Section 1500 Specialized Returnsf or Individuals

INDIVIDUALS 1500 Specialized Returns for individuals 1510 Estate Tax 1510.01 The estate tax and the gift tax are both excise taxes on the transfers of property. The estate tax is imposed on the amount of a decedent’s net wealth (fair market value of total assets less debts and expenses) that passes to their heirs at death. The gift tax is imposed on the value of property transferred during an individual’s life. a. Only a relatively small percentage of taxpayers are affected by the gift or estate tax since they apply only when the transfer of wealth is substantial. Transfer taxes (gift and estate taxes) are triggered in 2023 only when transfers exceed $12.92 million. Despite their limited application, for those to whom the taxes do apply, the cost can be significant. b. Generally, an estate tax return, Form 706, is not required for a death in 2023 unless the taxable estate of the deceased is more than the exemption amount, which is $12.92 million in 2023. The estate tax return is due nine months after the date of death, though it is possible to extend the return for another six months automatically. c. In 1976, the gift tax and estate tax were combined into what is conceptually a unified transfer tax. In years 2012 and after, the gift and estate taxes are unified. As an individual makes taxable gifts during life, the gift tax is computed on a cumulative basis. To calculate the tax on current year gifts, the donor must add all taxable gifts made in prior years (since 1976) to the current gifts, calculate the gross tax on the sum of the lifetime transfers, and then subtract gift taxes assessed on the prior years’ gifts. The remainder is the current year gift tax. When the individual dies, the estate tax is computed in a similar manner by adding all prior taxable gifts to the taxable estate, applying the appropriate rate and subtracting any prior gift taxes assessed. It is helpful to think of the transfer at death as the final gift. 249 INDIVIDUALS 250 d. As a practical matter, the estate and gift tax does not apply to most taxpayers. To eliminate the administrative problems that would result if the gift tax were imposed on all gifts (e.g., birthday presents), the gift tax is imposed only on those transfers that exceed a certain threshold known as the “annual exclusion.” In 2023, this amount is $17,000. Technically, individuals are entitled to an exclusion of the annual exclusion amount per donee, per year. The exclusion enables an individual to make an unlimited number of gifts as long as they do not exceed $17,000 per donee in 2023. For married couples, these rules permit a husband and wife to give $34,000 in 2023 to a particular donee (e.g., a child) tax free by electing to make joint gifts. In addition to the annual exclusion, gifts to a spouse, charity, or transfers for educational or medical purposes normally are not taxable. In addition to the annual exclusion and the unlimited gifting opportunity for medical and education related gifts, in 2023, a taxpayer may gift up to $12.92 million in gifts before such gifts become taxable. This exclusion applies to gifts made during life, and also applies to testamentary gifts to the extent the $12.92 million exclusion was not used during life. e. Once either inter vivos or testamentary transfers exceed the exclusion amount, the transfer is taxed at up to 40 percent (progressive rate depending on taxable amount of gifts) in 2023. f. A decedent’s estate tax liability is based on his or her net wealth and whether he or she leaves it to a surviving spouse or to a qualified charity. The procedure for computing the federal estate tax liability is discussed below. The first step in computing the estate tax is to identify the decedent’s gross estate. A decedent’s gross estate includes the value of all property owned at date of death, wherever located. This includes the proceeds of an insurance policy on the life of the decedent if the decedent’s estate is the beneficiary, or if the decedent had any ownership rights in the policy at time of death. Property is generally included in the gross estate at its fair market value as of the date of death or the fair market INDIVIDUALS value at the alternative valuation date six months from the date of death. The alternative valuation date may be used only if it results in a reduction of the applicable estate tax. g. 1510.02 The taxable estate is the gross estate reduced by deductions allowed for funeral and administrative expenses, debts of the decedent, certain taxes and losses, state death taxes and charitable gifts made from the decedent’s estate. It is important to note that there is no limit imposed on the charitable deduction. If an individual is willing to leave his or her entire estate to a charity or to a spouse, there will be no taxable estate. An unlimited marital deduction is allowed for the value of property passing to a surviving spouse. Thus, if a married taxpayer leaves all of his or her property to the surviving spouse, no federal estate tax will be imposed on the estate. On the death of the surviving spouse, the couple’s wealth may be subject to taxation. Gross estate The gross estate of the decedent consists of the fair market value at date of death of everything a decedent owned or had an interest in at time of death. The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests, and other assets. The gross estate will likely include non‐probate as well as probate property. Generally, the gross estate does not include property owned solely by the decedent’s spouse or other individuals. Lifetime gifts that are complete (no powers or other control over the gifts are retained) are not included in the gross estate (but taxable gifts are used in the computation of the estate tax). Life estates given to the decedent by others in which the decedent has no further control or power at the date of death are not included. The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent’s gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the 251 INDIVIDUALS sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate. An heir takes a tax basis in gifted property generally equal to the donor’s basis if the property is sold at a gain. If the property is depreciated at the time it is gifted and the property is subsequently sold at a loss, the donee’s basis will be the property’s fair market value at the time of the gift. An individual’s basis in inherited property is the property’s fair market value at the decedent’s date of death. If the alternative valuation date is used to value the property, then the property’s basis is the fair market value of the property six months from the date of death. The gross estate includes all property in which the decedent had an interest (including real property outside the United States). It also includes: 252 a. Certain transfers made during the decedent’s life without an adequate and full consideration in money or money's worth; b. Annuities; c. The includible portion of joint estates with right of survivorship; d. The includible portion of tenancies by the entirety; e. Certain life insurance proceeds (even though payable to beneficiaries other than the estate, see the instructions for Schedule D); f. Property over which the decedent possessed a general power of appointment; g. Dower or curtesy (or statutory estate) of the surviving spouse; and h. Community property to the extent of the decedent’s interest as defined by applicable law. INDIVIDUALS 1. Alternative valuation date An executor may elect the alternative valuation date regarding the time at which property included in a decedent’s gross estate will be valued: the date of death (the usual valuation date), or a date that is six months after the date of death (the alternate valuation date). Once made, the selection of the valuation date generally applies to all property in the estate for purposes of computing the estate tax liability. If the executor elects the alternate valuation date, an exception exists for property that is sold or otherwise disposed of within the six‐month period between the date of death and the alternate valuation date: such property is valued as of the date it was sold or disposed of. The alternate valuation date rule is designed to be a relief provision in cases where the value of a decedent’s estate declines in the six‐month period following his or her death. If an executor uses the alternate valuation date for assets, this lower valuation amount also sets the basis that heirs will have in the assets they receive from the estate. If they have a lower basis, they can expect to face a higher capital gains tax liability when they later sell these properties. In order to use the alternative valuation date, three requirements must be met: a. The total value of the gross estate must decrease by using the alternative valuation date; b. The amount of the estate tax must decrease by using the alternative valuation date; and c. The person who files the deceased person’s estate tax return must make the proper election on the return. 253 INDIVIDUALS The executor can only elect to use the alternative valuation method if it will lower both: a. The value of the gross estate; and b. The sum of the estate tax and GST tax after taking the application of all allowable credits against these taxes. Estates that owe no federal estate tax or no generation skipping tax may not use the alternative valuation method. This election must be made within one year after the due date of the federal estate tax return (including extensions). There is no exception to this one‐year rule. The election is irrevocable. 2. Generation Skipping Transfer Tax (GST Tax) A donor is liable for the GST when he or she makes an inter vivos direct skip, which is a transfer made during the donor’s lifetime that is subject to the gift tax, of an interest in property, and made to a skip person. A donee, who is a natural person, is a skip person if that donee is assigned to a generation that is two or more generations below the generation assignment of the donor. The exemption for the GST tax in 2023 is $12.92 million. 1510.03 Taxable estate (calculations and payments) One of the primary deductions for married decedents is the marital deduction. All property that is included in the gross estate and passes to the surviving spouse is eligible for the marital deduction. The property must pass “outright.” In some cases, certain life estates also qualify for the marital deduction. If the decedent leaves property to a qualifying charity, it is deductible from the gross estate. Additional deductions include mortgages and debt, administration expenses of the estate, and losses during estate administration. The following tax formula sets forth how the estate tax liability is determined: 254 INDIVIDUALS – – – – – – – = + = Gross estate Administrative and funeral expenses Debts Losses Taxes Charitable bequests State death tax deduction Marital deduction* Taxable estate Post‐1976 taxable gifts Total taxable transfers – – – – = Tax on total transfers Gift taxes paid on post‐1976 gifts Applicable credit amount State death tax credits Other credits Estate tax liability * Every married individual may give an unlimited amount of assets either by gift or bequest to his or her spouse without the imposition of any federal gift or estate taxes. In effect, the unlimited marital deduction allows married couples to delay the payment of estate taxes at the passing of the first spouse because at the death of the surviving spouse, all assets in the estate over applicable exclusion amount ($12.92 million in 2023) will be included in the survivor’s taxable estate. It is important to note that the unlimited marital deduction is only available to surviving spouses who are United States citizens. 