Category Archives: PFIC

General Explanation Of The 1986 Tax Reform Act – PFIC Edition

PFICs were introduced as part of the 1986 tax reform. In order to understand the intent of the PFIC rules it is useful to read the general explanation of the tax reform act. The explanation starts at page 1021 of the document or page 1037 of the pdf. It is worth the read …

https://web.archive.org/web/20120507115421/https://www.jct.gov/jcs-10-87.pdf/

jcs-10-87

John Richardson – Follow me on Twitter @Expatriationlaw

Part 45 – “Some” examples where the U.S. creates unrealized “foreign income” before a realization event in the source country

Let There Be Income And There Was Income!

The United States has an increasing propensity to create “deemed income” in circumstances where the taxpayer has received no income to pay the tax.

In some cases the “deemed income” created is “foreign source” income. In other cases it is purely domestic source.

When the “deemed income” is “foreign source” income over which the other country has primary taxing rights, the “deemed income” event creates a U.S. tax owing before an actual realization event in the foreign country.

The implications are experienced by both the country of source and the individual taxpayer.

1. Impact on country of source: The U.S. collecting tax owing before the source country has the opportunity to tax it

2. Impact on individual taxpayer: The U.S. creating a deemed realization event resulting in real taxation means that the taxpayer is more likely to experience double taxation. The taxpayer will first pay the U.S. tax and then (when an actual realization event takes place) pay the tax in the country of source.

“Some” examples of “deemed realization” of foreign source income

Note that each of these examples in found in Subtitle A of the Internal Revenue Code (income tax)

877A Exit Tax,

951 Subpart F

965 Transition Tax,

951A GILTI

1291 PFIC

988 Phantom Capital Gains

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Interested in Moore (pun intended) about the § 965 transition tax?

Read “The Little Red Transition Tax Book“.

John Richardson – Follow me on Twitter @Expatriationlaw

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U.S. Canada Tax Treaty – 1980

7. Where at any time an individual is treated for the purposes of taxation by a Contracting State as
having alienated a property and is taxed in that State by reason thereof and the domestic law of the
other Contracting State at such time defers (but does not forgive) taxation, that individual may elect in
his annual return of income for the year of such alienation to be liable to tax in the other Contracting
State in that year as if he had, immediately before that time, sold and repurchased such property for an
amount equal to its fair market value at that time

https://www.irs.gov/pub/irs-trty/canada.pdf

Paragraph 7 provides a rule to coordinate U.S. and Canadian taxation of gains in circumstances where an individual is subject to tax in both Contracting States and one Contracting State deems a taxable alienation of property by such person to have occurred, while the other Contracting State at that time does not find a realization or recognition of income and thus defers, but does not forgive taxation. In such a case the individual may elect in his annual return of income for the year of such alienation to be liable to tax in the latter Contracting State as if he had sold and repurchased the property for an amount equal to its fair market value at a time immediately prior to the deemed alienation. The provision would, for example, apply in the case of a gift by a U.S. citizen or a U.S. resident individual which Canada deems to be an income producing event for its tax purposes but with respect to which the United States defers taxation while assigning the donor’s basis to the donee. The provision would also apply in the case of a U.S. citizen who, for Canadian tax purposes, is deemed to recognize income upon his departure from Canada, but not to a Canadian resident (not a U.S. citizen) who is deemed to recognize such income. The rule does not apply in the case death, although Canada also deems that to be a taxable event, because the United States in effect forgives income taxation of economic gains at death. If in one Contracting State there are losses and gains from deemed alienations of different properties, then paragraph 7 must be applied consistently in the other Contracting State within the taxable period with respect to all such properties. Paragraph 7 only applies, however, if the deemed alienations of the properties result in a net gain.

https://www.irs.gov/pub/irs-trty/canatech.pdf

Protocol to Canada/U.S. Tax Treaty 2007 – Article VIII – Replacing Article XIII Paragraph 7 in the 1980 Treaty

3. Paragraph 7 of Article XIII (Gains) of the Convention shall be deleted and replaced by the following:

7. Where at any time an individual is treated for the purposes of taxation by a Contracting State as having alienated a property and is taxed in that State by reason thereof, the individual may elect to be treated for the purposes of taxation in the other Contracting State, in the year that includes that time and all subsequent years, as if the individual had, immediately before that time, sold and repurchased the property for an amount equal to its fair market value at that time.

https://home.treasury.gov/system/files/131/Treaty-Canada-Pr2-9-21-2007.pdf

Technical explanation of the 2007 Protocol

Paragraph 3

Paragraph 3 of Article 8 of the Protocol replaces paragraph 7 of Article XIII.

