Foreign Targeted Obligation to Bond Registration Requirement. In general, a registration required obligation is any obligation other than one that: (1) is made by a natural person; (2) matures in one year or less; (3) is not of a type offered to the public; or (4) is a foreign targeted obligation. A foreign targeted obligation is one satisfying the following requirements: (a) there are arrangements reasonably designed to ensure that the obligation will be sold (or resold in connection with the original issue) only to non U.S. persons; (b) interest is payable only outside the U.S. and its possessions; and (c) the face of the obligation contains a statement that any U.S. person who holds this obligation will be subject to limitations under the U.S. income tax laws.
Various sanctions apply to registration-required obligations that are not issued in registered form (i.e., they are issued as bearer bonds):
- An issuer's deduction for interest is disallowed.
- The interest paid on state or local bonds won't qualify for tax exemption.
- An excise tax applies to the issuer.
- Any gain realized by the beneficial owner on the sale or other disposition of the obligation is treated as ordinary income (rather than capital gain), unless the issuer of the obligation as subject to the excise tax (see above).
- Deductions for losses realized by beneficial owners are disallowed.
For the purposes of ordinary income treatment and denial of deduction for losses, a registration-required obligation is any obligation other than one that:
(1) is made by a natural person;
(2) matures in one year or less; or
(3) is not of a type offered to the public.
Payments of U.S.-source fixed or determinable annual or periodical income (e.g., interest and dividends) that are made to foreign persons are subject to a 30% U.S. withholding tax, unless the withholding agent can establish that the beneficial owner of the amount is eligible for an exemption from withholding or a reduced rate of withholding under an income tax treaty. The 30% tax does not apply to portfolio interest received by a nonresident individual or foreign corporation from sources within the U.S. Portfolio interest means any interest (including original issue discount) that is (1) paid on an obligation that is in registered form and for which the beneficial owner has provided to the U.S. withholding agent a statement certifying that the beneficial owner is not a U.S. person, or (2) paid on an obligation that is not in registered form and that meets the foreign targeting requirements. Portfolio interest, however, does not include interest received by a 10% shareholder, certain contingent interest, interest received by a controlled foreign corporation from a related person, or interest received by a bank on an extension of credit made pursuant to a loan agreement entered into in the ordinary course of its trade or business.
New law. For debt obligations issued after the date which is two years after the enactment date, the Act repeals the foreign targeted obligation exception to the denial of (1) a deduction for interest on bonds not issued in registered form, and (2) a tax exemption on interest on State and local bonds not issued in registered form. However, the foreign targeted obligation exception is available with respect to the excise tax applicable to issuers of registration-required obligations that are not in registered form. ( Code Sec. 163(f)(2) , as amended by Act Sec. 502(a))
The Act also repeals the treatment as portfolio interest of interest paid on bonds that are not issued in registered form but meet the foreign targeting requirements of Code Sec. 163(f)(2)(B) . ( Code Sec. 871(h)(2) , as amended by Act Sec. 502(b)) As a result, interest paid to a foreign person on an obligation that is not issued in registered form is subject to 30% U.S. withholding tax unless the withholding agent can establish that the beneficial owner of the amount is eligible for an exemption from withholding other than the portfolio interest exemption or for a reduced rate of withholding under an income tax treaty. (Committee Report) The Act also provides that a debt obligation held through a dematerialized book entry system, or other book entry system specified by IRS, is treated, for purposes of Code Sec. 163(f) , as held through a book entry system for the purpose of treating the obligation as in registered form. ( Code Sec. 163(f)(3) , as amended by Act Sec. 502(c))
Individuals Must File Disclosure Statement for “Specified Foreign Financial Asset” With Return. Every U.S. person who has a financial interest in, or signature or other authority over, bank accounts, securities accounts, or other financial accounts in foreign countries, must make a report on Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts or FBAR) for each calendar year during which the aggregate value of the accounts exceeded $10,000. Failure to do so subjects the person to penalties. Since the FBAR filing obligation doesn't arise under the Code: (1) collection of delinquent penalties can only be made through court proceedings; and (2) because of non-disclosure restraints, information on income tax returns (including the Schedule B information regarding foreign bank accounts) isn't readily available to those within IRS who administer FBAR compliance.
