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U.S. TAX OF FOREIGN-U.S. TAX OF FOREIGN-RELATED TRANSACTIONSRELATED TRANSACTIONS (1 (1
of 2)of 2)
Jurisdiction to taxTaxation of U.S. citizens &
resident aliensTaxation of nonresident aliensTaxation of U.S. businesses
operating abroad
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U.S. TAX OF FOREIGN-U.S. TAX OF FOREIGN-RELATED TRANSACTIONSRELATED TRANSACTIONS (2 (2
of 2)of 2)
Tax planning considerationsCompliance and procedural
considerationsFinancial statement implications
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Jurisdiction to TaxJurisdiction to Tax
U.S. authority to tax foreign-related transactions based on 3 factorsTaxpayer’s country of citizenshipTaxpayer’s country of residenceLocation where the income is
earned
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Taxation of U.S. Citizens Taxation of U.S. Citizens and Resident Aliensand Resident Aliens
U.S. citizens and resident aliens taxed on worldwide income
Income earned in foreign countries or U.S. possessions receives special treatment
Foreign tax creditForeign earned exclusion
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Foreign Tax Credit (FTC)(1 of 5)
FTC permits U.S. citizens and residents to avoid double taxation
FTC directly reduces U.S. tax liabilityCreditable taxes
Taxes paid or accrued in foreign countryU.S. citizens and residents eligible
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Foreign Tax Credit (FTC)(2 of 5)
Translation of foreign tax paymentsCash basis taxpayers use exchange
rate on date of paymentAccrual taxpayers use average
exchange rate for the year
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Foreign Tax Credit (FTC)(3 of 5)
FTC limited to lesser of Foreign tax actually paid OR
foreign taxable income U.S. taxworldwide taxable income x liability
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Foreign Tax Credit (FTC)(4 of 5)
FTC deducted after nonrefundable credits
Unused FTC carried back 1 year and forward 10 years on a FIFO basis to a year where taxpayer has an excess credit limitation
Source of income rules on p. C16-6Used to determine numerator of FTC
formula
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Foreign Tax Credit (FTC)(5 of 5)
Special FTC limitation9 separate baskets of income
Foreign tax credit calculated for each basket of income
See pages C16-5 and 16-6 for partial list of baskets
Excess FTC from 1 basket cannot offset excess limitation amounts in another basket
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Foreign Earned Income Exclusion (FEI) (1 of 5)
FEI available to U.S. citizens and resident aliens working abroad
EligibilityBona fide resident test
Resident of foreign country uninterrupted for entire tax year and maintain tax home in foreign country
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Foreign Earned Income Exclusion (FEI) (2 of 5)
Eligibility (continued)Physical presence test
Taxpayer must be physically present in a foreign country for 330 full days during a 12-month period, AND
Maintain a tax home in a foreign country during that period
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Foreign Earned Income Exclusion (FEI) (3 of 5)
Foreign earned incomeWages, salaries, & fees as compensation
for personal services actually renderedAmount of exclusion
Lesser of $87,600, ORForeign earned income for current year, OR$239.34 ($87,600/365 days) x no. of
qualifying days in current year
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Foreign Earned Income Exclusion (FEI) (4 of 5)
Additional exclusion for taxable housing allowanceLimitation lesser of
Actual housing amount included in income, OR$14,016* ($38.30) x (qualifying days/365)
Housing costs incurred in excess of $14,016 are for an AGI deduction if not provided by employer
*Estimated at time of publication
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Foreign Earned Income Exclusion (FEI) (5 of 5)
Housing allowance exclusion (continued)Allowance limited to lesser of employer-
provided amount or the individual’s FEIHousing allowance exclusion reduces amount
eligible for FEI exclusionFTC & FEI exclusion are mutually exclusive
Claim either the FTC or the FEI exclusion on foreign earned income, but not both
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Taxation of Nonresident Taxation of Nonresident AliensAliens
Resident/nonresident definitionsInvestment incomeTrade or business incomeCalculating U.S. income tax
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Resident/Nonresident Definitions (1 of 2)
Resident aliens are taxed same as U.S. citizens
Nonresident aliens generally taxed only on U.S. source income
Taxpayer is a resident alien if they meet one of the two tests
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Resident/Nonresident Definitions (2 of 2)
Green-card testPermanent resident w/ “green card” visa
Physical presence testPresent 31 days during current calendar
year AND present 183 weighted average days during a 3-year periodCurrent year: 1 day counted as 1 dayPrior year: 1 day counted as 1/3 day 2nd prior year: 1 day counted as 1/6 day
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Investment Income(1 of 2)
Most U.S. source passive or investment income is taxed at 30%30% applied to gross amountU.S. payer must withhold tax
U.S. payer responsible for tax if not withheld
Tax rate often reduced by tax treaties
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Investment Income(2 of 2)
Income exempt from U.S. taxationNon-USToB capital gains if individual
physically present < 183 days during yearNon-USToB interest from banks or other
financial institutions not taxedPortfolio interestIncome from casual sale of personal
property
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Trade or Business Income
U.S. Trade or business (USToB)Conducting business in U.S. on regular
basis with intent to make a profitIncome exempt from U.S. tax if
In U.S. < 90 days/yr, employed by nonresident entity, and earn < $3,000
Real estate income may be treated as USToB instead of passive income
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Calculating U.S. Income Tax
Individuals must itemize deductionsCannot claim standard deduction
Normal deductions apply for items “effectively connected” to a USToBGains from real property considered
“effected connected” to a USToBTax treaties often reduce or eliminate
U.S. for many types of income
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Taxation of U.S. Taxation of U.S. Businesses Operating Businesses Operating
AbroadAbroad
Domestic corps & Foreign branchesForeign corporationsDeemed paid foreign tax creditControlled foreign corporationsInversions§482 rules and tax avoidanceForeign Sales Corporations & Extra-
territorial Income Exclusion
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Domestic Corporations
Domestic subsidiary corporationsCan file consolidated return w/ parentParent protected from foreign creditors
of subsidiaryForeign branches
Income and losses taxed currentlyEligible for direct FTC (described earlier)
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Foreign Corporations
If domestic corp owns 10% of foreign corp, domestic corp eligible for “deemed paid credit” for dividends received from foreign corp
10% domestic corp owner cannot claim DRD on non-USToB earnings
U.S. tax on foreign sub’s income deferred until dividends received
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Deemed Paid Foreign Tax Credit
Separate basket if own ≥ 10% & ≤ 50%Called Sec. 902 or 10/50 dividends
Div paid to domestic corp from undistrib
earnings
All undistributed
earnings
XCreditable taxes paid or accrued by foreign
corp
=Deemed
paid foreign
tax credit
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Controlled ForeignCorporations (CFC) (1 of 3)
Typical tax-avoidance scenario of a CFC
U.S.
