Category Archives: Business Structuring And Estate Planning

EXEMPTION FROM U.S. FEDERAL TAXATION

By Coleman Jackson, Attorney, CPA
March 18, 2017

EXEMPTION FROM U.S. FEDERAL TAXATION

Who is exempt from U.S. Federal Taxation?  How did they become exempt?  How do they maintain their exemption status?  We will attempt to answer these three questions in this blog.  But first, it must be clearly understood that exemption from U.S. federal taxation is a special privilege under U.S. federal tax laws because the general rule is a U.S. citizen or resident of the United States must file a federal tax return reporting their gross income unless they can be claimed as a dependent on another taxpayer’s return.  The terms U.S. citizen or resident are not limited to natural people, these terms also can include, legal fictions, such as, corporations, partnerships, agencies and other types of entities created under international, federal, state and local laws.  United States tax law at, 26 U.S.C.S §61, generally defines gross income as all income from whatever source derived, including (but not limited to) the following items:

  1. Compensation for services, including fees, commissions, fringe benefits, and similar items;
  2. Gross income derived from business;
  3. Gains derived from dealings in property;
  4. Interest;
  5. Rents;
  6. Royalties;
  7. Dividends;
  8. Alimony and separate maintenance payments;
  9. Annuities;
  10. Income from life insurance and endowment contracts;
  11. Pensions;
  12. Income from discharge of indebtedness;
  13. Distributive share of partnership gross income;
  14. Income in respect of a decedent; and
  15. Income from an interest in an estate or trust.

This gross income list is not exhaustive, which means, gross income can arise out of other types of transactions or economic events that exist today or may exist in the future.  What is difficult for many immigrants to the United States (and also many Americans born here) to understand is that the United States federal tax laws reaches to the ends of the earth; meaning, U.S. citizens and residents are required to file federal tax returns reporting their worldwide income regardless of where they reside in the world and regardless of where their income was earned in the world.  We have talked about these concepts and effects of international tax treaties in past blogs, if you are interested in knowing more about this; visit our blog site and google.   We will not focus on this in detail in this particular blog.  As stated in the opening of this blog, we want to explore three questions regarding exemption from U.S. federal taxation in this blog as follows:

  1. Who is exempt from U.S. federal taxation?
  2. How did they become exempt from U.S. federal taxation?
  3. How do they maintain their exemption status?

The phrasing of these questions reminds me of an Owl… the Who How.

Who is Exempt from U.S. Federal Taxation?

 Who is Exempt from U.S. Federal Taxation?

The Internal Revenue Code: 26 U.S.C.S. §§501 and 401 sets forth the organizations that are exempt from federal taxation unless the exemption is denied by the U.S. Treasury (IRS), and application of §502 or §503.   The scope of the exemption is discussed further below.  In general terms (what we mean by this term is that we are discussing these matters in very general terms since tax law is complex)… there are many, many conditions, effective dates and other provisions that could apply to this generalized list of exempt organizations.   The list of organizations that are exempt under §501(c) are as follows:

  1. Any corporation organized under an Act of Congress which is an instrumentality of the U.S.;
  2. Any corporation organized for the exclusive purpose of holding title to property, collecting income and turning the entire collected amount less expenses to an organization that is exempt under §501(c);
  3. Any corporation, and any community chest, fund, or foundation, organized exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
  4. Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local association of municipal employees where net earnings are devoted exclusively to charitable, educational or recreational purposes;
  5. Labor, agricultural, or horticultural organizations;
  6. Business leagues, chambers of commerce, real-estate boards of trade, or professional football leagues organized as non-profits and whose earnings never in anyway inure to the benefit of any private shareholder;
  7. Clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder;
  8. Fraternal beneficiary societies, orders, or associations operating under the lodge system and providing for the payment of life, sick, accident, or other benefits to the fraternal benefit societies, order or association’s members or their dependents;
  9. Voluntary employees’ beneficiary associations providing for payment of life, sick, accident, or other benefits to the association’s members or their dependents or designated beneficiaries if no association earnings inure to the benefit of a shareholder or individual;
  10. Domestic fraternal societies, orders, or associates, operating under the lodge system where the net earnings are devoted exclusively to religious, charitable, scientific, literary, educational and fraternal purposes and never provide life, sick, accident, or other benefits;
  11. Teacher’s retirement fund associations of a purely local character, if none of its earnings inures (other than through payment of retirement benefits) to the benefit of any private shareholder or individual and the association’s income consist solely of amounts received from public taxation, assessments on member-teacher salaries, and income in respect of investments;
  12. Benevolent life insurance associations, mutual ditch or irrigation companies, mutual or cooperative telephone companies, or like organizations, etc.;
  13. Cemetery companies owned and operated exclusively for the benefit of their members or which are not operated for profit; and any corporation chartered solely for the purpose of  the disposal of bodies by burial or cremation which is not permitted by its charter to engage in any business not necessarily incident to that purpose and no part of the net earnings of which inures to the benefit of any private shareholder or individual;
  14. Credit unions and mutual savings banks, etc. organized and operated for mutual purposes and without profit;
  15. Insurance companies other than life insurance companies.
  16. Subchapter Part IV corporations
  17.  Supplemental unemployment compensation trusts;
  18. A pre-June 25, 1959 trust or trusts forming part of a plan providing for payment of benefits under a pension plan funded only by contributions of employees;
  19. A post or organization of past or present members of the Armed Forces of the United States, or an auxiliary unit or society of, or a trust or foundation for, any such post or organization organized in the U.S. or any of its possessions with none of its earnings inuring to any shareholder or individual;
  20. Subsection §501(c) (20) was repealed by Pub.L. 113-295 on December 19, 2014;
  21. This is the Black Lung Disability Acts Trust Provision which refers to part C of title IV of the Federal Mine Safety and Health Act of 1977 and any State law providing compensation for disability or death due to pneumoconiosis;
  22. This is the Employee Retirement Income Security Act of 1974 Trust provision;
  23. Any association organized before 1880 more than 75 percent of the members of which are present or past members of the Armed Forces and a principal purpose of which is to provide insurance and other benefits to veterans or their dependents;
  24. This is the Single-Employer Pension Plan Amendments Act of 1986 ERISA Section 4049 Trust provision;
  25. Any corporation or trust with 35 or fewer shareholders or beneficiaries and one class of stock or beneficiary interest and organized for the exclusive purpose of acquiring real property and holding title to, and collecting income from, such property, and remitting all of it less expenses to one or more §501(c)(3) organizations;
  26. Any organization established by a State exclusively to provide coverage for medical care through insurance issued by the organization, or health maintenance organization under an arrangement with the organization exclusively for residence of the State who cannot obtain medical care coverage – and so forth;
  27. Any State organized entity established before June 1, 1996 to exclusively reimburse its members for losses arising under workmen’s compensation acts;
  28. The National Railroad Retirement Investment Trust established under section 15(j) of the Railroad Retirement Act of 1974; and
  29. CO-OP health insurance issuers qualified under section 1322 of the Patient Protection and Affordable Care Act;