1510.04 Unified credit In 2012 and thereafter, taxpayers can take advantage of the portability rule, which provides that any credit that remains unused as of the death of a spouse who dies after 2010 is portable; that is, the unused amount is generally available for use by the surviving spouse as an addition to the surviving spouse’s exemption. In 2023, portability effectively allows a married couple to exempt up to $25.84 million from the estate tax. If a surviving spouse is predeceased by more than one spouse, the amount of unused credit that is available for use by such 255 INDIVIDUALS surviving spouse is limited to unused exclusion of the last such deceased spouse. The first spouse to die must file an estate tax return (IRS Form 706) even though he or she may not owe any estate tax since the amount of unused credit must be determined. The unused exclusion amount is available to a surviving spouse only if the executor of the estate of the deceased spouse files an estate tax return on which such amount is computed and makes an election on such return that such amount may be used. The election is irrevocable. The election cannot be made unless that estate tax return is filed on a timely basis as extended. Thus, even if a decedent normally is not required to file an estate tax return, filing an estate tax return is now necessary simply to preserve the unused estate tax exclusion amount of the first spouse to die. 1510.05 Life insurance Life insurance death benefit proceeds are usually federal‐income‐ tax‐free. However, the proceeds from any policy on a decedent’s life are included in his or her estate for federal estate tax purposes if the decedent had any incidents of ownership in the policy. Incidents of ownership include: a. The right to change the beneficiary. b. The right to surrender or cancel the policy. c. The right to assign the policy. d. The right to revoke an assignment of the policy. e. The right to pledge the policy for a loan. f. The right to obtain a loan from the insurer against the surrender value of the policy. In addition, proceeds from a life insurance policy are included in the insured’s gross estate if the insured had any incident of ownership in the policy and the insured transferred the policy within three years of his or her death. On the other hand, as long as certain conditions are met, namely, the insured does not possess any of the incidents of ownership when he or she dies, the proceeds of the life insurance policy are not paid to the insured’s estate, and the insured does not transfer any incidents of ownership in the policy within three years of his or her death, 256 INDIVIDUALS the proceeds will not be included in the insured’s gross estate for estate tax purposes. The life insurance ownership rule is more likely to adversely affect unmarried people because death benefit proceeds from a policy on the life of a married person can be left to the surviving spouse without any immediate federal estate tax hit, thanks to the unlimited marital deduction privilege (assuming the surviving spouse is a U.S citizen). However, all the insurance money going to a surviving spouse could cause his or her estate to eventually exceed the federal estate tax exemption. The estate‐tax‐saving solution is to set up an irrevocable life insurance trust to own the policies on the taxpayer’s life. Since the trust, rather than the taxpayer, owns the policies, the death benefit proceeds are not counted as part of the taxpayer’s estate (unless the estate is named as the policy beneficiary which would defeat the purpose). The taxpayer is still able to direct who gets the insurance money because the taxpayer may name the beneficiaries of the irrevocable life insurance trust (typically the taxpayer’s children and/or grandchildren). One complicating factor is that when a taxpayer moves existing insurance policies into the trust, he or she must live for at least three years or the death benefit proceeds will be included in the decedent’s estate, just as if he or she still owned the policies at the time of death. Also, when existing whole life policies are transferred into the trust, their cash values are treated as gifts to the trust beneficiaries. A taxpayer with a large estate that will owe some federal estate tax can set up an irrevocable life insurance trust to buy coverage on his or her life. The death benefit proceeds can then be used to cover all or part of the estate tax bill after the insured dies. This result is achieved by authorizing the trustee of the life insurance trust to purchase assets from decedent’s estate or make loans to the estate. The extra liquidity is then used to cover the estate tax bill. When the irrevocable life insurance trust is eventually liquidated by distributing its assets to the trust beneficiaries (usually insured’s children and/or grandchildren), the beneficiaries will wind up with the assets purchased from taxpayer’s estate or with liabilities owed to them. The end result 257 INDIVIDUALS is that the federal estate tax bill gets paid with dollars that are not themselves subject to the federal estate tax. 1510.06 Filing requirements The executor of a decedent’s estate uses Form 706 to figure the estate tax. This tax is levied on the entire taxable estate and not just on the share received by a particular beneficiary. For decedents dying in 2023 or later, Form 706 must be filed by the executor for the estate of every U.S. citizen or resident: a. Whose gross estate, plus adjusted taxable gifts and specific exemption, is more than $12.92 million (in 2023); or b. Whose executor wants to make the election to permit the decedent’s surviving spouse to use the decedent’s unused exclusion amount, regardless of the size of the decedent’s gross estate. If it is determined that filing a return for the estate is not required, the estate should nonetheless file a return if the executor wishes to elect to allow the decedent’s surviving spouse to use the decedent’s unused exclusion amount for estate and gift tax purposes. A taxpayer must file Form 706 to report estate and/or GST tax within nine months after the date of the decedent’s death. If the taxpayer is unable to file Form 706 by the due date, the estate may receive an extension of time to file. Use Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation‐Skipping Transfer) Taxes, to apply for an automatic six‐month extension of time to file. 258 INDIVIDUALS 1510.07 Jointly‐held property 1. Joint tenants with rights of survivorship If the property was held by both spouses as joint tenants with rights of survivorship (i.e., they each owned half of the property and each half automatically passes to the other), then each spouse is considered to own 50 percent of the property’s value. Thus, 50 percent of the value will be considered part of the estate and potentially subject to estate tax. Because of the rights of survivorship, that half will automatically pass into possession of the surviving spouse, typically without any probate process. Furthermore, because spouses are entitled to a tax deduction on the value of estates passed to them from a marriage partner, the surviving spouse likely will not end up owing estate tax on the value of this jointly held property. This arrangement may only delay the tax rather than allow the heirs to forego it entirely. Because the property need not go through probate when one spouse dies, estate tax requirements are not considered at that time. But when the final surviving spouse passes away, the property ‐‐ valued in its entirety ‐‐ will have to go through probate and will be considered taxable to the estate. 2. Tenancy by the entirety Tenancy by the entirety means that the two spouses do not have an independent interest in the property and are considered to be one legal unit that owns the whole property. This means that there is nothing to pass upon the death of one spouse, as each owned the entire estate during life. The right of survivorship means one person succeeds to exclusive ownership; therefore, no estate tax applies. It is important to note; however, that this arrangement is currently available only to husbands and wives by marriage and cannot be used by any other individuals to avoid estate tax requirements when property is transferred. 259 INDIVIDUALS 3. When two or more non‐married people own property together with rights of survivorship When the joint tenants with rights of survivorship are not married, the full value of the property in question will be included in the estate and taxed accordingly upon the passing of one of the owners. This does not apply if the surviving individual can prove they paid for the acquisition of their part of the property. In other words, if two business partners jointly own an office building, and one passes away, the surviving business partner must show proof of the payments he or she personally made for his or her share of the building. If he or she proves that he or she paid for 70 percent of the building, then the remaining 30 percent will be regarded as owned by the deceased and only that 30 percent will be subject to the estate tax. 1510.08 Marital deduction and other marital issues If a taxpayer’s spouse is a U.S. citizen, the taxpayer can leave any amount to him or her with no federal estate tax, and if the taxpayer is a U.S. citizen, the taxpayer’s spouse can do the same. This is the so‐called unlimited marital deduction privilege. For married couples, the $12.92 million federal estate tax exemption and the unlimited marital deduction privilege provide significant federal estate tax shelter for those who died in 2023. For 2023, a taxpayer can direct the executor of his or her estate to leave any unused federal estate tax exemption to his or her surviving spouse. For example, if a taxpayer dies in 2023, he or she can bequeath all his or her property to his or her spouse, including his or her unused $12.92 million exemption. The surviving spouse would then have a $25.84 million exemption if he or she died in 2023 (his or her own $12.92 million exemption plus the deceased spouse’s unused $12.92 million exemption). Portability was made permanent for 2013 and after. Portability requires that an estate tax return (Form 706) be filed and portability be elected on that return even if there is no federal estate tax liability. 260 INDIVIDUALS 1510.09 IRAs and retirement plans Upon the death of an owner of an IRA or a qualified plan, any remaining balance is included in the calculation of the gross estate. After death, income payments made from retirement accounts to the designated beneficiaries will be taxed when they are received as ordinary income. Although qualified plans and IRAs are generally a very good way to accumulate dollars for retirement, they are not necessarily good vehicles for passing money to future generations. At death, these assets trigger tax and are known as “income in respect of a decedent” (IRD) assets. For income tax purposes, IRD assets, unlike other assets, do not receive a step‐up in basis at the death of the owner. The bottom line is that such assets are theoretically subject to both estate tax and income tax. When a participant dies with a qualified plan or IRA asset, it is included in his or her estate subject to estate tax. Then, in the year(s) it is distributed to the named beneficiary, it must be included in the recipient’s income for tax purposes and is taxed again. Even though the recipient beneficiary is allowed a deduction for the estate tax attributed to the amount received, this “double tax” can substantially reduce the value passing to the heirs. The IRD deduction is a Schedule A deduction not subject to the 2 percent AGI limitation. The IRD deduction is taken in proportion to how much of the IRD income is included by the distributee. A taxpayer does not run out of time to claim the IRD deduction and can claim the deduction until the account is totally distributed. There is no dollar limit on the amount of IRD deduction that can be claimed, but the taxpayer can only take the deduction against IRD income that he or she reports. If a taxpayer missed taking the IRD deduction, he or she may go back three years (the statute of limitations) and amend his or her federal income tax returns to claim the IRD deductions that he or she missed. If there are still funds in the IRA or employer‐sponsored plan the taxpayer inherited, he or she can keep taking the IRD deduction against future distributions as long as those funds last. 261 INDIVIDUALS 1520 Gift Tax 1520.01 Introduction The purpose of the federal gift tax is to prevent a taxpayer’s avoidance of the estate tax. To arrive