I received an email inquiry from a CPA friend about this, so I thought I would share it generally.

Question

Does the 2010 repeal of the estate tax apply to nonresidents of the United States?

Answer

Yes.  The repeal applies to residents and nonresidents alike.

Background

The estate tax disappeared on December 31, 2009.  It is designed to re-appear on January 1, 2011.  Tag that:  #politicalgames

The Tax Geek’s explanation

Section 2210(a) of the Internal Revenue Code says:

“Except as provided in subsection (b), this chapter shall not apply to estates of decedents dying after December 31, 2009.”

“This chapter” means Internal Revenue Code, Subtitle B, Chapter 11, which contains Sections 2001 through 2210.  These are the estate tax rules.  Thus, the estate tax rules are universally not applied to decedents dying after December 31, 2009.

The estate tax as it applies to nonresidents is described in Sections 2101 through 2108 of the Internal Revenue Code.  These sections are within Chapter 11.  The same Chapter 11 that does not apply to people dying after December 31, 2009.

Therefore, nonresidents are not subjected to U.S. estate taxation if they die after December 31, 2009.

Reinstatement of estate tax in 2011

The estate tax comes back in 2011, for residents and nonresidents alike.  Here’s the magic language, which is from Section 901 (Sunset of Provisions of Act) of Pub. L. 107-16, as amended by Pub. L. 107-358:

(a) IN GENERAL.–All provisions of, and amendments made by, this Act shall not apply–

(1) to taxable, plan, or limitation years beginning after December 31, 2010, or

(2) in the case of title V, to estates of decedents dying, gifts made, or generation skipping transfers, after December 31, 2010.

(b) APPLICATION OF CERTAIN LAWS.–The Internal Revenue Code of 1986 and the Employee Retirement Income Security Act of 1974 shall be applied and administered to years, estates, gifts, and transfers described in subsection (a) as if the provisions and amendments described in subsection (a) had never been enacted.

(c) EXCEPTION.-Subsection (a) shall not apply to section 803 (relating to no federal income tax on restitution received by victims of the Nazi regime or their heirs or estates).

Reinstatement means 2001 rules apply

For your purposes, Section 901(a)(1) is what matters. The “Act” (which is what put the estate tax on ice for 2010) does not apply at all after December 31, 2010. That means you look at the law as if the “Act” never existed. And that, in turn, means that you look at estate tax law as it existed in 2001 to see what the tax rules will be.

Trust me. The estate tax rules apply to nonresidents in 2011.

I understand that the Swiss government has processed all of the 4,450 cases for disclosure to the IRS.

Those of you pinning your hopes on Swiss court protecting you? I have heard from people who were rejected by the Swiss court. So it’s not a slam dunk. And if you fail, you can appeal. But you have to notify the US government that you’re appealing the rejecting the rejection of your privacy request by the Swiss courts.

I will be at the EB-5 Investor CLE Conference in Boston on August 27, 2010.  This time it will be the unusual (for me) experience of sitting in the audience rather than speaking.  :-)

If you’re going to the conference, or if you are in Boston and want to meet, shoot me a message.  I arrive Thursday afternoon, August 27, 2010.

Find me on Twitter at @philiphodgen, SMS/call my mobile at +1-626-437-2500, or email me at phil at my surname dot com.

I’m flying back to Los Angeles on Saturday.

For those of you who do not live and breath U.S. immigration law :-) “EB-5″ is a category of visa in which you invest $500,000 or $1,000,000 and in return get a permanent resident visa for the United States.  See Wikipedia’s article about the EB-5 visa.

No, we do not do immigration law. (And we don’t want to.  Lord knows there’s enough to keep up with in the tax world.)  We do the pre-immigration tax planning for people who enter the United States using this method.

This is a reprise of an investigation method of a few years ago.  The IRS has revealed that it is chasing offshore accounts via credit cards and PayPal.

