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A Plain English Tax Guide For
U. S. Owners of
Controlled Foreign Corporations and International Business Companies |
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There is an enormous amount of nonsense being spread about the tax benefits of owning a foreign International Business Company (IBC) or corporation in a tax haven country by U.S. shareholders. The Internet is full of misleading information that is going to get a lot of U.S. investors and business owners in serious trouble with the IRS. Within some very limited circumstances , it is possible for a U.S. person to defer taxes with a foreign operating (non-investment) corporation or IBC.
This non-technical report is for the benefit of U.S. investors and entrepreneurs who have non-tax reasons for "going offshore" and who want to avoid future problems with the IRS. As much as possible, the authors have described these rules in plain English but the guide includes an extensive glossary to define any tax jargon or acronyms that are used in the book.
Do you own a foreign corporation or international business company? Are you thinking about creating one to save taxes? Here are plain English answers to your questions about the complicated and confusing U.S. tax rules that apply to foreign corporations controlled by U.S. shareholders.
The Controlled Foreign Corporation Tax Guide (3rd Edition) by Vernon K. Jacobs, CPA and J. Richard Duke, J.D., LL.M. provides understandable and straight explanations of what's legal and what's not.
In order to avoid
problems with the IRS,
this report is a must
read.
If you are inclined to engage in some "shady" tax strategies, this report will tell you what kind of problems you may have if you are ever audited.
Jacobs and Duke are the co-authors of Offshore Tax Strategies and Legal Ways to Save Taxes Offshore & Onshore,published by Offshore Press, Inc. Duke is a highly respected international tax lawyer and an adjunct professor of international tax law. Jacobs is a tax CPA with a focus on international tax planning and over 25 years of experiences as a tax editor for consumer tax publications. Duke is the legal expert. Jacobs knows how to explain it.
Their Controlled Foreign Corporation Tax Guide is a 180 page explanation of the basic
rules that apply to foreign
corporations and international business companies (IBC) owned and
controlled by U.S. shareholders.
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How to
Order This Book
The CFC Tax report
is included in the International Wealth Protection On-Line Library. and
The CFC Tax Report is available as an e-Book for $43. |
Don't let yourself be conned by slick promoters who tell you how easy it is to save taxes with an offshore corporation or IBC. There are some tax savings available but they aren't easy. If you don't follow the rules, you could be guilty of tax evasion -- which is a felony in the U.S. The IRS may not try to put you in jail but they can make your life a living hell if they ever suspect that you own a foreign corporation and aren't complying with the tax rules.
This is the only understandable and accurate tax manual available on this subject.
The only other accurate guides on this subject are highly complicated and nearly impossible to read tax manuals for tax professionals. Jacobs and Duke have translated and condensed these complicated tax rules for the benefit of taxpayers and financial or legal advisors who are not international tax specialists. Here is a table of the contents of the Controlled Foreign Corporation Tax Guide and some selected excerpts. (Most of the excerpts provided are only portions of the material in the related topic section.)
Controlled Foreign Corporations
Under limited circumstances, a U.S. person can be a shareholder of a foreign corporation who is not required to pay U.S. income taxes on the income of the corporation until that income is distributed to the U.S. owners as a dividend (or possibly as a salary). However, there is no easy or short way to explain these rules.
The foreign corporation rules and the controlled foreign corporation rules are so complicated that it is either impossible or almost impossible to explain them without simply copying the relevant tax code sections and IRS regulations. Due to these complex rules, promoters offer convincing arguments that their tax avoidance or tax deferral schemes are legal. It is a gross exaggeration to say that all income of a foreign corporation is not currently taxable, but it is also inaccurate to say that all income of a foreign corporation is currently taxable to its U.S. shareholders.
Many years ago, the income of foreign corporations was not taxed unless it was derived from U.S. sources. In 1962, new tax laws were created to deter the use of foreign corporations as a way to avoid taxes. These rules have evolved into the insanely complex rules referred to as the "controlled foreign corporation" rules. U.S. shareholders of a controlled foreign corporation (CFC) are subject to current income tax on "certain" income of the CFC. Generally, foreign investment income, U.S. source income and certain kinds of foreign source business income are subject to current taxation to U.S. shareholders.
This report provides a simplified and abbreviated explanation of the "certain" types of income that are taxable and not taxable.
