We’ve known for some time that the Internal Revenue Service (IRS) has been mining heaps of data provided to it by banks in Switzerland and elsewhere, as well as examining treasure troves of financial information from various leaks (think “Panama Papers”) looking not only for tax dollars, interest and penalties but also for individuals (including “enablers”) to serve as “examples” to others who may flout the tax laws. At a conference held in late May, an IRS official commented that the agency “has taken action on 100 potential criminal cases and another 14,000 potential civil” cases as a result of its data mining exercises. Add to this data, the information coming to the IRS from foreign (that is, non-US) financial institutions under the “Foreign Account Tax Compliance Act” (“FATCA”) and you have a recipe for some serious problems as the tax noose keeps tightening.
I believe that a US tax issue is now gaining momentum particularly for many non-US families in the Middle East and North African (MENA) region as well as the Asian region, which are localities in which I deal extensively. This troublesome issue affects many very innocent parties and will only continue unabated as financial transparency becomes the order of the day.
US Persons As Nominees – Dangerous Liaisons
In my tax practice in the MENA and Asian regions, it is very common for family members to have legal title to assets they do not own beneficially. For example, it is common for a parent to have the eldest son hold legal title to property in which the child has no beneficial interest whatsoever. This is called a “nominee” relationship. A nominee is a person or entity named by another party simply to hold title to a certain property. The nominee is the registered owner of the property but he is not the beneficial owner. All rights and incidents of true ownership belong to the beneficial owner and essentially, the nominee stands in a position of trust to follow the orders of the beneficial owner with respect to the asset. In cases with which I am familiar, sometimes the nominee relationship is entered into in an attempt to circumvent forced inheritance shares of Sharia law, or in order to avoid probate. Other times it is simply a method to protect aging parents who have become uncomfortable dealing with their financial affairs, or who have become incapable of effectively handling them.
Most people in such family relationships do not document the existence of the nominee relationship. This is a big mistake for various reasons. In the aforementioned example, what if the son turned against his parent and decided to disregard the nominee relationship, voting the shares as his own, keeping the dividend income, or selling the shares and keeping the proceeds? If the parent has died, and other siblings claim their share of the stock, what messy situation will result? A legal wrangle may also be inevitable in the event the son and his spouse will divorce – what if the spouse demands a share of these assets in the divorce proceedings?
What Must the Nominee Report?
From a US tax perspective, things can also get very messy. With FATCA now in full swing, questions will arise once the IRS starts receiving information from a foreign financial institution about a US account holder who, for example, has not reported income from the account or reported ownership of the asset on the various US tax forms mandated for this purpose (e.g., reporting duties on Form 5471, Form 8938 or FBAR etc.). When a US person acting as a mere nominee holds stock in a foreign corporation for a non-US person, or holds a bank account as a nominee for such a person, do the US reporting duties simply disappear because of the nominee status? How should this matter be handled for the foreign family and the US nominee? For example, the so-called FBAR must be filed if the $10,000 aggregate accounts threshold is met. This remains so, for example, even if a US person holds interests in a foreign financial account(s) only as a nominee for a non-US person. Foreign families with whom I work loathe the idea that the US government will have detailed information about their financial affairs when the family and activities have nothing to do with the United States. My response to such comments is very simple: “Dump that US nominee”.
I saw these problems on the horizon the minute FATCA was enacted, but it seems that many practitioners are blissfully unaware of the huge pitfalls that lie ahead. Foreign families with US persons must be aware of the problem and take heed with proper solutions. Such solutions include terminating nominee relationships with US persons and replacing them with non-US persons, documenting the nominee relationship and making clear when it began even if the document itself is only being very recently prepared. In addition advice should be taken from a US tax professional about how the reporting issues might be addressed, including past reporting deficiencies.
All the US tax information you need, every week — Just follow me on Twitter @VLJeker