The purpose of paragraph 7, in both its former and revised form, is to provide a rule to coordinate U.S. and Canadian taxation of gains in the case of a timing mismatch.

Such a mismatch may occur, for example, where a Canadian resident is deemed, for Canadian tax purposes, to recognize capital gain upon emigrating from Canada to the United States, or in the case of a gift that Canada deems to be an income producing event for its tax purposes but with respect to which the United States defers taxation while assigning the donor’s basis to the donee. The former paragraph 7 resolved the timing mismatch of taxable events by allowing the individual to elect to be liable to tax in the deferring Contracting State as if he had sold and repurchased the property for an amount equal to its fair market value at a time immediately prior to the deemed alienation.

The election under former paragraph 7 was not available to certain non-U.S. citizens subject to tax in Canada by virtue of a deemed alienation because such individuals could not elect to be liable to tax in the United States. To address this problem, the Protocol replaces the election provided in former paragraph 7, with an
election by the taxpayer to be treated by a Contracting State as having sold and repurchased the property for its fair market value immediately before the taxable event in the other Contracting State. The election in new paragraph 7 therefore will be available to any individual who emigrates from Canada to the United States, without regard to whether the person is a U.S. citizen immediately before ceasing to be a resident of Canada. If the individual is not subject to U.S. tax at that time, the effect of the election will be to give the individual an adjusted basis for U.S. tax purposes equal to the fair market value of the property as of the date of the deemed alienation in Canada, with the result that only post-emigration gain will be subject to U.S. tax when there is an actual alienation. If the Canadian resident is also a U.S. citizen at the time of his emigration from Canada, then the provisions of new paragraph 7 would allow the U.S. citizen to
accelerate the tax under U.S. tax law and allow tax credits to be used to avoid double taxation. This would also be the case if the person, while not a U.S. citizen, would otherwise be subject to taxation in the United States on a disposition of the property.

In the case of Canadian taxation of appreciated property given as a gift, absent paragraph 7, the donor could be subject to tax in Canada upon making the gift, and the donee may be subject to tax in the United States upon a later disposition of the property on all or a portion of the same gain in the property without the availability of any foreign tax credit for the tax paid to Canada. Under new paragraph 7, the election will be available to any individual who pays taxes in Canada on a gain arising from the individual’s gifting of a property, without regard to whether the person is a U.S. taxpayer at the time of the gift. The effect of the election in such case will be to give the donee an adjusted basis for U.S. tax purposes equal to the fair market value as of the date of the gift. If the donor is a U.S. taxpayer, the effect of the election will be the realization of gain or loss for U.S. purposes immediately before the gift. The acceleration of the U.S.
tax liability by reason of the election in such case enables the donor to utilize foreign tax credits and avoid double taxation with respect to the disposition of the property.

Generally, the rule does not apply in the case of death. Note, however, that Article XXIX B (Taxes Imposed by Reason of Death) of the Convention provides rules that coordinate the income tax that Canada imposes by reason of death with the U.S. estate tax.

If in one Contracting State there are losses and gains from deemed alienations of different properties, then paragraph 7 must be applied consistently in the other Contracting State within the taxable period with respect to all such properties. Paragraph 7 only applies, however, if the deemed alienations of the properties result in a net gain.

Taxpayers may make the election provided by new paragraph 7 only with respect to property that is subject to a Contracting State’s deemed disposition rules and with respect to which gain on a deemed alienation is recognized for that Contracting State’s tax purposes in the taxable year of the deemed alienation. At the time the Protocol was signed, the following were the main types of property that were excluded from the
deemed disposition rules in the case of individuals (including trusts) who cease to be residents of Canada: real property situated in Canada; interests and rights in respect of pensions; life insurance policies (other than segregated fund (investment) policies); rights in respect of annuities; interests in testamentary trusts, unless acquired for consideration; employee stock options; property used in a business carried on through a permanent establishment in Canada (including intangibles and inventory); interests in most Canadian
personal trusts; Canadian resource property; and timber resource property.

