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Can I extend filing of my US 1040 return beyond October 15? And how about form 3520?

Weekly Q&A

US citizens living outside the US (i.e. abroad) have an automatic 2-month extension of time to file the individual income tax return from April 15th to June 15th.   If a further extension is needed, Form 4868 must be filed on or before June 15th, to receive an automatic extension of time to file their US individual income tax return to October 15th.

Still not enough time to properly file your US individual tax return and related schedules? Treasury Regulation 1.6081-1(a) authorizes the Commissioner to grant an extension to US citizens abroad to December 15th.  A letter explaining why an additional 2-month extension is required must be sent to the Internal Revenue Service (“IRS”) on or before October 15th.

The authorization to grant an addition 2-month extension of time to file to December 15th applies to any return, declaration, statement or other document which relates to any tax imposed by subtitle A or F of the Internal Revenue Code (“IRC”).  For example, Form 3520 “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts” may also be extended to December 15th as the return filing obligation is imposed by subtitle A, subchapter J of the IRC.  When writing the letter be sure to include the tax return, information return, statement or other document, including the tax year for which the extension is requested.  You must also include a reason for needing additional time to file the required tax and information returns.

The above refers to the extension of time to file a return, and not the extension of time to pay.  All tax payments must be made by April 15th to avoid interest and late payment penalty charges.

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Can we eliminate GILTI tax by making the 962 Election?

Weekly Q&A

Pursuant to Barry v Commissioner, the courts concluded that dividends paid out of a CFC (following a 962 election) in a country in which has no treaty with a US, is a dividend but taxed at ordinary rates. It has always been my understanding that if a CFC that is otherwise not a PFIC and is situated in country who is party to US treaty, such as Canada, distributes a dividend following a 962 election, would be eligible for qualified dividend rates. In Barry V Commissioner, the courts concluded that the dividend was not considered as paid out of a notional domestic corporation (as the petitioner contends) and neither is considered as paid out of qualified foreign corporation (i.e. non-PFIC in a country that has a treaty with the US) and is therefore subject to ordinary rates.

GILTI will have its own basket with or without a 962 election. However, the proposed regulations do not contain rules on the foreign tax credit as it relates to GILTI, much less the appropriate basket when a distribution is paid out of the notional corporation (under 962). Such guidance is still pending. Neither is it clear that assuming the 962 election is not made and a dividend is distributed concurrently (assuming all income is active business income) in the same year as the GILTI inclusion, that the Canadian tax would also fall into the GILTI basket (or in the general basket if there is no income inclusion (under pre-TCJA Sec. 904) in the US due to PTI or under the CFC look-through rules), or whether or not the Canadian tax would be subject to a grind. Therefore, I would reserve any conclusions with respect to foreign tax credits.

Under the 962 election, we are still waiting for guidance if the 50% deduction under Sec. 250(a)(1)(B) is available to an individual shareholder who makes the 962 election. There is speculation that it would be however, without the 50% deduction, my tentative calculation (again absent any further guidance) demonstrates that a 26.3% tax rate is required in Canada in order to eliminate the GILTI tax on a 962 election. If the 50% deduction is available to individuals on a 962 election, then a 13.125% tax in Canada would eliminate GILTI (again based my tentative calculations). There is also a possibility that Congress may consider extending the 50% deduction to individual shareholders but would require a legislative fix.

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4 Days Left for OVDP What’s Next

IRS Compliance Deadlines

On September 28, 2018, i.e. in four days, the IRS is terminating the 2014 Offshore Voluntary Disclosure Program (O.V.D.P.) which may trigger very serious legal consequences for eligible non-compliant US taxpayers. The program allows US persons who are willfully non-compliant with their US tax- and foreign financial accounts reporting obligations to avoid criminal charges and excessive civil penalties that would otherwise apply, by voluntarily disclosing all their foreign assets, filing original or amended US tax returns for the previous 8 tax years and paying outstanding taxes, along with penalties for outstanding tax liabilities.

