Marital Dissolution in Community Property States

The complexity and differences between the community property statutes of the nine mostly western states* that have adopted them have created a tax consulting and preparation quagmire that can intimidate even the most knowledgeable accountants and attorneys.  We will begin by addressing some basic Federal tax implications, and follow up in future posts with valuation issues.


Definition:  “Generally, community property is property that you, your spouse (or your registered domestic partner), or both acquire during your marriage (or registered domestic partnership) while you and your spouse (or registered domestic partner) are domiciled in a community property state”.  IRS Publication 555.

Continue reading “Marital Dissolution in Community Property States”

Surviving Divorce: Eight Steps to Starting Over

No one ever expects to get to this point.  The anger, deception, frustration and fear have taken over your normally rational mind and you are not thinking clearly.  Your friends, family and work place associates are all experts at telling you what to do, yet they have not been through it themselves and only have few facts relevant to your situation.  The situation creates it’s own momentum and you are confused and unsure of what to do next.  Following are suggestions for getting on track and moving forward.

Continue reading “Surviving Divorce: Eight Steps to Starting Over”

Audit Committee Standards

While there are many requirements and expectations of an issuer’s audit committee, the 1934 Exchange Act under rule 10A(3) mandates five specific standards in order for a company to be listed.

1.  Independence – each member of the audit committee must be a member of the Board of Directors of the listed issuer, and must otherwise be independent:

–  there can be no consulting, advisory or compensatory relationship, outside of that as a member

–  members of the AC can not be affiliated persons as defined of the issuer or any subsidiary.

2.  Responsibility – the audit committee, as a sub-committee of the Board of Directors must be directly responsible for the appointment, consultation with, and retention of the registered independent accounting firm, while including oversight including problem resolution between management and the auditor.

3.  Complaint Resolution – the AC must establish procedures for addressing complaints received by the issuer including anonymous submission by employees.

4.  Advisers – the AC must have the authority to engage advisers, including accountants, auditors, attorneys and consultants they feel are reasonable and necessary to carry out the duties of the committee.

5.  Funding –  the issuer must provide appropriate funding to allow the AC to carry out their duties as a committee of the Board of Directors.

Our experience has been that if there is a failure in meeting the requirements for an audit committee established by the ’34 Act it typically is for one of two reasons:  first, and most common there is often confusion as to who the auditor should be responsible to – the AC or management.  All too frequently, the unofficial role that management can play in the selection of the auditor becomes significant.  Second, is the ‘step-child’ status many audit committees relegate complaint resolution too.  this absolutely can not be the case if the issuer is going to minimize exposure, considering our litigious society.


MD & A Are You Blowing an Opportunity?

As a service to our public company clients we routinely perform an extensive review of the other information included in their annual report.  While  completing a large number of such reviews recently for our clients with December 31 year-ends we became aware of opportunities that are regularly over-looked by issuers.  In preparing Management’s Discussion and Analysis there are some critical elements that will make them more effective.

Attitude – your MD & A is an opportunity to tell the story of the company in a positive way.    As is your web page, your SEC filings are the ‘face’ of the company to potential shareholders, investors and others considering doing business with you.  Do not minimize this opportunity by viewing it primarily as an obligation.  We all have a tendency to spend less time on things we view as ‘necessary evils’ as opposed to ‘opportunities’.

Approach – the primary purpose of the MD & A is to allow the reader to “look at the company through the eyes of management by providing both a short and long-term analysis of the business of the company” (SEC Financial Reporting Policies sec. 501).    The MD & A is intended to be entirely prospective, not historical.  Too frequently we see comments like “As of 12/31/x1 revenues declined $xxx,xxx which was a reduction of x% over revenues of $xxx,xxx as of 12/31/x0”.  That’s historical, not prospective, and anyone could calculate it from the financials.  It provides no additional information of any value to the reader.

 Executive Level Overview – Sec. 501.12 is a gift from the SEC that most issuers don’t open.  This is a chance to tell your story.  Because many companies have become larger, global and more complex, and the disclosure rules correspondingly so,  MD & A has  become lengthy and complex and correspondingly, boring and so not read as thoroughly as it should be.   In an effort to improve clarity and understandability many company’s are incorporating an Executive Level Overview (ELO) as an introductory section  summarizing the most significant areas of the MD & A that management wants to emphasize.  Typically this includes:  economic or industry wide factors; how the company earns revenues and generates cash; lines of business, locations, principle products, services; and provide insight into material opportunities, challenges and risks which management is most focused on.

