Hey. I’m in Singapore, meeting with bankers, lawyers, and clients. I’m headed for Jakarta tomorrow night, and will be there for 3 days. I’ll be back in the office on March 8 (Monday).

It’s good to do a face-to-face with people we’ve worked with over the phone and the internet. Skype is a wonderful thing but there’s nothing like meeting someone face-to-face.

Every time I get on a plane I marvel at how my head tells me “Oh, it’s just to hard and too expensive to travel.” It is neither. The hardest part is dealing with saying goodbye to my family at the airport. “Why do you have to go, Daddy?” has no really good answer.

Upcoming trips: Mexico and the Middle East, then back to Asia.

Anecdotes or leading indicators?

Here’s what I’m seeing from my meetings:

§                  U.S. expatriates who ran afoul of the IRS’s FBAR Crusade are grumpy. (Seriously, who can blame them? A normal person, living a normal life outside the U.S., owing in some cases a trivial amount of tax, and for that the IRS wants to throw massive penalties at them?)

§                  U.S. expatriates who are not (yet) fully compliant in reporting the existence of offshore bank accounts have no interest in coming forward due to the uncertainty as to how they’ll be penalized, and the current harsh penalty regime. Anecdotal or a trendline indicating how the IRS has trained a whole set of otherwise law-abiding people to deliberately lie on their tax returns?

§                  An increasing willingness to give up U.S. citizenship. One of my reasons for coming to Asia this time was to meet with people who are launching the expatriation process. Anecdotal or a trendline? And if it is a trendline, what is causing productive, high achieving people to cut all ties with the United States?

§                  Bankers are hesitant to set up and administer trusts which have U.S. beneficiaries. Anything touching the United States has highly complex accounting and paperwork requirements. Anecdotal or trendline indicating that the cost of doing business in/with the United States is getting too high?

§                  Interest in buying U.S. real estate. The dollar is cheap compared to many Asian currencies, and the U.S. market, well, I don’t need to tell you what’s happening there. Anecdotal or trendline? My job here is to make it happen — make the real estate deal occur, set up the tax planning, etc.

Recommended

Fullerton Hotel in Singapore. www.fullertonhotel.com.

XpenseTracker app for the iPhone. Easiest travel expense tracking app I’ve used yet. And I’ve tried a bunch, on the Treo, Blackberry, Windows Mobile phones, and iPhone.

. . . look at Italy.

Quiet, simple, no heavy penalties, nothing required from the taxpayer which would rat out someone else.

Ninety! Five! Billion! Euros! declared, and another € 30 billion expected because they extended the deadline from 15 December 2009 to April 30, 2010.

Dear IRS,

Your long-term profit-maximizing strategy is to get people legal, declared, and on the table. Then you’ll collect income tax during their lives, and estate tax when they die.

Your profit-maximizing strategy is not well-served by enticing volunteers to step forward then poking them with a pointed stick dropping a 16 ton weight (YouTube) on their heads.

Love,

Phil

The fate of approximately 4,200 U.S. customers of UBS is hanging on what happens next in Swiss Parliament.

Recap

Here’s where things are right now:

• UBS and the U.S. government signed a settlement agreement in August, 2009 in which UBS agreed to turn over the names of 4,450 U.S. customers of the bank.
• In February, 2010 a Swiss court ruled that this was an attempt to amend the income tax treaty between the United States and Switzerland without following proper procedures (“proper procedures” meaning it should be approved by the Swiss Parliament).
• This had the effect of stopping disclosure for 4,200 U.S. customers of UBS. The other 250 people had indicia of “tax fraud” (as that term is defined in Switzerland) so their names could be given to the United States under the terms of the treaty as it currently exists.

Current reality

The positions of the players in this game at the moment:

• A U.S. person who had an account at UBS in his or her own name as a human being (no corporations, trusts, foundations, anstalts, or other fun and games) was protected by the Swiss court ruling.
• The Swiss government is facing an swarm of belligerent U.S. bureaucrats.
• That swarm of U.S. bureaucrats? I’ll let you imagine why they’re agitated.

Latest development

The Swiss government has announced plans to put the settlement to Parliament for approval. This will happen in March.

At the moment the settlement of August, 2009 is a “mutual agreement” between governments. It is not a formal treaty. Parliamentary approval would make it a formal mutual treaty between the United States and Switzerland. This would overcome the objections of the Swiss court, and disclosures could proceed.