Many taxpayers may believe they always have a choice to take the less expensive route offered by the Streamlined disclosure procedures by mistakenly considering themselves eligible. Indeed, coming in compliance under Streamlined Domestic Offshore Procedures  would only cost a taxpayer 5% penalty over the highest balance of their unreported foreign financial accounts (or even no penalty at all for qualified non-residents under Streamlined Foreign Offshore Procedures) and result in paying the outstanding tax liabilities for only 3 to maximum 6 years in some cases, with no additional tax penalties, as well as in filing fewer tax forms. But as appealing as it may sound, in certain cases Streamlined Procedure may not be an available option. 

 Unlike with O.V.D.P. program, Streamlined Procedures are not considered amnesty and thus filing under Streamlined Procedures does not fully protect taxpayers from civil penalties and criminal charges should IRS doubt the conduct was non-willful. Therefore, for those non-compliant US persons who were aware of FBAR reporting requirements and their US tax obligations, the O.V.D.P. program currently remains the safest and the only solution to receive the amnesty and avoid civil penalties and even criminal charges. 

 It is always suggested to seek professional assistance from a qualified cross-border tax specialist to find out whether you qualify under O.V.D.P. or under a Streamlined Procedure. And since the O.V.D.P. program will be gone in just 4 days, we urge those US persons who think they may not be eligible under Streamlined Procedures to get professional advice immediately and to use this last chance to come forth and take advantage of the O.V.D.P. amnesty program while it is still possible. 

 The IRS has also announced on numerous occasions this year that the Streamlined Procedures may also be closed in the near future. But this information has neither been confirmed yet, nor was the date officially set. Those taxpayers who were unaware of their US tax obligations and foreign assets reporting obligations or were otherwise non-willful, are urged to come into compliance under the Streamlined Procedures while they remain available. 

 

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ARE NEW US PROFIT SOURCING RULES IMPACTING YOUR (CANADIAN) BUSINESS BOTTOM LINE?

PROFIT SOURCING RULES

Effective for tax years after December 31, 2017, as part of the Tax Cuts and Jobs Act, certain significant changes were made to profits recognition from sales derived from production activities in Canada and furnished to the US (and vice-versa).  Previously, the sales were generally sourced based on a 50/50 method. For Canadian businesses that manufactured inventory (wholly or partially) in Canada and sold to the US, 50% of the sales were sourced to the production location and 50% were sourced to where the sale occurred (i.e., where the title to the inventory passed).

Going forward, the new rule requires that sales be sourced entirely based on location of the production, regardless of where the title shifts from the seller to the buyer.

One would think that under the new law gains, profits and income from the inventory produced in Canada and sold to the US will be all sourced back to Canada and none of it would taxed in the US? Wrong!  When enacting the law, the Congress was focusing on US companies with domestic production and foreign sales.  If there is no permanent establishment in the foreign country where sales happen the US manufacturer would completely escape foreign taxation. Furthermore, even if the US manufacturer has an office in the foreign country which materially participates in sales, the new provision prevents income to be resourced to the foreign country.

The rules applicable to foreign manufacturers with sales to the US happen to work quite differently. For foreign (e.g., Canadian) producers selling to the US, if they have a US office and actively solicit sales in the US, all the income from the sales will be treated as US source despite of the newly enacted source-of-production rule.

This discriminatory treatment is due to an existing overriding section which was in effect under the old method and which was likely not considered given the speed at which the new law was advanced.  Hopefully, this oversight will soon be revised.  Meanwhile, Canadian companies with productions in Canada and sales to the US must revisit their operating strategy to minimize what is brought under the US taxing jurisdiction.

Please consult your Hanson Crossborder tax professional to assist with your tax strategy.