How to order the CFC Tax Guide
The U.S. does not have the legal authority or right to impose a tax on a foreign person or foreign corporation unless that person or corporation has U.S. source income. However, the U.S. does have the authority and legal power to impose a tax on the U.S. shareholders of a foreign corporation -- even if the corporation has no income from U.S. sources.
A controlled foreign corporation is one in which U.S. shareholders own more than 50 percent, by vote or value, of the foreign corporation. Only U.S. persons can be "U.S. shareholders." IRC Section 957(c) refers to IRC Section 7701(a)(30) for the definition of a U.S. person, which is very broadly defined to include individuals, partnerships, corporations, trusts and estates.
A U.S. shareholder, for purposes of determining whether there is a controlled foreign corporation, is one who owns 10 percent or more, by vote, of the foreign corporation [IRC Section 951(b)]. In determining the 10 percent or more ownership, the attribution rules (described in the book) of both IRC Section 958(a) and IRC Section 958(b) apply. Once it is determined (through direct ownership, indirect ownership under IRC Section 958(a) and constructive ownership under IRC Section 958(b)), that there are, in the aggregate, U.S. shareholders who own more than 50 percent, by vote or value, in the foreign corporation, it is classified as a controlled foreign corporation (CFC).
Please note that only those shareholders that own (directly or indirectly) 10 percent or more of the foreign corporation stock are included in the "more than 50 percent" ownership test. Thus, a foreign corporation with twenty U.S. shareholders with equal shares of 5 percent of the foreign corporation is not a CFC. Or, if one or more foreign persons own 50 percent or more of the corporation, then no combination of U.S. persons can own "more than 50 percent" of the foreign corporation. If one U.S. person owns 40 percent of a foreign corporation, and ten U.S. persons each own 6 percent, it is not a CFC, even though U.S. persons own 100 percent of the stock. Only one of those U.S. persons is a "U.S. shareholder" as defined for this purpose.
However, each U.S. person's ownership percentage is determined by taking into account the attribution and constructive ownership rules. The phrase "attribution" means that one taxpayer is deemed to own the shares of certain other related taxpayers - such as a spouse, child or parent - because the law presumes that these persons have a common interest. "Constructive ownership" is the same as attribution but it is usually applied with respect to entities in which the taxpayer has some control or beneficial interest. A beneficiary of a trust or estate is deemed to own a portion of any stock owned by the trust or estate, based on the rights of the beneficiary with respect to distributions from the trust or estate.
A 50 percent or more shareholder of a corporation or the owner of 50 percent or more of a partnership is deemed to have a proportionate interest in stock owned by the corporation or partnership. Thus, ownership of a foreign corporation is derived from the direct ownership of the taxpayer plus any indirect ownership arising from the attribution and constructive ownership rules. With respect to foreign corporations, these rules are insanely complicated and this is the shortest explanation we can offer without getting involved in the maze of code sections relating to this subject.
However, these terms are further discussed in connection with the explanation of "subpart F" income in the book.
NOTE: Even if a foreign corporation is
not a controlled foreign
corporation, U.S. shareholders may still be subject to tax on the
income
of the corporation if it is a passive foreign investment company --
which is a foreign corporation that has over 50% of it's assets
invested to earn passive income or that receives over 75% of its total
income from passive investment sources such as interest, dividends and
capital gains.
How to order the CFC Tax Guide
The August 17, 1999 issue of Business Week describes a "tax scheme" that was promoted by a broker for Paine Webber - but apparently without the knowledge of Paine Webber. Apparently this broker recommended a Bahamian international business company ("IBC") for Americans to avoid current income taxation on their investment income. An IBC is generally formed in a no-tax jurisdiction by non-residents (such as Americans). The scheme apparently worked for a while because the Bahamian IBC's are not required to disclose who owns the company. Thus, Paine Webber allegedly thought it was dealing with a foreign corporation that is allowed to invest in certain kinds of U.S. securities, tax-free.
The thrust of the article is that the
broker should have known
better and was promoting a tax evasion scheme. U.S. citizens and
residents are required to pay taxes on their worldwide income and, if a
U.S. person controls a foreign corporation, that U.S. person is
required to pay income taxes on certain (subpart F) income of the
foreign corporation. Generally, any investment type income is subject
to
tax by the U.S. owners of the foreign corporation.
