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MERICAN BAR ASSOCIATION
Section of Real Property, Trust & Estate Law
19th Annual Spring Symposia, Washington, D.C.
May 1-2,2008
Panel: "Grandma Died with a Cook Islands Trust: Now What?"
Curing Non-Compliance: Practical Factors to Consider
By Michael G. Pfeifer and Lucy S. Lee, Caplin & Drysdale, Chartered
Washington, DC
2008 Michael G. Pfeifer and Lucy S. Lee
[*2] Curing Non-Compliance: Practical Factors to Consider
I. Introduction
A. Root of the Problem Tax Law Complexity
The rules that govern a taxpayer's obligation to file a tax return and
pay taxes in the United States - principally the U.S. Internal Revenue Code
of 1986, as amended (the "Code"), and the Treasury regulations and
administrative practices and procedures thereunder - are exceedingly
complex. For the individual income tax return, the most widely filed return
,2 taxpayers and their representatives, including commercial tax preparation
services, tax accountants and lawyers, annually spend enormous amounts of
time collecting and compiling relevant financial information and determining
how best to complete the return .3 In addition, taxpayers and their
representatives must determine which of a multitude of supporting schedules
and tax information returns should be filed along with, or in addition to,
the tax return.
There are a number of commercially available computer software
programs to assist U.S. taxpayers with their tax returns. Owing to the
complexity of the tax laws, even professional tax preparers use computer
programs (generally more sophisticated than those sold at retail) to assist
taxpayers. However, even that doesn't always ensure that a tax return is
completed correctly or filed timely. This is particularly true for U.S.
taxpayers with income or assets outside the United States and foreign
persons with U.S. income, assets or other connections. Even in an
FN1 Unless otherwise noted, all section references herein are to the Code
and the regulations thereunder.
FN2 For 2005, the most recent year for which complete information is
available, U.S. taxpayers filed 134,372,678 individual income tax returns on
Form 1040 (including Forms 1040A and 1040EZ and electronic returns). IRS
Statistics of Income Bulletin available at www.irs.gov/taxstats
FN3 The Government is obliged to furnish an estimate of the time required
to prepare tax and information returns. The instructions to the 2007 Form
1040, the return filed by most (the instructions say 69%) U.S. citizens and
residents, estimate that an average of 33.5 hours is normally required to
collect, compile and analyze the information necessary to complete and file
the form (at an average cost of $267!). The instructions to the 2007 Form
1O4ONR, the basic income tax return filed by nonresident alien individuals
and foreign trusts, estimate an average time of 29.5 hours (at an average
cost of $204!).
FN4 TurboTax, produced by Intuit, Inc., and TaxCut, produced by H &R
Block, are probably the leading brands available commercially, each
promising the "maximum" refund available. In addition, the instructions to
Form 1040 indicate that, if an individual has 2007 adjusted gross income of
$54,000 or less, he is eligible to use Free File, a service offered by the
Internal Revenue Service ("IRS") in partnership with the Free File Alliance,
a group of tax preparation software companies.
[*3] increasingly "global" economy, it probably is the case that many, if
not most, professional tax advisors do not frequently see - and, therefore,
are not thoroughly familiar with - many of the complex issues that can arise
for U.S. taxpayers with foreign income and assets and foreign persons with
U.S. income, assets and other connections. This is certainly true of the
more exotic and arcane areas of, e.g., foreign trusts, "controlled foreign
corporations" and "passive foreign investment companies."
B. Dealing with "Unforeseen Circumstances
As if the complexity of the Code's foreign tax provisions were not
enough, taxpayers and their tax advisers are often faced with wholly
unforeseen - and oftentimes "murky" circumstances. These might range from
the relatively innocuous receipt of a large foreign gift or bequest from a
remote foreign relative to the more complex and troublesome inheritance of
substantial foreign assets - previously unknown and of questionable origin -
from a U.S. parent.