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July 2: IRS Announces Five Additional Compliance Campaigns

cryptocurrency

Virtual currency and the repatriation of foreign profits under Section 965 are the two out of five most recently added IRS compliance campaigns administered by the IRS Large Business and International (“LB&I”) Division. The objective of the narrowly defined campaigns is to “improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources”.  The new campaigns added on July 2 represent the fourth batch introduced since January 2017 that currently amount to 40 initiatives in total.

Virtual Currency

Virtual currency taxation campaign is designed to focus on tax issues related to cryptocurrency by both educating the taxpayers and enforcing their compliance with reporting income from cryptocurrencies.  Since the IRS has not yet issued formal guidance and IRS practice units on this subject, it also hopes to receive feedback and learn issues associated with virtual currency, including recordkeeping and foreign-based wallets provided by virtual currency exchanges.

Currently the IRS has no intention to introduce an amnesty pertaining to delinquent reporting and taxation of cryptocurrency. Instead, taxpayers who failed to adequately disclose and pay tax, can use one of the existing voluntary disclosure program or procedures.

Section 965 Transition Tax

The transition tax, as introduced by the 2017 Tax Cuts and Jobs Act, is effectively a toll charge on previously untaxed earnings of a specific foreign corporation.  The government imposes this one-time tax on shareholders as part of the overhaul of the US international tax system transitioning from the worldwide to quasi territorial taxation. The current guidance on this tax has been limited to 3 IRS Notices, IRS Publications and a set of Frequently Asked Questions, addressing both filing and payment obligations.

Since the guidance supporting the transition tax has been fraught with complexity and ambiguity, the campaign is mostly targeting smaller shareholders who may be unaware of their filing obligations, such as individuals, S-corporations and partnerships.  The LB&I refers to Sec 965 campaign as a “heads-up” campaign.

If you receive a letter under any of the campaigns, whether an outreach or traditional examination, and require technical support, do not hesitate to contact us at Hanson Crossborder Tax Inc.

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IRS provides an extension for the 1st installment payment where the deadline is missed

The first installment payment due date for the Transition Tax is fast approaching, due June 15, 2018 for US individual shareholders whose tax homes and abodes are outside of the United States and Puerto Rico.

On June 4, 2018, the IRS released additional guidance and relief in respect of the transition tax, which may be payable over the course of an eight-year period in installments provided certain conditions apply, including the timely filed election to pay in installments. If such election is filed, the first installment is payable on the due date of the filing of the return, determined without regard to any extension. If there is an addition to tax for failure to timely pay any installment, the entire transition tax liability may be accelerated. The additional guidance provided relief in respect of the first installment of the transition tax for US individual shareholders. If the individual’s transition tax for the 2017 taxation year is less than $1 million, the individual makes the timely election to pay in installments and the first and second installments are paid by the due date of the second installment, the transition tax will not be accelerated for the failure to pay the first installment by the due date. Therefore, US individual shareholders living outside of the US have until June 15, 2019 (April 15, 2019 for US individuals living in the US) to pay the first and second installments of the transition tax. However, interest will apply from the due date of the first installment.

In addition, the IRS also clarified that no addition to tax for an underpayment of estimated taxes for 2018 regular tax installments may apply in cases where the first required installment for 2018 was due on April 18, 2018, provided that the first and second installments are paid by the due date of the second installment (that is, June 15, 2018 for calendar year taxpayers).

It should also be noted that any over-payment of the transition tax will not be refundable or creditable against the regular tax owed unless all the transition tax installments have been fully paid. Such excess will be carried forward and applied to the subsequent transition tax installments required.

The payment for the transition tax should be made separately from the regular tax owed either by wire transfer or check or money order. For a wire payment, the taxpayer should use a 5-digit tax type code of 09650. For a check or money order payment, a completed payment voucher such as Form 1040-V should be submitted along with the payment, which should indicate “2017 965 Tax” on the front of the payment.

Please seek your Hanson Crossborder Tax Professional for assistance with the Transition Tax and any further inquiries.