New law . For tax years beginning after the enactment date, the Act provides that individuals with an interest in a “specified foreign financial asset” during the tax year must attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000. ( Code Sec. 6038D(a) , as added by Act Sec. 511(a)) In addition, to the extent provided by IRS in regs or other guidance, Code Sec. 6038D will apply to any domestic entity formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if the entity were an individual. ( Code Sec. 6038D(f) ) Although the nature of the information required is similar to the information currently required to be disclosed on an FBAR, it isn't identical. (Committee Report)
“Specified foreign financial assets” are:
(1) depository or custodial accounts at foreign financial institutions, and
(2) to the extent not held in an account at a financial institution,
(a) stocks or securities issued by foreign persons,
(b) any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and
(c) any interest in a foreign entity. ( Code Sec. 6038D(b) )
Individuals who fail to make the required disclosures are subject to a penalty of $10,000 for the tax year. An additional $10,000 penalty per each 30 days of failure to disclose (or fraction of such 30-day period) applies if the failure to disclose continues for more than 90 days after IRS notifies an individual by mail of his failure to disclose, up to a $50,000 maximum penalty. ( Code Sec. 6038D(d) ) No penalty is imposed where an individual can establish that the failure was due to reasonable cause and not willful neglect. A foreign law prohibition against disclosure of the required information doesn't constitute reasonable cause. ( Code Sec. 6038D(g) )
Illustration: An individual who postpones remedial action until the 181st day is subject to the maximum penalty of $50,000: the base amount of $10,000, plus $30,000 for the three 30-day periods, plus $10,000 for the one fraction (i.e., the single day) of a 30-day period following the lapse of 90 days after the notice of noncompliance was mailed. (Committee Report)
To the extent IRS determines that an individual has an interest in one or more foreign financial assets, and he doesn't provide sufficient information to enable IRS to determine the aggregate value of such assets, the aggregate value of the identified foreign financial assets is presumed to exceed $50,000 for purposes of assessing the penalty. ( Code Sec. 6038D(e) )
IRS is given authority to issue regs necessary to carry out the intent of these rules, including exceptions for nonresident aliens and specified classes of assets and exceptions to avoid duplicative reporting requirements. ( Code Sec. 6038D(h) )
Penalty Imposed on Undisclosed Foreign Financial Assets Understatement. A 20% accuracy-related penalty under Code Sec. 6662 applies to the portion of any underpayment attributable to:
(1) negligence or disregard of rules or regs,
(2) any substantial understatement of income tax,
(3) any substantial valuation misstatement,
(4) any substantial overstatement of pension liabilities, or
(5) any substantial estate or gift tax valuation understatement.
New law . For tax years beginning after the enactment date, the Act provides that a 40% penalty is imposed on any understatement attributable to an undisclosed foreign financial asset. ( Code Sec. 6662(j)(3) , as amended by Act Sec. 512(a)) The term “undisclosed foreign financial asset” includes all assets subject to information reporting requirements under Code Sec. 6038 (U.S. person who controls a foreign corporation or partnership must furnish IRS with certain information about the entity), Code Sec. 6038B (information reporting required by U.S. persons who make certain “outbound” transfers to foreign entities), Code Sec. 6038D (self-reporting required for “specified foreign financial assets”), Code Sec. 6046A (return must be filed by a U.S. person who acquires or disposes of certain foreign partnership interests or whose proportional interest in a foreign partnership changes substantially), or Code Sec. 6048 (certain information reporting with respect to foreign trusts) for which the required information wasn't provided by the taxpayer as required under the applicable reporting provisions. ( Code Sec. 6662(j)(2) ) An understatement is attributable to an undisclosed foreign financial asset if it is attributable to any transaction involving the asset. ( Code Sec. 6662(j)(1) ) For example, if a taxpayer fails to disclose amounts held in a foreign financial account, any underpayment of tax related to the transaction that gave rise to the income is subject to the penalty provision, as is any underpayment related to interest, dividends or other returns accrued on such undisclosed amounts. (Committee Report)
Six-year Limitations Period on Understatements Due to Foreign Financial Assets. With some exceptions, taxes generally must be assessed within 3 years after a taxpayer's return was filed, whether or not it was timely filed. If a false or fraudulent return filed with the intent to evade tax, or if the taxpayer fails to file a required return, the tax may be assessed, or a proceeding in court for collection of the tax may be begun without assessment, at any time. A special 6-year period of limitations applies when a taxpayer omits from gross income an amount that's greater than 25% of the amount of gross income stated in the return. This extended 6-year assessment period also applies where a partnership omits an amount from gross income that is over 25% of gross income stated on the partnership return.