According to Tax Notes Today at 2010 TNT 163-2:

The IRS has opened three initiatives intended to uncover undisclosed offshore accounts, according to an official speaking at an American Law Institute-American Bar Association conference on August 20 in Chicago. John McDougal, an attorney in the IRS Office of Associate Chief Counsel (Small-Business/Self-Employed), said the initiatives have already produced John Doe summonses.

The Offshore Merchant Account Initiative uses the data stored by electronic payment processors, which are “usually totally innocent intermediaries who happen to have the information” that is subject to summonses if in the United States, McDougal said.

Offshore merchant accounts are especially prevalent among e-commerce businesses and members of high-risk industries, such as pornography and gambling, that domestic banks refuse to take as customers. Domestic businesses that already need to seek offshore banking arrangements often avail themselves of the potential for tax evasion, McDougal said.

For the electronic payments initiative, John Doe summonses have been sent to Internet payment portal PayPal. Like the electronic account processors, PayPal is “just a lead to the foreign account” from which a user transfers funds to make Internet purchases, McDougal explained.

This happened in 2000, when American Express and MasterCard were hit with Federal court orders to turn over data to the IRS. The IRS had a “Come to Jesus!” moment in 2003 with credit card holders called the Offshore Voluntary Compliance Initiative.

Pop quiz

The IRS knows how to rattle taxpayers. You don’t need to have an offshore account to have experienced that. It knows how to put the screws on U.S. companies to turn over data (American Express, MasterCard, PayPal). It knows how to put the screws on non-U.S. companies with U.S. presence (UBS).

I do not believe that the Treasury Department (policy poobahs), the IRS and Department of Justice (cops on the street) know how to assess the impact of their actions.

OK, class. Here’s your assignment. Let’s ask the common sense question. “If I make life expensive and risky for U.S. and non-U.S. financial institutions doing international business, then what will happen?” The first person pronoun is the Internal Revenue Service. It is a question hardly ever asked — and answered — in government circles. Apply common sense and write a 300 word essay, due Friday.

• An example of oh-so-obvious expected outcome: “Credit Card Interest Rates Much Higher” (Atlantic Magazine).

For those of you with offshore accounts

If you have undeclared offshore accounts you have to understand the landscape and your risks. Take action. Have a long term strategy. Obscurity is not a strategy.

Short term, you have some risks. Long term, you have to decide whether to sever all ties with the United States or not.

From a correspondent today via email (and with permission):

I’ve just returned to [Country where I live now] from [New Country I am moving to].

I am amazed however, at the number of normal Americans with normal jobs abroad who have never heard of the FBAR witch hunt and have no intention of participating.  In addition, the fairly consistent message by Americans who have spent more than a few years abroad is that the benefits of holding the little blue book are hard to quantify and pale in comparison to the nightmare of compliance with the oppressive American tax regime.  Over 12 days in [New Country], I heard the words “renouncing my citizenship” over 20 times.

I am aghast that our government would continue to force intelligent Americans, who otherwise fully intend to move back to the US for their retirement – if not before – to this conclusion.  Clearly, the benefits of repatriating a group of internationally adept, high net worth citizens is preferable to losing them to “competing” economies.  [New Country welcomes people like that] whilst our government seems to be focused on forcing them away.

I appreciate you drawing to my attention the lengthy letter of objection from the Geneva-based American Citizens Abroad regarding the new legislation and penalties.  I plan to get involved with a similar interest group as soon as I settle in [New Country].  However, I’m beginning to think there really is little reason to fight the multi-headed IRS hydra when there are many other safe, beautiful, and tax-benign, places to live in the world than the US.

I too, may be having a blue book burning party soon.

best regards

[Name]

Clickable link: American Citizens Abroad

If you are in the Voluntary Disclosure Program and your offshore account had mutual funds in it, you had an extra layer of fun waiting for you in the Pain Factory:

• That mutual fund was a “Passive Foreign Investment Company.”
• You have to report income/loss from the mutual fund on Form 8621.
• Getting the data to do so was either impossible or damn near impossible.
• The tax results were either uncertain or horrific or both.

