US Citizens who own Foreign Corporations

Issues for a US Citizen who owns a

Foreign Corporation

The general rule is that shareholders do not pay tax on corporate income until the income is distributed as a dividend.

1. FOREIGN PERSONAL HOLDING COMPANY Is your foreign corporation a “personal holding company”

The foreign corporation can be both a domestic personal holding corporation and a foreign holding corporation. Test for both basically the same.

A. Test for if the corp. is a FPHC.

1. More than 50% of the stock is owned by fewer than 5 people. (FPHC does not apply if 11 s/h own equal shares =9.99% each)
AND

2. 60% of its adjusted GROSS ordinary income is from

Personal Holding Company Income

(1) Dividends, etc. Dividends, interest, royalties (other than
mineral, oil, or gas royalties or copyright royalties), and annuities.

(2) Rents The adjusted income from rents; except that such adjusted income shall not be included if—
(A) such adjusted income constitutes 50 percent or more of the adjusted ordinary gross income,
and
(B) the sum of dividends paid and deemed and consented paid > than X. X = PHCI – (10% X OGI)

For example,

PHCI is 40,000 and OGI is 30,000

Dividends have to be paid > 7,000 (40,000-33,000)

(3) Mineral, oil, and gas royalties
(4) Copyright royalties
(5) Produced film rents
(6) Use of corporate property by shareholder
(7) Personal service contracts

(A) Amounts received under a contract under which the corporation is to furnish personal services; if some person other than the corporation has the right to designate (by name or by description) the individual who is to perform the services, or if the individual who is to perform the services is designated (by name or by description) in the contract; and
(B) amounts received from the sale or other disposition of such a contract.
(8) Estates and trusts

2. PASSIVE FOREIGN INVESTMENT COMPANIES

The foreign corporation is PFIC if either:

A. 75% or more of its gross income is from passive income
(Dividends, Interest, Rents)

B. 50% or more of the average value of the corporate’s ASSETS during the year: 1. produce passive income

2. or held for the production-of passive income. (for example holding raw land)

The asset test is met if 50% or more of the foreign corporation’s average assets (as defined in the IR Code) produce, or could produce passive income, or are assets (such as cash and bare land) that produce no income. The test is applied based on the foreign corporation’s adjusted basis, for U.S. tax purposes, of the assets, or at the election of the particular shareholder, fair market values of the assets.

Look-thru of 25% subsidiaries: Interests in 25% or more owned foreign corporations are treated similarly to partnership interests (i.e., looked through) for the income test and the asset test.

NOT PFIC income

1. Rents from an active business

2. Banking income

3. Dividends or interest received from a related person
Incorporated in the same country as PFIC

Can be subject to these rules even if you own just one share.

Indirect shareholder of a PFIC must report. Generally, a U.S. person is an indirect shareholder of a PFIC if it is:

A 50%-or-more shareholder of a foreign corporation that is not a PFIC and that directly or indirectly owns stock of a PFIC,

A shareholder of a PFIC where the PFIC itself is a shareholder of another PFIC,

A 50%-or-more shareholder of a domestic corporation where the domestic corporation owns a section 1291 fund, or

A direct or indirect owner of a pass-through entity where the pass-through entity itself is a direct or indirect shareholder of a PFIC. For more information on determining whether a U.S. person is an indirect shareholder, see Temporary Regulations section 1.1291-1T(b)(8) and Notice 2014-28.

For purposes of these rules, a pass-through entity is a partnership, S Corporation, trust, or estate.

NO DEEMED DISTRIBUTION

But when distributions are made taxed at highest rate + interest.

Can avoid by making election to include % of income even though not distributed.

A taxpayer may avoid the regime by purging the PFIC taint by a deemed sale election, a deemed dividend election, or by means of two alternative elections: (1) the qualified electing fund (QEF) or (2) the mark-to-market election. If a QEF election is made, a taxpayer usually includes in income each year its pro rata share of the PFIC’s ordinary earnings and its pro rata share of the PFIC’s net capital gain. Taxpayers holding marketable PFIC stock may make the mark-to-market election to include annually in gross income the excess of the fair market value over the PFIC stock’s adjusted basis

3. CONTROLLED FOREIGN CORPORATION DEEMED DISTRIBUTION

I Ownership Test.