New law . For returns filed after the enactment date and for any other return for which the Code Sec. 6501 assessment period has not yet expired as of the enactment date, the Act provides that a new 6-year limitations period applies for assessment of tax on understatements of income attributable to foreign financial assets. This limitations period applies if there is an omission of gross income in excess of $5,000, and the omitted gross income is attributable to an asset for which information reports are required under Code Sec. 6038D , applied without regard to the dollar threshold, the statutory exception for nonresident aliens and any exceptions provided by regs. ( Code Sec. 6501(e)(1)(A) , as amended by Act Sec. 513(a)) The extended limitations period rules for foreign financial asset omissions is also applicable where a partnership omits such foreign financial assets. ( Code Sec. 6229(c)(2) , as amended by Act Sec. 513(a)) If a domestic entity is formed or availed of to hold foreign financial assets and is subject to the reporting requirements of Code Sec. 6038D in the same way as an individual, the 6-year limitations period may also apply to that entity. (Committee Report)
Observation: In contrast to the above effective date for the Code Sec. 6501 amendments by the Act, the Code Sec. 6038D reporting rules, as amended by the Act, are applicable to tax years beginning after the enactment date.
The current rule that provides a 6-year period for substantial omission of an amount equal to 25% of the gross income reported on the return isn't changed. (Committee Report)
Under the Act, both the special definition of gross income for a trade or business and the rule treating adequately disclosed items on the return (or attachment) as not omitted, which applies to more-than-25%-gross-income omissions, also applies for foreign financial asset omissions. ( Code Sec. 6501(e)(1)(B) )
Limitations Period Suspended for Failure to File Information Returns for PFICs and Self-Reporting Foreign Financial Assets. With some exceptions, taxes generally must be assessed within 3 years after a taxpayer's return was filed, whether or not it was timely filed. Under an exception, the running of the limitations period is suspended where information returns weren't filed for certain foreign cross-border transactions. The assessment period doesn't expire any earlier than 3 years after the required information is actually provided to IRS by the person required to file the return. Required information reporting subject to this 3-year rule includes reporting under Code Sec. 6038 (certain foreign corporations and partnerships), Code Sec. 6038A (certain foreign-owned corporations), Code Sec. 6038B (certain transfers to foreign persons), Code Sec. 6046 (organizations, reorganizations, and acquisitions of stock of foreign corporations), Code Sec. 6046A (interests in foreign partnerships), and Code Sec. 6048 (certain foreign trusts).
New law. For returns filed after the enactment date and for any other return for which the Code Sec. 6501 assessment period has not yet expired as of the enactment date, the Act provides that the limitations period for assessment is suspended if a taxpayer fails to provide timely information returns required with regard to: (1) a passive foreign investment company (PFIC) under Code Sec. 1295(b) (election by a PFIC shareholder to have the PFIC treated as a qualified electing fund) or under Code Sec. 1298(f) , as amended by the Act (requiring a U.S. person that is a PFIC shareholder to file an annual report); or (2) the new self-reporting of foreign financial assets information required under Code Sec. 6038D , as added by the Act (required self-reporting of “specified foreign financial assets”). ( Code Sec. 6501(c)(8) , as amended by Act Sec. 513(b)) The 3-year limitations period won't begin to run until the required information has been furnished to IRS.
