International Buyers - Joseph R. Schortz, CPA, PLLC

Presenter: Joseph R. Schortz, CPA
June 22nd, 2012
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Introduction
Speaker:
 Licensing
 Professional organizations
 Boards
 Experience
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What we will not cover today:
 FIRPTA
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 Property held jointly between a USA Citizen
and a nonresident alien
 Gift tax responsibilities of nonresident aliens
 Expected estate tax changes as of 01/01/13
 Advanced planning for nonresident aliens
 USA expatriates
What we will cover today:
 Actual 2011 case example
 The differences between income and
estate taxation of nonresident aliens
 Alternative methods of owning USA
realty by a nonresident alien
References:
 The Internal Revenue Code and U.S.
Treasury Regulations
 U.S. Treasury Regulations
 U.S. Tax Court Cases Publications and
periodicals
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Facts:
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1. A married Austrian citizen purchased a home in Punta Gorda in the mid 1990's.
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2. The home was purchased solely in the name of the wife.
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3. The home cost $280,000 in 1996.
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4. The home was purchased outright [no mortgage].
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5. The Austrian woman died in 2011.
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6. At the date of her death the home was valued, by an independent appraisal, at $290,000.
 7. The will of the decedent bequeathed the home to her husband.
Analysis:
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1. The Austrian woman was a nonresident alien for USA estate tax purposes.
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2. For 2011 a USA person was allowed a $5,000,000 unified gift and estate tax exemption.
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3. For 2011 a USA person was allowed an unlimited marital deduction for transfers to a USA spouse.
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4. For 2011 a nonresident alien was allowed a $60,000 estate tax exemption.
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5. For 2011, in absence of a qualified domestic trust [QDOT], a nonresident alien was allowed no marital deduction for
transfers to a nonresident alien spouse.
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6. A nonresident alien is allowed the same annual gift tax exclusion as a USA person [$13,000 in 2011].
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7. Separate from the annual gift tax exclusion, a nonresident alien is allowed a gift tax deduction for gifts to a
nonresident alien spouse [$136,000 in 2011].
A compulsory financial contribution imposed by a
government to raise revenues, levied on:
income of persons
property of persons
income of organizations
property of organizations
production costs of goods or services
sales of goods or services, or use of property
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Income - annual
 on persons
 on organizations
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Property
 tangible personal property tax - annual tax on the value of property used by businesses
 realty transfer tax - a transactional tax on the sale, transfer or exchange of real property
 real estate tax - annual tax on the value of property owned by persons and non-tax exempt organizations
 death taxes - a transactional tax on the value of assets owned by persons at their demise - now called estate,
transfer or inheritance taxes
 gift tax - a transactional tax coupled and coordinated with estate tax
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Sales – transactional
 state sales tax - on the sales price of goods and services, including rentals
 local sales tax - on the sales price of goods and services, including rentals
 municipal - tax on short term realty rentals
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Social – annual
 on persons and organizations - to fund social programs, e.g., Medicare, social security, unemployment
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Income Tax of Noncitizens [Internal Revenue Code Section {IRC Sec.} 7701(b)]
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A noncitizen of the United States of America {USA} will be treated as a resident for income tax purposes in
any calendar year in which the individual is:
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a. admitted as a lawful permanent resident:
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Typical Scenario: you hold a Green Card
OR
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b. substantially present in the USA.
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Typical Scenario: you meet the "Substantial Presence Test”
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To meet this test you must be physically present in the USA on at least:
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1. 31 days during the current year
AND
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2. 183 days during the 3 year period that includes the current and two preceding years. The 183
days are counted/calculated as follows:
 a. all of days you were physically present during the current year, plus;
 b. 1/3 of the days you were physically present during the preceding year, plus;
 c. 1/6 of the days you were physically present during the second preceding year.
 There are certain exceptions, such as the "closer connection" exception,
and technical variations, such as those for certain students, trainees, etc.,
to the 183 day rule.
 Definition of resident alien and nonresident alien.
 (1) In general. For purposes of this title (other than subtitle B)—
 (A) Resident alien. An alien individual shall be treated as a resident of the
United States with respect to any calendar year if (and only if) such individual
meets the requirements of clause (i), (ii), or (iii):
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(i) Lawfully admitted for permanent residence. Such individual is a lawful permanent
resident of the United States at any time during such calendar year.
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(ii) Substantial presence test. Such individual meets the substantial presence test of
paragraph (3).
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(iii) First year election. Such individual makes the election provided in paragraph (4).
 (B) Nonresident alien. An individual is a nonresident alien if such individual is
neither a citizen of the United States nor a resident of the United States (within
the meaning of subparagraph (A).