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Transition Tax Relief-One Last Chance on a One Year Lookback – Calendar year-end CFCs

Transition Tax Relief-One Last Chance

If you are an individual US shareholder of a controlled foreign corporation (CFC), residing in the US, who paid or is expected to pay the transition tax in 2017, you may be able to recover some or all of the transition tax paid. This can be done by paying yourself a dividend from the CFC  in 2018 if such dividend attracts a foreign tax, which is usually a non-resident withholding tax. Similarly, if paid to a US shareholder resident of a foreign country, let’s say Canada, the dividend would be subject to Canadian tax at preferential rates that can be very close or even exceed the transition tax rates.

Under US tax law, the foreign tax paid can be utilized as a foreign tax credit under the one-year carryback rule. Any unused portion can be carried forward. By incurring foreign tax in 2018 and applying it as a foreign tax credit to 2017 the shareholder should be able to recover some or all of the transition tax cost.

We strongly suggest that you consult with your tax advisor before paying yourself a dividend.

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IRC Section 965, solution for your Repatriation Transition tax computation

If you are in the business of accounting, tax and/or law, you are likely experiencing an influx of clients who need help with IRC Section 965,  Mandatory Repatriation Tax. The rules are very complex, the results can be quite punitive, and the direction we have received from the IRS to-date has been vague, at best.

This one-time repatriation tax impacts the filings for the 2017 tax year if foreign corporations (non-US corporations) held by US individual or corporate shareholders have a calendar year end. The tax due was April 17, 2018 for US residents and June 15, 2018 for US persons resident outside of the US.

Based on the Conference Committee Report and the three IRS communications released so far, the recommendation is to attach a statement to the 2017 tax return showing the 965 income, tax, election(s), schedule of taxes due per year, tax due this year, etc. It is further recommended that electronic filers wait until on or after 2 April 2018 to file to account for any further system changes from the IRS.

Failing to submit returns that use the new guidance may result in rejection or delays in processing tax returns or the issuance of erroneous notices.

As cross-border tax experts, Hanson Crossborder Tax Inc. is at the forefront of developing innovative tools to assist our clients with complex tax rules like this one, and we are ready to assist your clients as well.

In response to this new tax, we have developed Section 965 Repatriation Transition Tax Software for Foreign Corporations with Calendar Year-End. As part of our service, we will:

  • Prepare the computation of Section 965 Repatriation Transition tax
  • Generate Section 965 Repatriation Transition tax statement to be attached to the shareholder’s US tax return
  • Determine the eligible portion of foreign tax credit to apply against Section 965 Repatriation Transition tax
  • Provide IRS-prescribed election statements, where appropriate

Since we are not preparing the tax returns, but rather computing taxes based on client information, the service is offered starting at a flat fee of $2,000 CAD.

Please call us at toll-free number 1-855-640-1730 or our Calgary office at 587-329-0481. Alternatively, you can email us at mail@hcbtax.com with your questions and contact information.

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WARNING TO NON-COMPLIANT US CITIZENS THE IRS 2014 OFFSHORE VOLUNTARY DISCLOSURE PROGRAM TO BE SHUT DOWN!

OVDP

On March 13, 2018, the IRS announced that it will be winding down its 2014 Offshore Voluntary Disclosure Program (“OVDP”) by September 28, 2018.  The OVDP is a modified version of earlier OVDP’s and was made available to taxpayers who wish to voluntarily disclose their offshore accounts and assets to avoid the risk of criminal prosecution and limit exposure to civil penalties.  Accuracy related penalties including penalties for failure to file and failure to pay are assessed.  In addition, the “offshore penalty” for failure to report all offshore financial assets is equal to 27.5% (50% in some cases) of the highest aggregate value of assets subject to the OVDP.  Pre-clearance with the Criminal Investigation Lead Development Center is required prior to participation in the OVDP.