Observation: In contrast to the above effective date for the Code Sec. 6501 amendments by the Act, the new Code Sec. 1298(f) PFIC shareholder annual reporting requirement is effective as of the enactment date, and the new Code Sec. 6038D foreign financial asset self-reporting rules are applicable for tax years beginning after the enactment date.
The Act also modifies the Code Sec. 6501(c)(8) assessment limitations period suspension rule generally to provide that for any information required to be reported under these provisions, the statute of limitations for any “tax return, event, or period” to which that information relates won't expire before the date that is 3 years after the date the required information is furnished to IRS. ( Code Sec. 6501(c)(8) ) This change clarifies that the suspension of the limitations period isn't limited to adjustments to income related to the information required to be reported by one of the enumerated sections. (Committee Report)
PFIC Shareholder Must File Annual Information Return. A passive foreign investment company (PFIC) is generally defined as any foreign corporation if 75% or more of its gross income for the tax year consists of passive income, or 50% or more of its assets consist of assets that produce, or are held for the production of, passive income. Under pre-Act law, a U.S. person that is a direct or indirect shareholder of a PFIC must file Form 8621, Return by a Shareholder of a Passive Foreign Investment Company or Qualifying Electing Fund, for each tax year in which that U.S. person: (1) recognizes gain on a direct or indirect disposition of PFIC stock; (2) receives certain direct or indirect distributions from a PFIC; or (3) is making a reportable election.
New law. Effective on the enactment date, unless otherwise provided by IRS, the Act provides that each U.S. person who is a shareholder of a PFIC must file an annual information return containing information as IRS may require. ( Code Sec. 1298(f) , as amended by Act Sec. 521(a)) However, a person meeting this new reporting requirement may also have to meet the new reporting rule requiring disclosure of information with respect to foreign financial assets (see above). It is anticipated that IRS will exercise its regulatory authority to avoid duplicative reporting. (Committee Report)
IRS Can Require Electronic Filing by Financial Institutions
IRS's authority to issue regs requiring a taxpayer file electronically is limited. Among the restrictions under pre-Act law, such regs can only apply to persons required to file at least 250 returns during the year. Under these rules, IRS requires corporations and tax-exempt organizations that have assets of $10 million or more and file at least 250 returns during a calendar year, including income tax, information, excise tax, and employment tax returns, to file electronically their Form 1120/1120-S income tax returns and Form 990 information returns. Private foundations and charitable trusts that file at least 250 returns during a calendar year must file electronically their Form 990-PF information returns, regardless of their asset size. With certain exceptions for corporations and partnerships, a failure to comply with the regs mandating electronic filing cannot in itself support a penalty for failure to file an information return.
RIA observation: For returns filed after Dec. 31, 2010, Code Sec. 6011(e)(3) , as amended by the recently enacted Worker, Homeownership, and Business Act of 2009, provides that any individual tax return, including any return of the tax imposed by subtitle A on individuals, estates, or trusts, prepared by a tax return preparer, must be filed electronically unless the tax return preparer reasonably expects to file ten or fewer tax returns during such calendar year. See Federal Taxes Weekly Alert 11/12/2009 .
Under Code Sec. 1461 , every withholding agent (i.e., any person required to withhold U.S. income tax under Code Sec. 1441 , Code Sec. 1442 , Code Sec. 1443 , or Code Sec. 1461 ) must file an annual return with IRS on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, reporting all taxes withheld during the preceding year and remitting any taxes still owing.