Dealing with such unforeseen circumstances can raise a host of
questions and potentially complex tax issues for a U.S. tax practitioner. He
generally will know who his client is (although even this can "shift" as he
familiarizes himself with the circumstances). However, he must determine
whether, and to what extent, his client is a potential taxpayer in
connection with the circumstances. This will, of course, vary with the
circumstances. Were the circumstances and the attendant tax issues
completely unforeseen, or did the client have some knowledge of the
circumstances? What was the level of the client's knowledge, and when and
how did he acquire it? In particular, did the client have some
responsibility in creating the circumstances giving rise to the potential
tax issues?
As with any client matter, the U.S. practitioner has to gather the
facts relevant to the determination and resolution of his client's potential
tax issues, but he may have to go beyond the usual scope of such
information-gathering to understand all of the surrounding circumstances,
which may include facts remote in time and place from his client but that
may have an indirect and substantial effect on the clients ultimate U.S. tax
liability. How and when did the client's "unforeseen circumstances" come to
exist? In particular, who put them in motion and with what? Frequently,
events of which a client had no previous knowledge and for which he had no
responsibility will dictate or, at least, influence the strategy that a U.S.
practitioner employs to protect his client from unfortunate U.S. tax
consequences.
In determining how best to handle his client's situation, a U.S. tax
practitioner has to be aware of a multitude of legal and ethical standards.
What are clients obligations as a U.S. taxpayer to file a tax return? What
are client's potential tax liabilities? What are the limitations periods
applicable to the client's circumstances and issues? All of these factors
may be affected by the client's knowledge and potential responsibility for
the circumstances. A U.S. tax practitioner must also be aware of his own
legal and ethical issues relating to his client's unforeseen circumstances
and the issues arising therefrom. Does he have any potential liabilities?
Ultimately, a U.S. tax practitioner must devise a strategy to deal
with, and hopefully resolve, his clients issues in the most tax-efficient
manner possible (which might not always [*4] result in the client paying the
lowest taxes possible). This might range from recommending that the client
take relatively simple compliance steps to correct any prior tax
"mis-steps." Or the practitioner might recommend that the client undertake
"voluntary disclosure," which might be approached in different ways
depending upon the potential seriousness of the clients tax issues and
potential liability.
The balance of this paper will examine
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comment on this article:
The author takes no account of the fact that the US tax on such a foreign
stash of cash might equal or exceed 100% because of the compound interest
portion of the tax on accumulations in foreign trusts.
The correct answer in many cases is to disclaim. A good foreign trust will
have alternative dispositions, perhaps to a foreign charity or to non-US
alternative beneficiaries.
If the foreign "trust" is not in fact a trust but a foundation (Stiftung)
treated as a trust for US tax purposes, but without any US persons in
control, then the answer may be different. The Stiftung (or Anstalt) could
establish a genuine business and then pay salaries for genuine work done
abroad, fully taxable in a foreign country (perhaps one with a totalization
agreement, so no double social security taxation, and the income tax
available for US tax credit; or perhaps exempt as foreign earned income if
the facts are right). Or the foreign trust may have the capacity in its
charter or agreement for foreign trustees to do that.
There are always the issue of "shadow directors" (de facto controlling
persons) and imputed income, but these can be worked around. The authors of
this article didn't want to know: they would, seemingly, expose everything
to the IRS instead of disclaiming. If the major parties in interest are
non-US persons and if the trust was not properly designed as an "immigration
trust" (generally 5 years or so before a foreigner becomes a US person) then
there should be no issues.
There are also the interesting and not uncommon problems of (1) diplomatic
(or quasi-diplomatic) immunity on the part of one person physically present
in the USA but not of that person's spouse (who may be an American citizen,
or may be employed in a non-diplomatic, commercial capacity without tax
privileges). And (2) dual or multiple nationalities, with accidental
American citizenship (the GAO did a report some years ago on nonfiling of US
tax returns, and over a million American citizens abroad never file; most
may not need to). There must be hundreds, perhaps thousands, of
American-Israelis who are technically in violation of US tax law. Most are
middle-class and without the means to deal with US tax law.
Imagine a Libyan-American or a Cuban-American (or one of the other "pariah"
states), resident in that other country and ipso facto in contravention of
all kinds of US laws, tax and other.
The article isn't really about Grandma at all. That was just a catchy title.