Internal Revenue Code §501(a) provides an exemption for any organization described in §501(c) above and §401(a) with some stipulations described in §502 and §503.  But the federal tax exemption status of an organization does not shield gross income from federal taxation received from sources and activities unrelated to the particular exempt purpose of the organization.  Exempt organizations engaged in for-profit activities are subject to the same tax rates and same federal tax rules as for-profit organizations and individuals.  In Louisiana Credit Union League v United States, 693 F2.d 525 (5th Cir. 1982), the Court ruled that the league’s regular engagement in businesses unrelated to its tax-exempt function was taxable.

How did they become exempt from U.S. federal taxation?


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First of all, a careful reading of the various 501(c) exemption provisions reveals that business structuring is the very first step if an organization intends to operate as a non-profit entity.  The entity organizational or founding documents must contain the appropriate language depending upon the applicable exemption provision that is being relied upon by the entity.  Those starting non-profit organizations must have appropriate tax awareness before they file organizational documents with the Secretary of State’s Office or other governmental entity.

Some organizations are deemed to be non-profit under U.S. federal tax laws.  The following types of organizations are considered tax exempt whether they officially apply for tax exempt status or not:

  1. Organizations that sit underneath a tax-exempt umbrella organization enjoy the tax exempt status given to organizations under that particular umbrella (many traditional denominational churches are perfect examples of the umbrella exemption category).  In these cases, the main denomination holds an exemption certificate issued to it by the U.S. Treasury;
  2. Churches and other religious organizations; however, are deemed tax exempt whether they fall under an umbrella organization or not.

Even though independent churches and other religious organizations are deemed to be non-profits, it may be prudent to officially obtain non-exempt status by filing a Form 1023 with the United States Treasury because a favorable recognition by the U.S. Treasury relates back to the inception of the organization if Form 1023 is filed within 15 months of issuance by the State to the entity its Organizational Certificate.  Furthermore, if through IRS audit or otherwise the IRS challenges an organizations exemption claims, an organization will be in much better shape if it has an official exemption certificate.  There are also mandatory notice requirements to claim exemption under some §501 categories; for example, The Protecting Americans From Tax Hikes Act of 2015 requires organizations claiming exemption under §501(c)(4) to give the IRS notice of its intent to operate as a non-profit entity within 60 days of receiving their Certificate of Organization.  As mention before, awareness of tax implications are very important organizing a non-profit entity. 

Organizations claiming exemption through the §501(c)(3) category become officially tax exempt by timely filing Form 1023 and receiving an approval letter from the U.S. Treasury.  Other organizations seeking official declarations of exemption from federal taxation must obtain exemption certification by filing Form 1024 with the U.S. Treasury.   There are also streamlined versions of these forms for certain small organizations.

How do they maintain their exemption status?

 
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This is a good question because there are many ways as to how an exempt organization can violate the terms of its particular exemption provision through (a) failing to properly organize the business under the appropriate Section of the Internal Revenue Code, or (b) failing to operate the business within the confines of its exempt purposes, (c) omission or misstatement of material fact(s) in application for exempt status, or (c) engaging in political campaigns and or opposing politicians as an organization.  Organizations exemption status can be revoked for numerous reasons; even when the U.S. Treasury issues the initial exemption declaration in error; the courts have said the IRS can revoke an exemption certificate and retroactively assess tax on the profits of the entity as though the entity was a for-profit-enterprise from its inception.  That was the United States Court of Appeals for the Fifth Circuit’s ruling in a case entitled, Etter Grain Co. v. United States, 462 F.2d 259, 263 (5th Cir. 1972).  During an IRS audit examination, it was revealed that Etter Grain Co. was not organized and operated as a cooperative corporation like it had represented it would be in its exemption application.  The Court found that Etter Grain Co. was not properly structured and operated.  The three lessons out of Etter Grain Co. are (1) organizations must be properly structured pursuant to the claimed exemption, (2) organizations must be very careful when completing and filing Form 1023 and Form 1024 because revocation and subsequent retroactive taxation of the entity can be based on factual or legal grounds, or both, and (3) organizations must operate in a manner consistent with the claimed exemption.    If the entity is disingenuous or make careless representation to the IRS in obtaining the exempt status, these can subject the entity to revocation of its exempt status and retroactive taxation.  Fraudulently claiming an exemption to evade federal taxes could likely result in criminal prosecution and conviction; this was the case of United States v. J. Masat, 948 F.2d 923 (5th Cir. 1991) where the taxpayer failed to file tax returns and claimed exemption from taxation based on religious institution.