at taxable gifts for the year, the taxpayer’s total gifts may be reduced by the annual exclusion and by the deductions allowed for property transferred to a spouse or charity. The annual exclusion is $17,000 in 2023. The annual exclusion is allowed each year even if the donor has made gifts in the prior years to the same donee. As a practical matter, the $12.92 million transfer tax exemption ($25.84 million for married couples), protects most individuals from the estate and gift tax. However, for high wealth individuals, gifts can produce substantial savings. For example, a gift of income producing property (e.g., dividend paying stock or rental real estate) to children who may be in lower tax brackets not only reduces the income tax that might be paid but also removes all of the accumulated income from the donor’s estate. In addition, a gift of property that is appreciating or will increase in value (e.g., land, stock, art, life insurance), removes all of the appreciation from the estate by transferring ownership of the property. Under current federal estate tax laws, taxable gifts made after 1976 are added to the taxable estate to arrive at total taxable transfers. A tentative estate tax is then computed on the base amount. All gift taxes paid on post‐1976 gifts, as well as certain tax credits, are subtracted from this tentative tax in arriving at the federal estate tax due, if any. Most estate tax credits have a single underlying purpose ‐‐ to reduce or eliminate the effect of multiple taxation of a single estate. Estate taxes paid to the various states or foreign countries on property owned by the decedent and located within their boundaries are examples of estate tax credits. However, the major credit available to reduce the federal estate tax has been the unified credit. The unified credit protects all but the wealthiest of taxpayers from the estate and gift tax. The credit is unified in the sense that it can be used to offset gift taxes during the taxpayer’s life. However, any credit used for gift tax purposes is not available at death. 262 INDIVIDUALS A citizen or resident of the United States must file a gift tax return (whether or not any tax is ultimately due) in the following situations. If taxpayer gave gifts to someone in 2023 totaling more than $17,000 (other than to a spouse), Form 709 must be filed. Certain gifts, called future interests, are not subject to the $17,000 annual exclusion (for 2023) and the taxpayer must file Form 709 even if the gift was under $17,000. A husband and wife may not file a joint gift tax return. Each individual is responsible for his or her own Form 709. A taxpayer must file a gift tax return to split gifts with spouse (regardless of their amount). a. If a gift is of community property, it is considered made one‐half by each spouse. For example, a gift of $100,000 of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return. b. Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety. c. Only individuals are required to file gift tax returns. If a trust, estate, partnership, or corporation makes a gift, the individual beneficiaries, partners, or stockholders are considered donors and may be liable for the gift and GST taxes. d. The donor is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax. e. If a donor dies before filing a return, the donor's executor must file the return. If a taxpayer meets all of the following requirements, he or she is not required to file Form 709: a. Taxpayer made no gifts during the year to his or her spouse; b. Taxpayer did not give more than $17,000 to any one donee in 2023; and c. All the gifts made were of present interests. 263 INDIVIDUALS The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. The gift tax applies to the transfer by gift of any property. A taxpayer makes a gift if he or she gives property (including money) or the use of or income from property, without expecting to receive something of at least equal value in return. If a taxpayer sells something at less than its full value or if a taxpayer makes an interest‐free or reduced‐interest loan, he or she may be making a gift. The donor is generally responsible for paying the gift tax. Under special arrangements, the donee may agree to pay the tax instead. Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return is a gift. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts: a. Gifts that are not more than the annual exclusion for the calendar year ‐‐ $17,000 for 2023; b. Tuition or medical expenses a taxpayer pays for someone (the educational and medical exclusions); c. Gifts to a taxpayer’s spouse; and d. Gifts to a political organization for its use. In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made. Making a gift or leaving an estate to a taxpayer’s heirs does not ordinarily affect a taxpayer’s federal income tax. The taxpayer cannot deduct the value of gifts he or she makes (other than gifts that are deductible charitable contributions). 264 INDIVIDUALS 1520.02 Gift‐splitting Another unique feature of the federal gift tax involves the gift‐ splitting election available to a married donor. If a donor makes the election on his or her current gift tax return, one half of all gifts made during the year will be considered to have been made by the donor’s spouse. The election is valid only if both spouses consent to gift‐splitting. If each spouse agrees, each can then take the annual exclusion for his or her part of the gift. For 2023, the gift splitting election allows married couples to give up to $34,000 to a person without making a taxable gift. If spouses split a gift, each must file a gift tax return (Form 709) to show that the spouses have agreed to split gifts. The taxpayers must file a Form 709 even if half of the split gift is less than the annual exclusion. The consent is effective for the entire calendar year; therefore, all gifts made by both spouses to third parties during the calendar year (while they were married) must be split. If the consent is effective, the liability for the entire gift tax of each spouse is joint and several. 1520.03 Annual per donee exclusion The annual exclusion is the maximum amount that an individual is allowed to give another person without incurring federal gift tax. The annual exclusion for 2023 is $17,000 per year per recipient. There is no limit on the number of these gifts an individual can make to different people in a year. To qualify as a gift, the transfer must be of a “present interest,” meaning that the recipient can make use of the gift immediately, and the donor must not have any control over the asset after it is given. a. Gifts of future interests cannot be excluded under the annual exclusion. A gift of a future interest is a gift that is limited so that its use, possession, or enjoyment will begin at some point in the future. If the taxpayer is married, both spouses can separately give gifts valued up to $17,000 to the same person without making a taxable gift in 2023. b. As part of an overall strategy to minimize or eliminate estate taxes, many taxpayers take advantage of the annual exclusion from gift tax, the ability in 2023 to gift a present interest in property of up to $17,000, or $34,000 if gift 265 INDIVIDUALS splitting is elected, to as many individuals as the donor wishes. In addition to the annual exclusion, an individual may utilize the $12.92 million gift tax exemption amount for 2023 for gifts made during the individual’s lifetime. Gifts serve to remove the appreciation on the gifted property after the gift, as well as any income earned after the gift is made, from the estate of the donor. Some tax practitioners recommend that their clients utilize the $12.92 million lifetime exemption (for 2023) as quickly as possible when the donor will be gifting rapidly appreciating property so as to avoid gift or estate taxation on the future appreciation. c. 1520.04 Gifts to nonspouse individuals in excess of an individual’s annual exclusion gifts and his or her lifetime exemption are generally taxable. Although the tax rate schedules for gift tax and estate tax appear to be the same in terms of applicable rates, the amounts against which these rates are applied are different. Gift taxes are computed only on the amount the recipient actually receives, whereas estate taxes are computed on the total of the assets in the estate prior to any distribution. As a result of this difference in computation, the highest gift tax rate is effectively lower than the lowest estate tax rate. Unified credit The unified credit applies to both the gift tax and the estate tax, and it equals the tax on the applicable exclusion amount. The donor must subtract the unified credit from any gift or estate tax that he or she owes. Any unified credit a taxpayer uses against gift tax in one year reduces the amount of credit that he or she can use against gift or estate taxes in a later year. Beginning in 2011, the amount of unified credit available to a person equals the tax on the basic exclusion amount plus the tax on any deceased spousal unused exclusion (DSUE) amount. The DSUE is only available if an election was made on the deceased spouse’s Form 706. 266 INDIVIDUALS The unified credit amount of $12.92 million is in effect for 2023, and allows an individual to make gifts or bequests to any person up to $12.92 million free of estate and gift taxes. If the estate exceeded $12.92 million in 2023, the excess would be subject to estate and gift taxed at a 40 percent rate. When a person dies, his or her total taxable lifetime gifts (gifts in excess of the annual gift exclusion) are added to his or her gross estate to compute the estate tax, if any. The same gift tax rates apply to estate taxes; however, a tax credit is given based on prior gift taxes paid. This is why estate and gift taxes are referred to as a unified tax regime. Basically, any unified credit not used to eliminate gift tax can be used to eliminate or reduce estate tax. However, to determine the unified credit available for use against the estate tax, the taxpayer must complete the Estate Tax return, Form 706. Although it may seem counterintuitive to make taxable gifts in excess of the $12.92 million exemption amount for 2023, it may make economic sense to do so if the estate tax exemption would not otherwise exceed the value of the taxable estate at the time of the donor’s death. In addition, gifting income‐generating assets allows the income and appreciation related to those assets to inure to the transferees rather than to the transferor. Although there are clearly certain offsetting factors, such as loss of a “stepped up” basis at death and loss of the use of the money used to pay gift taxes, in many cases these offsetting factors do not outweigh the benefits of making taxable gifts during the owner’s lifetime. 1. Gifts for education and medical expenses Gifts used for tuition or medical expenses are not limited by the $17,000 (in 2023) maximum annual exclusion limitation. An unlimited gift tax exclusion is allowed for amounts paid on behalf of a donee directly to an educational organization, provided such amounts constitute tuition payments. Amounts paid for books and dormitory fees on behalf of the donee are not eligible for the exclusion. Amounts paid directly to health care providers for medical services on behalf of a donee also qualify for the unlimited gift tax exclusion. 267 INDIVIDUALS Many donors have historically used minority interest and marketability discounts to leverage the value of both their annual exclusion gifts as well as their lifetime exemption gifts when interests are transferred where discounting would be appropriate. Gifts of limited partnership interests, for example, in family limited partnerships, are often subject to substantial discounts. The magnitude of discounts taken has varied depending upon the kind of property gifted and whether or not minority interest discounts apply. 