IRS Audit Campaign Targets Nonresident Alien U.S. Real Estate Activities

Two IRS audit campaigns have recently been introduced with prospect to increase NRA compliance with the extensive and complex U.S. tax rules in relation to U.S. real property transactions. 

On October 5^th, 2020, the IRS LB&I (Large Business and International Division) announced the introduction of their latest audit campaign which targets NRA’s (non-resident aliens) who do not correctly report rental income from their U.S. properties.

Another audit campaign was issued on September 14^th 2020 by the LB&I which targeted the non-compliance of NRAs in relation with the withholding of tax and reporting obligations (on the disposition of U.S. real property interests under the FIRPTA 1980)

Key reasons for the introduction of the two audit campaigns:

• Purchase of U.S. real estate by foreign nationals in a major source of investment in the United States.
• In 2019, there was a total of $78 billion of property sales to foreign buyers.
• Figures show that in recent years, the largest share of foreign residential buyers originated from China, Canada, and Mexico.

FIRPTA 1980 – Foreign Investment in Real Property Tax Act of 1980

The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA 1980) was introduced to ensure that investors pay U.S. federal tax on the sale or disposition of U.S. real property interests (also known as USRPI)

U.S. Real Property Interest (USRPI)

A USRPI is an individual, other than a creditor, who holds an in interest in real property located in the U.S. 

U.S. Taxation of Rental Income

Non resident aliens are subject to a 30% U.S. withholding tax on the gross amount of rent received. This is applied on top of the FIRPTA taxation regime that applies to the disposition of the USRPI.

Conclusion

The main purpose of the newly introduced audit campaigns for U.S. real estate that targets non-resident aliens is to focus on NRA non-compliance.

The initiatives behind the two campaigns are to improve and encourage NRA compliance through guidance and examinations implemented by the IRS.

Due to the complexity of the subject, it is advisable that NRA investors seek appropriate and professional advice before the purchase of any U.S. real estate property.

We have highly experienced professionals on our team who would be happy to help. Please call for further information.

FBAR filing requirements 

The FBAR (Foreign Bank and Financial Account Reporting) is necessary for a U.S. person to report their foreign accounts and they may be penalised if they fail to report their foreign bank and financial accounts to the IRS on time.

Therefore, it would be ideal to engage with experienced tax advisors if representation is needed.

Foreign Account Representation

The FBAR Form (also known as FinCEN Form 114) is required to be filed if a U.S. person holds foreign accounts and meets the reporting threshold; the deadline to file this form is normally April 15 although it may be possible to file an extension.

A U.S. person may be subject to fines and penalties if there is a failure to file an FBAR form or filing a late and/or incomplete form and they may still be liable to penalisation if the violation is unintentional. Criminal penalties can also be applied; however, this is uncommon. 

Choosing the right tax advisors to file your FBAR:

We are experienced tax advisors:

Our tax advisors have more than 20 years of professional experience.

A key factor in offshore disclosure is the development and implementation of a legal approach and strategy; for this reason, it is crucial to find a tax advisor who specialises in this area of Tax.

FBAR disclosure experience:

Although acquiring Enrolled agent, tax and accounting qualifications may aid the case, it does not substitute for extensive offshore disclosure experience.

We are experienced tax advisors who deal with Streamlined Foreign Offshore Procedure cases continually with positive results.

If you would like to discuss this further, please contact us.

What is Expatriation?

Expatriation is the process of renouncing a U.S person’s status. 

Expatriation does not necessarily involve exit tax, and whether a person qualifies as an expatriate is not determined wholly by their net worth. If an expatriate is able to apply proper exit tax planning, they could potentially avoid, or minimise, exit tax.

Expatriation is not only for U.S. Citizens

An expatriate can also be a permanent resident as well as a U.S. citizen renouncing their U.S citizenship.

When a legal permanent resident has maintained the legal permanent resident status for a minimum of eight of the last 15 years, they are considered a long-term resident and subject to the covered expatriate analysis.

Please also note that allowing your green card to expire is not an acceptable or valid act of expatriation.

Covered Expatriates

In order to be considered a covered expatriate, the expatriate must meet one of the three tests below:

• Net income tax liability
• Net worth
• Unable to certify tax compliance for five prior years.

Expatriation Methods:

The method of which a U.S. person takes to complete the expatriating act depends on whether a person is a long-term resident or a US citizen. This needs discussion and it is likely advice will be required to complete this process.