 Estates of Nonresidents Not Citizens Tax [Internal Revenue Code Sections {IRC
Sec.} 2101 to 2108]
 For USA estate and gift tax purposes, "resident" means an individual who has his or
her "domicile" [United States Treasury Regulation {Reg.} 20.1-1(b)] in the USA. A
"nonresident" decedent is a person whose domicile was outside of the USA at the
time of death. The domicile of a person is the place he or she voluntarily selected as
his or her permanent principal home, with no definite present intention of leaving.
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Domicile requires two elements, both of which are essential:
1. actual residence
AND
 2. an intent to remain indefinitely
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An individual cannot abandon an old domicile and acquire a new one unless both
elements are present. The intent to change domicile will not establish a new domicile
without an actual change in residence. Moving to a new place will not establish a new
domicile unless the move is coupled with an intent to remain there indefinitely.
 Pursuant to IRC Sec. 2101, the value of the gross
estate of every decedent nonresident not a citizen
of the USA is that part of the decedent's gross
estate [determined pursuant to IRC Sec. 2031]
which at the time of his death is situated in the
USA [commonly referred to as "USA situs
property"].
 The Internal Revenue Code [IRC] does not provide a clear definition of
USA situs property. USA real property, tangible personal property [e.g.,
art, jewelry, furniture, etc.] and stock in a USA domestic corporation are
examples of USA situs property. Debt obligations of a USA person, or of
the USA, a state, or any political subdivision are subject to USA estate
tax as are certain bank deposits.
 Note: if a decedent's real property is encumbered [mortgaged] and the
debt is recourse [meaning it is the personal obligation of the decedent],
the full value of the real property, unreduced by the mortgage, is subject
to USA estate tax.
 An Interest in U.S. Real Property [USRPI]
 A. Investor, a nonresident alien individual [NRA), owns the USRPI directly in
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his own name.
B. Investor, a foreign corporation [FC], owned by a NRA, owns the USRPI
directly in its own name.
C. Investor, a FC owned by a NRA, creates a U.S. Domestic Corporation
[USCO] that owns the USRPI.
D. Investor, a USCO owned by a NRA, owns the USRPI.
E. Investor, a U.S. Domestic Limited Liability Company [LLC] owned by a
NRA, owns the USRPI.
F. Investor, a NRA, creates a U.S. Domestic Partnership [USP] or a Foreign
Partnership [FP] that owns the USRPI.
G. Investor, a NRA, creates a U.S. Domestic Trust [UST] or a Foreign Trust
[FT] that owns the USRPI.
Generally, stock in a Florida corporation that
is owned by a nonresident alien who is not
domiciled in the USA is, pursuant to IRC Sec.
2104(a), included in the value of the gross
estate of a nonresident alien and subject to
USA estate tax.
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Alternative C above is often employed to avoid this conclusion, however, in some instances there are
treaties in place with foreign countries that eliminate the need for this alternative.
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An example of such a treaty is the Estates, Inheritances, Gifts and Generation-Skipping Transfers
Convention between the United States of America and Austria. This treaty, which was signed by
then President Regan on June 21, 1982, became effective as of July 1, 1983. This type of agreement
is known as a "domicile treaty." A domicile treaty typically overrides provisions of a statute as to
taxation.
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Article 7(1) of this treaty provides that stock in a USA domestic corporation held by an
Austrian resident citizen is not subject to USA estate taxes and is subject to Austrian estate
taxes, if any.
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This treaty also provides, under Article 5(2), that a U.S. real property interest held directly by an
Austrian resident citizen is taxed based on the location of the real property. Therefore,
corporate ownership of the U.S. real property interest avoids USA estate tax but direct
ownership does not.
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To avoid the consequence of Article 5(2) if a corporation is used, it is necessary for the
corporation to continue to be active and to maintain corporate formalities, such as annual
minutes of shareholder and board of director meetings, etc.
Germany, as an example, has a treaty with the USA that mirrors
the Austrian treaty discussed above. Treaties must be reviewed on
a case by case basis.
Other countries with which the USA had Estate and Gift Tax
Treaties in 2011 include Australia, Canada [through the income
tax treaty], Denmark, Finland, France, Greece, Ireland, Italy,
Japan, Netherlands, Norway, South Africa, Switzerland and the
United Kingdom.
These treaties would need to be reviewed individually to determine
specific applicability and benefits.