It is a ‘highlight’ of those things that are important to the company, reported elsewhere as well (e.g. Risk Factors, or Business Description).

Liquidity, Capital Resources, Results of Operations – You must address each of these areas specifically.   When drafting these comments keep in mind that you should address three questions for the reader: (1) What happened? (2) Why did it happen? and most importantly (3) Is it expected to continue?  That last one is the crux of the MD & A.  Remember – the reader is entitled to assume that “past performance is indicative of future performance” unless you tell him different.

Other Tips – (1) If you’ve previously discussed it in your Form 10k you don’t need to keep beating it to death unless it applies to new information in the current interim filing .  Most companies over disclose information that they’ve previously discussed numerous times.  The unwelcome result is that the points you want to make get buried in the irrelevant.  (2)  Discussion for interim reports should be limited to material changes occurring subsequent to the last annual report.  Over disclosure, again,  can result in burying relevant information in the minutiae.  (3) The SEC requires that it be “presented in clear and understandable language”.  That means you need to lose the ‘legalese’.   (4)   In the words of an internationally recognized securities attorney with whom we’ve worked – “Disclosure is too important to leave up to only the attorneys”.  While their focus is compliance, as it should be, this is more than a compliance document.  It is  the public face of your company.  Remember it is an opportunity to ‘sell’ to investors, financiers and those people you want to do business with.  (5)  Finally, sentence structure,  grammar and spelling are critical.  If your MD & A is sloppy, those reading it will assume the company is run the same way.

You have a great company with a great business plan and outlook for the future.  Tell the world in your MD & A.


A Road-map for IRS Audits . . . Schedule UTP has Arrived!

The following is part I of a two part blog post, which will describe the specific reporting requirements of Schedule UTP and discuss the IRS’ objectives and rational for its new reporting requirements. Part 2 will apply the  requirements of Schedule UTP to specific factual situations and reconcile the resulting reporting requirements to those requirements under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”).

The much anticipated IRS audit road-map, Schedule UTP, is now reality for certain large corporate taxpayers.   Corporations that file Form 1120, U.S. Corporation Income Tax Return, Form 1120-F, U.S. Income Tax Return of a Foreign Corporation and certain insurance companies with assets of more than $100 million must file a Schedule UTP starting in 2010. To view Schedule UTP, click here. To view the IRS instructions to Schedule UTP, click here. Schedule UTP must be attached to a calendar year 2010 tax return or to a fiscal year-end return that begins in 2010 and ends in 2011

The initial reporting threshold of $100 million of total assets will be reduced to $50 million starting in 2012 and to $10 million for the 2014 tax year.  Only a corporate taxpayer or related party that has issued audited financial statements covering all or a portion of the corporation’s tax year is required to file a Schedule UTP.  Compiled or reviewed financial statements are not audited financial statements.

Note that a corporation without audited financial statements is still required to file Schedule UTP if it meets the related party definition.   A “related party” is any entity that has a relationship described in IRC Section 267(b), Section 318(a), or that is included in the consolidated audited financial statements in which a corporation with audited financial statements is also included.

A corporation must report tax positions taken on a U.S. federal income tax return if:

  • The corporation has taken a position on its federal income tax return for the current year or for a prior year, and
  • The corporation or a related party has either
    • Recorded a reserve with respect to that tax position in audited financial statements, or
    • Not recorded a reserve for a tax position because the corporation expects to litigate the position.

A tax position taken on a return is defined as one that would result in an adjustment  to a line item on a return or that would be included in a Section 481(a) adjustment (i.e. a change in a method of accounting) if the position were not sustained on upon an IRS audit. If multiple positions affect a single line on the tax return, each tax position is treated as a separate tax position. A tax position is based on a unit of account used to prepare the audited financial statements in which the reserve has been recorded. The unit of account must be the same unit of account used by the taxpayer in its financial statements for purposes of FIN 48.  If no FIN 48 reserve was required, the tax position need not be reported on Schedule UTP.

