The U.S. government’s crackdown on offshore tax evasion has placed the Report of Foreign Bank and Financial Accounts (FBAR) in the spotlight. Many U.S. taxpayers with foreign accounts may not fully understand their obligation to disclose these accounts, and even fewer realize the severe penalties that come with failing to comply. For U.S. citizens, residents, and entities with foreign financial accounts, the stakes are high.

Understanding FBAR requirements and the line between non-willful and willful violations, including recklessness, can mean the difference between a reasonable penalty or a financial disaster. A key case illustrating this legal battlefield is Bedrosian v. United States, a cautionary tale for those who might be unaware—or choose to remain unaware—of their filing obligations.

FBAR Reporting Requirements And Penalties: An Overview

U.S. citizens, residents, and certain entities are required to file an FBAR if the aggregate value of their foreign accounts exceeds $10,000 at any point during the calendar year. This requirement applies even if the accounts don’t generate taxable income. The FBAR is filed annually with FinCEN, separate from tax returns.

Penalties for failing to comply are steep:

• Non-Willful Violations: Penalties for non-willful violations are generally capped at $10,000 per violation unless the taxpayer can show reasonable cause.
• Willful Violations: For willful violations, penalties can be far more significant, often up to 50% of the account balance or $100,000, whichever is greater. In some cases, criminal charges can also be brought.

The difference between willful and non-willful violations is central to determining penalties, and recent court cases and IRS guidance have clarified that recklessness can meet the standard for willful conduct.

Bedrosian Case: Recklessness Redefined

In Bedrosian v. United States, the issue of recklessness in the context of FBAR penalties took center stage. Arthur Bedrosian, a successful businessman from Pennsylvania, had held foreign accounts with UBS in Switzerland. Despite being aware of his FBAR obligations, he failed to report one of his accounts in 2007. The IRS imposed a $975,789 penalty, citing willful failure to file.

Initially, the district court sided with Bedrosian, ruling that his actions were non-willful, and reduced the penalty to $10,000. However, on appeal, the 3rd Circuit Court found that the district court had applied an incorrect standard of willfulness, specifically underestimating the role of recklessness in FBAR violations. The 3rd Circuit clarified that recklessness can indeed qualify as willfulness, and remanded the case for further review. Upon reconsideration, the district court determined that Bedrosian’s failure to report the account demonstrated at least reckless disregard, and the original penalty was reinstated.

Key Case On Recklessness: McBride And FBAR Penalties

A landmark case discussing recklessness in FBAR violations is United States v. McBride. In this case, the taxpayer, Michael McBride, failed to file an FBAR for his offshore accounts. The court found that McBride acted with reckless disregard of the filing requirements, even though he claimed ignorance. The court emphasized that recklessness could be inferred from a taxpayer’s knowledge of the law and his failure to comply with it, even if there wasn’t a clear intent to break the law.

The McBride decision underscored that a taxpayer doesn’t need to knowingly violate FBAR obligations to be penalized severely. Acting recklessly—such as choosing not to learn the rules or ignoring clear indications that filing is required—can be sufficient to trigger the harshest penalties.

IRS’s Approach To Determining Willfulness: The Role Of Evidence

The IRS takes a broad approach when assessing whether an FBAR violation was willful or reckless. In doing so, the agency looks at various forms of evidence to determine whether a taxpayer’s failure to file was due to deliberate intent, recklessness, or negligence. Key factors include:

• Prior Filings And Disclosures: The IRS may review past tax returns and FBAR filings to assess whether the taxpayer has consistently disclosed foreign accounts. A pattern of non-disclosure could suggest willfulness.
• Foreign Bank Communications: Correspondence between the taxpayer and their foreign bank can provide clues about willfulness. For instance, if the bank warned the taxpayer about FBAR requirements, and they still failed to comply, this could indicate recklessness.
• Education and Background Of The Taxpayer: The IRS will also take into account the taxpayer’s background and sophistication. For instance, someone with a high level of financial literacy, such as a business owner or an individual working in finance, is more likely to be held to a higher standard of knowledge regarding their obligations. In Bedrosian, for example, his years of financial dealings and awareness of offshore accounts contributed to the court’s determination of recklessness.
• Taxpayer Behavior: Deliberate concealment, such as moving funds to different jurisdictions or closing accounts after learning of an investigation, can be viewed as willful.

The Internal Revenue Manual also provides guidelines for IRS examiners to follow when assessing willfulness. The IRS is particularly focused on patterns of behavior that demonstrate a conscious choice to disregard the law.

What Does This Mean For Taxpayers?