The obvious solution

The obvious solution to these problems was a little thing called a “mark-to-market” election.  Basically it allowed you to trump all of the hard tax calculations, and calculate your gain/loss on foreign mutual funds by looking at the value of the mutual fund at the beginning of the year and the end of the year.  If the value went up, you had ordinary income.  If the value went down, you had ordinary loss.  Simple.

The obvious solution didn’t work

Unfortunately, in order to make the “mark-to-market” election you had to do so on a timely-filed income tax return.  Duh.  If you’re in the Voluntary Disclosure Program you self-evidently didn’t make a “mark-to-market” election on a timely-filed income tax return.

The obvious solution now works, by executive fiat

The IRS has authority to waive the requirement that you must make the “mark-to-market” election on a timely filed income tax return.  This is under Regs. Section 301.9100-3, for those of you who are singing along with the choir. Usually this requires a specific application for a letter ruling, months of delay, etc. etc.

Thanks to Chuck Rettig and a few others, the IRS brass appears to have consumed a few sanity pills which will ease the procedures for participants in the Voluntary Disclosure Program.  Effectively you can use the “mark-to-market” election procedures for 2003-2008, even if you didn’t make the timely election.

Revenue Agents around the country who have Voluntary Disclosure Programs will shortly be advised of the following:

Taxpayers who have been accepted within the VDP will be provided an opportunity to elect into a procedure for the resolution of all PFIC issues for tax years through December 31, 2008. For those who elect to have this PFIC procedure apply, the proposal will apply to all of the taxpayer’s PFIC assets and will generally provide as follows:

1. A first mark-to-market (MTM) determination of the net asset value (NAV) for all PFIC assets as of 12/31/2003.
2. The basis in PFIC assets for the first MTM exercise is to be determined with the Revenue Agents based on historical asset cost. If the taxpayer can not locate the actual historical cost data, they should attempt to work out the NAV with the Revenue Agents based on whatever information is available.
3. There will be a standard tax rate of 20% on all MTM gains and distributions post-12/31/2002, instead of the statutory PFIC (ordinary income) rates.
4. Losses will be limited to prior year PFIC inclusions. Any tax benefit arising from PFIC losses will be determined at the same 20% rate that applied to the PFIC gains and distributions.
5. A 7% annual interest charge will be applied to the PFIC liability from the date of asset acquisition through 12/31/03. The 7% was basically determined by a weighted average of the underpayment rate using a 3-year holding period (and is not-negotiable under the proposal). This computation is only required in the first year of a conversion to the MTM treatment (generally 2003, under this methodology) and would be calculated starting with the due date of the return for the year of acquisition and ending on the due date of the return for the first MTM year. The 7% interest charge is in lieu of the interest required within the deferred tax computation of Section 1296(c)(1)(B) and eliminates the look-back interest computation resulting from allocating the gain to all periods over which the PFIC investment was held. Subsequent period income adjustments to the year end NAV would be subjected to the 20% rate, gain or loss [see (3) and (4) above]. There would continue to be an underpayment interest charge from the due date of that first year (4/15/2004 for 2003) to the actual date paid.
6. Electing taxpayers will be required to remain with the MTM mechanism for PFIC securities held post-12/31/2008 but the PFIC rate will revert to the statutory (ordinary income) rate for gains and losses arising after 12/31/2008.
7. The 20% accuracy-related penalty under the VDP will apply to PFIC tax liabilities arising during 2003-2008.
8. The foregoing alternative, elective PFIC procedure is available to all VDP applicants, whether or not they had a PFIC excess distribution between 2003 and 2008.
9. Taxpayers who do not elect into the foregoing alternative PFIC procedure will have their PFIC tax liabilities determined under the normal rules applicable under Sections 1291-1298, requiring a look-back tax computation for the entire holding period of their PFIC assets.