Covered Expatriate – Post Expatriation Consequences

It is best for the expatriate to avoid covered expatriate status as even after a covered expatriate leaves the United States, there may be following issues, such as:

• Annual Form 8854 filings
• Gift tax consequences for gifts from covered expatriates to U.S. persons (which will result in an immediate tax liability to the US person).

Exit Tax: Mark-to-Market & Deemed Distribution

Just because a person is considered a covered expatriate, does not mean they will owe exit tax.

The person must evaluate their assets to determine which assets are subject to the mark-to-mark analysis on the unrealized capital, and which assets are possibly subject to the deemed distribution rules.

If you would like to discuss this further, please contact us.

When renouncing their U.S. status, U.S. citizens and Green Card Holders may be subject to Exit Tax. In this circumstance, the IRS requires covered expatriates to prepare an exit tax calculation and certify prior years’ foreign income and accounts compliance.

When a person is considering leaving the U.S. permanently, there may be exit tax planning issues to consider.

Exit Tax and Expatriation involve certain key issues. These typically include:

• • Renouncing U.S. Citizenship
  • Relinquishing a Green Card
  • Exit Tax
  • Form 8854
  • Covered Expatriates

FAQs

What is U.S. Exit Tax?

U.S. Exit Tax is the IRS method of making individuals who are considered U.S. Citizens or Long-Term Residents to pay a tax upon “Exiting” or “Expatriating” from the U.S.

Is there a U.S. Exit Tax for Green Card Holders?

Yes. 

How much is the Exit Tax?

The amount of Exit Tax due is based on various factors, depending on the type and source of income, it may be immediately taxable or taxed at a future date, once the income becomes distributed and taxable.

How much is the Expatriation Tax?

Expatriation Tax and Exit Tax are the same.

How is Exit Tax Calculated?

If the taxpayer is a Long-Term Resident or Citizen with no exception, the person must verify if they meet one of the three threshold requirements to be considered a “Covered Expatriate.” 

1. Net income tax liability
2. Net worth
3. Unable to certify tax compliance for five prior years.

Then, the person calculates the exit tax based on each specific asset.

Categories of individuals and their reasons for exit tax planning:

Long-Term Residents

For some people, they may have citizenship in a foreign country but are considered Legal Permanent Residents (aka Green Card Holders) in the United States and were never made aware of the true tax consequences of being considered a US person (especially worldwide taxation).

Accidental Americans

The typical example of an Accidental American is an individual who is required to report and pay taxes to the United States although they do not consider themselves as an ‘American’; but their parents are/were US citizens and they may have been born in the United States or outside of the United States to U.S. Citizen parents.

U.S. Citizens/Green Card Holder Turned “Expat”

US citizens who have simply moved outside of the United States 

As a result, the idea of paying continual US tax seems illogical and therefore leads to renouncing their US citizenship.

Key Exit Tax Planning Tips

The following are a few key tips to keep in mind:

• Avoid becoming a legal permanent resident to prevent being subject to exit and expatriate tax.

• Avoid being a long-term resident by being a legal permanent resident for less than 8 out of 15 years; to be classified as a long-term resident, the individual would need to be considered a LPR for 8 out of 15 years.

• When it comes time to abandon the legal permanent resident status, it must be done voluntarily. 

• Reduce their net worth to below $2 million, they will not meet the first net value test. One way to reduce net worth is by gifting accounts, money, and assets. 

Avoid the 5-Year Trap

Be sure to be in tax compliance for the five years prior to expatriation. If you have been out of compliance and prior years you may consider offshore disclosure to get into compliance and anticipation of expatriation.

If you would like to discuss this further, please contact us.

We would like to remind you that the deadline for filing the FBAR form, also known as FinCEN Form 114, for 2019 is October 15th 2020. Please ensure you submit your form online by this due date. You can complete and file the form at

Click Here

The Department of Treasury has powers to levy significant penalties if you do not meet your obligations to file.

On August 28, the IRS announced that it would temporarily allow the use of digital signatures on certain forms that cannot be filed electronically. The agency added several more forms (PDF) to that list.

The IRS made this decision to help protect the health of taxpayers and tax professionals during the COVID-19 pandemic. The change will help to reduce in-person contact and lessen the risk to taxpayers and tax professionals, allowing both groups to work remotely to timely file forms.

The IRS added the following forms to the list of those being accepted digitally:

• Form 706, U.S. Estate (and Generation-Skipping Transfer) Tax Return;
• Form 706-NA, U.S. Estate (and Generation-Skipping Transfer) Tax Return;
• Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return;
• Form 1120-ND, Return for Nuclear Decommissioning Funds and Certain Related Persons;
• Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts; and
• Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner.