2. Gifting and §529 Plans A qualified tuition program (§529 plan) is a program set up to allow an individual to either prepay, or contribute to an account established for paying, a student’s qualified education expenses at an eligible educational institution. A §529 plan can be established and maintained by states (or agencies or instrumentalities of a state) and eligible educational institutions. The amount invested grows tax‐ deferred, and distributions to pay for the beneficiary’s college costs come out federally tax‐free. In a §529 plan, the donor remains in control of the account even though the funding of the account is a completed gift. With a few exceptions, the named beneficiary has no rights to the funds. The donor decides when withdrawals are taken and for what purpose. Most §529 plans even allow the donor to reclaim the funds any time he or she desires; however, the earnings portion of the “non‐qualified” withdrawal will be subject to income tax and an additional 10 percent penalty tax. There are no tax consequences if the designated beneficiary of an account is changed to a member of the beneficiary’s family. 268 INDIVIDUALS 3. Five‐year front‐loaded annual exclusion gifts With respect to the gift and estate tax treatment of an investment in a §529 plan, the contribution is treated as a gift to the named beneficiary for gift tax and generation‐ skipping transfer tax purposes; however, the contribution qualifies for the $17,000 (in 2023) annual gift tax exclusion. An individual who makes a contribution of between $17,000 and $85,000 in 2023 for a beneficiary can elect to treat the contribution as made over a five calendar‐year period. This allows the donor to utilize as much as $85,000 in annual exclusions to shelter a contribution ($170,000 if the spousal election is utilized in 2023). The advantage of “front loading” §529 plan contributions is that the growth of the funds invested in the account is removed from the donor’s estate faster than if the donor made $17,000 annual exclusion contributions each year. The unified credit equals the tax on the applicable exclusion amount applies to both the gift tax and the estate tax. In calculating the gift or estate tax, the taxpayer will subtract the unified credit from any gift or estate tax owed. Any unified credit used against gift tax in one year reduces the amount of credit that the taxpayer can use against gift or estate taxes in a later year. 1520.05 Effect on estate tax (e.g., Generation skipping transfer tax) The federal generation skipping tax (GST) applies when a donor conveys in excess of a stated dollar limitation (GST limitation) to a generation beyond the next living generation, for example, skipping over living children in favor of grandchildren, etc. (known as a “generation skip”). The dollar limitation for the GST limitation has historically been the same dollar amount as the unified credit against estate taxes (i.e., $12.92 million in 2023). In effect, this means that fully utilizing the GST limitation transfers by means of a generation skip (e.g., to grandchildren, etc.) passes without the estate(s) of the skipped generation (e.g., children) ever being exposed to imposition of any estate or gift tax on such a transfer. As to amounts above the GST limitation, the GST essentially recaptures these prospective savings immediately. 269 INDIVIDUALS Gifts of the annual exclusion amount to children, grandchildren, and other beneficiaries are often recommended as an excellent way to reduce taxable estate at no transfer tax cost. Outright gifts to grandchildren of the annual exclusion amount will also be exempt from the GST. Gifts in trust for grandchildren that qualify for the gift tax annual exclusion can also qualify for exclusion from the GST if the trust is properly structured. Payments of tuition, if paid directly to the educational institution, and payments of medical expenses, if paid directly to the provider of the services, are also transfers that are not considered taxable gifts and are not subject to GST. The exemption from the GST for 2023 is $12.92 million, the same as for gifts and estates. Hence transfers of this amount or less are not subject to the GST. The GST tax may apply to gifts during a taxpayer’s life or transfers occurring at the taxpayer’s death, called bequests, made to skip persons. A skip person is a person who belongs to a generation that is two or more generations below the generation of the donor. For instance, a grandchild will generally be a skip person to a taxpayer or to his or her spouse. The GST tax is figured on the amount of the gift or bequest transferred to a skip person after subtracting any GST exemption allocated to the gift or bequest at the maximum gift and estate tax rates. Each individual has a GST exemption equal to the basic exclusion amount, as indexed for inflation, for the year involved. GSTs have three forms: direct skip, taxable distribution, and taxable termination. A direct skip is a transfer made during the taxpayer’s life or occurring at his or her death that is: a. Subject to the gift or estate tax; b. Of an interest in property; and c. Made to a skip person. A taxable distribution is any distribution from a trust to a skip person which is not a direct skip or a taxable termination. A taxable termination is the end of a trust’s interest in property where the property interest will be transferred to a skip person. 270 INDIVIDUALS 1520.06 Filing requirements Generally, an individual taxpayer must file a gift tax return (Form 709) if any of the following apply: a. Taxpayer gave gifts to at least one person (other than his or her spouse) that are more than the annual exclusion for the year ‐‐ $17,000 for 2023. A husband and wife may not file a joint gift tax return. Each individual is responsible for his or her own Form 709; b. Taxpayer gave someone (other than his or her spouse) a gift of a future interest that he or she cannot actually possess, enjoy, or receive income from until sometime in the future; or c. Taxpayer gave his or her spouse an interest in property that will be ended by some future event. A taxpayer does not have to file a gift tax return to report gifts to (or for the use of) political organizations and gifts made by paying someone’s tuition or medical expenses. A taxpayer does not need to report the following deductible gifts made to charities: 1. a. The taxpayer’s entire interest in property, if no other interest has been transferred for less than adequate consideration or for other than a charitable use; or b. A qualified conservation contribution that is a perpetual restriction on the use of real property. Gifts to charities If the only gifts a taxpayer made during the year are deductible as gifts to charities, he or she does not need to file a return as long as the taxpayer transferred his or her entire interest in the property to qualifying charities. If the taxpayer transferred only a partial interest, or transferred part of his or her interest to someone other than a charity, he or she must still file a return and report all of his or her gifts to charities. If a taxpayer is required to file a return to report noncharitable gifts and he or she made gifts to charities, he or she must include all of his or her gifts to charities on the return. 271 INDIVIDUALS 2. Filing Form 709 Generally, a donor must file Form 709 no earlier than January 1, but not later than April 15, of the year after the gift was made. If the donor died during 2023, the executor must file the donor’s 2023 Form 709 not later than the earlier of: 3. • The due date (with extensions) for filing the donor's estate tax return; or • April 15, 2024, or the extended due date granted for filing the donor's gift tax return. Who must file Form 709 Generally, a citizen or resident of the United States must file a gift tax return (whether or not any tax is ultimately due) in the following situations: 272 • If the taxpayer gave gifts to someone in 2023 totaling more than $17,000 (other than to a spouse), he or she probably must file Form 709. • Certain gifts, called future interests, are not subject to the $17,000 annual exclusion and the donor must file Form 709 even if the gift was under $17,000. • A husband and wife may not file a joint gift tax return. Each individual is responsible for his or her own Form 709. • A taxpayer must file a gift tax return to split gifts with his or her spouse (regardless of their amount). • If a gift is of community property, it is considered made one‐half by each spouse. For example, a gift of $100,000 of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return. Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety. INDIVIDUALS 1530 International Information Reporting 1530.01 FinCEN Form 114 In a global economy with diversified investment portfolios that oftentimes include an international component, more and more American people are impacted by the provisions of the law known as the Bank Secrecy Act. More than any other country, the United States has a significant number of permanent resident immigrants who maintain economic ties with their countries of birth, economic ties that are associated with bank accounts in that respective country. FinCen Form 114 is a disclosure form (informational purposes only, no tax due associated with the Form itself) that must be filed by a United States person (defined below) that has: a. Financial interest in or signature or other authority over at least one financial account located outside the United States if b. The aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported. One common question filers have refers to whether they have a filing obligation when the foreign bank accounts maintained abroad each have a balance below $10,000. The answer is “yes” to the extent the aggregate of the balances held in each account amounts to $10,000. The highest balance does not need to be measured at the same time. Each highest balance has to be considered throughout the year independent of when the other accounts have reached their own highest balance for purposes of determining whether the filing threshold has been reached. The $10,000 amount does not double for a married filing jointly couple. 273 INDIVIDUALS One very important aspect to remember is that even though the filing threshold of $10,000 has not been reached by a certain taxpayer (John Smith is the owner of a single foreign account in France holding 8,000 euros), the question in Part III, Schedule B (Form 1040) should still be marked YES. In this case, the correct way of reporting this would be as per below: What is a United States person? United States Person means United States citizens (including minor children), residents, entities (including corporations, partnerships, limited liability companies created or organized in the United States, trusts or estates formed under the laws of the United States). The tax treatment for purposes of Title 26 does not have any bearing over the obligation to file. For instance, a disregarded entity or a grantor trust still has an obligation to file if it meets the filing requirements. United States resident is defined as an alien residing the United States by applying the residency tests in 26 U.S.C. section 7701(b). As such, a foreign national who meets the presence tests as described in Section 7701(b) may have a filing requirement if the other tests are met. He or she does is not required to hold a Green Card to be considered a resident. What is Signature Authority? “Signature Authority is the authority of an individual (alone or in conjunction with another individual) to control the disposition of the assets held in a foreign financial account by direct communication to the bank.” 274 INDIVIDUALS What is a Foreign Financial Account? A foreign financial account is a financial account located outside of the United States. An account maintained with a foreign bank within the United States does not constitute a foreign financial account: holding a money market account at UBS or Credit Suisse within the United States will not give rise to a filing requirement. However, holding an account with Citibank in the UK will give rise to a filing requirement if the reporting threshold is reached. What is a financial interest? A U.S. person has a financial interest in a foreign financial account if:   The U.S. person is the owner of record or holder of legal title in the following: o A corporation in which the U.S. person owns directly or indirectly more than 50% of the total value of the