Taxpayers who hold foreign accounts must be aware of the serious consequences of failing to comply with FBAR requirements. The distinction between willful and non-willful violations is often determined by the taxpayer’s behavior and the totality of the circumstances, not just their direct knowledge of the law. The IRS will scrutinize the individual’s past filings, communications, and behavior to determine whether their failure to file was reckless or deliberate.

As seen in McBride and Bedrosian, recklessness doesn’t require overt intent to evade the law. Simply failing to act on information, or ignoring a known legal duty, can lead to penalties amounting to 50% of the account balance. The IRS’s focus on recklessness means that taxpayers cannot afford to be passive about their foreign accounts. They must actively ensure compliance or risk facing substantial financial penalties.

Conclusion

With the growing focus on offshore tax evasion, the U.S. government has ramped up its enforcement of FBAR penalties. The Bedrosian and McBride cases highlight the importance of understanding the broad definition of willfulness, which includes reckless conduct. Taxpayers who fail to disclose foreign accounts may face severe penalties, even if they claim ignorance. Staying informed and seeking expert advice is critical for anyone with international financial interests.

Declaring Foreign Business Interests

Navigating the U.S. tax code can feel like tiptoeing through a minefield, especially when you throw in international dealings. 

If you’re a U.S. person or corporation with foreign business interests, two forms in particular—Forms 5471 and 5472—might already haunt your dreams. 

Dubbed the “Terrible Twosome” by some beleaguered taxpayers, these forms come with stringent filing requirements and draconian penalties for non-compliance. 

Here’s why you should never forget to file these forms, what the consequences of forgetting are, and some recent developments that might surprise you.

What Are Forms 5471 And 5472?

Form 5471 is essentially an information return that must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations. 

The form requires detailed disclosure about the foreign corporation’s income, assets, and shareholders.

Form 5472 on the other hand, is used by U.S. corporations that are at least 25% foreign-owned, or by foreign corporations engaged in a U.S. trade or business. 

This form requires disclosure of reportable transactions between the reporting corporation and related foreign parties.

While both forms may seem like just another piece of paperwork, failure to file them—or filing them incorrectly—can lead to massive penalties.

The Fines:

Staggering and Unforgiving The IRS takes non-compliance with Forms 5471 and 5472 very seriously, with penalties that could make even the most seasoned tax veteran wince. 

For Form 5471 the penalty starts at $10,000 per year per foreign corporation. 

If the taxpayer fails to correct the omission within 90 days of being notified by the IRS, additional penalties of $10,000 accrue every 30 days, up to a maximum of $50,000. 

Form 5472 penalties are even harsher, starting at $25,000 for each accounting period the form is not filed. 

After the IRS sends a notice of failure, an additional $25,000 penalty kicks in for each subsequent 30-day period of non-compliance, with no cap on the penalties. 

These penalties apply whether the non-compliance was willful or due to an innocent mistake, although options for relief exist in cases of non-willful conduct. 

However, this relief is often difficult to obtain and requires demonstrating reasonable cause for the failure. 

No Statute Of Limitations? Yes, You Read That Right

One of the most terrifying aspects of failing to file these forms is that it can leave your entire tax return open to scrutiny indefinitely. 

Normally, the IRS has three years from the date you file your return to audit it. 

However, if you fail to file Forms 5471 or 5472, that statute of limitations does not apply. The IRS could theoretically go back and audit that return 10, 15, or 20 years later. 

Recent Developments: A Small Ray of Hope?

A recent Tax Court case, Farhy v. Commissioner, had thrown a wrench into the IRS’s penalty regime. 

In April 2023, the court ruled that the IRS did not have the statutory authority to assess penalties under Section 6038(b) for failing to file Form 5471. 

The IRS had been enforcing these penalties for years, but the court found that there was no legal basis for these assessments.

However this Tax Court Ruling was subsequently overturned by the United States Court of Appeals, District of Columbia Circuit on  3 May 2024.

Conclusion: Don’t Tempt Fate

If you have foreign business interests and think you might need to file Form 5471 or 5472, the best advice is simple: file them. 

Even if the forms are a headache and the rules seem complex, the potential costs of non-compliance—financial and otherwise—are simply too high to ignore. 

And as the Farhy case shows, while there may be occasional victories against the IRS, they are the exception rather than the rule. 

So, stay vigilant, keep those forms in mind, and avoid becoming another cautionary tale in the annals of tax non-compliance. 

The “Terrible Twosome” might be formidable, but with careful attention and professional guidance, they don’t have to be your undoing.

For many people the United States is a major investment jurisdiction.

Whether that investment is made into stocks, bonds, managed funds, real estate or shares in US private companies – the size and scale of the US market is often irresistible for international investors.

