Ways for U.S. Taxpayers with Undisclosed Foreign Financial Assets to get back to Tax Compliance

Recent major modifications by IRS give an opportunity to taxpayers to get back to tax compliance with substantially reduced or no penalties.

By BALJEET SINGH

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In an effort to encourage the reporting of offshore assets, Internal Revenue Services (IRS) recently announced major modifications to the terms of its existing offshore voluntary disclosure programs. The new procedure offered by IRS gives an easy opportunity to the taxpayers, depending on individual circumstances, to fix the previous errors and get back to tax compliance with substantially reduced or no penalties. The taxpayer must not be under a civil examination or a criminal investigation by the IRS, and have not already been contacted by the IRS about the non-compliance to avail benefit of any of the options. Currently the following are the various options offered by the IRS:

2014 Offshore Voluntary Disclosure Program

The Offshore Voluntary Disclosure Program (OVDP) is a voluntary disclosure program specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report foreign financial assets and pay all tax due in respect of those assets.  OVDP provides taxpayers with such exposure a protection from criminal liability and terms for resolving their civil tax and penalty obligations. Under this program, the base penalty is 27.5 percent of the highest aggregate value of the foreign bank accounts or assets during the period covered by the disclosure. The penalty will be increased to 50 percent for any foreign financial accounts that were held at a bank that has been publicly identified as being under investigation or as cooperating with a government investigation.

Streamlined Filing Compliance Procedures

The streamlined filing compliance procedures are available to taxpayers whose failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part.  The procedures are designed to provide to taxpayers in such situations a streamlined procedure for filing amended or delinquent returns and terms for resolving their tax and penalty obligations.

The modified streamlined filing compliance procedures are designed for only individual taxpayers, including estates of individual taxpayers.  The procedures are available to both U.S. individual taxpayers residing outside the United States and U.S. individual taxpayers residing in the United States. Taxpayers using the Procedures will be required to certify that the failure to report all income, pay all tax, and submit all required information returns, including FBARs (FinCEN Form 114, previously Form TD F 90-22.1), was due to non-willful conduct.

Tax returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties, and even criminal liability, if appropriate. Taxpayers who are concerned that their failure to report income, pay tax, and submit required information returns was due to willful conduct and who therefore seek assurances that they will not be subject to criminal liability and/or substantial monetary penalties should consider participating in the Offshore Voluntary Disclosure Program (OVDP) and should consult with their professional tax or legal advisers.

Eligible US taxpayers who resided outside the US in any one of the most recent three years for which US tax returns due date (including extension) has passed, will not pay any penalties. Eligible US taxpayers who resided in the US during this period will pay a penalty of 5% of the highest aggregate balance/value of taxpayers’ foreign financial account during the three years period covered by the tax return or six years covered by the FBAR.  The IRS will not impose accuracy related penalty, information return penalties, or FBAR penalties.

The taxpayers who are currently participating under Offshore Voluntary Disclosure Program may be eligible for reduced penalties under the new streamlined filing procedures. A taxpayer seeking such treatment does not need to opt out of OVDP, but will be required to certify, in accordance with the instructions, that the failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct

Delinquent FBAR Submission/Information Return Procedures

These procedures allow taxpayers to file delinquent Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1) and/or information returns along with a statement of reasonable cause for late filing. No penalty will be imposed by the IRS for the failure to file the delinquent FBARs or information return if the taxpayer properly reported on U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported.

Given the ongoing efforts of the IRS to ensure tax compliance with regards to foreign financial assets, pressure on foreign bank to disclose US account holder information and recently announced cooperation among the governments around the world, it is highly recommended that US taxpayers having undeclared accounts review their individual situation with their CPA’s and/or legal counsel and opt for the best course of action.

Write to Baljeet Singh at baljeetsinghcpa@gmail.com

20 Year-Round Tax Tips for Businesses

Among many challenges faced by business owners, tax compliance is one of the most significant one. Here are the important tax tips that you don’t want to miss out.

By BALJEET SINGH

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Being a business owner is a great thing; however it comes with many responsibilities and challenges. Tax compliance is one of the main challenges that business owners have to face. It is significant to know that tax compliance or planning is not limited to once in a year meetings with your tax accountant, year-end tax planning or filing annual income tax returns. All business transactions should be analyzed from a tax prospective on an ongoing basis. Here are a few year-round tax tips for business owners that could help them to comply with tax laws and save on taxes, potential interest and penalties.