The initial FIN 48 reserve for financial statement purposes will trigger the reporting requirement on Schedule UTP. Interestingly, subsequent increases or decreases in the FIN 48 reserve will not require additional Schedule UTP reporting. Additionally, no Schedule UTP disclosure is required with respect to tax positions taken on a return before January 1, 2010, even if a corporation records a reserve for financial statements issued in 2010 or later.

A corporation must report on Schedule UTP a tax position for which it did not record a reserve based on its expectation to litigate the position if: (i) the probability of settling with the IRS is less than 50% and (ii) no reserve was recorded in the financial statements because the corporation intends to litigate the tax position and has determined that it is more likely than not to prevail on the merits in litigation.

Schedule UTP is divided into three parts. In part I, the corporate taxpayer reports tax positions taken in the current year that meet the definition of a UTP disclosure position. Part II is used to report tax positions taken by a corporation in a prior year that has not been reported on Schedule UTP.  Part III is used to provide a concise description of each uncertain tax position reported in parts I and II.

For each UTP, the corporate taxpayer must provide the following information:

  • Identify the Internal Revenue Code section related to each UTP (up to three code sections).
  • Indicate whether the UTP is temporary and/or permanent book-tax difference.
  • If the UTP relates to a pass-through entity (e.g. partnership, S corporation, etc.) the EIN of the pass-through must be reported.
  • Disclosure with respect to those UTPs whose relative size (by amount of dollar reserve) is greater than or equal to 10% of all UTPs listed on parts I and II of Schedule UTP for that tax year.
  • All UTPs on parts I and II must be ranked based on size with the number “1” assigned to the largest, “2” to the next largest, and so on. The letter T must be provided for all transfer pricing related issues and the letter G for all other UTPs.

IRS Commission Doug Shulman announced the following goals of Schedule UTP

  • Create certainty regarding a taxpayer’s obligation sooner rather than later.
  • Cut down on the time it takes that IRS to find issues and complete an audit.
  • Provide consistent treatment across taxpayers.
  • Make efficient use of government resources by focusing on issues the pose the greatest risk of noncompliance.
  • Ensure that both the IRS and taxpayer spend more time discussing the law as it applies to the facts and less time looking for information.
  • Help the IRS prioritize taxpayers for examination
  • Help the IRS identify issues where there is uncertainty and where further guidance is necessary.
  • Help the IRS prioritize selection of issues during an audit.
  • Obtain key information regarding uncertain tax positions without getting into the heads of the taxpayer or their advisors as it relates to quantifying risk.

The practical impact of Schedule UTP is that the affected corporate taxpayer must now carefully consider its FIN 48 analysis and disclosure in conjunction the preparation of Schedule UTP and its defense of its tax position.  In part 2, we will apply the new disclosure requirements to specific factual situations.


Treasury Issues Final Regulations on FBAR Filing Requirements and IRS Releases Revised FBAR Form

On February 24, 2011, the Treasury Department issued final regulations (the “Regulations”) regarding the Report of Foreign Bank and Financial Accounts (“FBAR”). The Regulations, which can be found here, are effective March 28, 2011 and apply to FBARs for 2010 due on June 30, 2011, as well as any FBARs for prior years which were deferred under prior IRS guidance. The Treasury also noted that it plans to permit electronic filing of the FBAR (once technology updates are implemented), but did not announce a specific time frame for electronic filing.

The Regulations (i) addresses the scope of the persons that are required to file reports of foreign financial accounts; (ii) specifies the types of accounts that are reportable; (iii) provides filing relief in the form of exemptions for certain persons with signature or other authority over foreign financial accounts; and (iv) adopts provisions intended to prevent persons subject to the rule from avoiding their reporting requirement.


The Regulations generally require a US person who has a financial interest in, or signature or other authority over one or more foreign financial accounts that have an aggregate value exceeding $10,000 at any time during the calendar year to disclose that interest to the IRS. The disclosure must be made on Form TD F 90-22.1, FBAR, and form must be filed on or before June 30 of each calendar year for accounts maintained during the previous calendar year.  In March 2011, the IRS published a revised FBAR form with accompanying instructions that reflect the changes made by the Regulations.