How to order the CFC Tax Guide
A non-resident alien (including a non-resident foreign corporation) can invest in U.S. stocks and any gains are not subject to U.S. taxes. A non-resident alien is not taxed on interest on investments in U.S. government securities or certain kinds of U.S. bank or S&L obligations. In addition, any income or gains derived from investing in any non-U.S. investments are tax-free if the corporation is domiciled in a tax haven. A great many U.S. taxpayers want to be the owner of a foreign corporation that can generate tax-free investments, but they clearly are not aware of the complicated obstacles that Congress has put in their path.
A U.S. person who funds a foreign trust or entity with cash may believe a secret account can then be created. However, transfers of large sums of money may leave a trail. Transfers of small sums are not adequate to offset the fees to create and maintain the entity and pay the money manager. Secret accounts or investments may be detected in a number of ways. Telephone calls, faxes, mail and travel to visit with money managers of the assets for the foreign trust or foreign entity leave a trail.
The U.S. tax law imposes severe penalties for not filing various reports for this kind of arrangement. A corporation is more visible than a secret bank account, and is more likely to be noticed by an inquisitive auditor. Or the corporation may be reported to the IRS by an angry former partner, former spouse, former lover or another person.
Also, foreign money managers can mismanage the assets in the secret account or misappropriate the money for their own benefit. This leaves one in a serious situation. Should he file suit in a foreign jurisdiction against the money manager? If suit is filed against the money manager, it may become public knowledge in this particular jurisdiction and spread, even to the U.S. and possibly to the IRS. Again, the point is that so-called secret accounts cause serious potential issues to arise.
Are you willing to trust a promoter who helps you break U.S. laws? If he is dishonest in one area, why do you believe he will be honest in dealing with you?
How to order the CFC Tax Guide
Some of the stuff we see about saving taxes offshore is so blatantly false, we have to believe the people making these claims are not smart enough to be real con artists. Here’s an example of a portion of a letter we received in the mail. The writer is promoting a newsletter that promises to show you how to secure high returns of from 50 percent to 100 percent a year from offshore investments and says:
The promoter apparently believes that because no information return is sent to the IRS, the income is not taxable. All income is taxable to U.S. persons, regardless of whether an information return is sent to the IRS. Those who fail to report all of their income are risking the chance of very punitive interest and penalties at some future date. And, any tax return with omitted income remains open to an audit for an unlimited time.
There are some legal ways to save taxes offshore, just as there are legal ways to save taxes in the U.S. But forming a foreign corporation and then using it to hide investment income from the IRS is not one of them.
How to order the CFC Tax Guide
If you find this information to be discouraging, it may be because you haven't taken a close look at the various legal methods that are available to reduce your taxes.
There are ways to save or defer taxes
offshore with a foreign
corporation, but they aren't simple or easy to accomplish. Basically,
there are no legal ways to avoid or to defer taxes on investment
income offshore just by purchasing the investments through a foreign
corporation or IBC. However, you can legally defer taxes on investment
income with an offshore variable annuity issued by a foreign insurance
company. You can also defer taxes on investment income with a foreign
variable life insurance policy.
For business income, you can legally avoid U.S. income taxes on up to $82,400 per year (in 2007) of earned income (or self-employment income) by living and working outside the U.S. for at least a year. If you are married and your spouse is able to work with you, then you can double the exempt income.
In some limited circumstances, if you have a foreign corporation that is domiciled in a low-tax or tax-free country and the corporation is engaged in buying, selling or manufacturing products, you may be able to defer the income tax on gains from selling such products outside the U.S. There are a number of obstacles and tax traps that must be navigated to achieve this result, but it is possible. Whether it's worth the cost and the hassle is an economic question that depends on the facts and circumstances of each company.
If you give up your U.S. citizenship (after acquiring a citizenship in another country), most other countries of the world only tax permanent residents on their world-wide income. Thus, if you become a citizen of one of those countries and then become a non-resident by moving to a tax haven, the investment income earned outside the tax haven will most likely be tax-free. If you form an international business company in a tax haven any investment income the IBC receives is not taxable in the tax haven.
If you don't want to give up your U.S. citizenship and leave the U.S. to reduce your taxes, then the alternative is to spend some time learning about the various tax avoidance opportunities that are available within the U.S. There are many good reasons to "go offshore," but for the U.S. investor, saving taxes is not one of them.