New law . For returns the due date for which (determined without regard to extensions) is after the enactment date, the Act provides that IRS can issue regs requiring filing on magnetic media for any return filed by a financial institution with respect to any taxes withheld by it for which it is personally liable under Code Sec. 1461 (withholding required by withholding agents) or Code Sec. 1474(a) (new withholding required on foreign accounts under the Act). Thus, IRS may issue regs requiring a financial institution to electronically file returns for taxes withheld by the financial institution even if the financial institution files less than 250 returns during the year. ( Code Sec. 6011(e)(4) , as amended by Act Sec. 522(a)) In addition, IRS can assert a failure to file penalty under Code Sec. 6721 against a financial institution that fails to comply with this electronic filing requirements. ( Code Sec. 6724(c) , as amended by Act Sec. 522(b))
Clarification of When Foreign Trust Has U.S. Beneficiary. Under the grantor trust rules, with exceptions for transfers by reason of death or for fair market value, a U.S. person who transfers property to a foreign trust is treated as the owner of the portion of the trust comprising the transferred property for any tax year in which there is a U.S. beneficiary of any portion of the trust. A trust is treated as having a U.S. beneficiary for a tax year unless:
(1) under the terms of the trust, no part of the trust's income or corpus may be paid or accumulated during the tax year to or for the benefit of a U.S. person, and
(2) if the trust is terminated at any time during the tax year, no part of the income or corpus could be paid to or for the benefit of a U.S. person. Regs under Code Sec. 679 generally provide that a foreign trust is treated as having a U.S. beneficiary if any current, future or contingent beneficiary of the trust is a U.S. person.
New law. Effective on the enactment date, in determining whether a foreign trust has a U.S. beneficiary under Code Sec. 679 , the Act provides that an amount is treated as accumulated for the benefit of a U.S. person even if the U.S. person's interest in the trust is contingent on a future event. ( Code Sec. 679(c)(1) , as amended by Act Sec. 531(a)) In addition, if any person has the discretion (by authority given in the trust agreement, by power of appointment, or otherwise) to make a distribution from the trust to, or for the benefit of, any person, the trust is treated as having a U.S. beneficiary unless:
(1) the trust terms specifically identify the class of persons to whom the distributions may be made; and
(2) none of those persons is a U.S. person during the tax year. ( Code Sec. 679(c)(4) ) These rules are meant to be consistent with existing Code Sec. 679 regs. (Committee Report) Further, if any U.S. person who directly or indirectly transfers property to the trust is directly or indirectly involved in any agreement or understanding (whether written, oral, or otherwise) that may result in the income or corpus of the trust being paid or accumulated to or for the benefit of a U.S. person, that agreement or understanding is treated as a term of the trust. ( Code Sec. 679(c)(5) )
Presumption of U.S. Beneficiary on Transfers to Foreign Trust. Under the grantor trust rules, a U.S. person who transfers property to a foreign trust is generally treated as the owner of the portion of the trust comprising the transferred property for any tax year in which there is a U.S. beneficiary of any portion of the trust. Under Code Sec. 6048 , various reporting obligations are imposed on foreign trusts and persons creating, making transfers to, or receiving distributions from such trusts. For example, within 90 days after a U.S. person transfers property to a foreign trust, the transferor must provide written notice of the transfer to IRS. If a notice or return is not filed when due or is filed without all required information, the person required to file is generally subject to a penalty.
New law. The Act creates a rebuttable presumption that a foreign trust has U.S. beneficiaries. Specifically, for transfers of property after the enactment date, the Act provides that if a U.S. person directly or indirectly transfers property to a foreign trust, IRS can treat the trust as having a U.S. beneficiary for Code Sec. 679 purposes unless the U.S. person submits information as required by IRS and demonstrates to its satisfaction that: (1) under the terms of the trust, no part of the income or corpus of the trust may be paid or accumulated during the tax year to or for the benefit of a U.S. person; and (2) if the trust were terminated during the tax year, no part of the income or corpus of the trust could be paid to or for the benefit of a U.S. person. ( Code Sec. 679(d) , as amended by Act Sec. 532)
Uncompensated Use of Foreign Trust Property Treated as Distribution. Under pre-Act law, Code Sec. 643(i) provides that a loan of cash or marketable securities made by a foreign trust to any U.S. grantor, U.S. beneficiary, or any other U.S. person who is related to a U.S. grantor or U.S. beneficiary is generally treated as a distribution by the foreign trust to such grantor or beneficiary.