shares of stock OR more than 50% of the voting power of all shares of stock. o A partnership in which is the U.S. person owns directly or indirectly an interest in more than 50% of the partnership’s profits or more than 50% in the partnership’s capital. o A trust of which the U.S. person is either the grantor or has an ownership interest in the trust, or a trust in which the U.S. person has a greater than 50% present beneficial interest in the assets or income of the trust for the calendar year. o Any other entity in which the U.S. person owns directly or indirectly more than 50% of the voting power, value of equity or interest in profits. All bank accounts that hold cash or securities are considered a financial account. A financial account also includes a commodity, futures, or options account, an insurance policy with a cash value (such as a whole life insurance policy), an annuity policy with a cash value, and shares in a mutual fund or similar pooled fund (i.e., a fund 275 INDIVIDUALS that is available to the general public with a regular net asset value determination and regular redemptions). Example: John Smith is a 55% owner in Foreign Co Ltd. – a corporation under the laws of United Kingdom. Foreign Co maintains two money market accounts at the local bank – HSBC London. Each account maintains a balance of the equivalent of $14,000. John would have to disclose his interest in the two accounts held by Foreign Co in which he is deemed to have a foreign financial interest. For purposes of defining interest in a joint account, joint account refers to an account that is held by any two or more people and does not necessarily imply ownership held by two spouses. Exceptions from filing: A. 276 The spouse of an individual who files an FBAR (foreign bank account reporting) is not required to file a separate FBAR if:  All the financial accounts that the non‐filing spouse is required to report are jointly owned with the filing spouse and  The filing spouse reports the jointly owned accounts on a timely filed FBAR electronically signed and  The filers have completed and signed Form 114A “Record of Authorization to electronically File FBARs. B. Consolidated FBAR. If a U.S. person is included in a consolidated FBAR filed by a greater than 50% owner, such entity is not required to file a separate FBAR. C. Correspondent/Nostro Account – maintained by banks and used solely for bank‐to‐bank settlements. D. Governmental entities – a foreign financial account held by any governmental entity of the United States. E. IRA or Tax Qualified Retirements Plans owners and beneficiaries – an owner or beneficiary of an IRA or retirement plan defined in Sections 401(a), 403(a) or INDIVIDUALS 403(b) is not required to report a foreign financial account held by those respective plans. F. Trust beneficiaries – if the trust, trustee, or agent of the trust is a U.S. person that files an FBAR disclosing the trust’s foreign financial accounts. Practice Note: Interest in foreign pension plans does not constitute interest in a foreign financial account for Form 114 purposes, but it does constitute an interest in a foreign asset that may need to be disclosed on Forms 8938 or 3520, discussed later. When and Where to File The FBAR is an annual report and must be filed on or before April 15 of the year following the calendar year being reported. For example, the 2023 FBAR would be due by April 15 of 2024 and must be filed electronically either by tax preparers, using their e‐ file software or directly by the taxpayer using the FinCEN’s BSA E‐ filing System http://bsaefiling.fincen.treas.gov/. Filers who do not file by April 15 are granted an automatic extension to October 15. Records that contain information such as: the name in which each account is maintained, number or other designation of the account, name and address of the foreign financial institution, maximum value of each account during the reporting period must be retained for a period of 5 years from April 15 of the year following the calendar year reported or the date filed (if later). An officer or an employee who files an FBAR to report signature authority over an employer’s foreign financial account is not required to personally retain records regarding these accounts. To determine the maximum amount held in each account monthly statements for that account can be used in the local currency. For conversion to U.S. dollars, taxpayers are encouraged to use the rates published by the Treasury Financial Management Service (www.fms.treas.gov) or any other verifiable exchange rate as long as the source is provided. 277 INDIVIDUALS For a U.S. person with a financial interest in 25 or more foreign financial accounts should check the YES box in Part I, item 14a, and indicate the number of accounts. The U.S. person should not complete Part II or Part III of the report but maintain records of the information. A U.S. person who has signature authority in 25 or more foreign financial accounts should check the YES box in Part I, Item 14b and indicate the number of accounts in the space provided. The two categories: financial interest and signature authority are not aggregated for purposes of meeting the 25 or more filing disclosure. For instance, if Emily holds 13 foreign financial interests and has signature authority in 14 other accounts, she still needs to list the accounts separately since each category is under 25 accounts. Penalties Failure to file an FBAR when required may result in civil penalties, criminal penalties, or both. A filer who became aware of an FBAR filing requirement should use the online system to submit any delinquent FBAR as soon as possible. The system allows for late filing as well as submitting an explanation for the late filing. If the foreign financial account is properly reported on a late‐filed FBAR, and the IRS determines that the FBAR violation was due to reasonable cause, no penalty is imposed. 278 INDIVIDUALS Those required to file an FBAR who fail to properly file a complete and correct FBAR may be subject to civil monetary penalties. Violation Civil Penalty Criminal Penalty Negligent Violation Up to $1,350 N/A Non‐Willful Violation Up to $15,611 for each negligent violation N/A Pattern of Negligent Activity In addition to penalty under § 5321(a)(6)(A) with respect to any such violation, not more than $105,083. N/A Willful ‐ Failure to File FBAR or retain records of Account Up to the greater of $156,107, or 50 percent of the amount in the account at the time of the violation. Up to $250,000 or 5 years or both Willful – Failure to File FBAR or retain records of account while violating other laws Up to the greater of $100,000, or 50 percent of the amount in the account at the time of the violation. Up to $500,000 or 10 years or both Knowingly and Willfully Filing False FBAR Up to the greater of $100,000, or 50 percent of the amount in the account at the time of the violation. $10,000 or 5 years or both Civil and Criminal Penalties may be imposed together under IRS Code Section 5321(d) Note regarding civil penalty assessment prior to August 1, 2016: For those violations occurring on or before November 2, 2015, the IRS may assess a civil penalty not to exceed $10,000 per violation for non‐willful violations that are not due to reasonable cause. For willful violations, the penalty may be the greater of $100,000 or 50 percent of the balance in the account at the time of the violation, for each violation. In a recent court case, U.S. v. Kaufman, a district court had found that the $10,000 non‐willful FBAR penalty applies per FBAR form, not per the number of bank accounts required to be reported on the form. Two district courts have reached to the same conclusion in similar cases. One district court has found the opposite. 279 INDIVIDUALS 1530.02 Form 8938 Form 8938 is used for reporting specified foreign financial assets which are valued in aggregate at or more than:  $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year for unmarried taxpayers living in the United States.  $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year for married taxpayers filing a joint income tax returns living in the United States. A married individual filing a separate return living in the United States will have the same filing thresholds as a single individual living in the United States  $200,000 on the last day of the tax year or more than $300,000 at any time during the year for a single individual living outside of the United States  $400,000 on the last of the tax year or more than $600,000 at any time during the year for married taxpayers filing a joint income tax return living outside of the United States  $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year for a specified entity (defined below). The presence abroad test is satisfied if the U.S. citizen has been a bona fide resident of a foreign country for an interrupted period that includes an entire tax year or a U.S. citizen or resident who is present in a foreign country for at least 330 full days during any period of 12 consecutive months that ends in the tax year being reported. Example: Jean McDavid accepted a new position with Nestle Switzerland on June 1, 2023. Jean has been living in Switzerland since. Although Jean does not meet the 330‐day test for physical presence abroad during the calendar year 01/01/2023–12/31/2023, she will meet the test for the year starting 06/01/2023–05/31/2024. If Jean files an extension to file, she can claim she meets the 330‐day test for presence abroad. 280 INDIVIDUALS Form 8938 must be filed and submitted by a specified individual or specified entity. A specified individual is:  A U.S. citizen  A resident alien of the United States for any part of the tax year (as defined in Publication 519)  A nonresident alien who makes an election to be treated as a resident alien for purposes of filing a joint return A specified entity is:  A closely held domestic corporation that has at least 50% of its gross income from passive income  A closely held domestic corporation if at least 50% of its assets produce passive income  A closely held domestic partnership with at least 50% of its gross income from passive income  A closely held domestic partnership if at least 50% of its assets produce passive income  A domestic trust described in section 7701(a)(30)(E) that has one or more specified persons (a specified individual or a specified domestic entity) as a current beneficiary. Generally, for purposes of measuring the highest value, fair market value is used. If fair market value is impractical to be determined, then the highest value of the interest can be used. For instance, if an interest in a foreign partnership is valued at $120,000 and an additional of $10,000 contribution is made, the highest value of the interest in the partnership that must be reported is $130,000. For interests in a foreign estate, pension plan or deferred compensation plan the value would be determined as of the last day of the year adding back any distributions made throughout the year. Where the fair market value cannot be ascertained or the specified financial asset is less than zero, use zero for the value of the asset. 281 INDIVIDUALS Foreign financial assets that must be reported on 8938:  Financial accounts maintained by a foreign financial institution  Stock or securities issued by a foreign entity and not owned through an investment account (direct or indirect ownership)  An outright interest in a foreign entity  Any financial instrument or contract that has an issuer/counterparty a person that is NOT as a U.S. person. Examples:  Stock issued by a foreign corporation.  A capital or profits interest in a foreign partnership.  A note, bond, debenture, or other form of indebtedness issued by a foreign person.  An interest in a foreign trust or foreign estate.  An interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty.  