Roadblocks to disclosure

The 4,200 U.S. taxpayers? It’s not over yet. They may yet be safe from forced disclosure. The game has morphed into what is largely a Swiss domestic political struggle. In order for disclosures to proceed:

• It must be determined as a matter of Swiss law that the approval of this settlement does NOT trigger the optional national referendum process by which the question of approval could go to the Swiss voters for approval. My guess? If Parliament self-declares that it has the constitutional authority to approve the settlement, someone will take this to court in Switzerland. Expect delays and uncertainty.
• Assuming that hurdle is jumped, and Parliament indeed has the authority under the Swiss constitution to approve the settlement. Now the Universal Truth of Politics trumps all considerations: “If I vote for this, will my constituents re-elect me?” Ask yourself what your random U.S. Congressman would say if another country was presenting the United States with a BOHICA ultimatum. Boggles the mind, doesn’t it? :-) There will be a large minority in Swiss Parliament which will object to approving the UBS settlement on national sovereignty and national pride, and who will be willing to vote “GDIAF.” They will vote this way because it is domestically politically expedient to them, and they don’t care about IRS careers, Department of Justice press releases, or the November, 2010 elections.
• I am not clear on this (as a matter of Swiss legislative process) but I wonder whether the Swiss Parliament — even though it theoretically could have the power to approve the settlement — might nevertheless have the ability to dodge a vote and pass the question through to the voters for a referendum anyway. This happens in California, for instance. Our spineless politicians in Sacramento have the ability to put a proposition on the ballot for statewide vote because they are not willing to stick their necks out and make a possibly career-ending vote.

What’s next?

This is moving along a predicted path. It will be interesting to see what happens in Switzerland next month.

I think there’s a decent chance that the approval may founder somewhere along the path. The easiest way to torpedo this and let it die a quiet death would be for the Swiss members of Parliament to vote in such a way that makes them look compliant to the U.S. bureaucrats and diplomats, but then let the Swiss courts or the Swiss voters do the dirty work. In that way the diplomatic tea parties can continue to be ever so polite. Plausible deniability, I think they call it. :-)

If you’re cleaning up your tax messes with a voluntary disclosure process (oh, hypothetically, offshore accounts that were unreported) it is important to do it right. As the saying goes “Half-measures availed us nothing.” Put it all on the table and clean it up entirely.

Jack Townsend has a post today summarizing United States v Salisbury. This is a cautionary tale about a gent who thought he could come clean and continue to lie.

Oh, I know. “Lie” is such a strong word. “Take an aggressive tax reporting position” sounds much nicer, doesn’t it?

Memo to all personnel: when you’re trying to avoid prison and/or life-altering fines, be smart. Don’t poke the bear with a pointed stick (YouTube) when the bear has your head in his mouth. Remember your primary purpose, and calibrate your actions to achieve it. (Hint for Mr. Salisbury and others like him: your primary purpose is to Stay. Out. Of. Prison. FFS.)

Note: this is another answer for the accountants who took my all-day courses in Pleasanton in January.

The “Net Election” is an election by a nonresident of the United States who owns U.S. real estate. This is an almost mandatory election for a nonresident investor. The default U.S. income tax paid by a nonresident on rental income is 30% of the total rent received, without any allowance for operating expenses. The “Net Election” changes a nonresident’s U.S. income tax treatment so that the nonresident is taxed exactly as a U.S. resident is taxed — on the net income (rent collected minus operating expenses) from the property.

The “Net Election” takes its name from the fact that it changes the income tax payable by the nonresident investor to a method by which that investor is tax on net income.

Sometimes partnerships are used to hold U.S. real estate. A nonresident individual or a non-U.S. corporation will be the partner. In that case, who makes the Net Election — the partnership or the foreign partner?

Answer: the election is made by the foreign partner. The nonresident individual makes this election on Form 1040-NR, while a foreign corporation makes the election on Form 1120-F.

If a non-resident alien individual or foreign corporation is a member of a partnership which has income described in paragraph (b)(1) of this section from real property, any election to be made under this section in respect of such income shall be made by the partners and not by the partnership. [Emphasis added.] A nonresident alien or foreign corporation that makes an election generally must provide the partnership a Form W-8ECI, “Certificate of Foreign Person’s Claim for Exemption from Withholding on Income Effectively Connected with the Conduct of a Trade or Business in the United States,” and attach to such form a copy of the election (or a statement that indicates that the nonresident alien or foreign corporation will make the election). However, if the nonresident alien or foreign corporation has already submitted a valid form to the partnership that establishes such partner’s foreign status, the partner shall furnish the partnership a copy of the election (or a statement that indicates that the nonresident alien or foreign corporation will make the election). To the extent the partnership has income to which the election pertains, the partnership shall treat such income as effectively connected income subject to withholding under section 1446. See also section 1.1446-2.