Nor was it much about undisclosed foreign assets, especially not about those
which (for example real estate) have to pass under foreign and not US law.
Lots of these cases involve retirees who leave the USA permanently to go
back the old country and effectively abandon US ties -- but not US-born
children and other heirs, which is how the matter comes to the attention of
a US lawyer, one who may know nothing of the real-life workings of conflict
of laws in taxation (where the penalties in one or the other country can be
punitive and confiscatory, but where the cost of compliance, say for someone
who has a house now worth $1 million but annual income of only $20,000
(common enough in Europe today) can be disproportionate and unaffordable.
Punitive issues can arise in rather innocent circumstances: purchase of a
foreign mutual fund, for example, where the internal profits and gains of
the fund are, in principle, taxable immediately whether rolled up or not,
and whether the owner of the shares knows what those internal profits and
gains actually amount to. This can be true of foreign pensions as well,
unless there is a tax treaty provision that derogates from the rule. Do I
hear someone say "double taxation"?
Lots of times the US lawyer should just decline to take the case and advise
the survivors to consult a foreign lawyer with US training and knowledge of
US taxes and probate law. But what US lawyer is going to do that when it
means he won't get the nice fees that go with a case like these?
On 21/04/2008 21:19, in article C432B557.CE6A%papadillos@hotmail.com,
"Papadillos" <papadillos@hotmail.com> wrote:
AMERICAN BAR ASSOCIATION
Section of Real Property, Trust & Estate Law
19th Annual Spring Symposia, Washington, D.C.
May 1-2,2008
Panel: "Grandma Died with a Cook Islands Trust: Now What?"
Curing Non-Compliance: Practical Factors to Consider
By Michael G. Pfeifer and Lucy S. Lee, Caplin & Drysdale, Chartered
Washington, DC
2008 Michael G. Pfeifer and Lucy S. Lee
[*2] Curing Non-Compliance: Practical Factors to Consider
I. Introduction
A. Root of the Problem Tax Law Complexity
The rules that govern a taxpayer's obligation to file a tax return and
pay taxes in the United States - principally the U.S. Internal Revenue Code
of 1986, as amended (the "Code"), and the Treasury regulations and
administrative practices and procedures thereunder - are exceedingly
complex. For the individual income tax return, the most widely filed return
,2 taxpayers and their representatives, including commercial tax preparation
services, tax accountants and lawyers, annually spend enormous amounts of
time collecting and compiling relevant financial information and determining
how best to complete the return .3 In addition, taxpayers and their
representatives must determine which of a multitude of supporting schedules
and tax information returns should be filed along with, or in addition to,
the tax return.
There are a number of commercially available computer software
programs to assist U.S. taxpayers with their tax returns. Owing to the
complexity of the tax laws, even professional tax preparers use computer
programs (generally more sophisticated than those sold at retail) to assist
taxpayers. However, even that doesn't always ensure that a tax return is
completed correctly or filed timely. This is particularly true for U.S.
taxpayers with income or assets outside the United States and foreign
persons with U.S. income, assets or other connections. Even in an
FN1 Unless otherwise noted, all section references herein are to the Code
and the regulations thereunder.
FN2 For 2005, the most recent year for which complete information is
available, U.S. taxpayers filed 134,372,678 individual income tax returns on
Form 1040 (including Forms 1040A and 1040EZ and electronic returns). IRS
Statistics of Income Bulletin available at www.irs.gov/taxstats
FN3 The Government is obliged to furnish an estimate of the time required
to prepare tax and information returns. The instructions to the 2007 Form
1040, the return filed by most (the instructions say 69%) U.S. citizens and
residents, estimate that an average of 33.5 hours is normally required to
collect, compile and analyze the information necessary to complete and file
the form (at an average cost of $267!). The instructions to the 2007 Form
1O4ONR, the basic income tax return filed by nonresident alien individuals
and foreign trusts, estimate an average time of 29.5 hours (at an average
cost of $204!).
FN4 TurboTax, produced by Intuit, Inc., and TaxCut, produced by H &R
Block, are probably the leading brands available commercially, each
promising the "maximum" refund available. I
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