New law. For loans made and uses of property after the enactment date, the Act expands Code Sec. 643(i) to provide that any use of trust property by a U.S. grantor, U.S. beneficiary, or any U.S. person related to a U.S. grantor or U.S. beneficiary is treated as a distribution of the fair market value (FMV) of the use of the property to the U.S. grantor or U.S. beneficiary. ( Code Sec. 643(i)(1) , as amended by Act Sec. 533) A subsequent return of property treated as a distribution under Code Sec. 643(i) is disregarded for tax purposes. ( Code Sec. 643(i)(3))
The rule treating the use of a foreign trust's property by the U.S. grantor, U.S. beneficiary or any related U.S. person as a distribution to the U.S. grantor or U.S. beneficiary does not apply to the extent that the trust is paid the FMV of the use of the property within a reasonable period of time of the use. ( Code Sec. 643(i)(2)(E) )
In addition, for purposes of determining whether a foreign trust has a U.S. beneficiary under Code Sec. 679 , a loan of cash or marketable securities or the use of any other trust property by a U.S. person is treated as a payment from the trust to the U.S. person in the amount of the loan or the FMV of the use of the property. This rule doesn't apply to the extent that the U.S. person repays the loan at a market rate of interest or pays the FMV for the use of the trust property within a reasonable period of time. ( Code Sec. 679(c)(6) , as amended by Act Sec. 533(c))
Observation: Thus, the loan or the use of other trust property to or by a U.S. person will cause the foreign trust to be treated as having a U.S. beneficiary, and as a result the trust will be treated as a grantor trust.
Reporting Requirement for U.S. Owners of Foreign Trust. Under Code Sec. 6048 , various reporting obligations are imposed on foreign trusts and persons creating, making transfers to, or receiving distributions from such trusts. If a U.S. person is treated as the owner of any portion of a foreign trust under the rules of subpart E of part I of subchapter J of chapter 1 (grantor trust provisions), the U.S. person is responsible for ensuring that the trust files an information return for the year and that the trust provides other information as IRS may require to each U.S. person who (1) is treated as the owner of any portion of the trust, or (2) receives (directly or indirectly) any distribution from the trust.
New law. For tax years beginning after the enactment date, the Act provides that a U.S. person who is treated as an owner of any portion of a foreign trust under the rules of subpart E of part I of subchapter J of chapter 1 of the Code must provide information as IRS may require with respect to the trust, in addition to ensuring that the trust complies with its reporting obligations. ( Code Sec. 6048(b)(1) , as amended by Act Sec. 534(a))
Increased Minimum Penalty for Failure to Report on Foreign Trust. Under Code Sec. 6048 , various reporting obligations apply to foreign trusts, and persons creating, making transfers to, or receiving distributions from such trusts. If a notice or return is not filed when due or is filed without all required information, the person required to file is generally subject to a penalty based on the “gross reportable amount.” This is:
(1) the value of the property transferred to the foreign trust if the delinquency is for failure to file notice of the creation of or a transfer to a foreign trust; (2) the value (on the last day of the year) of the portion of a grantor trust owned by a U.S. person who fails to cause an annual return to be filed for the trust; and (3) the amount distributed to a distributee who fails to report distributions. Under pre-Act law, the initial penalty was 35% of the gross reportable amount in situations (1) and (3) and 5% in situation (2). If the return is more than 90 days late, an additional $10,000 penalty is imposed for every 30 days the delinquency continues, except that under pre-Act law, the aggregate of the penalties couldn't exceed the gross reportable amount.