In general an entity maintains its exemption status by clearly identifying its exempt organizational purposes in its founding documents, claiming exemption under the right tax provision, timely filing the appropriate exemption paperwork with the U.S. Treasury in proper form and accurately, and operating its organization consistent with its exempt purposes. Honesty and integrity is the way to go.

This law blog is written by the Taxation | Litigation | Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader.  You should consult with legal counsel in your geographical area with respect to any legal issues impacting you, your family or business.

Coleman Jackson, P.C. | Taxation, Litigation, Immigration Law Firm | English (214) 599-0431 | Spanish (214) 599-0432

Third Parties Reporting Very Likely to Expose Non-Compliant Offshore Account Holders to IRS

By:  Coleman Jackson, Attorney, CPA
November 15, 2016

Third Parties Reporting Very Likely to Expose Non-Compliant Offshore Account Holders to IRS

For approximately two years now, banks and other financial institutions, otherwise known as “Third Parties” located in foreign countries have been reporting account holders’ information, either directly to the Internal Revenue Service or indirectly through local governmental agencies pursuant to U.S. Treasury Department Intergovernmental agreements.  The logical conclusion is that as U.S. persons (U.S. Citizen & Green Card Holder) foreign bank account information is turned over to the U.S. Treasury or IRS, increasingly non-compliant offshore account holders will be fully known to the IRS

This third parties disclosure of offshore account holders to the IRS has increased the number of account holders who are taking advantage of the IRS Offshore Voluntary Disclosure Programs. The IRS Commissioner in recent days stated that,

“The IRS has passed several major milestones in our offshore efforts, collecting a combined $10 billion with 100,000 taxpayers coming back into compliance.  As we receive more information on foreign accounts, people’s ability to avoid detection becomes harder and harder.  The IRS continues to urge those people with international tax issues to come forward to meet their tax obligations.”

The word to the wise non-complaint offshore account holder is to act responsibly because if caught, the penalties for non-compliance can be very very stiff… civil penalties and possibly criminal prosecution.  The taxpayer has only two options, and option (a) below is a foolish course of action: 

  1. Do nothing and increasingly expose themselves, their families and businesses to financial ruin and possible jail. This is the big-bird with its head in the sand option; or
  2. Seek acceptance into the appropriate IRS voluntary disclosure program while applicants are still being accepted.

Just think about it with head out of the sand!  The IRS reportedly collected $10 billion from 100,000 taxpayers who voluntarily disclosed their offshore accounts.  That is a lot of money; it would not be shocking if the IRS implement extremely aggressive collection procedures in their attempt to collect even more money from non-compliant offshore account holders exposed in the Third Parties disclosures.  If the IRS has the foreign account holders’ information; it is simply a matter of time and IRS resources and priorities as to how they bring offshore account holders into tax compliance; or pressure-encourage all non-complaint offshore account holders to voluntarily come into compliance with U.S. tax laws, including the Foreign Accounts Tax Compliance Act (FATCA); and the laws governing Foreign Bank and Financial Accounts, otherwise known as the FBAR.  Wise people have wisdom; but, fools act against wisdom.

This law blog is written by the Taxation | Litigation | Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader.  You should consult with legal counsel in your geographical area with respect to any legal issues impacting you, your family or business.

Foreigners and Persons Purchasing and Selling United States Real Property Interests to and from Foreigners Must Consider U.S. Tax Consequences

By:  Coleman Jackson, Attorney, CPA
October 05, 2016

Foreigners are subject to United States tax laws under certain circumstances.  Resident and nonresident aliens (foreigners) are taxed differently under U.S. tax laws.

Here are realities effecting buying and selling United States Real Property Interests to or from Foreigners:  Foreigners are subject to United States tax laws under certain circumstances.  Resident and nonresident aliens (foreigners) are taxed differently under U.S. tax laws.

Resident aliens (Green Card Holders and foreigners meeting the substantial presence test) are taxed in the United States, generally speaking, the same way United States citizens are taxed under 26 United States Code.  Resident’s are taxed on their worldwide income, from whatever source, the same as United States citizens regardless where they reside and regardless where the income is earned.  Resident foreigners use the same tax tables as U.S. citizens.

Nonresident foreigners (foreigners who do not meet the substantial presence test or Green Card) are taxed based on the source of their income and whether or not their income is effectively connected with a United States trade or business.  Nonresident foreigner’s income from sources within the U.S. is subject to U.S. income tax and must be separated into two pools as follows:

a) Income that is effectively connected with a trade or business in the United States, and
b) Income that is not effectively connected with a trade or business in the United States

Income in pool (a) is taxed at the same graduated tax rates as applied to U.S. citizens. Income in pool (b) is taxed at a flat thirty percent (30%) tax rate or lower tax treaty tax rate.

Special tax rules apply to nonresident foreigners purchasing or selling United States Real Property interest.  Gains and losses from the sale or exchange of United States real property interests are taxed as if the foreigner is engaged in a trade or business in the United States.

Moreover, special tax withholding rules under 26 U.S.C. (Internal Revenue Code) requires under certain circumstances for buyers buying United States Real property from a foreigner to withhold taxes unless certain exemptions are applicable.  United States real property interest is defined as real estate located inside the United States, and includes amongst other things, residential single family homes, multi-unit dwellings, commercial buildings and so forth.  It is extremely important to consult legal counsel concerning tax law implications; and other not so obvious legal hazards, when buying United States real property interest from a foreigner.  Your typical real estate agent or broker is not a lawyer and cannot lawfully advise parties in a real property transaction regarding tax implications and other legal jeopardy concerns associated with real property interest dispositions involving foreigners.

What exactly is the withholding requirement associated with buying United States real property interests from a foreigner?  Internal Revenue Code Sec. 1445 (a) imposes a duty on buyers to withhold income tax on dispositions of U.S. real property interests involving nonresident foreigners.   The law imposes legal liability on the buyer for the tax due on the transaction if the buyer fails to comply with IRC Sec. 1445 (a).