 Using Trusts – G
 By creating and implementing an irrevocable U.S. domestic trust a nonresident
alien may be able to exclude a USA situs real property interest from his USA
estate, as well as be taxed at favorable capital gains rates on a gain from
disposition of the real property interest [assuming the real property interest is
held more than one year]. The key to this planning opportunity is that the
nonresident alien creator may not retain any interest in the trust. If any interest
is deemed to be maintained than the real property interest would be included in
the USA estate of the nonresident alien. If the creator reserves the power to
alter, amend, revoke or terminate the trust, under IRC Sec. 2038, he has
"retained an interest" in the trust and therefore the real property interest is
includable in his USA estate.
 The use of this technique demands that the nonresident alien be willing to part
with control of the trust property. This is often a reason that this technique is
not used.
 If the nonresident alien has already acquired a U.S. real property interest and
desires to implement this strategy an issue arises in conjunction with USA gift
tax. When the U.S. real property interest is deposited to the trust a gift to the
trust beneficiaries is made. Since the nonresident alien is subject to the USA gift
tax rules, if the amount of the gift exceeds the annual exclusion amount, the
nonresident alien would need to file a USA gift tax return, which could result in
a reduced USA estate tax exclusion amount or the payment of gift tax.
Alternatively, by contributing cash [preferably from a non USA bank account]
to the trust and then having the trust acquire the U.S. real property interest, the
nonresident alien will not be subject to USA gift taxation on the cash
contribution.
 This technique will avoid probate and the associated costs (often 4% of the
value of the probated assets) of probate upon the demise of the creator of the
trust.
If the U.S. real property interest is the ownership of a house and the
nonresident alien or others wish to use the house, the use must be on
an arm's length basis. Rent would need to be paid to the trust, at
market rates, and the trust would need to use the rental income to
pay the expenses and costs of owning and maintaining the rental
property and keeping the trust in good standing. Trust formalities
would need to be maintained. Additional income tax consequences
result from whether the rental is determined to be effectively
connected with a U.S. trade or business or fixed or determinable
periodic income [FDAPI].
 Using Corporations – C
 Shares of stock issued by a U.S. domestic corporation, regardless of the location
in which the certificates are held, are USA situs property subject to USA estate
tax. Shares of stock issued by a foreign corporation, regardless of the location
in which the certificates are held, are not USA situs property and are not subject
to USA estate tax. This may constitute a planning opportunity. The foreign
corporation will be respected and avoid its assets being subject to USA estate tax
as long as it engages in legitimate business activities and operates in an arm's
length fashion. The foreign corporation would own the shares of the USA
domestic corporation. The U.S. domestic corporation would own the U.S. real
property interest. This structure is USA estate tax efficient in that it avoids the
USA estate tax entirely, but it is not income tax efficient in that if there is a gain
on the disposition of the U.S. real property interest, the gain will not be subject
to favorable capital gains rates and is subject to state income tax in Florida.
 Although IRC Sec. 351 contains tax free incorporation provisions, if the
nonresident alien already owns the U.S. real property interest in his
individual name, this provision would only apply if he transferred the
U.S. real property interest to a U.S. domestic corporation and
immediately after the transfer or exchange he was in control of the
corporation pursuant to the provisions of IRC Sec. 368(c). Ultimately he
would have to transfer his ownership interest to the foreign corporation.
 This technique avoids FIRPTA withholding and probate while providing
limited liability and anonymity. On the other hand it is an expensive
structure to maintain.
 If the U.S. real property interest is the ownership of a house and the
nonresident alien or others wish to use the house, the use must be on an
arm's length basis. Rent would need to be paid to the corporation, at
market rates, and the corporation would need to use the rental income to
pay the expenses and costs of owning and maintaining the rental
property and keeping the corporation in good standing. Corporate
formalities would need to be kept current, including minutes of
shareholder and board of director meetings, etc. Additional income tax
consequences result from whether the rental is determined to be
effectively connected with a U.S. trade or business or fixed or
determinable periodic income [FDAPI].
 Using Partnerships – F
 Neither the Internal Revenue Code nor the U.S. Treasury Regulations
specifically address the situs of partnership interests for USA estate tax or gift
tax purposes. Case law and rulings in this area are not conclusive. The issue
appears to be focused on the two alternative pass-through entity/partnership
theories: the aggregate theory, and; the entity theory. Under the aggregate
theory the partnership is seen as a transparent aggregate of its underlying assets
causing the partners to be deemed to own a share of the partnership assets.
Under the aggregate theory, the share of partnership assets would be deemed
USA situs property. Under the entity theory, the partners are deemed to own an
intangible asset which at least one court case found to avoid USA estate tax.