ManufacturingCorporation
(Chicago)
Foreign SalesSubsidiary
(Island Corporation)
ForeignPurchasers
of U.S.Manufacturer’s
Products
Billing of tax haven sales
subsidiary by U.S. manufacturer
Billing of foreign purchasers by tax
haven sales subsidiary
Physical flow of goods
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Controlled ForeignCorporations (CFC) (2 of 3)
CFC definition>50% of foreign corp stock owned by U.S.
shareholdersU.S. shareholder defined if owns 10% of
stock
Some income forms (Subpart F income) of the CFC are taxed in the year in which they are earnedSee Figure C16-2
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Controlled ForeignCorporations (CFC) (3 of 3)
Tax-deferred earnings can be taxed under Subpart F when invested in U.S. property
Previously taxed income distributed tax-free
Special rules apply to the sale or exchange of CFC stock
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§482 Rules & Tax Avoidance(1 of 3)
Tax avoidance opportunity high for domestic parent and 100% owned subsidiary (see slide 16-26)U.S. parent sells goods/services at
less than FMV to 100% foreign sub, OR
Foreign sub pays less than FMV for use of U.S. parent’s intangibles (e.g., patents)
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§482 Rules & Tax Avoidance(2 of 3)
§482 authorizes IRS to distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among controlled entities
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§482 Rules & Tax Avoidance(3 of 3)
§482 Regs hold that transactions between entities must meet arm’s-length standardConsistent w/ transactions
between uncontrolled entitiesComparable transaction under
comparable circumstances
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Inversions (1 of 3)
U.S. corps subject to U.S. tax on world- wide (WW) income, while foreign corps only taxed on U.S. source income
This encourages U.S. corps with substantial foreign-source income to reorganize in a foreign country through an inversion
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Inversions (2 of 3)
Basics of inversions1.U.S. corp merges into a foreign entity or
transfers its assets to a foreign entity2.Owners of U.S. corp exchange U.S. corp’s
stock for equity in foreign entity3.Same owners continue to conduct both
U.S. and foreign business through the new foreign entity, but only U.S. source business subject to U.S. taxation
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Inversions (3 of 3)
§§367 & 7874 added to prevent erosion of U.S. tax base
Under §367 a foreign corp (FC) will be deemed to be a U.S. corp if
FC acquired all assets of U.S. corp Former U.S. corp s/hs own ≥80% of
FC & FC does not conduct much business
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Tax Planning Tax Planning ConsiderationsConsiderations
(1 of 2)(1 of 2)
Deduction vs. credit for foreign taxesDeduction may be beneficial when
taxpayer has foreign losses or when credit is limited
Election to accrue foreign taxesCash method taxpayers can elect to
accrue foreign taxesBinding for all tax years and can only be
revoked with IRS consent
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Tax Planning Tax Planning ConsiderationsConsiderations
(2 of 2)(2 of 2)
Special earned income electionsTaxpayers may revoke election to
exclude foreign-earned income whenEmployed in foreign country where
foreign tax rate > U.S. tax rate ORTaxpayer incurs substantial loss from
overseas employment
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Compliance and Compliance and Procedural Procedural
Considerations Considerations (1 of 2)(1 of 2)
Foreign operations of U.S. corpForm 1120 Schedule N
Foreign tax creditForm 1118 (corp), Form 1116
(individual)Foreign earned income exclusion
Form 2555 or 2555-EZ
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Compliance and Compliance and Procedural Procedural
Considerations Considerations (2 of 2)(2 of 2)
Nonresident aliens Form 1040-NR
Foreign corporationsForm 1120-F
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Financial Statement Financial Statement Implications Implications (1 of 2)(1 of 2)
Foreign tax creditExcess FTC creates deferred tax
assetDeferred foreign earnings
Normally would create a deferred tax asset
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Financial Statement Financial Statement Implications Implications (2 of 2)(2 of 2)
Deferred foreign earnings (continued)SFAS No. 109 adopts APB No. 23
exception for indefinite reinvestmentNo deferred tax asset unless
temporary difference expected to reverse in foreseeable future
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