New IRS Initiative to Discover Unreported Income and Proposed Foreign Account Tax Compliance Act of 2009
On Monday, IRS Commissioner Douglas Shulman announced the creation of a new enforcement unit dubbed the Global High Wealth Industry Group, to target wealthy individuals for audit with specific emphasis on offshore trusts, international sourcing of income, foreign tax residences, offshore accounts and real estate investments, royalty and licensing agreements, revenue-based or equity-sharing arrangements, private foundations, privately-held companies, partnerships and other flow-through entities, and other complex schemes used to hide income.
On Tuesday, the next prong of the government’s assault on unreported income was disclosed when House Ways and Means Committee Chairman Charles Rangel, Senate Finance Committee Chairman Max Baucus, Ways and Means Select Revenue Subcommittee Chairman Richard Neal, and senior Senate Finance Committee member John Kerry released their proposed Foreign Account Tax Compliance Act of 2009. The proposed legislation generally provides the Treasury Department with new tools to detect, deter, and discourage offshore tax abuses.
Below is a brief description of certain provisions in the bill.
Increased Disclosure of Beneficial Owners
Foreign Bank Accounts. In an effort to increase reporting by foreign financial institutions of foreign accounts having U.S. beneficial owners, the bill provides for the imposition of a 30% withholding tax on payments to a foreign financial institution of “interest (including any original issue discount), dividends, rents, salaries, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income … [and] any gross proceeds from the sale of any property of a type which can produce interest or dividends from sources within the U.S.” Generally, a foreign financial institution may exempt such payments from being subject to such a withholding tax if it agrees to disclose the identity of any U.S. individual with an account at the institution (or the institution’s affiliates) or account of foreign entity with substantial U.S. owners, and to annually report on the account balance, gross receipts and gross withdrawals or payments from such account. As proposed, these disclosure and reporting requirements would be in addition to any requirements imposed under the Qualified Intermediary program pursuant to Section 1441 of Internal Revenue Code of 1986, as amended (“Code”).
Foreign Entities and Foreign Trusts. The proposed legislation provides for the imposition of a 30% withholding tax on payments to a non-financial foreign corporation if such corporation fails to provide withholding agents with the name, address, and tax identification number of any U.S. individual that is a substantial owner of the foreign corporation (i.e., owns more than 10% of the foreign corporation’s stock (by vote or value)). Similar rules apply for foreign partnerships and foreign trusts. The bill provides an exemption for publicly-traded and certain other foreign corporations.
It should be noted that the bill provides that to the extent payments are subject to withholding as described above, such payments shall not be subject to withholding under Section 1441 or Section 1445 of the Code. These withholding provisions are proposed to be effective for payments made after December 31, 2010.
Foreign Financial Asset Reporting
Disclosure of Foreign Financial Assets. In an effort to increase reporting of foreign financial assets of individuals, the proposed legislation expands the required reporting by U.S. individuals of offshore assets by requiring any individual that holds more than $50,000 (in the aggregate) in (a) a depository or custodial account maintained by a foreign financial institution or (b) any foreign stock, interest in a foreign entity, or financial instrument with a foreign counterparty not held in a custodial account of a financial institution, to report information about these accounts and/or assets on the individual’s annual income tax return. Examples of the information to be reported include: the name and address of the financial institution in which the account is maintained and the number of such account; the name and address of the issuer of stock or other security and other identifying information; and names and addresses of issuers and counterparties with respect to other instruments, contracts, or interests. A failure to comply with this reporting requirement would be subject to a penalty of $10,000, and a greater penalty of up to $50,000, could apply if any such failure is not remedied within 90 days following notification from the Treasury Department.
Penalties for Underpayments Attributable to Undisclosed Foreign Financial Assets. The proposed legislation imposes a 40% penalty on the understatement of income attributable to an undisclosed foreign financial asset.
Modification of Statute of Limitations. The proposed legislation expands the circumstances under which a six year statute of limitations applies for assessment by the IRS to include an omitted item of gross income that is attributable to one or more reportable foreign assets and is greater than $5,000.