Any buyer or transferee purchasing or exchanging a United States real property interest with a nonresident foreigner before February 17, 2016 must withhold a tax equal to 10% of the amount realized on the disposition.  For U.S. real property interests purchased or exchanged with a nonresident foreigner after February 16, 2016, the rate of withholding is generally 15% unless the property is going to be used by the buyer as a residence and the amount realized does not exceed $1,000,000.  In that case, the withholding tax remains at 10%.  These withholding obligations are the responsibility of the buyer of U.S. real property interests from nonresident foreigners; which means, buyers are exposed to potential tax liability or jeopardy if they fail to withhold the required tax in the correct amount at the time of closing the real property transaction.  The withholding requirement is based on the gross amount realized; which means, real estate commissions are not subtracted in applying the correct withholding tax percentage.

This withholding provision potentially creates a genuine conflict of interest between a buyer and their realtor or broker.  Likewise a conflict of interest could likely exist between a nonresident foreigner selling  U.S. real property interests and their real estate agent or broker,  especially involving the exemptions availability and selection of buyers .  It is probably prudent for buyer and seller of real property interest involving nonresident foreigners to have their independent legal counsel separate and distinct from their respective real estate agents or brokers because tax laws are implicated with potential for substantial financial consequences could have impact on real estate selling decisions by buyers and sellers of U.S. real property interest involving nonresident foreigners. Also, nondiscrimination laws in sale and purchase of real estate in the United States could impact these transactions.

But as for the exemptions to the withholding requirement; the following are very broad generalizations concerning exemptions that could apply (depending on all the facts and circumstances) to the withholding requirements of IRC Sec. 1445:

The buyer is not required to withhold any amount under Sec. 1445 (a) if one or more of the following applies to the transaction:

  1. The nonresident foreigner supplies an affidavit testifying that they are not a foreign person;
  2. Private domestic corporation supplies an affidavit testifying that their interests in the corporation is not an United States real property interests;
  3. IRS issues a qualifying statement to buyer (or seller) satisfying the requirements set forth in IRC Sec. 871(b)(1) or 882(a)(1);
  4. The amount realized on the U.S. real property interests transaction does not exceed $300,000 and the buyer intends to use the real property as its residence; or
  5. A wash sale is involved pursuant to IRC Sec. 8997(h) (5).

These exemptions have been abbreviated and only state the basic nature of the statutory exemption.  As with any statute effected parties must consult the applicable Internal Revenue Code Section(s), Internal Revenue Regulation(s), Revenue Ruling(s), Tax Court Opinion(s) and decision(s) of other Courts having interpreted and established precedence regarding how and when these tax withholding exemptions might or might not apply to withholding of tax on dispositions of United States real property interests involving nonresident foreigners.  Anyone buying or selling U.S. real property interest to a nonresident foreigner should perform their due diligence prior to entering an earnest money contract or any other kind of contract of purchase.  Likewise foreigners should perform their due diligence regarding applicable tax laws and other U.S. laws before entering into U.S. real property interest transactions involving nonresident foreigners.  Unintended tax consequences could lurk behind every U.S. real property interest transaction involving nonresident foreigners as well as exposure to unintended consequences of other state and federal laws governing disposition of real property interest.

This law blog is written by the Taxation | Litigation | Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader.  You should consult with legal counsel in your geographical area with respect to any legal issues impacting you, your family or business.

Coleman Jackson, P.C. | Taxation, Litigation, Immigration Law Firm | English (214) 599-0431 | Spanish (214) 599-0432

FOREIGN TRUSTS WITH UNITED STATES BENEFICIARIES

By Coleman Jackson, Attorney, CPA
January 28, 2015

FOREIGN TRUSTS WITH UNITED STATES BENEFICIARIES

If all the items of money or property constituting the corpus of a foreign trust are transferred to the trust by a U.S. person, the entire foreign trust is a foreign trust created by a U.S. person.  Where there are transfers of money or property by both a U.S. person and a person other than a U.S. person to a foreign trust, and it is necessary, either by reason of the provisions of the governing instrument of the trust or by reason of some other requirement such as local law, that the trustee treat the entire foreign trust as composed of two separate funds, one consisting of the money or property (including all accumulated earnings, profits, or gains attributable to such money or property) transferred by the U.S. person and the other consisting of the money or property (including all accumulated earnings, profits, or gains attributable to such money or property) transferred by the person other than the U.S. person, the foreign trust created by a U.S. person shall be the fund consisting of the money or property transferred by the U.S. person.

For purposes of United States tax laws, a U.S. person includes U.S. citizens, resident aliens of the United States, domestic trusts, domestic estates, and domestic entities.  As a general rule, U.S. persons are subject to taxation on their worldwide income regardless of where it’s earned or where they actually physically reside in the world.  U.S. persons that have an interest in foreign financial accounts and meet specified reporting requirements must submit Form 114, Foreign Bank and Financial Accounts (FBAR) annually.  Moreover, specified individuals, which include U.S. citizens, resident aliens, and certain non-resident aliens that have an interest in specified foreign financial assets and meet the reporting threshold must file annually Form 8938, Statement of Specified Foreign Financial Assets.  Foreign trusts with U.S. person beneficiaries fall squarely within these reporting requirements if specified reporting thresholds are met.  Likewise income tax law applies to the income or earnings of foreign trusts with U.S. person beneficiaries.

For purposes of United States tax laws, if a nonresident alien has a U.S. residency that begins within five years of them directly or indirectly transferring property into a foreign trust, property transferred into such trust is treated as though it was transferred into the trust as of the date of the nonresident’s U.S. residency. Undistributed net income for periods before the nonresident’s U.S. residency is treated as property transferred into such trust in determining the trust corpus.  But prior to residency undistributed net income is not accounted for with regards to income taxation.  Pre-immigration trusts must comply with special tax rules in order to avoid unintended tax consequences.