An option or other derivative instrument with respect to any of these examples or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer. An interest in the Social Security program, social insurance or other similar program of a foreign government is NOT a specified foreign financial asset. Interests in property transferred in connection with the performance of services (i.e., foreign stock option plans). Taxpayers are considered to have an interest in property transferred in connection with the performance of services on the first date that the property is substantially vested or if a valid section 83(b) election is in place with respect to the property, on the date of transfer of the property. 282 INDIVIDUALS Interests held through disregarded entities or grantor trusts are reportable if they meet the filing threshold. Interest in foreign estates and foreign trusts is not a specified foreign financial asset unless a value can be ascertained for the interest. If a distribution is received from said foreign estate or trust, the taxpayer is considered to know of the interest. Interests in foreign pension plans and deferred compensation plans are reported in Part IV of Form 8938. Assets held by those plans need not be reported separately. The reporting period is generally the calendar year for individuals. Some exceptions apply for dual status residents and other cases (i.e., taxpayer’s death). Assets not required to be reported include:  Financial accounts maintained by a U.S. payer, even if the U.S. payer is the U.S. branch of a foreign bank. Example: pension account held at a Barclays branch in New York.  Financial accounts maintained by dealers or traders in securities if all the holdings in the account are subject to the mark‐to‐market accounting rules or an election under section 475(e) or 475(f) is made for all the holdings in the account.  Foreign Social Security, social insurance, or similar program of a foreign government. Practice Note: If the foreign government has a Totalization Agreement with the United States, the amounts paid from those respective Social Security(ies) programs may not be taxable to the U.S. person. Duplicative reporting: If assets are reported timely on any of the following forms:  Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts  Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations 283 INDIVIDUALS  Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund  Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnership The information about the assets needs to be duplicated on Form 8938. Instead, indicate in Part IV of 8938 the type of return where the information is presented. 284 INDIVIDUALS Penalties: If you are required to file Form 8938 but do not file a complete and correct Form 8938 by the due date, you may be subject to a penalty of $10,000. If a taxpayer fails to file Form 8938 within 90 days after the IRS mailed a notice of a failure to file, there may be an additional penalty of $10,000 for each 30‐day period for which you continue to fail to file. The additional failure to file penalty caps at $50,000. For a married couple filing a joint return, the liability for failure to file penalty applies jointly and severally. Accuracy‐related penalty refers to an underpayment of tax as a result of a transaction involving an undisclosed specified foreign financial asset, a penalty of up to 40% of the underpayment may be assessed. In case of fraud, a penalty of 75% of the underpayment may be imposed. Statute of limitations remains open for 3 years. Reasonable Cause Exception: No penalty will be imposed if you fail to file Form 8938 or to disclose one or more specified foreign financial assets on Form 8938 and the failure is due to reasonable cause and not to willful neglect. You must affirmatively show the facts that support a reasonable cause claim. 1530.03 114A vs. 8938 Reporting Although the reporting requirements may seem at times duplicative, especially in terms of those taxpayers who report only foreign bank accounts as foreign financial assets, the two forms are very different. 114A or FBAR is a separate filing submitted on the Financial Crimes Enforcement Network’s (FinCEN) dedicated website: bsaefiling.fincen.treas.gov, whereas Form 8938 is submitted with the 1040 return. They both have April 15th deadlines, but 8938 is not automatically extended if the taxpayer has not filed a Form 4868 or 7004. 285 INDIVIDUALS FBAR has a much lower reporting threshold of $10,000 than Form 8938, and focuses mainly on bank accounts and investment accounts, whereas 8938 casts a much wider net, encompassing most of the foreign financial assets with a determinable value. Direct outright interests in foreign real estate properties do not constitute foreign financial assets, but an interest in a foreign real estate partnership is reportable on Form 8938. To the extent a foreign rental activity is associated with a foreign bank account whose balance exceeds $10,000, then the bank account and not the interest in the real estate property is reportable on 114A. Form 8938 relies more heavily on fair market values for reporting the foreign assets whereas 114A relies on periodic statements and converting to U.S. dollars using the end of the calendar year exchange rate. A side‐by‐side comprehensive comparison is offered by the IRS: https://www.irs.gov/businesses/comparison‐of‐form‐8938‐and‐ fbar‐requirements. 1530.04 Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts Form 3520 is an informational form that discloses “reportable events” between the U.S. owners/beneficiaries/executors and their respective foreign trusts. It is also used to report gifts/bequests received by U.S. persons from foreign persons (nonresident aliens or foreign estates) of $100,000 or more. In case of receipt of gift from a foreign corporation or foreign partnership, the reporting threshold for a U.S. person is $16,649 or more. Examples of reportable events include receipt of distributions from a foreign trust; receipt of a loan of cash or marketable securities from a foreign trust, when the receiving party is the trust’s beneficiary or the owner, uncompensated use of a foreign trust property. Practice note: In many cases, depending on the type of funding (for instance, if employer funded or employee funded) and other requirements, interests in foreign pensions can be classified as an interest in a foreign grantor trust. As such, distributions, contributions or even earnings in such trusts would be subject to disclosure on Form 3520 or Form 3520‐A. Rev. Proc. 2020‐17 286 INDIVIDUALS updated this requirement by exempting foreign trust information reporting on Form 3520 and 3520‐A for certain U.S. individuals’ transactions with, and ownership of, certain tax‐favored trusts that are established and exclusively or almost exclusively to provide pension or retirement benefits, or to provide medical disability or educational benefits. For example, a U.S. taxpayer who temporarily lived in the UK and financed a pension plan under the UK pension scheme with mostly his funds would be considered the owner of a foreign grantor trust from U.S. tax perspective. However, Rev. Proc. 2020‐17 exempts the U.S. taxpayer from filing Form 3520 in this case. The interest in the foreign pension plan is still reportable on Form 8938. Penalties Under Section 6677, a penalty for untimely, incomplete or incorrect return may be assessed in the amount equal to the greater of $10,000 or:    35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation or transfer to a foreign trust in Part I. 35% of the gross value of distributions received from a foreign trust for failure to report the distributions received from a foreign trust in Part III. 5% of the gross value of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (section 671 through 679), if the foreign trust either fails to file a timely Form 3520‐A and provide the required annual statements to its U.S. owners/beneficiaries or does not provide all of the information required by section 6048(b) or includes incorrect information. Under Section 6039(F) in case of a failure to timely report foreign gifts, the IRS may determine the income tax consequences of the receipt of such gift, and a penalty equal to 5% of the amount of such foreign gifts apply for each month for which the failure to report continues (not to exceed a total of 25%). No penalty will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect. 287 INDIVIDUALS Under Section 6662(j), if a U.S. owner of a foreign trust is subject to a penalty imposed under section 6662 for an underpayment of tax required to be shown on a return, then such penalty may be increased under section 6662(j) for any portion of an underpayment which is attributable to any transaction involving any asset with respect to which information was required to be provided on Form 3520‐A. Form 3520 is due on the 15th day of the 4th month following the end of the tax year. For individuals, the due date is April 15th. For U.S. citizens residing abroad, Form 3520 is due on the 15th day of the 6th month (June 15th) following the end of the tax year. In the case of a Form 3520 filed with respect to a U.S. decedent, the due date to file a Form 3520 is the 15th day of the 4th month following the end of the decedent’s last tax year for income tax purposes. 1530.05 Form 5471, Information Return of Persons with Respect to Certain Foreign Corporations Form 5471 is a very complex informational form that generally covers the events that occur between at least 10% owners/shareholders, directors and/or officers and foreign corporations. All U.S. persons that must complete Form 5471 are grouped and described in the five Categories of Filers. If filers fit more than one category, they need not duplicate the information but complete all items that apply. A separate 5471 is required for each applicable foreign corporation. Definitions: A U.S. Shareholder (Category 1 Filer) is a U.S. person who owns directly or indirectly 10% or more of the total combined voting power or, in a case of a tax year of a foreign corporation beginning after December 31, 2017, 10% or more of combined voting power of a specified foreign corporation. A U.S. Person (Categories 2 and 3 Filers) is a citizen or resident of the United States; or a domestic partnership, a domestic corporation, or an estate or trust that is not a foreign estate or trust as defined in section 7701(a)(31). 288 INDIVIDUALS A U.S. Person (Category 4 Filers) is a citizen or a resident of the United States or a non‐resident alien who elected to be treated as a resident of the United States, or an individual who became a resident during the year and are married to a citizen or resident of the United States, or a domestic partnership, a domestic corporation, an estate or trust that is not a foreign estate or trust. A U.S. Shareholder (Category 5) owns at least 10% or more of the total combined voting power of all classes of voting stock of controlled foreign corporation or owns any stock of a controlled foreign corporation that is also a captive insurance company. A controlled foreign corporation is a foreign corporation in which U.S. shareholders own more than 50% of the voting power of all classes of its voting stock or the total value of the stock at any point in time during the tax year of the foreign corporation. A Specified Foreign Corporation (SFC) is:  a controlled foreign corporation or  any foreign corporation that has a U.S. domestic corporation as a shareholder. Category 1 filers are U.S. shareholders who own 10% or more of a SFC (refer to definitions above). Category 2 filers are U.S. citizens or residents who are officers or directors of a foreign corporation in which a U.S. person has either acquired stock that meets the 10% ownership requirement or an additional 10% of the outstanding stock of the foreign corporation. Category 3 filers are filers who either purchase sufficient stock in a foreign corporation to meet the 10% stock ownership requirement, a person who acquires stock which meets the 10% ownership requirement or a person who disposes of a sufficient stock in the foreign corporation to reduce his/her interest to less than 10% stock ownership. Category 4 filers are U.S. persons who had control (defined as either more than 50% of the voting power or of the value of shares of all classes of stock) of a foreign corporation during the annual accounting period of the foreign corporation. 