Weapon of Mass Destruction: Your Foreign Corporation

OPINION ORLANDO

By Orlando Gotay, Tax Attorney

If the title did not catch your attention, I don’t know what would. I chose it to convey the potential to inflict serious, perhaps even catastrophic, damage by mishandled ownership in foreign corporations (FC).

Actually, FCs can be perfectly okay. However, US persons must understand that merely owning enough FC shares can trigger special IRS reporting requirements, even if no income is created. Worth noting: FCs are separate entities and are not your left pocket.

Contributing cash or property in excess of certain amounts triggers a reporting requirement. As mentioned, owning more than a certain percentage of FC stock triggers another. Being an officer or director…you guessed it. Another requirement. Every one of these requirements carries a very meaningful penalty for not complying.

In my time in Mexico, I have learned that some persons organize FCs to hold title to real estate—typically one’s home—perhaps trying to save on annual fideicomiso fees.

Are you renting from your own corporation? Probably not. But you are getting something of value from that FC: the use and enjoyment of the residence. That has value, Fair market value. If you did not pay rent, that value can be considered annual income to you and must be included in your federal return. It’s like an imputed dividend. You say huh? I say you did it to yourself.

If the property in the FC is actually being rented, it may become more complicated if the FC qualifies as a Passive Foreign Investment Company. PFIC’s are really bad. Congress doesn’t want you to have them because of the potential to park unreported income. Special reporting requirements and tax regimes—beyond “regular” FC ones—can apply.

Shares in an FC that holds real property may be a “Specified Foreign Financial Asset” and thus reportable in yet another IRS form. You, the flesh and bones person, may also be responsible for a Foreign Bank Account Report if you have control over a foreign financial account in the name of the FC.

Do you see a pattern here? The American taxman becomes very, very excited when his subjects organize foreign entities, as it does not have as much visibility on them as it does with domestic counterparts.

If needed, fideicomisos structured according to IRS rules are safe to have. You don’t have reporting requirements, you don’t have to pay rent to the trust, and you can sleep at night. Do your homework, learn the guardrails!

 

Orlando Gotay is a California licensed tax attorney (with a Master of Laws in Taxation) admitted to practice before the IRS, the U.S. Tax Court, and other taxing agencies. His love of things Mexican has led him to devote part of his practice to federal and state tax matters of U.S. expats in Mexico. He can be reached at tax@orlandogotay.com or Facebook: GotayTaxLawyer. This is just a most general outline. It is informational only and not meant as legal advice.

 

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