New law . For notices and returns required to be filed after Dec. 31, 2009, the Act provides that the initial penalty for failing to report under Code Sec. 6048 is the greater of $10,000 or 35% of the gross reportable amount in cases (1) and (3) and the greater of $10,000 or 5% of the gross reportable amount in case (2). ( Code Sec. 6677(a) , as amended by Act Sec. 535(a)) Thus, an initial penalty of $10,000 is imposed even where IRS has insufficient information to determine the gross reportable amount. The additional $10,000 penalty for every additional 30 days of delinquency continues to apply.
Penalties for failure to report on certain foreign trusts may exceed the gross reportable amount. (Committee Report) However, to the extent that a taxpayer provides sufficient information for IRS to determine that the aggregate amount of the penalties exceeds the gross reportable amount, IRS has to refund the excess to the taxpayer. ( Code Sec. 6677(a) )
Dividend Equivalents Treated as Dividends for Withholding Purposes
Dividend payments made to foreign investors are generally subject to withholding tax at a rate of 30% unless otherwise reduced by an applicable tax treaty. Dividends paid by a domestic corporation are generally U.S.-source and so potentially subject to withholding tax when paid to foreign persons. Under pre-Act law, the source of notional principal contract income generally is determined by reference to the residence of the recipient of the income. As a result, a foreign person's income related to a notional principal contract that references stock of a domestic corporation, including any amount attributable to, or calculated by reference to, dividends paid on the stock, is generally foreign source and so is not subject to U.S. withholding tax. A substitute dividend payment made to the transferor of stock in a securities lending transaction or a sale-repurchase transaction is sourced in the same manner as actual dividends paid on the transferred stock.
New law . For payments made on or after the date that is 180 days after the enactment date, the Act provides that a dividend equivalent is treated as a dividend from U.S. sources for purposes of Code Sec. 881 (30% withholding tax on income from sources within the U.S. received by a foreign corporation) and Code Sec. 4948(a) (foreign organizations subject to private foundation rules). ( Code Sec. 871(l)(1) , as amended by Act Sec. 541(a)) A dividend equivalent is: (1) any substitute dividend made pursuant to a securities lending or a sale-repurchase transaction that (directly or indirectly) is contingent upon, or determined by reference to, the payment of a dividend from sources within the U.S. or (2) any payment made under a “specified notional principal contract” (defined below) that directly or indirectly is contingent upon, or determined by reference to, the payment of a dividend from sources within the U.S. It also includes any other payment that IRS determines is substantially similar to a payment described above. ( Code Sec. 871(l)(2) ) For example, IRS may conclude that payments under certain forward contracts or other financial contracts that reference stock of U.S. corporations are dividend equivalents. (Committee Report)
A specified notional principal contract is any notional principal contract that has any of the following characteristics:
(1)in connection with entering into the contract, any long party to the contract—i.e., a party that is entitled to receive payment under the contract that is contingent on or determined by reference to the payment of a U.S.-source dividend on the underlying security—transfers the underlying security to any short party to the contract (i.e., a party other than a long party). An underlying security in a notional principal contract is the security with respect to which the dividend equivalent is paid;
(2) in connection with the termination of the contract, any short party to the contract transfers the underlying security to any long party to the contract;
(3) the underlying security is not readily tradable on an established securities market;
(4) in connection with entering into the contract, any short party to the contract posts the underlying security as collateral any long party to the contract; or
(5) IRS identifies the contract as a specified notional principal contract. ( Code Sec. 871(l)(3)(A) )
For payments made more than two years after the date of enactment, a specified notional principal contract also includes any notional principal contract unless IRS determines that the contract is of a type that does not have the potential for tax avoidance. ( Code Sec. 871(l)(3)(B) )
The payments that are treated as U.S.-source dividends under these rules are the gross amounts that are used in computing any net amounts transferred to or from the taxpayer. ( Code Sec. 871(l)(5) )
Any index or fixed basket of securities is treated as a single security. It is intended that such a security will be deemed to be regularly traded on an established securities market if every component of the index or fixed basket is a security that is readily tradable on an established securities market. (Committee Report)
If there is a chain of dividend equivalents, and one or more of the dividend equivalents is subject to tax under Code Sec. 871(a) or Code Sec. 881 , IRS may reduce that tax, but only to the extent that the taxpayer either establishes that the tax has been paid on another dividend equivalent in the chain, or that the tax is not otherwise due, or as IRS determines is appropriate to address the role of financial intermediaries in such chain. An actual dividend is treated as a dividend equivalent for this purpose. ( Code Sec. 871(l)(6) )
RIA observation: This rule is intended to reduce the risk of multiple withholding obligations when each payee in a chain is treated as receiving U.S. source income subject to withholding, e.g., when the same shares of stock are loaned to successive foreign parties in multiple transactions.