A. 10% rule Must have one US shareholder who owns 10% of voting power

(CFC does not apply if 11 US shareholders own equal shares =9.99% each)

Is John Smith a shareholder in any corporation where a US shareholder has 10% interest.

And voting means can the 10% or more s/h elect in 10% or more of the Board of Directors.

10% count includes shares owned by family members, TRUST, stock thru intermediate corporations

John Smith owns 50% of F1 and F1 owns 30% of F2, John Smith is deemed to own 15% of F2.

AND

B. More than 50% of corp owned by US Shareholders.

II. Type of Income Test,

If CFC does the CFC have Income that is a problem

1. Foreign Personal Holding Company Income

2. Foreign Base Company Sales Income

US corp sets up overseas corp F that buys and sells to customers around world to take advantage of low tax rates for corp F.

3. Foreign Base Service Income

F Corp provides services for a related person (US parent for example) And services not perform in the country where F is located.

4. Foreign Base Shipping Income

5. Foreign Base Oil Income

We will ignore 2,3, 4, and 5.

Remember No “Deemed Distribution if CFC has no earning and profits.”

Additional RULE

If the CFC has passive assets = 25% of total assets, then
DEEMED DIVIDEND for excess passive assets.

GOOD NEWS only “US Shareholder” – 10% voting has “Deemed Distribution”

See your tax advisor before using this Memorandum.

Elections for 1st Year Real Estate Projects

ELECTIONS FOR 1st YEAR REAL ESTATE PROJECTS

When preparing the initial tax return here are the elections for 1st year real estate projects to consider.

1. Accrual of real estate taxes IRC 461(c) with the election included the following information as required by 1.461-1(c)(3)(i)

2. Start up expenses IRC 195(b)

3. IRC 709 Amortization of Organizational Expenditures.

4. De Minimis Safe Harbor Election 1.263(a)-1(f)

For the average taxpayer the amount of an item than can be expensed rather than capitalized is $2,500 1.263(a)-1(ii)(D).
An average taxpayer here is one who does not have audited financial statements.

If you use the de minimis safe harbor, do you have to capitalize all expenses that exceed the $2,500?

No. Amounts paid for the acquisition or production of tangible property that exceed the safe harbor limitations aren’t subject to the de minimis safe harbor election. Therefore, the safe harbor doesn’t require you to capitalize all amounts paid for tangible property in excess of the applicable limitation. If an amount doesn’t qualify under the de minimis safe harbor, you should treat the amount under the normal rules that apply, i.e., currently deductible if paid for incidental materials and supplies or for repair and maintenance. This treatment is proper regardless of whether the amount exceeds the applicable de minimis safe harbor limitation. The de minimis safe harbor is simply an administrative convenience that generally allows you to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules.

5. Amounts paid to improve tangible property – Election to Capitalize Repair and Maintenance Costs. 1.263(a)-3(n)

A taxpayer may elect to treat amounts paid during the taxable year for repair and maintenance (as defined under § 1.162-4) to tangible property as amounts paid to improve that property under this section and as an asset subject to the allowance for depreciation if the taxpayer incurs these amounts in carrying on the taxpayer’s trade or business and if the taxpayer treats these amounts as capital expenditures on its books and records regularly used in computing income (“books and records”)

6. Adoption of the method of accounting recurring time exception for accrual basis tax payer. 1.461-5(d)(1)

The election to adopt the as part of the method of accounting for the first taxable year in which that type of item is incurred.

Generally an accrual taxpayer can take a deduction in the taxable year in which all the event has occurred.

A. All events test,

All events have occurred that determine the fact of there being a liability.

The liability can be determined reasonably accurately.

B. Economic performance has occurred.

The Exception is to meeting B. – the economic performance
is granted IF

1. The economic performance does finally occur within 8 and ½ months of the year end.

2. The liability is recurring in nature.

And

The amount of the liability is not material

The accrual in the present tax period is a
“better match” with the related income for the
present period than when economic performance
actually occurs.