Air Asia from Singapore. Catching an EVA flight to Taipei in 2 hours. Jakarta airport.

I bought a visa when I arrived in Jakarta last week. I had to buy a second one just to transit through Jakarta. USD 25.00.

Long long line at immigration. That is where I am now. It ain’t moving. There goes my idea of eating here.

Still TBD: do I pay the IDR 150,000 exit tax? Do I have to go through customs?

My advice–this is not a good place to change flights. Still, I’m standing in front of the air conditioner at the moment. It feels good.

EDIT. OK that was brutal. I’m not doing that again. At least I am here at the gate with a boarding pass in hand. Yay.

DOUBLE EDIT. In fairness to Jakarta, the immigration and customs treatment at LAX can be brutal. #slow #surly This is true for me as a citizen, and clients who travel to the US report astonishingly bad treatment and tremendous delays.

Regular readers and informal fans of tax *ahem* problems facing innocent grannies will be up to speed on the fact that the U.S. government had announced it will chase HSBC accounts in India and Singapore.

I am currently in Singapore. That does not make me smart. :-) I spoke with a number of bankers here and they know what they’ve read in the newspapers. Same as you.

So let’s do a bit of Sherlock Holmes meets Occam’s Razor, shall we?

The recent spate of enforcement activity started with stolen bank records from Liechtenstein. Then we had Bradley Birkenfeld open the kimono at UBS. There have been other instances of stolen data (disgruntled employees) including at HSBC/Geneva.

This means that the governments of the world only get traction when they have an informant or they have a thief.

First deduction: to the extent the IRS has anything, it is due to exactly that — the IRS is squeezing all of the juice out of an HSBC banker.

The alternate explanation is that they developed data from the 15,000 cases they have on file with the amnesty. I do not think they would get sufficient data points to target specific individual taxpayers unless it was a situation with a joint account where one individual participated in the amnesty and the other didn’t. This would be rare in my experience. This is usually a family account and a mom is not going to sell out a son. Or vice versa.

Alternatively the amnesty could have identified hotspots of activity. HSBC might have appeared many times. But the government would be dumb to just announce “we are going after HSBC” without real facts. Otherwise they look toothless and impotent. So there must be real data behind it.

And real data will come from a disgruntled or frightened banker, or it will come from the institution itself.

The institution cannot cough up data without damage to market reputation and the wrath of the bank regulators where they operate.

HSBC will likely be unwilling in the extreme to have a reputation of opening the door to US government inquiries worldwide. Their business would be in the toilet instantly.

Governments and bank regulators in Singapore and India will want laws and procedures followed. See what happened in Switzerland. It ultimately took an act of Parliament to cause official information sharing. That may be an extreme case. But neither India not Singapore fall into the “cowboy country” category. Rules, processes, and diplomatic procedures are highly developed.

Second deduction: the IRS does not have bank-level access to data. This is a practical judgment. Time elapsed seems insufficient to get things done at a government level. This is a pure guess on my part and in international inter-government machinations I am an imbicile.

I hazard no guess as to the likelihood of actual sharing of information at a treaty-authorized level sometime in the future. It might happen. But I think not. The person at the IRS who wants this to happen will soon rotate out of government to make a mint on the other side of the table. Inertia will take this project down eventually.

Conclusion: we are back to the idea that it is an individual who has spilled a pile of beans. This is a “probabilities” conclusion. Remember that.

Now. Is that individual an informant or a thief? Given the US treatment of Bradley Birkenfeld as an informant (prison) I think it unlikely that they have a happy informant in for the bounty. It is just too scary to approach the IRS on this basis. They will throw you in jail given half a chance. Exhibit A: Mr. Birkenfeld.

So my money haha is on the thief theorem.

Next question. Is this a new thief or is this a thief we know about already, namely the HSBC/Geneva leak? My money again is on a new source, just because information sharing from Switzerland to India or vice versa seems to be farfetched. I can see accounts opened in Geneva and transferred to an Indian or Singapore branch. I can also see instances where trusts were administered from Switzerland on behalf of an account situated in India or Singapore.