With respect to individuals who are U.S. citizens or lawful permanent residents of the United States who has a domestic trust that becomes a foreign trust during the person’s life time, U.S. foreign trust tax laws applies as if such individual transferred property to such trust on the date such trust becomes a foreign trust an amount equal to the portion of such property previously transferred by such individual to such trust.

If a United States person directly or indirectly transfers property into a foreign trust, with a few exceptions, the U.S. Treasury will presume that the trust has United States beneficiaries for U.S. taxation purposes.  To rebut this presumption, the beneficiaries must submit timely, credible and sufficient rebuttal information to the Internal Revenue Service when challenged.

This tax blog is written by the Tax & Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader.  You should consult with legal counsel with respect to your particular set of circumstances.

Coleman Jackson, P.C. | Immigration & Tax Law Firm | www.cjacksonlaw.com | (214) 599-0431

Estate Planning Using Trust : Protect Your Assets, Pass Your Legacy and Manage Tax Liability

By:  Coleman Jackson, Attorney | Immigration & Tax Law Firm | www.cjacksonlaw.com

Apr 14, 2014

What is Estate Planning?

Estate plan using trustEstate planning is the field of discipline in preparation for yourself and your loved ones future.  Ideal estate planning happens when you protect your assets, pass your legacy, and manage your tax liability.  Estate planning is way more than drafting a set of documents.  Proper estate planning is more than documents!  Estate planning is not merely about passing your assets and values at the time of death; but, also managing and controlling your assets during your life time.  Estate planning can include life time gift planning, incapacity planning, digital asset planning, death planning and business structuring, winding down and exit strategy planning.  Proper estate planning permits you to give your assets to who you want, when you want, and how you want.

A variety of tools can be used in estate planning.  Generally, multiple combinations of these tools are used in any single estate plan depending upon the goals and objectives of the planner.  No two estate plans are exactly the same because goals, desires, values, and valuables are not the same from person to person; or even with the same person over time.  Over time, situations and circumstances change.  People grow.  People learn.  People expand.   For example, people grow older; people get married; people have children; people change; people die; people start businesses; people grow businesses; and people wind-down and dispose of businesses.  Life is in constant change; therefore, people’s estate plans must change too.  That is why it is not about the documents or tools of estate planning.  Estate planning is about capturing your goals, your values and your desires and adjusting the estate plan over time.  What do have and who do you want to give it to and why?  Who are these descendants, successors, hires, entities, charities- really?  These kinds of questions are explored and answered during estate planning with an estate planning counselor.  One tool in the tool box of an estate planning counselor is various kinds of trust.  You can establish a trust that takes effect during your lifetime or upon your death. Trust can be revocable (ones that can be changed during your life time) or irrevocable.  Trusts can be used to accomplish numerous estate planning goals.

 

What is a Trust?

what is trustA trust is a legal arrangement that permits a third party known as a trustee, to hold assets (such as property) on behalf of a beneficiary or beneficiaries. Lawful trusts can be arranged in many ways and can specify exactly how and when the assets pass to the beneficiaries. A trust is typically composed of four main entities:

  • Grantor: This is the person that sets up the trust.
  • Trustee and Successor Trustee: This is the person or entity that will follow your wishes as per the trust document (manage your trust) during your life or upon your death.
  • Property (Trust Assets): These are the items, money, physical properties, digital assets placed in the trust.
  • Beneficiaries: These are the individuals or organizations that will benefit from your trust assets.

A trust is a set of instructions written by you during your life time.  Trust can play a very important role in managing your life, your valuables, and your values during your life time; passing your assets on to your heirs upon your death, or in the event you are disabled, incapacitated or otherwise become incapable of managing your personal affairs. You get to write the rules that the trustee must abide by in administering the trust property.  You can add specific restrictions on distributions, attainment of certain goals for beneficiaries to receive trust property, and payment and replacement of the trustee and successor trustees under certain conditions.

Benefits of Estate Planning Using Trust

Trust does not have to be probated; that means that they can remain private because courts are not involved in administering trusts.  The terms and conditions governing the trust property can be kept confidential.  A trust could be used to manage estate taxes. A well formed trust can offer many other benefits; some of them are listed below.

Tax Benefits:

tax benefits using trustAt the moment, the estate tax exemption is $5 million.   That means if your estate upon your death is $5 million or less, your estate is exempt from U.S. estate taxation.

If you have an estate exceeding this exemption mark, then the assets in the trust will not be taxed until yours and your spouse’s death and will be applied when the assets passes to your children or hires.

Another benefit to setting up a trust is the generation skipping transfer tax. If you are passing any amount over $5 million to your grand children or more remote descendants then it would be taxed unless it is in a trust.

A Way to Protect Your Children:

children protection using trustThe estate plan should capture, promote and preserve your legacy to your loved ones and community. Trust is useful if you want to protect your child who is incompetent, incapacitated, or irresponsible in some way. If (s)he is underage, or struggling growing up; or growing up slower than normal, and you don’t want to leave the assets to them outright in their present condition, then you can set up a trust that only allows distribution if the child reach certain predetermined thresholds that are determined by you in your instructions to your trustee. Similar types of limiting instructions could possibly be written when the beneficiaries are charities or other entities.

Trust can also be used for incapacitation planning.  Unexpected accidents or illnesses could hit that make it impossible for you to manage yourself and your valuables.  In the event these unfortunate events occur, a trust in place could help carry on your values and manage your affairs and carry out your wishes.

Control Your Wealth:

wealth control using trustIn order to control your wealth you can specify the terms of a trust precisely, you can control when and to whom the distributions are to be made. You may also set up a revocable trust so that the trust assets remain accessible to you during your lifetime.  You could serve as the revocable trust trustee.