Key provisions of the Regulations include:

US Person

  • The term US person includes a US citizen, US resident or domestic entity (including, but not limited to a corporation, partnership, trust, or limited liability company). In the case of trusts, a US trustee must file the FBAR for the trust.
  • A legal permanent resident who elects under a tax treaty to be treated as a non-resident for tax purposes must nonetheless file the FBAR.

Financial Interest

The Regulations state that a US person has a financial interest in a bank, securities or other financial account in a foreign country if:

  • The US person is the owner of record or has legal title to the account, regardless of whether the account is maintained for his own benefit or for the benefit of others.
  • A person acts as an agent, nominee, attorney or in some other capacity on behalf of the US person with respect to the account.
  • The account is held by a corporation in which the US person owns directly or indirectly more than 50 percent of the voting power or the total value of the shares.
  • The account is held by a partnership in which the US person owns directly or indirectly more than 50 percent of the partnership’s profits or capital interest.
  • The account is held by any other entity in which the US person owns directly or indirectly more than 50 percent of the voting power, total value of the equity interest or assets, or interest in profits.
  • A trust, in which the US person is the trust grantor and the US person has an ownership interest in the trust for US Federal tax purposes.
  • The account is held by a trust in which a US person either has a present beneficial interest in more than 50 percent of the assets or from which such US person receives more than 50 percent of the current income.

Signature or Other Authority

An individual has “signature or other authority” over a financial account if he (alone or in conjunction with another) has the authority to control the disposition of money, funds or other assets held in the account by direct communication (whether in writing or otherwise) to the person maintaining the account.

The preamble to the Regulations states that the test for determining whether a US person has signature or other authority over an account (and thus a FBAR filing obligation) is whether the foreign financial institution will act upon a direct communication from such US person regarding the disposition of assets in that account. In addition, the preamble to the Regulations clarifies that officers and employees who are obligated to file FBARs because they have signature or other authority over an employer’s foreign financial accounts are not required to personally maintain the records of the foreign financial accounts of their employers.

The officers and employees with signature or other authority over the foreign financial account of the following entities are not required to report that he has signature or other authority over that account as long as he has no financial interest in the account:

  • Banks that are examined by the Office of the Comptroller of Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, or the National Credit Union Administration;
  • Financial institutions registered with and examined by the US Securities and Exchange Commission (the “SEC”) or the US Commodity Futures Trading Commission;
  • Entities that are registered with and examined by the SEC that provide services to investment companies registered under the Investment Company Act of 1940;
  • Entities with a class of equity securities (or American depository receipts) listed on any US national securities exchange, and US subsidiaries of US entities with a class of equity securities listed on a US national securities exchange if the US subsidiary is identified on a consolidated FBAR report filed by the parent.
  • Entities with a class of equity securities (or American depository receipts in respect f equity securities) registered under section 12(g) of the Securities Exchange Act.

Reportable Foreign Financial Accounts

  • Bank Accounts – A “bank account” is a savings deposit, demand deposit, checking, or any other account maintained with a person that is in the banking business.
  • Securities Account. A “securities account” is an account maintained with a person involved in the business of buying, selling, holding, or trading stock or other securities.
  • Other Financial Account. The term “other financial account” means (i) an account with a person in the business of accepting deposits as a financial agency; (ii) an account that is an insurance or annuity policy with a cash value ; (iii) an account with a person acting as a broker or dealer for futures or options transactions in any commodity on or subject to the rules of a commodity exchange or association; or (iv) an account with a mutual fund or similar pooled fund which issues shares that are available to the general public in addition to having a regular net asset value determination and regular redemptions.
  • The proposed regulations specifically reserved the treatment of investments companies other than mutual funds or similar pooled funds, and the Final Regulations continue to do so. As a result, for the time being, interests in other investment entities such as foreign hedge funds and private equity funds that have periodic redemptions are not considered foreign financial accounts, and therefore FBARs do not have to be filed with respect to such interests.
  • The preamble to the Regulations clarifies that an account is not a foreign account under the FBAR if it is maintained with a financial institution located in the US even though the account may contain holdings or assets of foreign entities. The preamble also clarifies that, in general, the FBAR rules do not apply to omnibus accounts in which a US bank, acting as a global custodian combines the assets of multiple investors and creates pooled cash and securities accounts in non-US markets. The preamble states that as long as the US customer cannot directly access their foreign assets maintained at the foreign institution, the US customer maintains an account with a financial institution located in the US, and therefore will not have to file a FBAR with respect to assets held in the omnibus account and maintained by the global custodian.