Citation: Treasury Regulations Section 1.871-10(d)(3).

Action step: if you are a nonresident investor in a partnership that holds U.S. real property, check to see that you have taken the necessary action steps to be taxed on net income rather than gross income.

By default a nonresident investor is taxed harshly on rental income from U.S. real estate holdings: 30% of gross rent is the Federal income tax, with no offset for operating expenses.

If you are collecting $1,000 per month in rent, this means your monthly income tax is $300, leaving $700 to pay the mortgage, property taxes, and other operating expenses. My experience is that this is a sure way to run a monthly cash flow loss.

You’d rather pay income taxes only on your net income: the rent you collect minus your tax-deductible operating expenses. These expenses include property taxes, mortgage interest, cost of repairs, depreciation, and other normal expenses associated with owning and operating real estate. Frequently these tax-deductible costs exceed the rent you collect, meaning that your taxable income is zero. Which of course means you pay no tax.

In order to get to this point, you need to make a special election on a U.S. income tax return. Use Form 1040-NR if you are a person, and Form 1120-F if the real estate is owned by a non-U.S. corporation. Write up a statement on a piece of paper and attach it to the back of the tax return. Your statement should consist of the following information:

• a schedule of all U.S. real property (or an interest therein) in which the taxpayer owns a beneficial interest;
• the extent of the taxpayer’s direct and beneficial interest in each item of U.S. real property;
• the location of each item of U.S. real property;
• a description of any substantial improvements on each item of U.S. real property; and
• an identification of the taxable year(s) in which a revocation or new net election has previously occurred.

For your reading pleasure, here are the Treasury Regulations:

1.871-10(d)(1) Election, Or Revocation, Without Consent Of Commissioner–

1.871-10(d)(1)(i) In General.

A nonresident alien individual or foreign corporation may, for the first taxable year for which the election under this section is to apply, make the initial election at any time before the expiration of the period prescribed by section 6511(a), or by section 6511(c) if the period for assessment is extended by agreement, for filing a claim for credit or refund of the tax imposed by Chapter 1 of the Code for such taxable year. This election may be made without the consent of the Commissioner. Having made the initial election, the taxpayer may, within the time prescribed for making the election for such taxable year, revoke the election without the consent of the Commissioner. If the revocation is timely and properly made, the taxpayer may make his initial election under this section for a later taxable year without the consent of the Commissioner. If the taxpayer revokes the initial election without the consent of the Commissioner he must file amended income tax returns, or claims for credit or refund, where applicable, for the taxable years to which the revocation applies.

1.871-10(d)(1)(ii) Statement To Be Filed With Return.

An election made under this section without the consent of the Commissioner shall be made for a taxable year by filing with the income tax return required under section 6012 and the regulations thereunder for such taxable year a statement to the effect that the election is being made. This statement shall include (a) a complete schedule of all real property, or any interest in real property, of which the taxpayer is titular or beneficial owner, which is located in the United States, (b) an indication of the extent to which the taxpayer has direct or beneficial ownership in each such item of real property, or interest in real property, (c) the location of the real property or interest therein, (d) a description of any substantial improvements on any such property, and (e) an identification of any taxable year or years in respect of which a revocation or new election under this section has previously occurred. This statement may not be filed with any return under section 6851 and the regulations thereunder.

1.871-10(d)(1)(iii) Exemption From Withholding Of Tax.

For statement to be filed with a withholding agent at the beginning of a taxable year in respect of which an election under this section is to be made, see paragraph (a) of § 1.1441-4.

I will be giving a speech to the East San Gabriel Valley Discussion Group of the California Society of CPAs on February 18, 2010, at 8:00 a.m. Topic: foreign bank accounts and all that normal hoo-hah. Event information here.

Location: Carrow’s Restaurant, 101 South Azusa Avenue, West Covina, California 91791 (Google Maps).

Breakfast. Continuing education credit. What more do you need?

Am I the only conspiracy theorist out here who sees the possibility of a diplomatic tit-for-tat? The Swiss government does the United States a favor by taking in two Guantanamo Uighars.

What could the IRS U.S. government do in return that would reward the Swiss for lancing Obama’s diplomatic boil? Hmmm. I can’t name names, but its initials are UBS.

The whole scene seems ripe with opportunities for plausible diplomatic deniability.

Jack Townsend has a good write-up of the latest guilty plea in the IRS’s pursuit of U.S. taxpayers with unreported Swiss accounts. This is one Dr. Silva, who did some Very Dumb Things. And now experiences the consequences. Go read Jack’s commentary.