Privacy and Probate Savings:

Probate is a matter of public record. It is a court proceeding; and your probate records might even be put online for the world to review.  A trust may allow assets to pass outside of probate and remain private; administering a trust could be cheaper because it also reduces the amount lost to court fees and other costs and expenses that are typically incurred in the probate process.

 

This blog is written by the Immigration & Tax Law Firm of Coleman Jackson, P.C.  It is for informational and educational purposes and does not create an attorney-client relationship between this law firm and the reader.  If you have questions about your particular situation regarding Estate Planning, Business Structuring, Business Succession Planning or other asset protection matters, you should consult with independent tax counsel with respect to your individual situation, circumstances or concerns.

Coleman Jackson, PC
Immigration & Tax Law Firm
6060 North Central Expressway
Suite 443
Dallas, Texas 75206
Law Firm Sitewww.cjacksonlaw.com

Main Line:   214-599-0431 ||| Spanish Line:  214-599-0432

Employee or Independent Contractor- Why does it Matter?

Employee or Independent Contractor

Why Does Classification of Workers Matter?

Blog Written By:  Coleman Jackson, Esq. | www.cjacksonlaw.com | 214-599-0431 and Spanish 214-599-0432.

July 18, 2013

How should you make a determination?

How does the Internal Revenue Service make a determination?

Typically when Internal Revenue Service auditors examine a business for the purpose of determining worker classification, the Service will generally follow the United States Supreme Court’s 1947 decision in a case called, United States vs. Silk.

In the Silk case, the Court said that whether a worker is properly classified as an employee or independent contractor turns on all the facts and circumstances. The Court delineated 20 factors, which if a majority of the factors can be answered yes, then the Internal Revenue Service is more likely than not, will classify the worker as an employee. These 20 factors are as follows:

  1. Is the worker required to comply with instructions about when, where, and how the work is to be done?
  2. Is the worker provided training that would enable them to perform the job in a particular way?
  3. Must the worker perform the services personally?
  4. Is there a continuing relationship between the worker and the entity that hired the worker?
  5. Are the services provided by the worker an integral part of the business’ operations?
  6. Does the entity hire, supervise or pay assistants to help the worker on the job?
  7. Does the recipient of the worker’s services set the work schedules?
  8. Is the worker required to devote his or her full time to the person for whom he or she performs services?
  9. Is the services performed at the place of business of the entity or at specific places designated by the business?
  10. Does the recipient of the services direct the sequence in which the work must be done?
  11. Is the method of payment hourly, weekly or monthly as opposed to commission or by the job?
  12. Are business and/or traveling expenses reimbursed by the business to the worker?
  13. Are regular oral or written reports required to be submitted by the worker?
  14. Does the company furnish computers, work tools and supplies used by the worker?
  15. Has the worker failed to invest in equipment or facilities used to provide services?
  16. Does the arrangement put the worker in the position of realizing either a loss or profit on the work?
  17. Does the worker perform services exclusively for the entity rather than working for various other entities at the same time?
  18. Does the worker make the worker’s services available to the general public?
  19. Is the worker subject to dismissal for reasons other than nonperformance of contract specifications?
  20. Can the worker terminate the relationship without incurring a liability for failure to complete the assigned job?

Why does it matter how a worker is classified?

  1. The cost for misclassification of workers can be tremendous.
  2. First and foremost your employees could be erroneously carrying the burden of self-employment taxes.
  3. Misclassification of your workers means that you (the employer) are not paying your fair share of taxes and that may subject you to back taxes, interest and penalties. The Service wants the taxes to be paid by the proper party.  Noncompliant entities could be eligible for certain safe-harbor provisions of the Internal Revenue Code.
  4.  There are also certain State of Texas consequences for failing to properly classify workers.  Therefore proper classification of workers is both a federal and state tax law issue.  There could be civil and criminal consequences for failing to properly classify workers in the State of Texas.
  5.  It is important that immigrants pay their fair share of taxes.  It is also fair for immigrants to be properly classified as employees or independent contracts depending upon all the facts and circumstances.

Why Risk Being Caught – Act Now!

If you are a worker and don’t know how you should be classified, you should contact a tax attorney to discuss all the facts and circumstances of your particular situation because we only discuss general principals in this blog.

If you are an employer and want to do the right thing and avoid possible huge consequences in the future for misclassification of your workers, get legal representation to review your situation today.

COLEMAN JACKSON, P.C.

Professional Legal Services Corporation
Immigration & Tax Law Firm

6060 North Central Expressway
Suite 443
Dallas, Texas 75206.
Office Phone:  (214) 599-0431 | Email:  cj@cjacksonlaw.com | Firm Site:  www.cjacksonlaw.com

Is the Mexican Land Trust Subject to U.S. Taxation?

Is the Mexican Land Trust (“Fideicomiso”) Subject to U.S. Taxation?

How About Other Arrangements with Foreign Trustees with U.S. Beneficiaries?

Written By:  Coleman Jackson, P.C.

Immigration & Tax Law Firm

Firm Site www.cjacksonlaw.com

Date:  June 27, 2013 at 2:36PM

A Mexican Land Trust is commonly referred to as the ‘fideicomiso’.  What is a fideicomiso?  Well in short, a Mexican Land Trust is how non-Mexican persons hold residential real property located in restricted zones in Mexico.   By the constitutional laws of Mexico, non-Mexican persons cannot directly own residential real property in “restricted zones” of Mexico.  Therefore many foreign nationals hold residential real property in Mexican Land Trust or ‘fideicomiso’.