https://home.treasury.gov/system/files/131/Treaty-Canada-Pr2-TE-9-21-2007.pdf

Model U.S. Tax Treaty 2016

The following provision appears first in the 2016 Model Tax Treaty. There is at present no technical explanation discussing the treaty. Therefore, it must be interpreted based on the presumed intent (which can be gleaned in part from the Canada U.S. Tax Treaty). Significantly, this provision is intended to prevent double taxation resulting from the deemed “alienation” of property upon severing tax residency. It is far narrower than the Article XIII – Paragraph 7 of the Canada U.S. Tax Treaty.

Article 13 – Paragraph 7

7. Where an individual who, upon ceasing to be a resident (as determined under paragraph 1
of Article 4 (Resident)) of one of the Contracting States, is treated under the taxation law of that
Contracting State as having alienated property for its fair market value and is taxed in that
Contracting State by reason thereof, the individual may elect to be treated for purposes of
taxation in the other Contracting State as if the individual had, immediately before ceasing to be
a resident of the first-mentioned Contracting State, alienated and reacquired such property for an
amount equal to its fair market value at such time.

https://home.treasury.gov/system/files/131/Treaty-US-Model-2016_1.pdf

Part 43 – The 1996 Treasury Regs, 2017 TCJA And The Looting Of Canadian Controlled Private Corporations

Punishing U.S. citizens who live outside the United States As Tax Residents Of Canada

The deadline for the submission of Amicus briefs in the Moore MRT appeal is rapidly approaching. As a result (partly by accident and partly by design) I have been rethinking a number of concepts including Subpart F generally, the 965 Transition Tax specifically, retroactivity in the context of the transition tax and (of course) the injustice inflicted by the U.S. “citizenship taxation” regime on dual Canada/US citizens who are resident in Canada. I just realized something that although obvious has not (to my knowledge) been discussed.

Bottom line: US citizens living in Canada who are subject to the 965 MRT AKA transition tax are (as individual shareholders of Canadian Controlled Private Corporations) subject to a tax that a U.S. citizen residing in the United States could NEVER be subject to!! Putting it another way: The U.S. citizen living in Canada is subject to a tax based on an activity (being a shareholder of a Canadian Controlled Private Corp) that a U.S. resident is not eligible to do. A U.S. citizen living in the United States is simply not eligible to be a shareholder of a Canadian Controlled Private Corporation that is a “Controlled Foreign Corporation”. A U.S. living in Canada is eligible to be a shareholder in a Canadian Controlled Private Corporation. Therefore, a Canadian resident is subject to the 965 transition tax with respect to a corporation that – vis-a-vis a U.S. resident – can never be a Controlled Foreign Corporation.

On the one hand this is clearly an abuse of U.S. citizens living in Canada (because of the U.S. citizenship tax regime) AND an attack on the Canadian tax base. On the other hand (as this post will demonstrate):

“It’s the American way!”

Part A – Prologue 1996: Treasury Creates The Legal Structure To Facilitate The 2017 Looting Of Canadian Controlled Private Corporations

America is obsessed with its corporations. The primary purpose of the 2017 TCJA was to lower the corporate tax rate from 35% to 21%. Individuals have a “love hate” relationship with Corporations. A country’s tax code is a reflection of the country’s values. The U.S. Internal Revenue Code has a hatred of “all things foreign”. But, nowhere is this hatred reflected more in the treatment of “foreign corporations” (think Subpart F, GILTI, transition tax and PFIC). Given the importance of corporations in U.S. culture and taxation, one would expect the Internal Revenue Code would define “corporation”. Shockingly it does not! The kinds of activities that are to be treated as corporations (unless there is an “opt out”) are defined NOT in the Internal Revenue Code, but in the Treasury Regulations – specifically the entity classification rules found in the 7701 entity classification regulations. These regulations were last subject to significant modification in 1996. The regulations created a class of entities that are called “**per se corporations”. A “per se corporation” is always treated as a “corporation”. This means that if they are “foreign corporations” they are always potentially subject to both the Subpart F and PFIC regimes. Notably almost ALL categories of Canadian corporations (including *Canadian Controlled Private Corporations) are treated as “per se” corporations. Because Canadian Controlled Private Corporations are deemed to be “per se corporations” they were “sitting ducks” for the 2017 TCJA changes – specifically GILT and the 965 Transition Tax.