289 INDIVIDUALS Category 5 filers are U.S. shareholders who own stock in a foreign corporation that is a CFC at any time during any tax year of the foreign corporation and who owned that stock on the last day in that year on which it was a CFC. The following table summarizes the Schedules that are required to be completed in reference to each category of filers as described above: 290 INDIVIDUALS 291 INDIVIDUALS Filers who own interests that meet the ownership requirement in foreign corporations that are “dormant” (inactive) are eligible to elect under a summary filing procedure, as described in Rev. Proc. 92‐70. Practice Note: The Tax Cuts and Jobs Act introduced a new tax – Global Intangible Low‐Taxed Income meant to close a well‐known loophole that allowed multinational companies to develop intangible assets using R&D resources in the United States but register the final product under the laws of a foreign jurisdiction with a lower income tax rate. Pre‐TCJA, the profits of the foreign affiliate would not be taxed by the United States until the profits got paid as a dividend to the U.S. parent. Global intangible low‐ taxed income (GILTI) tax is a tax on foreign earnings that exceed a 10% return on a company’s invested foreign assets. It is applicable only to those foreign jurisdictions whose tax is 13.125% or lower. For levels above this rate, there is no additional GILTI tax (GILTI tax will be discussed more in detail later in the chapter). Schedule I‐1 of Form 5471 is used to report information determined at the CFC level with respect to amounts used in the determination of income inclusions by U.S. shareholders under section 951A. Information reported on this schedule will be used of the U.S. shareholders to file Form 8992 “U.S. Shareholder Calculation of Global Intangible Low‐Taxed Income (GILTI) and may assist in completion of Form 1118 “ Foreign Tax Credits – Corporations” or Form 1116 “Foreign tax credit” for individuals, estates and trusts. Form 5471 is filed with the income tax return by the due date (including extensions). 292 INDIVIDUALS 1530.06 Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships Form 8865 is the reporting equivalent of Form 5471 but for partnerships. Similar to 5471, it has various categories of filers, described below. Generally, 8865 is used to report events between U.S. persons and U.S. partners and foreign partnerships. Information presented on Form 8865 will satisfy reporting requirements under IRS Code Sections 6038, 6038B and 6046A. If a taxpayer qualifies under multiple categories, they must submit all the schedules required under both categories. A separate Form 8865 must be filled out and filed for each applicable foreign partnership. A foreign partnership is a partnership that was not created or organized in the United States or under the law of the United States or of any state or the District of Columbia. A section 721(c) partnership is a domestic or foreign partnership if there is a contribution of 721(c) property and after the contribution, a. a related foreign person with respect to the U.S. transferor is a direct or indirect partner and b. the U.S. transferor and related persons own 80% or more of the interests in the partnership’s capital, profits, deductions or losses. U.S. Transferor is a U.S. person (a citizen or resident of the United States, a domestic partnership, a domestic corporation, and any estate or trust that isn’t foreign) other than a domestic partnership. For purposes of Form 8865, interest usually refers to capital, profits, deductions or losses. Category 1 Filer is a U.S. person who controlled (owned more than a 50% interest) the foreign partnership at any time during the partnership’s tax year. It also includes a U.S. transferor who must report certain information with respect to a section 721(c) partnership for the tax year of contribution. Category 2 Filer is a U.S. person who at any time during the tax year of the foreign partnership owned a 10% or greater interest in the partnership while the partnership was controlled by U.S. persons each owning at least 10% interest. Example: if 5 U.S. persons are partners in Foreign Partnership and each owns 10%, the partnership would meet the definition above. If the respective 293 INDIVIDUALS 5 U.S. partners’ interest were: 5%, 15%, 10%, 12% and 8%, the definition would not be met. If the foreign partnership has at least one Category 1 filer, then no person will be considered a Category 2 filer. Category 3 Filer is a U.S. person who contributed property during that person’s tax year to a foreign partnership in exchange for an interest in the partnership if that person owned directly or constructively at least 10% interest in the foreign partnership or the value of the property contributed exceeds $100,000. If a domestic partnership contributed property to a foreign partnership, the domestic partnership’s partners are considered to have transferred a proportionate share of the property to the foreign partnership themselves. If the domestic partnership files Form 8865 with its own tax return, the individual partners of the domestic partnership do not have a filing requirement with respect to that transfer. Category 4 Filer is a U.S. person that had a reportable event under IRS Code Section 6046A. Categories of reportable events are:  Acquisitions – if the person who did not previously own a 10% interest, but whose additional investment brings him/her over the 10% interest threshold. Or a person whose interest increased by at least 10% when compared to the person’s interest when the person last had a reportable event (from 12% to 22%).  Dispositions – if the person goes from a higher than 10% ownership interest in a foreign partnership to less than 10% ownership as a result of the disposition or their interest decreases by at least 10% when compared to the period of the last reportable event (from 21% to 11%). Exceptions to Filing: If during the tax year of the partnership more than one U.S. person qualifies as a Category 1 filer, only one of these Category 1 partners is required to file Form 8865. If one U.S. partner has a controlling interest in the losses and deductions and another one has the controlling interest in capital or profits, only the latter may file Form 8865. The Category 1 filer not filing the form must attach a statement entitled “Controlled Foreign Partnership Reporting” to that person’s income tax return. 294 INDIVIDUALS If a filer is deemed to be a Category 1 or 2 filers based on constructive ownership (as opposed to direct ownership) then U.S. person is not required to file Form 8865 if the form is filed the U.S. person through which the indirect partner constructively owns an interest in the foreign partnership or the U.S. person through which the indirect partner constructively owns an interest is also a constructive owner, or Form 8865 is filed by another Category 1 filer under the multiple Category 1 filers exception. If a foreign partnership files Form 1065 for its tax year, Category 1 and 2 filers may use a copy of the completed Form 1065 schedules in place of the equivalent schedules of Form 8865. Penalties: For failure to timely submit all information required under Categories 1 and 2 filers, a $10,000 penalty is imposed for each tax year of each foreign partnership. If the information is not submitted within 90 days after the IRS has mailed a notice of failure to the U.S. person, an additional $10,000 penalty per foreign partnership is charged for each 30‐day period, not to exceed $50,000. Any person who fails to provide all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit. If the failure continues 90 days or more after the date the IRS mails notice of failure, an additional 5% reduction is made for each 3‐month period or fraction thereof. Criminal penalties under sections 7203, 7206 and 7207 may apply for failure to file or for filing false or fraudulent information. For Category 3 filers, the failure to properly report a contribution to a foreign partnership is subject to a penalty of 10% of the fair market value of the property at the time of contribution, limited to $100,000 unless the failure is due to intentional disregard. In addition, the transferor must recognize gain on the contributed property as if he contributed property that sold for fair market value. 295 INDIVIDUALS For Category 4 filers, any person who fails to report information requested by section 6046A is subject to a $10,000 penalty in addition to the section 7203 criminal penalty. Penalties may be imposed under Section 6662(j) for underpayment attributable to undisclosed foreign financial assets understatements – an understatement of taxes caused by a transaction associated with an undisclosed financial asset. Form 8865 is filed with the income tax return for tax year beginning in 2020. 1530.07 Global intangible low taxed income (GILTI) The Tax Cuts and Jobs Act of 2017 (TCJA) introduced sweeping changes in the overall fiscal system of the United States. One of these sweeping changes impacted multinational entities by introducing a territorial tax system and by providing a 100% dividend‐received deduction for certain qualified dividends. To limit abuse, the TCJA also adopted a new tax – global intangible low taxed income (GILTI) – as an anti‐base erosion provision meant to discourage companies from using intellectual property to shift profits to outbound jurisdictions with lower tax rates. Its focus lies on active income as opposed to passive income and operates mainly as type of minimum tax on “portable income.” The provisions of GILTI tax are comprised in IRS Code Section 951A and apply to C and S corporations, partnerships, and individuals. The GILTI rules impact controlled foreign corporations. IRS defines a controlled foreign corporation (CFC) as any foreign corporation in which more than 50% of the total combined voting power of all classes of stick entitled to vote is owned directly, indirectly or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or more than 50% of the total value of stock is owned directly, indirectly or constructively by U.S. shareholders on any day during the taxable year of the corporation. Under the GILTI provisions any U.S. shareholder who owns a 10% interest in CFC must include in current income his/her pro‐rata share of GILTI income of the CFC. 296 INDIVIDUALS GILTI income is defined as the excess of the “net CFC tested income” over the U.S. shareholder’s “net deemed tangible income return” less interest expense. The formula is presented below: GILTI inclusion = Net CFC tested income – Deemed Tangible Return – Interest Expense Net CFC tested income is the CFC’s gross income less certain exclusions, such as U.S. effectively connected income, subpart F income, income that would be Subpart F, but is excluded due to high tax exceptions and others. Deductions associated with the income that is being excluded are added back. Net deemed tangible income return is a 10% return on the U.S. shareholder’s pro rata share of the adjusted tax basis of tangible depreciable property of CFCs that earn the tested income, reduced by allocable interest expense to the extent the interest expense reduced the tested income. Net Deemed Tangible Income Return = 10% QBAI – Specified interest QBAI is qualified business asset investment, which is tangible depreciable property used in a trade or business that produced the tested income. The assets considered depreciated using the ADS depreciation regime and life and do not include assets amortizable under section 197 (intangibles such as goodwill, patents, trademarks). C corporations and individuals electing to be taxed as a corporation (election discussed later) may deduct 50% of the GILTI inclusion, subject to limitations reducing the effective GILTI income tax rate from 21% to 10.5%. In addition, U.S. corporate shareholders may also claim an indirect foreign tax credit for 80% of the foreign tax paid by the foreign corporation on the income included in GILTI. Example: ABC, a U.S. corporation determines its share GILTI inclusion to be $1,000,000 from Foreign Corp A (a CFC). Foreign Corp A paid 20% local taxes on the $1,000,000 or $200,000. As a result, ABC is entitled to claim 80% of the foreign taxes paid by the CFC or 80% × $200,000 = $160,000. 