There is a potential tax reporting requirement triggered whenever persons residing in the United States invest in businesses or other forms of assets in a foreign country.  Because, as a general rule, United States Citizens and Legal Permanent Residence must file an annual report to the U.S. States Treasury to report transactions with foreign trusts and receipts of certain foreign gifts.  Failure to do so could subject the nondisclosures to a $10,000 penalty for each occasion.  These and other tax laws potentially places a tax filing duty on any U.S. person with offshore assets, such as ownership in offshore trusts.  You should consult an offshore assets lawyer to discuss your interest in foreign trusts or interest in other offshore assets.  U.S. laws such as the Foreign Account Tax Compliance Act (FATCA) and the Foreign Bank Account Report (FBAR) could apply, also, with respect to ownership of offshore assets.  We don’t address those rules at all in this paper.  Follow our tax and immigration law firm’s blog because, in it, we discuss various immigration and tax issues throughout the year that could be of interest to permanent resident immigrants as well as U.S. citizens.

This particular discussion is limited to situations described in a recent Revenue Ruling (Rev. Rul. 2013-14). The question addressed in that ruling was whether the fideicomiso or Mexican Land Trust arrangement (“MLT”) are considered a trust under Treasury Regulation §301.7701-4(a).

In particulars, Treasury Regulation §301.7701-4(a) says the following:

§ 301.7701–4 Trusts.

(a)  Ordinary trusts. In general, the term ‘‘trust’’ as used in the Internal Revenue Code refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust under the Internal Revenue Code if it was created for the purpose of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

(b)  Business trusts. There are other arrangements which are known as trusts because the legal

Title to property is conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for purposes of the Internal Revenue Code because they are not simply arrangements to protect or conserve the property for the beneficiaries. These trusts, which are often known as business or commercial trusts, generally are created by the beneficiaries simply as a device to carry on a profit making business which normally would have been carried on through business organizations that are classified as corporations or partnerships under the Internal Revenue Code.

However, the fact that the corpus of the trust is not supplied by the beneficiaries is not sufficient reason in itself for classifying the arrangement an ordinary trust rather than as an association or partnership.

The fact that any organization is technically cast in the trust form, by conveying title to property to trustees for the benefit of persons designated as beneficiaries, will not change the real character of the organization if the organization is more properly classified as a business entity under § 301.7701–2.

(c)  Certain investment trusts – (1) An “investment” trust will not be classified as a trust if there is owner under the trust agreement to vary the investment of the certificate holders.

See Commissioner v. North American Bond Trust, 122 F. 2d 545 (2d Cir. 1941), cert. denied, 314 U.S. 701 (1942). An investment trust with a single class of ownership interests, representing Undivided beneficial interests in the assets of the trust, will be classified as a trust if there is no power under the trust agreement to vary the investment of the certificate holders.

An investment trust with multiple classes of ownership interests ordinarily will be classified as a business entity under § 301.7701–2; however, an investment trust with multiple classes of ownership interests, in which there is no power under the trust agreement to vary the investment of the certificate holders, will be classified as a trust if the trust is formed to facilitate direct investment in the assets of the trust and the existence of multiple classes of ownership interests is incidental to that purpose.

The above rules could possibly apply to U.S. persons with offshore assets or trust interest in India, China, Korea, and Ethiopia, Spain and Columbia, Italy or any other foreign country.  Consult an offshore assets attorney with regards to particular questions about your foreign trust or other offshore assets.  We limit our discussion to the situations described in Rev. Rul. 2013-14 as it relates to the fideicomiso or Mexican Land Trust arrangement (“MLT”) as it relates to the application of Treasury Regulation §301.7701-4(a).  This discussion is an academic discussion with regards to the application of Treasury Regulation §301.7701-4(a) to the MLT.  The situations described are hypothetical and has no basis in real facts.  This discussion is not intended to be legal advice, tax advice or any other form of advice with regards to any particular taxpayer or person.  You should consult a tax advisor or tax attorney for any particular applications of these or any other laws or rules.

Now, what did Rev. Rul. 2013-14 say concerning the fideicomiso and the application of Treasury Regulation §301.7701-4(a)?

Situation 1

Dallas, a U.S. citizen, is the sole owner of Alejandro Ranchero, a limited liability company organized under the laws of Texas in the United States.  Alejandro Ranchero is disregarded as an entity separate from its owner under §301.7701-2(a) (a disregarded entity).  Dallas, through Alejandro Ranchero, wanted to purchase Blanca Marco Ranchero.  Blanca Marco Ranchero is Mexican residential real property located in a restricted zone.  Neither Dallas nor Alejandro Ranchero may hold title directly to Blanca Marco Ranchero under Mexican law.

Dallas obtained a permit from the Mexican Ministry of Foreign Affairs and signed an MLT agreement with Banco Azteca, a Mexican bank.  Alejandro Ranchero negotiated the purchase of Blanca Marco Ranchero directly with the seller of the property and paid the seller directly.  The seller had no interactions with Banco Azteca.  At the settlement, legal title to Blanca Marco Ranchero was transferred from the seller to Alejandro Ranchero, subject to the MLT agreement, as of the date of sale.  No property other Blanca Marco Ranchero is subject to the MLT agreement.

Under the terms of the MLT agreement, Alejandro Ranchero has the right to sell Blanca Marco Ranchero without the permission of Banco Azteca.   Further Banco Azteca must grant security interest in Blanca Marco Ranchero to a third party, such as a mortgage lender, if Alejandro Ranchero so requests.  Alejandro Ranchero is directly responsible for the payment of all liabilities relating to Blanca Marco Ranchero.  Alejandro Ranchero must pay any taxes due in Mexico with respect to Blanca Marco Ranchero directly to the Mexican taxing authority.  Alejandro Ranchero has the exclusive right to possess Blanca Marco Ranchero and to make any desired modifications, limited only by the need to obtain the proper licenses and permits in Mexico.  If Blanca Marco Ranchero is occasionally leased, Alejandro Ranchero directly receives the rental income and Dallas, as the owner of Alejandro Ranchero, reports the income on Dallas’ U.S. federal income tax return.