 Since a partnership is a pass-through entity, favorable capital gains rates are
applicable. If the partnership form was a limited partnership, then limited legal
liability would apply to all but the general partner(s).
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Since the issue of USA situs property is not legislatively or judicially settled, some
practitioners believe that assuming it cannot be USA situs property is overly aggressive
planning. However, other practitioners believe that if the Internal Revenue Service [IRS] took
the position that a partnership interest is USA situs property, such a position would not be a
sustainable interpretation. These latter practitioners are comfortable, taking the position that if
IRS challenges it, the law supports exclusion from the USA estate tax gross estate.
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If the U.S. real property interest is the ownership of a house and the nonresident alien or
others wish to use the house, the use must be on an arm's length basis. Rent would need to be
paid to the partnership, at market rates, and the partnership would need to use the rental
income to pay the expenses and costs of owning and maintaining the rental property and
keeping the partnership in good standing. Partnership formalities would need to maintained.
Additional income tax consequences result from whether the rental is determined to be
effectively connected with a U.S. trade or business or fixed or determinable periodic income
[FDAPI].
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IRC Sec. 721, et seq., contains provisions for tax-free contributions of capital, including
appreciated assets, to a partnership.
 Nonresident Alien Investor Owns Realty in his own Individual
Name – A
 Many practitioners believe this is the best way to hold a U.S. real
property interest. They address the negative of the inclusion for
USA estate tax by using a valid analogy. If a USA citizen expects
a significant estate tax bill upon their demise, the planning often
includes life insurance. If life insurance is owned by a nonresident
alien at their non-USA domicile, the life insurance proceeds will
not be included as a USA situs property and, as such, will not be
taxable in the USA gross estate.
Many foreign countries have entities which appear
to be corporate forms but which do not fit the
definition of corporation in the USA for tax
purposes.
A Swiss stiftungen [foundation] is an example.
Should an investor choose the corporation planning
alternative, qualifying the foreign corporation for
USA tax purposes is essential.
 Transfer to corporation controlled by transferor.
 (a) General rule.
 No gain or loss shall be recognized if property is transferred to a corporation
by one or more persons solely in exchange for stock in such corporation and
immediately after the exchange such person or persons are in control of the
corporation.
 Page 2,047 of the January 2008 IRC
 Non-recognition of gain or loss on contribution.
 (a) General Rule.
 No gain or loss shall be recognized to a partnership or to any of its partners
in the case of a contribution of property to the partnership in exchange for
an interest in the partnership.
 (b) Special Rule.
 Subsection (a) shall not apply to gain realized on a transfer of property to a
partnership which would be treated as an investment company (within the
meaning of section 351) if the partnership were incorporated.
 Page 3,064-3,065 of the January 2008 IRC
 Basis of contributing partner’s interest.
 The basis of an interest in a partnership acquired by a contribution of
property, including money, to the partnership shall be the amount of such
money and the adjusted basis of such property to the contributing partner at
the time of the contribution increased by the amount (if any) of gain
recognized under section 721(b) to the contributing partner at such time.
 Page 3,065 of the January 2008 IRC
 Basis of property contributed to partnership.
 The basis of property contributed to a partnership by a partner shall be the
adjusted basis of such property to the contributing partner at the time of the
contribution increased by the amount (if any) of gain recognized under
section 721(b) to the contributing partner at such time.
 Page 3,065 of the January 2008 IRC
Explanation of Abbreviations
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BLITBranch Level Interest Tax
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GIGross Income
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BPTBranch Profits Tax
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N/ANot Applicable
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ECIEffectively Connected Income
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NRANon-resident Alien
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ETBEngaged in a U.S Trade or
Business
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P.E.Permanent Establishment
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R.E.Real Estate
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RRRevenue Ruling
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TYTaxable Year
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US-United States
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USSI-United States Source Income
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FCForeign Corporation
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FDAPIFixed or Determinable
Annual or Periodical Gains, Profits
and Income
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FSIForeign Source Income
(A)
• INV (NRA)
USRPI
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Advantages:
 Possibly lowest income tax
rate (15% capital gain or 35%
maximum ordinary income)
if an individual and, less
likely, trust or estate; in event,
only 1 income tax.
 Least complex structure
 Can pay out U.S. tax-free
foreign source interest on U.S.
business. Related debt and
obtain deduction where
business assets secure such
debt or where debt is
“booked” to a U.S. trade or
business, subject to a
percentage limitation.
 No BPT or BLIT
Disadvantages:
 No anonymity
 Individual tax
return filing
 §1445 FIRPTA
withholding on
sale
 Unlimited legal
liability
 U.S. estate and gift
tax
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Disadvantages:
 BPT or BLIT and possible
regulatory elimination of the
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BPT complete termination
exception.