297 INDIVIDUALS ABC can claim a Section 250 Deduction and exclude 50% of its GILTI income inclusion, making the GILTI income inclusion to be $500,000 (the original $1,000,000 × 50%). U.S. tax on the GILTI income inclusion is 105,000 calculated as $500,000 × 21%. But ABC also has a foreign tax credit available as calculated above of $160,000 that effectively reduces the U.S. tax liability to zero ($105,000 less $160,000, excess is lost not carried over). In the example above, the indirect foreign tax credit was high enough to “wipe out” any U.S. tax liability. If we substitute the foreign tax rate of 20% with a 10% foreign tax rate, the U.S. tax liability goes from zero to $25,000. In this simple example, GILTI functions to level the playfield for competitors in various tax jurisdictions. In practice, due to the mechanics of calculating foreign income tax credits (credit cannot exceed the U.S. tax liability multiplied by the share of foreign profits/worldwide profits), U.S. corporations end up with a GILTI inclusion tax liability even when their CFC income comes and is being taxed in high tax countries like Mexico (rate is 30%). For an individual who does not elect to be taxed as a corporation, GILTI income inclusion comes with a higher price tag since individuals would not benefit from the indirect foreign tax credit. Example: Assume John Smith – a U.S. individual is the sole owner of a CFC. The CFC operates in a jurisdiction where the tax rate is 20%. the CFC pays $200,000 in foreign taxes. John Smith has a GILTI inclusion of $1,000,000. Assume his U.S. tax considering 2023 ordinary income tax brackets is $334,427. None of the foreign tax credit of $200,000 would offset the $334,427. In year 2, CFC has $800,000 of cash: $1,000,000 less taxes paid of $200,000. Foreign Corp A decides to distribute all of the cash to its sole shareholder – John Smith. Under the previously taxed income, John would have no additional ordinary income tax, but the foreign jurisdiction would impose a withholding tax at source for distributions made to nonresidents of 15%, for example. 298 INDIVIDUALS Based on the example above, the GILTI income inclusion would have a significant tax impact on an individual U.S. shareholder. Under section 962, an individual shareholder can elect to calculate tax as if imposed under Section 11 for a domestic corporation. As such, an individual can also claim the 50% deduction and the indirect foreign tax credit. GILTI Income inclusion is calculated on Form 8992, U.S. Shareholder Calculation of Global Intangible Low Taxed Income. Form 8993, Section 250 Deduction for Foreign Derived Intangible Income (FDII) and Global Intangible Low‐Taxed Income (GILTI), is used for calculating the GILTI deduction. An individual electing to be taxed as a corporation must attach both Forms 8992 and 8993 to his individual tax return. Both forms need to be filed by the due date, including extensions for that return. In addition to the two forms, as mentioned early in the 5471 section, Schedule I‐1 of Form 5471 also includes information on GILTI. 1530.08 Foreign Derived Intangible Income Deduction As a counterpart to GILTI, the foreign derived intangible income (FDII) deduction was introduced by the TCJA as an incentive for the U.S. companies to generate more revenue from foreign markets and enjoy a lower tax rate applied to that foreign derived income. Foreign derived intangible income is the portion of a domestic corporation’s intangible income that is derived from foreign income. Foreign derived means property sold to any person who is not a U.S. person or services provided by the U.S. entity to any person not located with the United States. Eligible income does not include Subpart F income, GILTI income, CFC dividends, foreign branch income, or financial services income. The deemed intangible income is the excess of total net income over a routine 10% rate of return on the adjusted tax basis of its total fixed assets. Another way of looking at it is that if income is not realized based on its tangible assets, then it is income connected to intangible assets. 299 INDIVIDUALS The formula for FDII is: Example: XYZ Corp has $100M in sales and $6M in taxable income. $60M if XYZ’ sales are to customers outside the United States. XYZ has $5M of tax basis in its depreciable assets. Step 1: Calculate deemed intangible income: Deemed Intangible Income = Deduction Eligible Income – 10% QBAI = $6,000,000 – 10% × $5,000,000 = $5,500,000 Step 2: Calculate foreign portion of deemed intangible income: $60,000,000/$100,000,000 = 60% Step 3: Calculate FDII: FDII = $5,500,000 × 60% = $3,300,000 Total taxable income is $6,000,000 with $3,300,000 taxed at 13.125% and $2,700,000 taxed at 21%. 1530.09 IRC Section 965 Transition Tax Section 965 as added by the TCJA applied to a U.S. person who directly, indirectly, or constructively owned 10% or more of the voting power or value any specified foreign corporation (SFC) on the last day of the last tax year beginning before January 1, 2018. An SFC included any controlled foreign corporation (defined in earlier) or any other foreign corporation that had at least one U.S. shareholder that is a corporation. As such, U.S. shareholders were required to include in income their proportionate share of the unrepatriated foreign earnings of those SFCs as a taxable subpart F inclusion under section 951. These unrepatriated foreign earnings would have accrued abroad during periods after 1986 during those years in which the foreign corporation was an SFC. This tax was imposed as a one‐time tax on taxpayers whose tax year ended in 2017 or 2018. Corporate taxpayers were allowed to 300 INDIVIDUALS claim reduced indirect foreign tax credits against their transition tax liability. Individuals and trusts did not enjoy the same benefit. Subsequent distributions of the same earnings would not be subject to federal income tax. Taxpayers were allowed to elect to pay their transition tax liability over eight years, with no interest charge imposed. Taxpayers owning foreign corporate stock through an S corporation were permitted to elect to defer their transition tax inclusions indefinitely. There are events that can trigger the acceleration of the liability. For those taxpayers who made a section 965(h) election on a prior year tax return and elected to pay the net tax liability over 8 years, the IRS published the table for the installment plan: Successive tax year payments should be made separately from income tax payments. Generally, the IRS will issue an installment notice and payment voucher for each successive installment approximately six to eight weeks before their respective due dates. The notice will provide the total amount of the unpaid 965(h) net tax liability and the net 965(h) liability currently due. 1530.10 Delinquent International Information Returns U.S. taxpayers with undisclosed financial assets have the following options for addressing previous failures to comply with U.S. tax and information return obligations with respect to non‐U.S. investments:  IRS Criminal Investigation Voluntary Disclosure Practice  Streamlined Filing Compliance Procedures  Delinquent FBAR Submission Procedures  Delinquent International Information Return Submission Procedures IRS Criminal Investigation Voluntary Disclosure Practice The Voluntary Disclosure Practice is an option for taxpayers who have committed tax or tax‐related crimes and have criminal 301 INDIVIDUALS exposure due to willful violation of the law and who seek protection from potential criminal prosecution. The IRS Criminal Investigation will consider if a taxpayer’s timely, accurate and complete voluntary disclosure is sufficient in the IRS not recommending prosecution. Aside from a truthful, timely, and complete disclosure, the Criminal Investigation will also require the taxpayers to cooperate in determining the correct tax liability and making good faith arrangements to pay in full the tax, the interest, and any applicable penalties. A disclosure is considered to be timely received only if the IRS has not already commenced a civil examination or criminal investigation, did not receive information from a third party alerting as to the taxpayer’s noncompliance or acquired the information directly related to specific noncompliance from a criminal enforcement action (search warrant, grand jury, subpoena, etc.). Participation in the program is a two‐part process that starts with filing Part I of Form 14457, Voluntary Disclosure Practice Preclearance Request and Application. This step determines the taxpayer’s eligibility but does not guarantee acceptance into the practice. Once the preclearance has been confirmed, Part II of Form 14457 should be submitted within 45 days or make a written request for additional time. Criminal Investigation will review the submission of Part II and determine if the taxpayer is allowed to participate in the Voluntary Disclosure Practice. Streamlined Filing Compliance Procedures Originally introduced in 2012, the modified streamlined filing compliance procedures are designed for individual taxpayers (and their estates) only. The eligibility of taxpayers has been extended to those residing in the United States. U.S. residents can follow the requirements of the Streamlined Domestic Offshore Procedures whereas non‐U.S. residents can use “Streamlined Foreign Offshore Procedures.” Under these procedures, taxpayers certify that their failure to report foreign financial assets and pay all the tax due in respect of those assets did not result from willful conduct on their part. Non‐ willful conduct is conduct that is due to negligence, inadvertence, 302 INDIVIDUALS or mistake or conduct that is the result of a good faith misunderstanding of the requirement of the law. A taxpayer who is already under examination or investigation, related or unrelated to delinquent reporting of foreign financial assets become ineligible for the program. Taxpayers who have previously filed delinquent or amended tax return in an attempt to address U.S. tax and information reporting obligation – “quiet disclosures” are still eligible to participate in the streamlined procedures program but the penalties already paid will not be abated. Tax returns submitted under this program will be processed like regular returns submitted to the IRS, thus no receipt or acknowledgment will be sent by the IRS and no closing agreement will be signed. Delinquent FBAR submission procedure Taxpayers who do not need to use either the IRS Criminal Investigation Voluntary Disclosure Practice or the Streamlined Filing Compliance Procedures to file delinquent or amended tax return to report and pay additional tax, but who:  Have not filed a Report of Foreign Bank and Financial Accounts (FBAR)  Are not under a civil examination or criminal investigation by the IRS  Have not already been contacted by the IRS about delinquent FBARs The above should file the delinquent FBAR as per form 114A instruction. The delinquent FBAR should be submitted online and on the cover page of the electronic form, a reason for the late filing should be stated. The IRS will not impose a penalty for failure to file delinquent FBARs if the taxpayer properly and timely reported all the income associated with the foreign bank accounts associated with the delinquent FBARs, provided that the taxpayer had not been already contacted by the IRS in this regard. 303 INDIVIDUALS Delinquent International Information Return Submission Procedures Taxpayers who have identified the need to file delinquent international information returns who are not under a civil examination or a criminal investigation by the IRS and have not already been contacted by the IRS about the delinquent information returns should file the returns in question through normal filing procedures. Penalties may be assessed in accordance with existing procedures:  All non‐3520 or non‐3520‐A international information returns should be attached to an amended return and filed according to the instructions.  All Forms 3520 and 3520‐A should be filed according to the applicable instructions for those forms. A reasonable cause statement can be attached to each delinquent information return filed for which reasonable cause is claimed. 304