SUBSEQUENT YEAR ELECTIONS NEEDED TO BE MADE EACH YEAR

1. De Minimis Safe Harbor Election 1.263(a)-1(f)(5)

A taxpayer makes the election by attaching a statement to the taxpayer’s timely filed original Federal tax return (including extensions) for the taxable year in which these amounts are paid. Sections 301.9100-1 through 301.9100-3 of this chapter provide the rules governing extensions of the time to make regulatory elections. The statement must be titled “Section 1.263(a)-1(f) de minimissafe harbor election” and include the taxpayer’s name, address, taxpayer identification number, and a statement that the taxpayer is making the de minimissafe harbor election under § 1.263(a)-1(f).

2. Election to capitalize repair and maintenance costs – 1.263(a)-3(n)

n(2)Time and manner of election. A taxpayer makes this election under this paragraph (n) by attaching a statement to the taxpayer’s timely filed original Federal tax return (including extensions) for the taxable year in which the taxpayer pays amounts described under paragraph (n)(1) of this paragraph. Sections 301.9100-1 through 301.9100-3 of this chapter provide the rules governing extensions of the time to make regulatory elections. The statement must be titled “Section 1.263(a)-3(n) Election” and include the taxpayer’s name, address, taxpayeridentification number, and a statement that the taxpayer is making the election to capitalize repair and maintenance costs under § 1.263(a)-3(n).

3. Amounts paid to improve tangible property -. 1.263(a)-3

(h)Safe harbor for small taxpayers –

(1)In general. A qualifying taxpayer (as defined in paragraph (h)(3) of this section) may elect to not apply paragraph (d) or paragraph (f) of this section to an eligible building property (as defined in paragraph (h)(4) of this section) if the total amount paid during the taxable year for repairs, maintenance, improvements, and similar activities performed on the eligible buildingproperty does not exceed the lesser of –

(i) 2 percent of the unadjusted basis (as defined under paragraph (h)(5) of this section) of the eligible building property; or

(ii) $10,000.

So if the item is lessor than 2% of the building basis or 10,000 the taxpayer can expenses under the Safe Harbor.

For example if you have a rental property with a unadjusted basis of 400,000 then 2% would be 8,000 and that would be your cut off to aggregate amount that could be expensed.

Time and manner of election. A taxpayer makes the election described in paragraph (h)(1) of this section by attaching a statement to the taxpayer’s timely filed original Federal tax return (including extensions) for the taxable year in which amounts are paid for repairs, maintenance, improvements, and similar activities performed on the eligible buildingproperty providing that such amounts qualify under the safe harbor provided in paragraph (h)(1) of this section.

SAFE HARBORS

1. For those of you who have a retail establishment or a restaurant and are wondering if your remodeling cost should be capitalized or expensed. The IRS offers a SAFE HARBOR of taking all of the costs of remodeling and allocating 75% to repairs and 25% to Capital improvement. Rev. Proc. 2015-56.

The incredible part is that you have to have an audited financial statement. However the audit fee could be well worth the cost to be able to write of 75% of the remodeling costs.

Late S Corporation election for year 2016

Do you need to make a late election for your C corporation to be a S Corporation for 2016?

1. Fill out the 2553.

2. Sign and date the 2553 and the following example. Make sure you see a qualified tax preparer to make sure the following form is sufficient for your situation.

3. Mail to the IRS Service Center: either Cincinnati OH or Ogden UT. I would suggest sending certified mail.

4. The IRS should send you notification one way or another is accepted or rejected.

EXAMPLE

ABC Inc.
Late S Corporation Election
2016
47-5411111

IRB 2013-36

Section 4 .03 General Procedures

1. Properly filled out form 2553 with “Filed Pursuant to Rev. Proc. 2013-30″ written across the top of the Form.

2. Statement of Reasonable Cause/ Inadvertent Statement

The Taxpayer’s failure to file Form 2553 timely was inadvertent; due to a miscommunication regarding the filing deadlines. As soon as the Taxpayer discovered that the 2553 was not filed, the Taxpayer file this 2553.