“Taxpayers have had several years to come into compliance with US tax laws under this program.  All along, we have been clear that we would close the program at the appropriate time, and we have reached that point.  Those who still wish to come forward have time do so” said Acting IRS Commissioner David Kautter.

Shutting down the OVDP does not mean that the IRS has decreased its enforcement activity.  On the contrary, the IRS has developed a number of tools to detect non-compliant taxpayers such as the Foreign Accounts Tax Compliance Act (“FATCA”), cooperation by other non-US banks in disclosing accounts owned by Americans and whistleblower leads.  Nevertheless, “stopping offshore tax noncompliance remains a top priority of the IRS” according to Don Fort, Chief, IRS Criminal Investigation.

The IRS will continue offering the following options to comply with US tax and information reporting obligations:

  • IRS-Criminal Investigation Voluntary Disclosure Program;
  • Streamlined Filing Compliance Procedures;
  • Delinquent FBAR submission procedures;
  • Delinquent international information return submission procedures.

The Streamlined Filing Compliance Procedures (“SFCP”) have been very popular among those non-compliant US taxpayers who are not at risk for criminal prosecution and whose delinquency did not result from willful conduct on the part of the taxpayer.  The program is available to US individual taxpayers residing out the US and those residing in the US.  Unlike the OVDP, penalties are abated but the risk of an audit or scrutiny of years prior to the covered years under the SFCP and criminal prosecution is not eliminated.

As with the OVDP, at some point in time, the IRS has expressed that the SFCP may also be eliminated.  Therefore, there is still time to come forward either under the formal amnesties – OVDP or the other options for complying with the US tax obligations. Otherwise, the taxpayer will have no choice but to come under the more stringent traditional voluntary disclosure programs.

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Trump’s Proposed Tax Changes – Mostly Bad News for Americans in Canada

On November 2 the Joint Committee on Taxation released the proposal for the tax reform bill H.R. 1, The Tax Cut and Jobs Act.  It appears that the reform does not eliminate or simplify the Code to the extent we had hoped. On the contrary, certain provisions, as the proposal stands, will result in additional tax and become costlier to comply.

Here is the summary of the proposed changes which impact US citizens if they own an incorporated business in Canada.  These changes will have a greater negative impact than the existing law:

  • Under the new Code section 951A, US citizens with Controlled Foreign Corporations (CFCs) will be required to apply a review test to determine taxability of the current income earned by the corporation.   There is the potential for up to 50% of corporate income to be deemed taxable in the hands of the US shareholder.
  • A revised Code Section 965 will impose a one-time 12% tax on earnings (prior to dividends distributed from them) that were previously allowed to be deferred in a CFC after Dec 31, 1986 and thereby avoid US taxation.  This is intended as a corrective measure to recoup lost tax revenue from the last 30 years.
  • Foreign Tax Credit under Code Section 901 may no longer be available for certain dividends distributed after Dec 31, 2017.
  • No simplification to the existing PFIC or Subpart F rules with regards to passive income held in Canadian corporations will apply.

The following changes will affect all US citizens in Canada.  We have broken them down into two parts – negative and positive developments.  Here is what unfortunately remains unchanged:

  • Taxation of US citizen income would still be world-wide.
  • FATCA would still require Canadian banks to report bank and financial accounts held by US citizens to IRS via CRA.
  • The reduction of US individual tax rates with the top federal rate going down to 25% will have no overall impact, since Americans in Canada are subject to taxation at the greater of the two tax rates (Canadian or US) and the top blended Canadian/Ontario rate is 53.53%.

And very few good developments…

  • The current estate tax exemption of $5.49 mil (for 2017) will increase to $10.98 mil after December 31, 2017 and the estate tax is scheduled to be completely eliminated after 2023.
  • A larger estate tax exemption utilized during one’s life time as gifting means less people will be trapped under the “covered expatriate” definition if they decide to give up US citizenship.

As further information is revealed by Congress, we shall pass it on.

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