  •  When you start a new business, consider different choices of business structures like sole proprietorships, LLC, C-corporation, S corporation etc. Choose the one that is more tax efficient and is best suited to your other business objectives. There are numerous factors that should be considered while making a choice of entity that you should review with your CPA. Once set up, keep reviewing the business structure on an ongoing basis and make the appropriate change if some different business structure is considered to be more tax favorable due to change in circumstances, your business objectives etc.
  • Give a careful consideration to the state where you would like your business to be incorporated. There are various factors that should be considered while making this decision. Some of the significant factors, that vary from state to state, include income taxes, sales taxes, franchise taxes, tax filing fees, business friendly laws and statutes. Of course, if some specific state otherwise makes more sense for you from a business prospective, you should go for that state.
  • Know the state income tax compliance requirements of any state where you carry out or intend to carry out business activities. Though the rules vary from state to state but in general, you need to register your business with a state and comply with tax filing requirements if you carry out major economic activity, generate revenue, have employees, rent or own office or property in the State. Be sure to get this evaluated before you indulge in business activities in any particular state and if required, get the registration done, obtain certificate of authority and comply with tax filing requirements.
  • Know the sales tax rules of the state where you carry out or intend to conduct business. The sales tax rules vary from state to state. Generally the sales tax is imposed on products, however many states now have sales tax on software services. Currently, there are many states that already require the sales tax on software services are Connecticut, Hawaii, Mississippi, Nebraska, New Mexico, South Dakota, South Carolina, Tennessee, West Virginia, Wyoming and Massachusetts.
  • Be aware of recordkeeping requirements by law. Have good systems in place to maintain books of accounts, supporting documentary evidences and additional details in a diary or log book or some other way. Maintain records for sufficient number of years generally for at least the period covered by the statute of limitation which is 3 years after the due date of the tax return or 2 years after the date the tax was paid whichever is later. (also read “Tax Records That Businesses Must Maintain” at https://baljeetsinghcpa.wordpress.com/2014/01/07/tax-records-that-businesses-must-maintain/)
  • Always keep separate bank accounts, credit cards, and other documents to keep track of business expenses separately.
  • Know the difference between employees and independent contractors, and classify them correctly. If an employee is wrongly classified as a contractor and IRS learns about the incorrect classification, it could result in back payroll taxes and penalties.
  • If any payment is made to stockholders/owners, be sure to classify it correctly as payroll or management fee or distribution depending on various factors like what role the stockholder is playing in the business? Are there other officers who are performing the actual operation of the corporation for which it was started? If an amount paid to the stockholder that is wrongly classified as a management fee instead of payroll, it could result in back payroll taxes and penalties.
  • Before an amount is distributed to an S-corporation stockholder, be sure that the stockholder is otherwise compensated by way of a payroll for services performed for the S-Corporation. If the stockholder is not sufficiently compensated for the services performed, then IRS could take a stand that distribution is made to stockholder instead of payroll as an attempt to avoid payroll taxes and could impose penalties on S-Corporation.
  • If a business give or take loans from shareholders, be sure to have a formal agreement to include the interest terms, repayment terms. If business financials reflect loan to or from stockholder, there should be corresponding interest income or expenses in the business’ financials and hence on the tax returns.
  • Be aware of requirements of issuing form 1099. Broadly form 1099 should be issued if any payment exceeding $600 is made during the course of your business to contractors either individual or partnership; payment of professional fee to an attorney, doctor, or other professional; payment to an individual or partnership, for rent for office space, machines, equipment. Payments include commissions, fees, interest, rents, royalties, annuities and any other type of compensation or income to a single recipient. Please note that form 1099 is required to be issued for payments to corporations only if they are for medical, health care, legal or fishing activities. Individuals are not required to send 1099-MISC for personal payments.
  • Be sure to timely deposit payroll taxes withheld from employee’s payroll. Do no use the taxes so withheld for the purposes of business operations. Using the payroll taxes for the purposes of business operation could attract criminal and civil penalties, and fines.
  • If you/your CPA decide to claim home office deduction on your income tax returns, be sure that the office must be used regularly and exclusively for conducting business. Further you can claim expenses including real estate taxes, mortgage interest, utilities and insurance for the portion the home is used for business.
  • If you receive some insurance proceeds for some causality loss, reduce the amount of causality loss by the insurance proceed before claiming the deduction for the same on the income tax return.
  • Be aware of passive loss limitation rules if you are an owner of pass through entities (e.g. S-Corporation, partnership etc.) and have losses in business. To deduct the losses, you should have sufficient level of participation in the business and should have sufficient records to evidence the participation. Also know the basis rules if you are an owner of pass through entity. The owners can deduct the losses to the extent of their basis in the business.
  • If you are considering issuing stock options, stock appreciation rights or other instruments to employees; you must consider getting a 409A valuation done to arrive at fair market price of the common stock of the corporation. Under Section 409A of Internal Revenue Code, a stock option having an exercise price less than the fair market value of the common stock determined as of the option grant date constitutes a deferred compensation arrangement. This typically will result in adverse tax consequences for the option recipient and a tax withholding responsibility for the company. It is indeed very significant to value the stock options correctly at the fair market value complying with 409A valuation rules to avoid such adverse tax consequences.
  • Be aware of transfer pricing regulations while entering in to any transactions with related parties. In general, the U.S. transfer pricing regulations require that transactions between related parties take place at the same prices that would be expected had the same transactions taken place between unrelated parties. Regulations describe a set of specified methods that may be used to determine whether the prices charged in controlled transactions are consistent with those that would be expected at arm’s length. Unspecified methods may also be used if they are likely to yield a more accurate result than the specified methods.
  • Know the reporting requirements related to signature authority, control, or ownership in foreign financial assets or other business entities in any foreign country. There are various forms that could be applicable based on facts and circumstances of each case such as form TD F 90-22.1, form 8938, form 5471, form 5472, form 8865, form 926, form 3520 and form 3521. Be sure to get the applicability of foreign reporting evaluated in your particular case and comply if applicable.
  • Plan to file your tax returns in time. If due to some reasons the filing of tax returns is extended, be sure to pay the taxes along with the extension. Know that extension of filing the tax return does not extend the date of payment of taxes. Else, you could end up paying interest on late payments.
  • Keep in mind important tax deadlines for your business; some most common tax deadlines are:
    • Due date for filing Income tax returns for most businesses following calendar year as their fiscal year is March 15, if incorporated business and April 15, if unincorporated business.
    • Estimated taxes for income earned or received during the year are paid on quarterly basis and due dates for payment are April 15, June 15, September 15, and January 15.
    • Due date for sales tax payment is either monthly or quarterly depending on state where you are subject to sales tax.
    • Payment of payroll taxes are due either weekly, monthly or quarterly depending on size of payroll. Form W2’s to employees should be issued by January 31. Quarterly federal payroll returns should be filed by the end of subsequent month of the quarter. Annual federal payroll return should be filed by January 31. Also be aware of state payroll forms and returns filing requirements.
    • Deadline to furnish form 1099 to payee is January 31. Form 1099 & 1096 should be mailed to IRS by February 28 if filed by paper, and by April 1 if filed electronically.