On 23 July 2020, the Treasury Department and the IRS published final regulations under Section 951A providing guidance with respect to the high-tax exception, which excepts certain ‘high-taxed’ income from being otherwise taxed as “Global Intangible Low-Tax Income” (GILTI). The final regulations maintain the same foreign tax rate threshold to be eligible for a high-taxed income exclusion while simultaneously modifying operational rules that may affect a U.S. individual’s decision to pursue the exclusion. In combination with these final regulations, Treasury and the IRS issued new proposed regulations conforming aspects of the Subpart F high-tax exception with the newly finalized GILTI high-tax exception, and providing for a single high-tax exception election under Section 954(b)(4).

Similar to the Subpart F High-Tax Exception, individual and corporate taxpayers may exclude from GILTI certain high-taxed income earned by a CFC. For this purpose, GILTI is deemed to be high-taxed if it is subject to an effective foreign tax rate in excess of 90% of the maximum U.S. corporate income tax rate. With a current U.S. corporate income tax rate of 21%, this equates to an 18.9% threshold for high-taxed income.

As compared to the proposed regulations, the final regulations offer more flexibility by allowing U.S. shareholders to elect into the high-tax exception on an annual basis. Generally, this applies for tax years beginning on or after July 23, 2020. This permits taxpayers to apply the election retroactively to any CFC tax year beginning after December 31, 2017, if they apply the final regulations consistently to each year for which the election is made.

U.S. individuals with interests in CFCs should discuss these changes with their U.S. tax advisors to better understand how to optimise the tax efficiency of their structures under these new regulations.

Taxpayers are now required to report and pay CGT within 30 days for gains arising on UK residential properties. All disposals of UK real property made on and after 6 April 2020 by UK resident and UK non-residents must be reported through the new CGT on UK property account, which is separate to their personal tax account. The old NRCGT form can now only be used for disposals made prior to 6 April 2020.

HMRC has confirmed that it has fixed an issue with verification that was preventing some taxpayers (particularly overseas taxpayers) from setting up a Government Gateway account in order to access the CGT on UK property account.

Chancellor of the Exchequer, Rishi Sunak, was due to deliver the next Budget in autumn. However, the Treasury have recently announced that the Autumn Budget will be scrapped this year because of the coronavirus pandemic. After borrowing and spending billions on the COVID-19 response so far, the Chancellor was reportedly considering different ways for this money to be clawed back. According to reports, a few of the areas that were going to be looked at were raising capital gains tax and corporation tax.

Mr Sunak has previously said some taxes will need to rise over the medium term. The reported tax increases under consideration included a sharp jump in corporation tax – reports suggested increasing corporation tax from 19% to 24% to increase revenue. Additionally, it was also suggested that capital gains tax might also be paid at the same rate as income tax to increase revenue.

The Chancellor has however insisted that a “horror show of tax rises” were not on the horizon. Mr Sunak said that while the Government “will need to do some difficult things” in an effort to “overcome short-term challenges”, this did not mean “a horror show of tax rises with no end in sight.” Mr Sunak also said that ministers will need to be honest with the public about the challenges ahead and show them how the Government plans to “correct our public finances and give our country the dynamic, low-tax economy we all want to see.”

Despite there being no Autumn Budget this year, there will be a spending review to set out the overall shape of government spending. Typically, the government outlines the state of the country’s finances in the Budget and, crucially, proposes tax changes. But any such decisions will now be put on hold until next year. Instead, the government will reveal how much each department is allowed to spend.

This could mean that the proposed tax changes are now just delayed. It is worthwhile taking these potential proposed changes into account during this period of ongoing uncertainty.

Please do not hesitate to contact us if you wish to discuss any of the matters above.

A number of taxpayers have received letters from HMRC recently outlining that HMRC has information about their offshore income and gains. These letters seem to be different to previous letters which seemed to be ‘fishing expeditions’.

The latest version of the letter confirms that HMRC compared the information received under information exchange agreements with other countries, to the individual’s tax record and tax returns, before sending the letter. This indicates that the letter is not speculative. HMRC is taking a risk-based approach and is only contacting taxpayers where it is unable to reconcile the figures received under information exchange agreements to tax records and tax returns.

All the letters include a “certificate of tax position” form which HMRC asks the individual to complete and return whether they have additional tax liabilities to disclose or not. This is to encourage a response from the individual. HMRC generally gives 30 days from the date of the letter to respond.

If you have received such a letter, you should consider your position very carefully and the subsequent action that should be taken, especially whether the ‘certificate of tax position’ should be signed and returned. Frontier can of course assist with this matter, if you have received such a letter.