Under penalties of perjury, I declare that I have examined this election, including accompanying documents, and, to the best of my knowledge and belief, the election contains all the relevant facts relating to the election, and such facts are true, correct, and complete.

___________ ___________________
Date Carol Smith
President ABC Inc.

Section 5 .02 Supplemental materials

3. Shareholder Statement of Consistent Treatment

As the sole 100% shareholder from the Effective date of the election, January 1, 2016, through today I have and will on subsequent tax returns, 1040s, report my income consistent with the S corporation status.

__________ _____________________
Date Carol Smith
Sole Shareholder

2016 Year End Tax Planning for Businesses

2016 YEAR END TAX PLANNING FOR BUSINESSES

Some points to consider as we come to the end of 2016.

1. RETIREMENT PLANS – a great opportunity to reduce your taxes.

A. 401K plans, Defined contributions, Defined benefit plans.

1. Need to be set up before the end of the year.

2. But you have til the due date of the 2016 return (could be extended to 9/15/17 for corps and partnerships) to fund the 2016 liability.
B. Tax credits for setting up retirement plan 1st year start up 50% of startup cost. At least one person in the plan must be a non highly comp employee.
For example, you pay 2,000 to ADP to start your 401K plan. But max credit is $500.

C. The SEP retirement plan can be established and funded in 2017 by the due date of the tax return including any extension.

2. EQUIPMENT – If you need new equipment, this is a good time to buy.

A. 179 expense personal property

New and used property is eligible

B. Bonus depreciation 50% write off

New property only
3. RECORDS. Good record keeping is critical to making sure you capture all of the deductions allowed.

A. Capture your deductions.

1. Checking account business (separate from personal)

2. Credit Card accounts (don’t mix and match)

3. Out of pocket costs cash purchases ( post office staples)

4. Mileage for auto + parking +tolls + actual costs (insurance repairs gas )

5. Office in the home

6. Equipment (desk, phone, lamp) purchased as personal item now used in business.

4. ACCELERATE EXPENSES AND DEFER INCOME. Defer billing in December with the idea that the delay will cause the receipt of payment until 2017.
5. REVIEW WHETHER FOR 2017 CHANGE FORM OF BUSINESS ENTITY.
6. AUTO RULES – two methods.
A. Standard 54 cents a mile + parking + tolls. If you want to use standard must elect first year. So your 2000 Ford Taurus needs a new transmission and air conditioning – you can switch to actual.
B. Actual

Once you elect Actual you cannot switch back to standard.

Repairs
Gas
Insurance
Car tax
Interest expense

Depreciation

1. New car 50% Bonus Depreciation max 1st year 8,000 (bonus) + = 11,160

2. Used car not eligible No 50% bonus
Standard depreciation 3,560.

3. 179 New and Used car qualifies (used more than 50% in business)

If your car weighs over 6,000 lbs, eligible for a $25,000 write off

If you car weights under 6,000 lbs then 1st year combined = 3,160 limit.
7. HEALTH CARE INSURANCE CREDIT.

The Small Business Health Care Tax Credit helps small businesses pay for health care coverage they offer their employees. You’re eligible for the credit if:

1. You buy the insurance thru SHOP Marketplace.

2. You have fewer than 25 employees who work full-time, or a combination of full-time and part-time, with average wage < 50K.

3. Pay at least 1/2 of premium.

4. The maximum credit is 50 percent of premiums paid for small business employers.
https://www.healthcare.gov/small-businesses/employers/

OID Coupon vs OID bond on a US Strip Treasury

How is a US Strip Treasury OID taxed for Coupon and Bond portions.

I am looking at a Schwab statement that has as description “US Treasury Strip O%26” and in box 8 of the 1099 INT is $3,037. So the idea is that some bright financier has purchase the whole bond and strip it into 2 components. The annual interest portion or the “Coupon” bond and then a second part the “Principal” bond.

For example: Bond pays 2.5% interest for 10 years before being split.

Principal Bond portion of Strip 80,000 (2016 FMV) —– 100,000 (2026 payout) OID is 20,000.

