Taxpayers are typically seeking means that they can use to minimize the amount paid on their taxes. While a taxpayer is under no obligation to maximize the amount he or she must remit to the U.S. government having a duty to only pay what he or she is legally obligated to pay, the taxpayer may not structure transactions for tax purposes only or engage in other structured transactions merely to evade or defeat a tax that is legally owed. Unfortunately, a certain class of tax preparers is all too eager to cave to client demands and engineer offshore schemes and practices that are likely to save clients money in the short-term while subjecting them to long-run penalties, fines, and potential criminal tax exposure.
It appears that the latest iteration of schemes to conceal overseas income involves controlled foreign corporations. U.S. taxpayers are obligated to pay taxes on their worldwide income, but some attempt to evade this obligation. However, it appears that the IRS is becoming wise to schemes that make use of multiple controlled foreign corporations to hide foreign income.
U.S. shareholders of controlled foreign corporations (CFCs) often have an obligation to report income derived from the foreign company under Internal Revenue Code (IRC) §951(a)(1)(A). This obligation can arise when the CFC earns certain types of income even if the organization does not actually pay any of the income to the individual shareholder during the CFC’s fiscal tax year. However, the calculation of a subpart F inclusion is complex and multi-faceted beginning with the computation of the foreign base company income (FBCI).
Generally, a CFC’s FBCI is computed through a process that begins with the computation of the organization’s gross income. The items involved in computing a gross income of a CFC involves:
Following this determination, aggregate FBCI and IRC §953 insurance income are adjusted by the de minimis and full inclusion rules. Additionally, a §952(c) limitation and high tax exception may apply. When the de minimis rule applies – the total of the CFC’s gross FBCI and insurance income is less than five percent of gross income or $1 million – none of the CFC’s gross income is taxed. Thus, taxpayers and shareholders can have a strong incentive to avoid crossing this threshold.
However, due to the release of a new audit guide, it appears that the IRS has identified serious concerns regarding improper foreign tax evasion. The problem identified by the IRS appears to be the use of multiple CFCs to conceal foreign income. In recognition of this problem, the IRS Large Business and International Division has released a new audit guide to guide efforts to identify and prosecute taxpayers who engage in these practices. FEN/9433.01_11(2016) sets forth measures IRS auditors should employ to identify circumstances where a taxpayer is organizing and maintaining multiple CFCs for the “principal” purpose of evading tax through fraudulent qualification under the de minimis test.
As set forth above, the international tax practice unit describes how an auditor should calculate FBCI. Furthermore, the practice unit instructs auditors to aggregate multiple CFC incomes thus treating the amounts as if they were earned by a single CFC. The aggregation of incomes should occur prior to the application of the de minimis test and full inclusion rules.
The tax audit guide instructs auditors to obtain supporting documentation from shareholders and taxpayers to determine the veracity of the information reported and the propriety of all calculations. Specific instructions regarding the application of the full inclusion rule are provided.
Taxpayers and U.S. shareholders of multiple foreign corporations should engage in careful tax planning with a tax professional due to the IRS’s increased focus on the use of multiple CFCs to minimize foreign tax obligations. The tax lawyers and the CPAs of the Tax Law Offices of David W. Klasing can provide on-point guidance. If you’ve been selected for an audit, David Klasing is a former public auditor who understands audit techniques and can provide an approach to mitigate the situation you face. He can serve as a buffer between you and the auditor to prevent missteps and maintain the professional nature of the proceedings. To schedule a reduced-rate tax consultation with an experienced tax professional call 800-681-1295 today or contact us online.