Other Special Rules

25 or more Foreign Financial Accounts – A US person that has a financial interest in, or signature or other authority over 25 or more foreign financial accounts is only required to provide the number of financial accounts and certain other basic information on the FBAR report; however, such US person will be required to provide detailed information concerning each account when requested by the IRS.

Consolidated Reports – US entities are permitted to file consolidated FBAR reports on behalf of itself and any entity in which it owns directly or indirectly more than a 50 percent interest.

Participants and Beneficiaries in Certain Retirement Plans – Participants, owners, and beneficiaries in retirement plans under IRC sections 401(a), 403(a), 403(b), 408, and 408A are not required to file a FBAR report for any foreign financial account held by or on behalf of the retirement plan.

IRS Releases New FBAR Form

The Internal Revenue Service has released a revised Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), which can be found here. The revised FBAR Form is used to disclose financial interests in or signature authority over foreign financial accounts where such accounts exceed $10,000 in the aggregate at any time during the calendar year. The revised FBAR Form implements the Regulations as discussed above and is to be used for the upcoming June 30, 2011 filing deadline and can be found here.

The instructions to the revised FBAR Form provide additional guidance to assist filers in completing the Form. Revised definitions, which include “United States Person,” “signature authority” and “foreign financial account,” track the changes described in the final Regulations. In addition, the instructions offer clarifying guidance on how to complete the Form, including, for example, where the filer is an individual with signature authority over a foreign financial account, is a disregarded entity, or is an entity that does not have a United States mailing address.

The revised instructions clarify that consolidated reporting is available for non-corporate as well as corporate affiliates, and instruct filers on how to determine the maximum account value of each account. The revised instructions also provide a reorganized list of exceptions to the filing requirement, which confirms the categories of exceptions as expanded under the final Regulations; this list indicates that the following persons, among others, are not required to file FBARs:

  • owners and beneficiaries of IRAs and participants in and beneficiaries of tax-qualified retirement plans;
  • officers and employees with signature authority but no financial interest in financial accounts of companies, the shares of which are registered with the SEC (including those listed on a US national securities exchange); and
  • officers and employees of entities which are registered with and examined by the SEC and provide services to registered investment companies (i.e., registered investment advisors) with signature authority but no financial interest in the financial accounts of such companies.



An IC-DISC can provide a permanent 20% tax savings (or even more) for qualifying U.S. manufactures and exporters.


For U.S. exporters operating their business via a sole proprietorship or pass-through entity (e.g., limited liability company (LLC), S corporation, limited partnership (LP)), the IC-DISC benefit is essentially tied to the differential between the qualified dividend rates and the ordinary income tax rates. This differential was originally set to expire on December 31, 2010 but Congress extended it in late December of 2010 to December 31, 2012.

Many practitioners strongly believe that this differential will be extended past 2012 even if tax rates on ordinary income increase. In addition to benefiting sole proprietorships and pass-through entities, exporters operating their business via a C corporation can benefit by using the IC-DISC to eliminate double taxation on a majority of their export income, as well as to reduce the need to incur additional payroll taxes on income paid to their shareholders/officers. The IC-DISC is not a tax shelter.

To qualify as an IC-DISC, a domestic corporation must pass two main tests known as the qualified export receipts test and the qualified export assets test. The qualified export receipts test requires that 95% of the gross receipts of the IC-DISC constitute qualified export receipts. The qualified export assets test requires that 95% of the assets of the IC-DISC be qualified export assets. Qualified export assets include accounts receivable, temporary investments, export property, and loans to producers.

Because most of the qualified export receipts categories focus on export property, it is critical that the exporter substantiate that its exports satisfy the definition of export property. Three requirements must be met in order for the IC-DISC to receive income from an export sale. The export property must:

(1) Be manufactured, produced, grown, or extracted in the U.S. by a person other than the IC-DISC.