Coupon portion 20,000 (2016 FMV) —– 25,000 (2026 payout) OID is 5,000.
Keep in mind with the Coupon portion you dont actually get 2,500 in cash each year, rather you get 25,000 in cash 10 years from now.

So the Schwab statement says the OID is $3,037 but I have no idea if the client owns the coupon bond portion of the Strip or the principal bond portion of the Strip. And I have concluded it does not matter.

If you look at IRS publication 1212 you get the following info:

“If you strip one or more coupons from a bond and then sell or otherwise dispose of the bond or the stripped coupons, they are treated as separate debt instruments issued with OID. The holder of a stripped bond has the right to receive the principal (redemption price) payment. The holder of a stripped coupon has the right to receive an interest payment on the bond. The rule requiring the holder of a debt instrument issued with OID to include the OID in gross income as it accrues applies to stripped bonds and coupons acquired after July 1, 1982. So the OID rule applies to both stripped bond portion and stripped coupon portion of the bond.”
The IRS goes on in Pub 1212,
“The amount shown in box 8 of the Form 1099-OID you receive for a stripped bond or coupon may not be the proper amount to include in income.” The IRS is confusing in its instructions. You can have US stripped bonds, state and city stripped bonds, and private stripped bonds. If you include in Box 8 then this is for state and city OID. In other words box 8 is for state and city bonds with OID that are tax exempt at the federal level but taxable at the state level if the bond is not a bond from your state ( an out of state bond). However interest on a federal obligation like a US Treasury Bill or Note or US Strip Treasuryies are taxable at the Federal level, but not at the state level. So the US OID has to be entered in Box 3.
I am going to pick up the OID as taxable federal and not taxable state. The question comes to mind why not just buy a treasury bond? Why would I want to recognize interest income and have no cash to show for it?

The other thought is that this US Strip Treasury bond is in a child’s name and with the time I spend figuring out the Kiddie tax form on 2 children’s 1040s and my cost and time does it really do the family any benefit investing in these US Strip Treasury obligations. The Kiddie tax on the 1st $1,050 of income is $0, so the savings in not including the US Strip Treasury interest is the parents rate at 25% or $262.50. The child’s rate is used on the interest income from $1,050 to $2,100 so that rate is 10% vs the parent rate leaves a savings of $157.50. On any income earned on the instrument from $2,100 to $3,037 is tax at the parents rate and so no benefit. So the total benefit is $420 and I charged $400 to do the child’s return.

Now IRS form 8814 allows the parent to elect to report the children’s interest and dividends on their tax return and thus avoid having to prepare a separate return and related cost for the child’s tax return preparation. The problem here is that once there is a stock or bond sale of one of the child’s investment a schedule D is required and then the parent cannot elect to use the 8814 form reporting of income and the child has to have a separate tax return prepared on their behalf.

Here is an example from Wikepedia:

Example Original Issue Discount

Bond Issuance Price	$7,462
Bond Redemption Price	$10,000
Original Issue Discount	$2,538

Most loans require interest payments. Loans that require inadequate or no interest payments bear original issue discount. Whether interest is adequate is determined with reference to the applicable federal rate (AFR). Under the Internal Revenue Code, original issue discounts on debt instruments are taxed each year, even though the debt may not be repaid until a later date. The tax system will impute an interest rate on the loan. The rules for calculating the original issue discount utilize a compounding interest formula, with the principal recalculated every six months. Section 1272(a) of the tax code requires that the Original Issue Discount is includible in the lender’s taxable income at the end of each tax year, or part of the tax year if the loan was not owned for the full year.

The daily portion of the discount uses a compounded interest formula with the principal recalculated every six months. The following table illustrates how to calculate the original issue discount for a $7,462 bond with a $10,000 repayment and a three-year maturity date:

Period	Adjusted Issue Price	Yield	Original Issue Discount
1	$7,462	.05	$373
2	$7,835	.05	$392
3	$8,227	.05	$411
4	$8,638	.05	$432
5	$9,070	.05	$454
6	$9,524	.05	$476
Redemption	$10,000

This is a general tax discussion. You need to consult your own tax preparer before taking any action on this discussion above. I hope this has been helpful on OID Coupon vs OID bond on a US Strip Treasury treatment.