On December 3, the American Bar Association, Section of Taxation: US Activities of Foreigners & Tax Treaties Committee (“Committee”) submitted to Congress various “Options” offering proposals for simplification and clarification of various international tax provisions of the Internal Revenue Code. The Committee made some excellent suggestions and one can only hope Congress will take heed. The Committee noted that a remedy is needed to remove many “traps for the unwary” and to ease compliance burdens that cannot reasonably be met.
Tax professionals can learn a great deal about the current law in the areas discussed by reading this proposal. Tax traps are carefully pointed out and the proposal should be required reading for practitioners involved with international tax issues. The full report can be accessed here.
FBARs and Other Compliance Problems
The Committee targeted various areas for reform. One area wisely chosen by the Committee involves the duplicative and confusing requirements of FBAR and Form 8938 (Reporting of “Specified Foreign Financial Assets”). The Committee proposed use of a “Combined Form” to be attached to the income tax return. It proposed increasing the account balance threshold from $10,000 to coincide with the Form 8938 threshold (which varies depending on a taxpayer’s filing status and domestic or overseas residency) and in cases when a return is not required to be filed, it proposed that the due date should be the same as when the tax return would be due if the individual were required to file a return and had requested an automatic extension. The Committee basically is attempting to get some practical changes effected to the rules that are the current cause of much confusion for overseas taxpayers. I have many clients telling me they don’t need to file Form 8938 “because they filed an FBAR” reporting those offshore accounts. Not only are penalty dollars at risk, but the statute of limitations will never start to run for that year’s tax return until the Form 8938 is filed.
Evidently, the Committee is keenly aware of the drastic increase in the number of expatriations. A number of proposals were made to address the taxation of expatriates, including those set out below:
Congress was asked to consider making annual inflation adjustments to the USD2m net worth threshold. It was also asked to consider amending the definition of long-term resident to require a longer period of residence, such as 17 of 20 years and to count a year toward residency only if the individual was resident during 183 days of that particular year. It also recommended that any year of residence for US income tax purposes be counted and not just the years the taxpayer held a green card. The current law which imposes the expatriation tax regime only on certain green card holders was viewed as a possible deterrent to attracting talented foreign individuals from obtaining green cards in the first place.
The Committee also sought to ease the insurmountable obstacles to obtaining adequate security in cases when a taxpayer seeks to defer payment of the Exit Tax to later years.
Another suggestion involves permitting a covered expatriate to exclude mark-to-market gain on the deemed sale of the principal residence to the same extent an actual sale of that residence would have been eligible for the exclusion under current law Section 121.
It also proposed that Congress repeal Section 2801, which subjects recipients of gifts or bequests from covered expatriates to the highest rate of Gift or Estate tax on the value of the gift or bequest, regardless of the number of years that elapsed between expatriation and receipt of the gift or bequest. Currently, this highest rate is at 40%. If the provision is retained, the Committee makes various laudable suggestions for change such as a limit on the amount subject to section 2801 being equal to the covered expatriate’s net worth as of the expatriation date or, alternatively, excluding any property derived by gifts or bequests to the covered expatriate from foreign persons. Another suggested modification is to exclude from tax any gifts, inheritances and trust distributions that do not exceed the threshold for reporting on Form 3520. It proposed limiting application of the rule only to gifts made within 10 years after expatriation and to bequests resulting from death within the earlier of 10 years following expatriation and 3 years after the actuarial life expectancy of the covered expatriate as of the date of expatriation. It also suggested permitting the deferral of the payment of tax by the recipient when the gift or bequest was comprised of illiquid assets (subject to the provision of adequate security) and permitting a rejection of gifts and bequests altogether. Importantly, the proposals explain how imposition of the taxes under the expatriation regime can result in what appears to be unintended double taxation since the foreign tax credit provisions of the Code are not applicable in certain instances, especially the area of deferred compensation and timing mismatches on asset sales. There was also significant discussion of how the expatriation rules work with regard to an expatriate’s interests in a trust and the changes needed in this area.
Various other Code provisions were targeted for simplification and reform including provisions of the “Foreign Investment in Real Property Tax Act”, commonly referred to as “FIRPTA” and partnership withholding. All of the suggestions were excellent.
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