In an earlier discussion how the 7701 Treasury entity classification regulations deemed Canadian Controlled Private Corporations to be “per se” corporations, I noted that:

Canadian corporations should NOT be deemed (under the Treasury entity classification regulations) to be “per se” corporations. The reality is that corporations play different roles in different tax and business cultures. Corporations in Canada have many uses and purposes, including operating as private pension plans for small business owners (including medical professionals).

Deeming Canadian corporations to be “per se” corporations means that they are always treated as “foreign corporations” for the purposes of US tax rules. This has resulted in their being treated as CFCs or as PFICs in circumstances which do not align with the purpose of the CFC and PFIC rules.

The 2017 965 Transition Tax confiscated the pensions of a large numbers of Canadian residents. The ongoing GILTI rules have made it very difficult for small business corporations to be used for their intended purposes in Canada.

Clearly Treasury deemed Canadian Controlled Private Corporations to be “per se” corporations without:

1. Understanding the use and role of these corporations in Canada; and

2. Assuming that ONLY US residents might be shareholders in Canadian corporations. As usual, the lives of US citizens living outside the United States were not considered.

These are the problems that inevitably arise under the US citizenship-based AKA extraterritorial tax regime, coupled with a lack of sensitivity to how these rules impact Americans abroad. The US citizenship-based AKA extraterritorial tax regime may be defined as:

The United States imposing worldwide taxation on the non-US source income of people who are tax residents of other countries and do not live in the United States!

It is imperative that the United States transition to a system of pure residence-based taxation!

Conclusion: The 1996 Treasury regulations deemed Canadian Controlled Private Corporations to be per se foreign corporations. Because they were deemed to be corporations this meant that they their “U.S. Shareholders” were subject to the Subpart F regime. Being subject to the Subpart F regime was both a necessary and sufficient condition for the 2017 looting of the retained earnings of those corporations through the 2017 965 MRT AKA transition tax.

Part B – The applicability of Subpart F, GILTI and the Transition Tax to “Canadian Controlled Private Corporations”

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Financial Planning For Americans Abroad and By Americans Abroad

Prologue

In the 21st century it has never been more true that:

On the one hand responsible money management, investing and financial planning is a necessity.

On the other hand Americans abroad have been severely disabled from those essential activities by the US tax system.

US citizens presumptively do NOT benefit from tax advantaged financial planning options outside the United States. The circumstance of US citizenship makes participation in non-US pension plans difficult. The PFIC regime operates to make even investing in non-US mutual funds a difficult proposition. Those Americans abroad who attempt to create private pension plans by using small business corporations will likely find that the CFC, Subpart F and GILTI rules make this difficult.

It’s entirely understandable that many Americans abroad have lost their incentive to care financially for themselves and their families.

The message is clear:

When it comes to investing, financial planning and retirement planning US citizenship is presumptively a disability!

That said, it’s essential that US citizens do NOT allow the US extra-territorial tax regime to cause them to NOT engage in retirement and financial planning! They must adopt a “can do” attitude and understand that even with the disability of US citizenship, they can – with the proper advisors – invest for retirement like the citizens of all other countries. In fact, those who are successful, can take pride in the fact that they succeeded NOT because they were American but in spite of being American! Those who are successful can proudly and defiantly say:

“I’m American, but I’m gonna invest for retirement anyway!”

For Americans abroad investing and retirement planning requires a positive mindset and often a competent advisor.

At a minimum, Americans abroad need financial advisors who understand what it means to be an American abroad.

Creveling and Creveling – Financial Planners For Americans Abroad By Americans Abroad

Investment advisors for Americans abroad is a growing industry. I recently had the opportunity to meet and talk with Peggy Creveling, who is one of the two Crevelings who is part of Creveling and Creveling a Thailand based financial planning firm. Investing and financial planning is a “long term” commitment in the same way that health and fitness is a long term commitment. Most people need a mentor and motivator. This requires that they meet the right kind of mentor who will guide them toward their specific goals.