Write to Baljeet Singh at baljeetsinghcpa@gmail.com

Introduction to the types of business entities, their formation and taxation

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“Nobody likes taxes, but they’ve been around forever. Taxes date back all the way back to the year one, when baby Jesus was visited by two wise men and an IRS agent, who demanded half the family’s frankincense.” -Jimmy Kimmel.

So there is nothing much we could do about existence of taxes and the fact that they are going to remain forever but what we could do is trying to know more about various options available when we start our business as to type of business structure available, their tax impact so that we go for one that best suits our circumstances. To start with, it will be interesting to go through the following to understand the types of business entities that are available.

  1. Sole Proprietorship – Sole proprietorship refers to the form of business when someone in his/her individual capacity engages in to business activity. There are no legal formalities required to start sole proprietorship except that registration may be required with city or county. All the income from business as a sole proprietorship is reported on individual tax returns of the owner as income from business. The main advantage of this form of business is that it is simple to start. The disadvantage is that the individual is personally liable for the liabilities of the business.
  2. Partnerships – When two or more person join together to do business then it is called a partnership. Like sole proprietorship there are no legal formalities required to start a business in partnership. Typically partners enter in to a formal agreement that specifies the terms of the partnership. Partnerships are flow through entities which means that the income of the partnership is not taxed at partnership level and flows to individual tax returns of the partners for their respective share of income where they pay taxes for their respective share though partnership does need to file a separate tax return which is an information return. Partners are jointly and severally personally liable for the liabilities of the partnership. There are two kind of partnerships; general and limited partnership. In general partnership all the partners have unlimited liability whereas in limited partnership, which needs to have one general partner at least, only general partners have unlimited liability. Some states do permit LLP (limited liability partnerships) to protect the liability of general partners.
  3. Limited Liability Companies (LLC’s) – LLC is formed under the State law by filing charter of the Company with the Secretary of State. The owners of the LLC’s are called members. Some states allow one member LLC to be formed.  One member LLC is a disregarded entity as per the tax laws that means LLC does not file any separate tax returns and all the income of the LLC is reported on member’s personal tax returns. Two or more members LLC’s are taxed like partnerships i.e. they are flow through entities which means that the income of the LLC is not taxed at the corporate level and flows to individual tax returns of the members for their respective share of income where they pay taxes for their respective share though LLC does need to file a separate tax return which is an information return. LLC, with one or more members, can choose to be taxed as a C-Corporation by making a specific election with the IRS within the specified time limit. The liability of the members is limited.
  4. C Corporation – C-corporation is formed under state law by filing charter of the company with the Secretary of the State. The owners of the Corporation are called stockholders. The income of the C-Corporation is taxed at a corporate level and if any distribution is made to stockholder after tax paid income that also becomes subject to taxes as dividend income. The stockholder of C-corporation has limited liability.
  5. S Corporations- S Corporation is initially formed as a C-Corporation under state law by filing a charter document with the Secretary of State and thereafter, an election if filed with the IRS requesting the entity to be taxed as S Corporation. The owners are called stockholders and have limited liability. S Corporation is a flow through entity which means the income of the S Corporation is not taxed at corporate level and flows to individual tax returns of the partners for their respective share of income. S Corporation needs to file a separate return which is an information return.
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