(2) Be held primarily for sale, lease, or rental for use, consumption, or disposition outside the United States

(3) Have a maximum of 50% foreign content.

Although exporters often think of newly produced property as export property, used equipment and even scrap also qualify.

In its most recent form, the IC-DISC can provide a permanent 20% tax savings (or even more) for qualifying U.S. exporters. In certain cases, it eliminates U.S. tax entirely on the majority of export income. In addition, distributions to individual shareholders are currently taxed at a maximum rate of 15% – providing a way to convert 35% ordinary income to 15% qualified dividend income. Of course, this assumes that the U.S. exporter generates operating profits and is creating taxable income in the U.S.

IC-DISC Structure

The IC-DISC is a “paper” entity used as a tax-savings vehicle. It does not require corporate substance or form, office space, employees, or tangible assets. It simply serves as a conduit for export tax savings. An important feature of the IC-DISC is that shareholders can be corporations, individuals, or a combination of these.

This is how an IC-DISC works:

  • Owner-managed exporting company forms a special U.S. corporation that elects to be an IC-DISC. The election is made on IRS Form 4876-A, which must be filed within 90 days after the beginning of the tax year.
  • Exporting company pays IC-DISC a commission.
  • Exporting company deducts commission from ordinary income taxed at up to 35%.
  • IC-DISC pays no tax on the commission as long as certain qualification standards are met such as the 95% qualified export assets and the 95% qualified export receipts requirements of Section 992(a)(1).
  • Shareholders of an IC-DISC are not taxed until the earnings are distributed as dividends. However, the shareholders must pay annual interest on the tax deferred.
  • Shareholders that are individuals pay income tax on qualified dividends at the capital gains rate of 15%. C Corporation shareholders are automatically considered to have received 1/17th of the IC-DISC’s taxable income even if no distributions are made.
  • The result may be a 20% or more tax savings on commission.

Permanent Tax Savings on Global Sales

Permanent tax savings begin with the exporting company deducting the commission it pays to the IC-DISC from its ordinary income, which is taxed at up to 35%. Tax law sets the commission rate, which is based on export sales revenue, as the greater of either 50% of net export income or 4% of export sale revenue. Because the IC-DISC is tax exempt, tax is paid only on distributions to shareholders. Individual and pass-through company shareholders pay income tax on qualified dividends at the long-term capital gains rate of 15%.

Ability to Leverage Cost of Capital

An IC-DISC is more than a tax-savings vehicle. It can also be used as a deferral tool to leverage a company’s cost of capital. IC-DISC earnings need not be distributed to shareholders; they can instead be used to perpetuate and grow the deductible dividend tax rate savings. Tax rate savings are perpetuated by lending accumulated IC-DISC earnings back to the exporting company in return for a note and interest. The exporting company can deduct the interest expense, and interest income is considered a dividend to the IC-DISC shareholders. Reinvesting IC-DISC earnings back into the exporting business results in additional tax rate savings and diminishes the group’s cost of capital.

Opportunities to Create Management Incentives

Businesses can also use ownership in the IC-DISC to provide incentives. Exporting company management and other personnel can be named as shareholders, which allows them to benefit from additional cash flow created by increasing global sales.

Means to Facilitate Succession Planning

An IC-DISC offers a number of ways to execute a succession plan. Among these, ownership in the IC-DISC can be used as a means of generating cash, which can be distributed to shareholders in a tax-advantaged manner. IC-DISC shareholders participating in a buyout of current or previous shareholders can leverage these tax-advantaged IC-DISC earnings to pursue the buyout plan.


For U.S. exporters, the IC-DISC is the only remaining tax-saving opportunity. If you are unsure about whether or not an IC-DISC will work, ask the following questions:

  • Do you have any transactions outside of the U.S.?
  • Do you use overseas distribution?
  • Does your product cross any borders?
  • Are you generating operating income?

If the answer to any of these questions is yes, an IC-DISC could be a valuable tax-savings vehicle for your business.