 Possibly more income tax
than individual ownership,
and no favorable capital gains
rate.
 §1445 FIRPTA withholding
on sale
 Expense of FC
 §163(j) interest-stripping
limitation and the related
foreign person guarantee rule
 BPT/BLIT/Passive
investment problems as to:
(i)sale using §453;
(ii)reinvestments of any
earning in passive property.
Limitations on PIE benefits
when using BPT/§453 rule.
Advantages:
 34/35% income tax
rate + state income
tax, but only one tax if
BPT termination rules
are followed
 No U.S. estate or gift
tax
 Limited legal liability
 Some anonymity
 Limited application of
§1441/1442 where no
E&P
(B)
INV (FC)
USRPI
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Advantages:

34/35% income tax rate
plus state income tax,
but only one tax
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No U.S. estate or gift tax
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Limited legal liability
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Extra level of anonymity
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No BPT or BLIT
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No §1445 FIRPTA
withholding on sale
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USCO may not be
subject to the
accumulated earnings
tax
(C)
INV (FC)
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Disadvantages:
 Occasional proposals, in
enacted, could result in more
than 56% federal double
taxation
 Income tax rate may be
USCO
greater than individual rate
 Expensive structure
 §163(j) interest-stripping
limitation and the related
foreign person guarantee rule
 Application of §1441/1442
USRPI
even where no
current/accumulated E&P
(D)
INV (USCO)
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USRPI
Disadvantages:
 U.S. estate tax
34/35% income tax
 Income tax rate may be
rate + state income
greater than individual
tax, but only one tax
rate
No U.S. gift tax
 Occasional proposals, if
enacted, could result in
Limited legal liability
more than 56% federal
No BPT or BLIT
double taxation
Some anonymity
 §163(j) interest-stripping
limitation and the related
No §1445 FIRPTA
foreign person guarantee
withholding on sale
rule
 Application of
§1441/1442 even where no
current accumulated E&P
Advantages:
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Disadvantages:
 Probably U.S.
estate tax
 §1445 withholding
(with no
adjustment for
NOL carryovers)
as LLC may be
treated as a
partnership for
federal tax
purposes
 Possibly U.S. gift
tax

Advantages:
 35% maximum ordinary
pass-through individual
federal tax rate (15% capital
gains rate) if classified as
partnership or disregarded
as an entity for federal tax
purposes and only one tax
 Limited legal liability
 Arguably, no U.S. gift tax,
but not clear a real risk
 No BPT or BLIT
 Some anonymity possible if
management via a manager
or managers in lieu of by
the members
(E)
INV (LLC)
USRPI

Advantages:
 Pass-through income tax
rate and 1 tax
 Possibility for favorable
15% long-term capital
gains rate
 If limited partnership and
a limited partner, limited
legal liability
 No BPT or BLIT
considerations
 Arguably, no U.S. gift tax,
but not clear, and maybe
same if a foreign
partnership
(F)
INV (NRA)
USP or FP
USRPI

Disadvantages:
 Trade or business status, or
permanent establishment
of partnership causes such
status at NRA partner level
 No real anonymity
 No limited legal liability if
a general partner unless
provided by a specific state
law
 Difficult to avoid U.S.
estate tax, if at all
 §1446 withholding on
ECTI of any foreign
partner (with no
adjustment for NOL
carryovers)
 Possibly U.S. gift tax
(G)
INV (NRA)
UST or FT
USRPI

Advantages:

 Pass-through income tax rate
and 1 tax
 Possibility for favorable 15%
long-term capital gains rate
 No BPT/BLIT considerations
 Arguably, no U.S. gift tax, but
not clear a real risk
 If a FT, can pay out U.S. taxfree foreign source interest on
U.S. business related debt and
obtain deduction where such
business assets secure such
debt or where debt is “booked”
to a U.S. trade or business
subject to a percentage
limitation.
Disadvantages:
 Trade or business status or
permanent establishment of
trust causes such status at
NRA beneficiary level
 No real anonymity
 No limited liability
 If irrevocable and no tainted
rights, powers, benefits,
interests etc. are retained, can
likely avoid U.S. estate tax
(otherwise U.S. estate tax and
possibly gift tax)
 Undistributed ECTI may be
subject to 35% tax rate at a
relatively low level of taxable
income
 Joseph R. Schortz, CPA (FL & NJ)
 Office Location:
 201 West Marion Avenue, Suite
1204
 Sunloft Center
 Punta Gorda, Florida 33950
 Email:
 [email protected]