Next question: one leaky source or two? Don’t know. I don’t know what common elements are shared here.

Conclusion: the IRS has stolen or leaked data, they don’t have “Board of Directors” level cooperation from HSBC, they don’t (yet) have diplomatic assistance in Singapore and India.

Please play Sherlock Holmes in the comments (or Poirot if you prefer) and tell me what your guess is.

And. FFS. If you are in this problem do not make a strategic decision based on this blog post.

This was composed on an iPhone in the taxi to Changi Airport and sitting at the Starbucks in Terminal 1. Please excuse the lack of editing.

And I am proud to have done a blog post in @tomiahonen style. :-) Read his blog for great insights into the mobile telecom business.

. . . was kpryor who correctly identified the lyrics as coming from Cosmic Wheels by Donovan.

For those of you who aren’t getting my Jell-O Shots email newsletter, sign up.  The newsletters aren’t posted on the web.

You’ll get hotel reviews (comparing Le Meridien Jakarta with Hotel Intercontinental Jeddah this time), perspectives on what I see business-wise, and of course obscure musical references.

It is early Friday morning in Jakarta.  I’ve been up since 5 a.m.  (Jet lag).  #coffee

EDIT:  Dmitriy K. is the second one to provide an answer.

Comment:

This little FAQ is a simple (for certain values of $SIMPLE) :-) explanation of the branch profits tax for nonresident investors in U.S. real estate.

As a general principle it is a Very Bad Idea for nonresidents to own income-generating U.S. real estate through foreign corporations. If you live in a country that has an income tax treaty with the United States, there may be a solution to the branch profits tax via the treaty.

What is the branch profits tax?

The branch profits tax is an extra income tax imposed by the United States on foreign corporations which earn profit from their U.S. investments or U.S. business operations.

How much will the branch profits tax cost?

The branch profits tax is imposed on a non-U.S. corporation’s after-tax net profit.  Simply put, the branch profits tax works like this:

• Calculate the non-U.S. corporation’s profits derived from U.S. investments or business operations.
• Pay regular corporation income tax on that profit.
• Whatever is left over is your after-tax net income.  Pay 30% of that after-tax net income as the branch profits tax.

Example of calculating branch profits tax

Let’s assume that a non-U.S. corporation owns U.S. real estate that is rented.  At the end of the year, after paying all business expenses, the corporation has a profit of $100.

First, the corporation will pay income tax. The tax rate is on a sliding scale (higher income means higher tax rate).  But let’s use 34%, the rate that applies for income of about $350,000 and up.  After paying the regular income tax, the corporation has $66 remaining.

Then the corporation pays the branch profits tax, which is 30% of the $66 remaining after payment of the regular income tax.  The branch profits tax is $19.80.

The total tax paid is $34.00 + $19.80 = $53.80, or 53.8% of net profit.

Only foreign corporations pay the branch profits tax

The branch profits tax is only imposed on foreign corporations.  This means two things:

• The entity must be viewed as a corporation from the perspective of the U.S. tax authorities; and
• The entity must be formed under the laws of a country other than the United States.

People, then, do not pay the branch profits tax, even if they are nonresidents of the United States.  Nor do partnerships or trusts.

What is a foreign corporation?

Be careful.  Sometimes you may have an entity that is called a corporation but is treated in the United States for tax purposes as something else.  Similarly, you may have an entity that is not called a corporation, but is treated as a corporation in the United States for tax purposes.

Many countries attribute residence of a corporation to its place of management.  This does not matter for U.S. tax purposes.  A corporation is foreign if the organizing documents (Articles of Incorporation or similar) say something to the effect of “This corporation is formed under the laws of ________” and the place named is not a place in the United States.