On the surface, the rules covering the IC-DISC may seem simple. However, to maximize the tax benefit, a qualified IC-DISC advisor should be engaged. Many times an IC-DISC expert can double if not triple the tax benefit the IC-DISC provides by applying their in-depth understanding of how to structure the IC-DISC and using the complex advance pricing rules that the Internal Revenue Code allows for determining the tax benefit. A firm that has proven IC-DISC expertise, offers fixed fees, and optimizes the IC-DISC on a transactional basis (which almost always provides the best result) should be chosen.



Form 5471 – A Harsh New Reality for US Shareholders of Foreign Corporations

Who is required to File Form 5471?

Certain US persons who are shareholders (both corporate and individual shareholders), officers or directors of a foreign corporation may be required to file Form 5471 on an annual basis. Here, is a link to the IRS Website on filing requirements l.

There are four categories (including corporate shareholders) that may be required to file the form, as follows:

1. A US person who is an officer or director of a foreign corporation in which any US person owns or acquires 10% or more of the stock of the foreign corporation.
2. A person who becomes a US person while owning 10% or more of the stock of the foreign corporation.
3. A US person who had control of a foreign corporation for at least 30 days.
4. A US shareholder who owns stock in a foreign corporation that is a controlled foreign corporation for an uninterrupted period of at least 30 days and who owned that stock on the last day of the that year.

What Information is Required?

The required information may be as minimal as the identification of the US shareholder and the name and address of the foreign corporation – or it may be as extensive as a comprehensive balance sheet and income statement converted from multiple foreign currencies into US dollars, including computations of cumulative earnings & profits and disclosure of related party transactions.

When is Form 5471 Due?

Form 5471 is due with the income tax return of the affected shareholder. For most corporations, that would March 15th or the extended due date. For most individuals, that would be April 15th or the extended due date.

How Long does it take to Prepare?

The IRS estimates the average time to prepare Form 5471 is approximately 38 hours, exclusive of record keeping time and the time required to learn about the relevant law and the instructions. The learning time could be much longer for someone who is not familiar with the pertinent sections of the tax law.

Harsh Penalties – A New Reality

For many years, it was extremely rare to get any IRS reply regarding a filing, even if the form was very late. The IRS has been warning in public statements that the Form 5471 penalties were coming and would be automatically assessed by the IRS computer. The penalty under IRC Section 6038(b)(1) is $10,000 for each late or incomplete Form 5471.

Remember, very often, the information on this form does not result in any taxable income or tax due for the taxpayer.  So, the $10,000 penalty is a “disclosure” penalty, unrelated to the actual tax consequences of the information provided on the Form 5471. The $10,000 penalty is real and is now being automatically assessed.

If the failure continues for more than 90 days after the date the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period or fraction thereof during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000.

Why should a US Corporation with NOLs still be Concerned?

With the economic downturn, many US corporations have build-up significant net operating losses (NOLs). Thus, management may not be overly concerned about filing Form 5471, based on its belief that the company’s NOLS will shelter any potential exposure. However, because the failure to file Form 5471 results in a penalty (not a tax), NOLs do not any shelter this exposure.

Thus, the often unforeseen result is a FIN 48 liability and hit to the P&L for $10,000 for each unfiled Form 5471. For example, a US corporation with four foreign subsidiaries for which Forms 5471 have not been filed in the three most recent tax years would be required to accrue a $120,000 (a $10,000 penalty for each unfiled Form 5471 x 4 subsidiaries x 3 tax years) FIN 48 liability and current year P&L expense, which can be a huge P&L hit for company with no US taxable income.

Additionally, the three year statute of limitations with respect to the underlying tax income tax return (Form 1120, 1040, etc.) does not start running until Form 5471 is properly filed, as the return was not complete at the time it was originally submitted.




Why You Shouldn’t Kill Your Rich Uncle Just Yet: Things You May Not Know About the Estate Tax Repeal

Estate and FInancial PlanningThe day is finally here. After hearing about it for the past nine years, the estate tax is repealed as of January 1, 2010. Yet, many questions remain. For example, one may wonder what will happen next year when the estate tax (presumably) returns and one is puzzled why U.S. Congress did not address the “estate tax issue” during the 2009 tax year.