A new bank

The bank involved was HSBC, and the allegation is that bank employees colluded with the taxpayer and a Swiss lawyer to disguise the account and repatriate the money to the United States.

My opinion? This focus on the particular bank involved is misplaced. When there’s a bank robbery we don’t get all worked up about the fact that the robber drove away in a Chevy. Nor should we get all worked up about the fact that a U.S. citizen had money in $RANDOMBANK. What matters? The humans. And what they did.

The fact that HSBC was involved is useful only to the IRS in its attempt to flush wavering taxpayers out into the open where they can be promptly dispatched. Frankly, dear IRS, that ship has sailed.

The naming of a new bank (HSBC) is also useful to the IRS because (in theory) the U.S. government can attempt to bring the banhammer down on HSBC. How far the government gets with this is unknown, given the recent court decisions in Switzerland. My guess is that all of this will end up with a “Go and sin no more” arrangement. Going backwards in time to forcibly uncover U.S. customers of Swiss banks? At the moment this looks extremely difficult given domestic Swiss political considerations.

Plain Vanilla Facts

Dr. Silva’s activities in disguising ownership seem to be extremely plain vanilla: a Liechtenstein trust. Oh, FFS, Dr. Silva. You went shopping for financial advice at a cocktail party, didn’t you?

I put no great shakes in the way things were done here. The IRS didn’t find anything unusual. Tax evaders use Liechtensten trusts (and trusts elsewhere) all day every day, and so do normal people doing their estate planning.

Darwin Award

The reason I think Dr. Silva ran into trouble? The structuring offense. Mailing cash to himself in little chunks.

Listen up, dear readers. The DoJ can make almost anything look like a money laundering offense. Don’t smuggle money back to the U.S., in big lumps or small. And “money” can mean many, many, many things. Don’t get clever.

Memo to all personnel

If you’re in a Dr. Silva position, here’s my advice:

1. As Rufus Rhoades is fond of reminding me, “It’s only money.” Or as I say to my clients, “Why convert a money problem into a jail problem?” Dr. Silva is going to prison for $200,000 he was trying to hide? Hardly worth it, I’d say.
2. Don’t buy your legal advice at a cocktail party, or from a banker, or from a lawyer who doesn’t know the laws of the United States down cold. Any fool of a U.S. tax lawyer would have told Dr. Silva about the structuring offense. I’m sure Dr. Silva wouldn’t have consulted a chiropracter in Burkina Faso for a heart disease diagnosis. Why did he go off the rails here?
3. Clean up your mess.
4. If you are just ever so enchanted with your cleverness, so much that you want to giggle at how smart you are, you might be the new Dr. Silva. (H/T Jeff Foxworthy).

One last thing

Jack Townsend quotes Ed Robbins in his blog post. Ed and I are on a panel next month talking about precisely this topic. I can’t wait.

March 16, 2010. Los Angeles County Bar Association and Loyola Law School. More info later.

Go to the TaxProf Blog for a quick summary of the IRS Oversight Board’s latest report on taxpayer attitudes.

Among the statistics highlighted by Paul Caron:

• How much, if any, do you think is an acceptable amount to cheat on your income taxes? A little here and there, 9% (highest in 6 years).
• How much influence does each of the following factors have on whether you report and pay your taxes honestly — Fear of an audit? Great deal of influence, 39% (all-time high).

These are important because this is where people are reporting on their own attitudes and behavior. Assuming that people tell the truth on surveys (rarely an accurate assumption), I see these as two interesting data points. Translated into English, I would say the message is:

People fear the IRS more, yet are willing to cheat more.

More fear (not respect in the integrity and fairness of the system, but rather fear of a system perceived to lack fairness and integrity) causes more willingness to cheat.

I’m viewing this through the lens of watching the IRS throw anvils at people for failure to file Form TD F 90-22.1 — the threat of penalties is astronomically disproportionate to the amount of unreported income. I know that people are deliberately choosing noncompliance precisely because threatened penalties are ambiguous in their application and vastly dwarf the actual tax liability involved.

“Keep doing what you’re doing, and you’ll keep getting what you’re getting.” This is my unsolicited advice to our trusted public servants at 1111 Constitution Avenue (pretty picture courtesy of Wikipedia).

Unsolicited advice to people sitting out there with tax problems? Deal with them. An old guy I knew long ago would say “Things just get worser and worser and worser.” (He would say this about a different problem in a different context). The point? Clean up your messes.