Form 5471 For U.S. Shareholders
of Foreign Corporations
If you are (1) a shareholder or officer in a foreign corporation, (2) the grantor of a trust that has formed a foreign corporation (aka IBC), or (3) your U.S. corporation or partnership owns shares in a foreign corporation, then you must determine whether you are required to file IRS Form 5471.
This is an "Information Return of U.S. Persons With Respect to Certain Foreign Corporations." It is required to be filed at the time that you file your corporate or personal tax return, including any extended filing date. A second copy must be sent to the Philadelphia office of the IRS.
The IRS estimates that the average time required for record-keeping to prepare this form is 87.5 hours, that the average time required for learning about the form is 26 hours and that the average time required to prepare the form is 32 hours. (That does not include the separate time estimates for schedules J, M, N and O.) Clearly, these time estimates are for fairly substantial business activity rather than for a foreign corporation with only a few transactions.
A nasty surprise that your preparer discovers when reading the instructions is that Schedules C, F and H must be prepared on the basis of U.S. based GAAP (generally accepted accounting principles). This precludes the use of the cash or hybrid method of accounting. The return itself is just four pages, but there are also four pages of worksheets included in the 15 pages of instructions.
You must find out if you or your company is required to file this form. If you have any ownership interest in a foreign corporation or if you are an officer or director of a foreign corporation, you may be required to file this form. If you are the grantor of a foreign trust and if the trust owns shares in a foreign corporation, you may have to file this form. The following is a partial list of who has to file.
This form is required to be filed by a
corporation on March 15 or for an individual shareholder on April 15 or
the extended due
date of your personal or corporate tax return.
Vernon K. Jacobs, C.P.A., C.L.U.
President, Offshore Press, Inc., P.O.
Box 8137, Prairie Village, KS
66208
Phone (913) 362-9667, email: jacobs -[@]-offshorepress.com
[Note: ignore the [ ] and - signs, which are included in order to
minimize the huge amount of spam mail tht we receive.]
Vernon Jacobs has more than 30 years
experience working as a tax and
financial consultant for investors and small business owners. He is the
author or co-author of 26 books including The Best Ways To Legally
Avoid Capital Gains Taxes , The Best Ways To Legally Avoid
Estate
Taxes, Taxwise Investing, The Zero Tax Portfolio Manual
and What’s
In It For Me? - a Guide to the 1997 Tax Laws. He is the co-author
of Risk Management for Amateur Investors
and a co-author of The
Controlled Foreign Corporation Tax
Guide . Vernon is a member of the American Institute of CPAs
International Tax Technical Resource Panel and Chair of a tax force on
the preparation of the Form 5471 for controlled foreign corporations.
He is a frequent speaker at professional or
investment
conferences and has been interviewed or quoted by numerous national
magazines, including USA Today, Bloomberg Wealth Manager, Forbes,
Industry Week, Offshore Finance USA, The Financial Privacy Report and
Forecasts & Strategies .
J. Richard Duke, J.D., LL.M.
Duke Law Firm, P.C., 550 Montgomery
Highway, Suite 300
Birmingham, AL, 35216-1841
Phone (205) 823-3900, Fax (205) 823-2630, email richard at
assetlaw.com. * http://www.assetlaw.com
J. Richard Duke, J.D., L.L.M. practices in the areas of international and domestic tax, estate and wealth preservation, wealth protection planning, and the structuring of offshore and onshore entities and trusts. He is an Adjunct Professor of International Tax and Asset Protection Law and is the author of "U.S. Tax Treatment of Low-Tax Jurisdictions," in International Taxation of Low-Tax Transactions, published by BNA International, Inc. (London, England, 1996). He is a Member of the Asset Protection Committee of the Real Property, Probate and Trust Law Section of the American Bar Association, an Editorial Advisor for the International Wealth Protection Monitor and co-author of The Controlled Foreign Corporation Tax Guide.
He is a partner in the Duke Law Firm, P.C., in Birmingham, Alabama. Duke Law Firm, P.C., is the exclusive U.S. member of the International Business Law Consortium of the Center for International Legal Studies, Salzburg, Austria.
He is a member of the American Bar Association, International Tax Planning Association, The Offshore Institute, the International Bar Association (Business Law), the Alabama State Bar, the Florida State Bar and the Estate Planning Council of Birmingham.
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