As part of my podcast series for the American Expat Financial News Journal I had the opportunity to meet and chat with Peggy Creveling. This resulted in the following two podcasts:

Part 1 – From growing up in Ohio to West Point to Thailand – The Making Of A Financial Planner
https://americanexpatfinance.com/podcasts/35-basic-financial-fundamentals-that-makes-all-the-difference-for-americans-who-live-abroad-3

Part 2 – Thinking about financial planning and investing – the difference between investing and speculating
https://americanexpatfinance.com/podcasts/36-thoughts-on-financial-planning-for-u-s-expats-part-2

Bottom line: Americans abroad really need to commit to investing and financial planning. You are likely to find the insights and thoughts of Peggy Creveling to be helpful!

John Richardson – Follow me on Twitter @Expatriationlaw

Thinking About Financial And Life Planning For US Citizens Living Outside The United States

Introduction

This week I am giving a (short) presentation on this topic. I created some slides that are designed to provide the categories for discussion. I thought I would share the slides in this blog post.

John Richardson – Follow me on Twitter @Expatrationlaw

IRS Relief Procedures For Former Citizens Update – Relief For Former Green Card Holders Coming!

Introduction

On December 17, 2019 Gary Carter published a post on Tax Connections, which outlined the “Options Available For U.S. Taxpayers With Undisclosed Foreign Financial Assets“. It contained an excellent overview and analysis which included a discussion of the IRS definition of “non-willfulness” under the Streamlined Program. In commenting on the definiton of “non-willful” he noted that:

The IRS definition of non-willful covers a lot of territory. Negligence, for example, includes “any failure to make a reasonable attempt to comply with the provisions of the Code” (IRC Sec. 6662(c)) or “to exercise ordinary and reasonable care in the preparation of a tax return” (Reg. Sec. 1.6662-3(b)(1)). Further, “negligence is a lack of due care in failing to do what a reasonable and ordinarily prudent person would have done under the particular circumstances.” (Kelly, Paul J., (1970) TC Memo 1970-250). The court also stated that a person may be guilty of negligence even though he is not guilty of bad faith. So the fact that you ignored the FBAR filing requirements for many years, and failed to report your foreign income, might be negligent behavior, but it’s probably not willful. That means you likely qualify for one of the new streamlined procedures. On the other hand, if you loaded piles of cash into a suitcase and lugged it over to Switzerland to conceal it from the IRS, you don’t qualify, because that is willful conduct. If you believe your behavior may have been willful under these guidelines, consult with an attorney before submitting returns through one of the streamlined procedures. We work with attorneys who are experts in this field and we would be happy to provide a referral, free of charge or obligation.

Notably, the definition of “non-willfulness” for the Streamlined Program is the same as the definition for the new “IRS Relief For Former Citizens Program”.

Part A – IRS Relief For Former Citizens Who Relinquished U.S. Citizenship After March 18, 2010 (the date FATCA became law)

The program was announced on September 6, 2019.

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Part 12 in series: The Emotional Toll of US Non-Resident Taxation and Banking Policies – “I Love the US but Feel Betrayed”

Before moving to the post, if you believe that Americans abroad are being treated unjustly by the United States Government: Join me on May 17, 2019 for a discussion of U.S. “citizenship-based taxation” as follows:

You are invited to submit your questions in advance. In fact, PLEASE submit questions. This is an opportunity to engage with Homelanders in general and the U.S. tax compliance community in particular.

Thanks to Professor Zelinsky for his willingness to engage in this discussion. Thanks to Kat Jennings of Tax Connections for hosting this discussion. Thanks to Professor William Byrnes for his willingness to moderate this discussion.

Tax Connections has published a large number of posts that I have written over the years (yes, hard to believe it has been years). As you may know I oppose FATCA, U.S. citizenship-based taxation and the use of FATCA to impose U.S. taxation on tax residents of other countries.
Tax Connections has also published a number of posts written by Professor Zelinsky (who apparently takes a contrary view).

You will find Part 1 to Part 11 of this series of posts here.

Laura Snyder discusses the “emotional toll of U.S. non-resident taxation and banking policies

Laura Snyder has written (in addition to her original four posts) a series of five posts describing and exploring “The Emotional Toll of US Non-Resident Taxation and Banking Policies. Part 10 of this series (comments of Nando Breiter) was a prologue to Ms. Snyder’s five posts.

Now over to Laura …

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