Although Banco Azteca is identified as a fiduciary in the MLT agreement, it disclaims all responsibility for Blanca Marco Ranchero, including obtaining clear title.  Banco Azteca has no duty to defend or maintain Blanca Marco Ranchero.  Banco Azteca collects a nominal annual fee from Alejandro Ranchero.  There is no other agreement or arrangement between or among Dallas, Alejandro Ranchero, Banco Azteca, or a third party that would cause the overall relationship to be classified as a partnership (or any other type of entity) for U.S. federal income tax purposes.

Conclusion

Rev. Rul. 2013-14 says the situation described in Situation 1 is not a trust subject to taxation under §301.7701-4(a) because:

  1. Banco Azteca’s only duties under the MLT arrangement are –
    1. Hold legal title,
    2. Transfer legal title at direction of Dallas
  2. Dallas retains the right to manage and control Blanca Marco Ranchero,
  3. Dallas has the right to collect all rents on Blanca Marco Ranchero,
  4. Dallas has the obligation to pay directly any taxes,
  5. Dallas has the obligation to pay directly any liabilities due with respect to Blanca Marco Ranchero,
  6. Blanca Marco is treated as a disregarded entity under U.S. tax laws,
  7. Dallas is treated as the owner of Blanca Marco Ranchero under U.S. tax laws.

Situation 2

The only differences in the facts are that Blanca Marco Ranchero is organized under the corporation laws of the state of Texas.

Conclusion

The MLT arrangement is not a trust, and the analysis is the same as in Situation 1 except that, because Alejandro Ranchero is treated as a corporation under §301.7701-2(a), Alejandro Ranchero is treated as the owner of Blanco Marco Ranchero.  If income is earned, Alejandro Ranchero reports such rental income on its corporate tax return assuming no Subchapter S selections have been made.  If an S selection has been made, the shareholders would report their share of the income or losses associated with the corporation.

Situation 3

The only differences in the facts as described in Situation 1 are:

  1. Dallas deals directly with Banco Azteca and does not use any other entity or party,
  2. Dallas obtains the permit from the Mexican Ministry of Foreign Affairs,
  3. Dallas signs the MLT arrangement directly with Banco Azteca,
  4. Dallas negotiates the residential property purchase,
  5. Dallas receives all rental income received from the rental of Blanca Marco Ranchero,
  6. There are no partnerships, joint venture, or any other form of arrangements between Dallas and anyone relating to the residential property that would subject the entity to Subchapter K of the Internal Revenue Code.
  7. Other than the changes 1 through 6, the facts are exactly as they were in Situation 1

Conclusion

Because Banco Azteca’s only duties under the MLT agreement are to hold the legal title to Blanca Marco Ranchero and transfer title at the direction of Dallas, the MLT is not a trust.  Dallas retains the right to manage and control Blanca Marco Ranchero.  Dallas has the right to collect any rent on Blanca Marco Ranchero.  In addition, Dallas has the obligation to pay directly any taxes and other liabilities due with respect to Blanca Marco Ranchero.  Accordingly, Dallas is treated as the owner of Blanca Marco Ranchero.

Situation 4

The MLT agreement is the same as Situation 1, but now, in addition to holding the title to Blanca Marco Ranchero, Blanco Azteca is required to collect all rents and pay all expenses associated with maintenance and upkeep of the property.

Conclusion

In Situation 4, the MLT arrangement is considered a trust within the meaning of §301.7701-2(a) because Rev. Rul. 2013-14 says that if Banco Azteca perform any services other than holding legal title to Blanca Marco Ranchero, the MTL arrangement would create tax responsibilities pursuant to the applicable provisions of the Internal Revenue Code as determinable by its federal tax classification.

Situation 5

The MLT agreement is the same as Situation 1, but in this instance, in addition to holding the title to Blanca Marco Ranchero, Blanca Azteca is permitted, but not required to collect the rents and pay the expenses associated with maintenance and upkeep of the property.  But Blanca Marco Ranchero is permitted to hire a property management company to perform these duties.

Conclusion

In Situation 5, Rev. Rul. 2013-14 does not apply because Banco Azteca is permitted to collect rental income on Blanca Marco Ranchero; therefore the MLT arrangement creates tax responsibilities under the appropriate provisions of the Internal Revenue Code.

Situation 6

The MLT agreement is the same as Situation 1, but in this instance, Blanca Marco Ranchero is owned by a partnership between Dallas and a non-banking division of Banco Azteca.  Banco Azteca holds title to Blanca Marco Ranchero and several other assets for the partnership.

Conclusion

In Situation 6, there is a partnership that holds several different assets; in which case, Rev. Rul. 2013-14 is not applicable.  In this situation the rules of §§301.7701-1 through 301.7701-4 will determine the federal tax classification of the MLT arrangement.

Situation 7

In Situation 7, all of the facts remain the same as Situation 1, except:

1.The country where the property is located is India and we assuming for analysis sake that India law likewise prohibit non-Indian persons from directly owning real property in certain areas of India, and

2.We are assuming India has a similar regulatory scheme as Mexico as far as “Ministry of Foreign Affairs”.

Conclusion

In Situation 7, the rules set out in Rev. Rul. 2013-14 would not be applicable because the ruling answers the question, “Is the fideicomiso or Mexican Land Trust arrangement (“MLT”) a trust under Treasury Regulation 301.7701-4.  Therefore, factual situations which create (foreign) trustee and U.S. person (beneficiary) situations must be carefully examined under all of the appropriate tax laws.

COLEMAN JACKSON, P.C.

Professional Legal Services Corporation
Immigration & Tax Law Firm

6060 North Central Expressway
Suite 443
Dallas, Texas 75206.
Office Phone:  (214) 599-0431
Em:  cj@cjacksonlaw.com
Firm Site:  www.cjacksonlaw.com