Why the branch profits tax exists

The branch profits tax is intended to cause non-U.S. corporations (and their shareholders) to be taxed identically to U.S. corporations (and their shareholders).  The idea is that a nonresident investor should be indifferent–from a U.S. tax perspective–between investing in the United States through a non-U.S. corporation or through a U.S. corporation.

If a non-U.S. person owned a U.S. corporation which made the equivalent investment, the net profit would be taxed at 34%.  Under the example I gave, this means that the corporation would contain $66.00 after paying its income tax.  If the shareholder wanted that cash, the corporation would pay a dividend to the non-U.S. shareholder.  As the dividend money leaves the United States there is a withholding tax imposed, at a default rate of 30% of the amount of the dividend.  (It can be less if the recipient lives in a country that has an income tax treaty with the United States.)

Thus, a non-U.S. investor who used a U.S. corporation would pay two levels of tax:  the regular corporate tax calculated at 34% of income, and the 30% withholding tax on the dividend paid by the corporation to the shareholder.

Compare that to the same investment made by a non-U.S. investor through a non-U.S. corporation.  The non-U.S. corporation earns $100.  It pays the regular income tax at 34%. 

It has $66.00 remaining in its bank account.  Now the shareholder wants a dividend.  The United States cannot tax that dividend because it is paid from a non-U.S. corporation to a non-U.S. shareholder.  The second level of tax–the 30% tax on dividends–will not be paid.

The branch profits tax plugs that hole.

The branch profits tax applies automatically

The branch profits tax automatically applies if there is a profit generated in a fiscal year for the non-U.S. corporation.  Compare that to the tax on a dividend:  here the corporation controls if and when the withholding tax on the dividend will be paid, by deciding to pay (or not) a dividend.

How a non-U.S. corporation avoids the branch profits tax

The branch profits tax is imposed in an automatic and mechanical way.  There are only a few ways to eliminate it:

• Reinvest your profits in the United States;
• Find an exemption in the income tax treaty between the United States and the country in which the corporation was formed (the United Kingdom, for instance, has an exemption); or
• Completely terminate all business and investment operations in the United States (also know as “sell your assets and take your money home”).

When the branch profits tax is harmless to real estate investors

The branch profits tax is harmless to nonresident real estate investors if the non-U.S. corporation owns one piece of U.S. real estate, and that property is not producing income.  Direct ownership of land is fine.  So is direct ownership by a non-U.S. corporation of a house which is used for personal purposes.

The branch profits tax does not matter in these situations because there is no annual rental income collected.  No income means nothing to tax.

In the year of sale there will be profit and the branch profits tax will apply.  But there is a simple exception which can be used to eliminate the branch profits tax in the year of sale–the branch profits tax will not apply if the non-U.S. corporation ceases all U.S. business and investment operations in the year of sale.

When the branch profits tax applied to rental property

The branch profits tax will apply to nonresident investors in U.S. real estate who have rental income held directly by a non U.S. corporation.  The income collected (after expenses) will be subjected to the branch profits tax.

When the branch profits tax applies to multiple properties

A non-U.S. corporation which owns many pieces of U.S. real estate will have a branch profits tax problem.

If any of the properties are rented, the rental income will be subjected to the branch profits tax.

If one of the pieces of real estate is sold, the profit on sale will be subjected to branch profits tax, and the exception traditionally used to eliminate the branch profits tax (the non-U.S. corporation ceases all U.S. investment and business operations in the year of sale) cannot be used, because the corporation continues to hold other pieces of real estate.

What to do if branch profits tax is a problem

If you have an existing situation which triggers branch profits tax, consider adding a U.S. corporation to the holding structure.  Instead of the non-U.S. corporation owning U.S. real estate directly, the non-U.S. corporation will own all of the shares of a U.S. subsidiary corporation, which in turn owns the U.S. real estate.

This type of restructuring will not trigger any tax if done correctly.  It is purely a paperwork exercise.

Since the owner of the real estate is now a U.S. corporation, the branch profits tax will no longer apply.  (Branch profits tax only applies to non-U.S. corporations).