For purposes of chapter 3 (withholding of tax on nonresident aliens and foreign corporations) and chapter 4 (taxes to enforce reporting on certain foreign accounts), each person that is a party to a contract or other arrangement that provides for the payment of a dividend equivalent is treated as having control of the payment. ( Code Sec. 871(l)(7) ) IRS may provide guidance requiring either party to withhold tax on dividend equivalents. (Committee Report)
Delay In Application of Worldwide Allocation of Interest. Under pre-Act law, for tax years beginning after Dec. 31, 2017, an election was to be available under which interest could be allocated among foreign and domestic corporations on a worldwide basis. Under this election, the common parent of a worldwide affiliated group (WAG) could determine the taxable income of each domestic corporation which is a member of the group by allocating and apportioning the interest expense of each member as if all members of the WAG were a single corporation. To determine the taxable income of the domestic members of the WAG from sources outside the U.S., the interest expense of the domestic members would be allocated and apportioned to the foreign source income in an amount equal to the excess of:
(a) the total interest expense of the WAG multiplied by the ratio which the foreign assets of the WAG bears to all the assets of the WAG; over
(b) the interest expense of all foreign corporations which are members of the WAG to the extent of the interest expense that would have been allocated to foreign source income if the worldwide interest allocation rules were applied to a group consisting of all the foreign corporations in the group.
The election to allocate interest on a worldwide basis could be made only by the common parent of the domestic affiliated group that is part of the WAG and could be made only for the first tax year beginning after Dec. 31, 2017 in which a WAG exists that includes the domestic affiliated group and at least one foreign corporation. This election, once made, will apply to the common parent and all other corporations that are members of the WAG for that tax year and all later years unless revoked with IRS consent.
New law. The Act provides that the effective date of the worldwide interest allocation rules are delayed for three years, until tax years beginning after Dec. 31, 2020. The required dates for making the WAG election and the financial institution group election are changed accordingly. ( Code Sec. 864(f) , as amended by Act Sec. 551(a))
Accelerated Estimated Tax Payment for Large ($1 Billion) Corporations
Under pre-Act law, under the 2009 Corporate Estimated Tax Shift Act §202(b)(1) ( P.L. 111-42, Sec. 202(b)(1) ), as amended by the 2009 Preference Extension Act §4 ( P.L. 111-124, Sec. 4 ), in the case of a corporation with assets of at least $1 billion (determined as of the end of the previous tax year), the amount of any required installment of corporate estimated tax that is otherwise due in July, Aug., or Sept. 2014 is 134.75% of that amount. The amount of the next required installment is appropriately reduced.
New law. The Act provides that the percentage under the 2009 Corporate Estimated Tax Shift Act §202(b)(1) in effect on the enactment date is increased by 23 percentage points. (Act Sec. 561(1))
The amount of any required installment of corporate estimated tax which is otherwise due in July, Aug., or Sept. of 2015 will be 121.5% of that amount. (Act Sec. 561(2))
The amount of any required installment of corporate estimated tax which is otherwise due in July, Aug., or Sept. of 2019 will be 106.5% of that amount. (Act Sec. 561(3))
The amount of the next required installment after the installment referred to above will be appropriately reduced to reflect the amount of the increase. (Act Sec.561(4))
Observation: Corporations with a fiscal year that begins July 1 will not be affected by the above rule, because they do not have any estimated tax payments due in July, Aug., or Sept.
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