The one-year repeal of the “death tax” was a typical congressional compromise. It involved the gradual decrease in marginal tax rates and increase in tax free amount (unified credit) through 2009 and the repeal of the tax for just one year in 2010. The current law reads that in 2011 the rates from 2001 will apply again (P.L. 107-16, 115 Stat 38 (June 7, 2001)).

What does this mean for taxpayers? Let’s assume Uncle Joseph’s taxable estate is valued at $5 million. If he died in 2001, $675,000 of the estate would have been tax free and the rest would have been taxed with a top marginal rate of 55%. Tax liability would have been about 2.17 million and effective tax rate about 43%. Had Uncle Joseph died in 2009, his tax due would have been $675,000 and his effective tax rate around 14% while a 2010 death would mean zero liability (see Table).

Year Top Marginal Tax Rate Unified Credit
(Exemption Equivalent)
Tax due after credit on $5 million estate Effective Tax Rate
2001 55% $220,550 ($675,000) $ 2,170,250 43%
2002 50% $345,800 ($1,000,000) $ 1,930,000 39%
2003 49% $345,800 ($1,000,000) $ 1,905,000 38%
2004 48% $555,800 ($1,500,000) $ 1,665,000 33%
2005 47% $555,800 ($1,500,000) $ 1,635,000 33%
2006 46% $780,800 ($2,000,000) $ 1,380,000 28%
2007 45% $780,800 ($2,000,000) $ 1,350,000 27%
2008 45% $780,800 ($2,000,000) $ 1,350,000 27%
2009 45% $1,455,800 ($3.5 million) $    675,000 14%
2010 NA NA No tax N/A
2011 55% $220,550 ($675,000) $ 2,170,250 43%

Questionable Policy Incentives

The stated policy reason for estate taxes has been that too much concentration of wealth is not good for a society. Aside from the fact that the estate tax has not done much in terms of reducing income and wealth inequality, the fact that Congress did not change the one-year repeal before January 1 of 2010, is an example of implementing quite questionable incentives. As the situation above shows, all else equal, the best year for Joseph to die is 2010. His heirs will receive the entire $5 million instead of only $4.3 million if he died in 2009 or $2.8 million if he dies in 2011. Of course, death of natural causes cannot be timed. What happens though if Joseph was in a serious accident in late 2009 without a DNR order in place? Would his heirs insist that he’d be kept alive until January 1 and then taken off life support? What if Joseph has an accident in December of 2010?

In order to prevent anybody of literally making life or death decisions in order to save taxes, Congress should have addressed the estate tax in 2009 before the repeal-year started. There were several proposals on the table. Considering the current budget shortfall and the Democratic majorities in both the House and the Senate it is not unlikely that the legislators will pass a law retroactively changing the 2010 repeal. Since tax returns are not due until nine months after the decedent’s death, a retroactive change is possible. For example, it may be possible that a “patch (i.e., keeping rates and credit like it was in 2009) will pass for 2010. Thus, contemplating death in light of a possible tax free year would be unwise considering the irreversibility of such action.

Other Negative Consequences

During 2001–2011 inflation was relatively low (around 2.3% on average). Using consumer price index measures, the value of a dollar in 2001 is about 1.25 more than in 2011. Given that in 2001, over 108,000 estate tax returns were filed, compared to only 38,000 in 2008 , we can assume that reverting back to 2001 law would mean that at least 130,000 returns will be due in 2011. This is good news to tax accountants but bad news for many individuals who did not expect to be subject to estate taxes.

In addition, the repeal of the estate tax for 2010 means that assets transferred at death during this year do not get a stepped-up basis. Thus, beneficiaries will have to pay larger amounts in income taxes when they sell the inheritance.

Last, the one-year repeal is also bad news for estates below the exemption equivalent. For these estates, the tax savings are zero while the elimination of the step-up in basis increases beneficiaries’ income tax when they sell the assets received. One can make the argument that this is a rule against the middle class and upper middle class since presumably most of these individuals would have never paid estate tax anyway but their heirs would benefit from the step-up in basis. If the law reverts back to 2001 law in 2011, the step-up will be back next year. Thus, while individuals with large estates have an incentive to die in 2010, others (most middle and upper middle class taxpayers) who have an estate below the exemption equivalent should not die in 2010.