One of the downsides of investing directly into the US can be that non-residents of the United States who own U.S. assets can be subject to U.S. estate tax.

This can significantly impact their estate planning strategies by imposing a significant cost on their estate.

This article discusses the exposure of non-residents to U.S. estate tax, the benefits of estate tax treaties, the relevance of international wealth in estate tax calculations, and the formalities required to transfer U.S. assets to beneficiaries. 

U.S. Estate Tax for Non-Residents

Non-residents of the U.S. are subject to estate tax on their U.S. situs assets, which include real estate, tangible personal property located in the U.S., and certain intangible assets such as stocks of U.S. corporations. 

The tax rates range from 18% to 40%.

Importantly the exemption amount is significantly lower for non-residents than for U.S. citizens and residents, currently only $60,000.

Estate Tax Treaties

The U.S. has estate tax treaties with several countries, including Australia, Canada, France, Germany, Italy, Japan, the Netherlands, South Africa, Switzerland, and the United Kingdom. 

These treaties can provide several benefits, including:

Unified Credit

Some treaties allow non-residents to use the unified credit available to U.S. citizens, which can significantly reduce the estate tax liability. 

Exclusions And Deductions:

Treaties may provide for exclusions of certain types of property or deductions for debts, taxes, and expenses.

Relief From Double Taxation:

Treaties can prevent double taxation by providing rules for the allocation of taxing rights between the U.S. and the treaty country.

Relevance Of International Wealth

For non-residents, the U.S. estate tax is generally limited to U.S. situs assets.  

However, the international wealth of foreigners can still be relevant in certain situations.

For example, under some treaties, the U.S. may consider the decedent’s worldwide assets to determine the allowable unified credit or to apply pro-rata deductions. 

Example Calculation (Singapore Resident: No Estate Tax Treaty With US)

The non-resident owns a $1,000,000 U.S. property and has no debts or other deductions: 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Exemption Amount: $60,000 

3. Taxable Estate: $940,000 

Using the U.S. estate tax rates, the estate tax liability would be calculated based on the progressive rates. 

For simplicity, assume the effective tax rate is around 34% for this taxable estate size: 

Estate Tax Due: $940,000 x 34% = $319,600

This is major cost on a deceased estate and something that can be planned for ahead of time.

They key point here is to be aware of strategies to minimize or eliminate US estate tax.

Example Calculation (Australian Resident: Estate Tax Treaty With US)

The U.S.- Australia Estate Tax Treaty can provide relief and reduce the tax liability. 

Consider an Australian resident who owns a $1,000,000 U.S. property and has $5,000,000 in worldwide assets. 

The unified credit for U.S. citizens in 2024 is $13,000,000. 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Worldwide Estate: $6,000,000 

The proration of the unified credit is calculated as follows: 

Prorated Unified Credit = U.S. Situs Assets/Worldwide Assets  X Unified Credit

Prorated Unified Credit = 1,000,000/6,000,000 x 13,000,000 = 2,166,66 

The effective exemption amount is $2,166,667. 

 3. Taxable Estate: 

Since the U.S. situs assets ($1,000,000) are less than the prorated unified credit ($2,166,667), the taxable estate is reduced to zero. 

 4. Estate Tax Due: 

 With a taxable estate of zero, the estate tax liability is also zero.

Formalities For Transferring U.S. Assets

For those beneficiaries of deceased estates that have to deal with the transfer of U.S. assets from a deceased resident to a beneficiary, the following steps are required:  

1. Obtain A Transfer Certificate: 

The IRS requires a Transfer Certificate (Form 5173) to release the U.S. assets. 

This certificate ensures that all applicable estate taxes have been paid or secured. 

2. File Form 706-NA: 

The executor must file Form 706-NA, U.S. Estate (and Generation-Skipping Transfer) Tax Return, to report the U.S. situs assets and calculate the estate tax due. 

3. Pay Estate Tax: 

Any estate tax due must be paid. 

In the above examples, in Singapore the estate tax due is $319,600. Whereas in the case of the Australian estate no tax is due. 

4. Submit Documentation: 

Provide the IRS with necessary documentation, including the death certificate, will or trust documents, and appraisals of the U.S. assets. 

 5. Transfer of Title: 

Once the Transfer Certificate is obtained, the executor can proceed with the transfer of title of the U.S. assets to the beneficiaries as per the deceased’s will or trust documents. 

Conclusion

Other strategies exist to manage this exposure, including the formation of trusts in certain US states to hold assets.

The key point here is to plan the way you hold your U.S. assets as early as you can.

Indeed, those people who are non-residents of the U.S. holding US assets from countries that do not have an Estate Tax Treaty with the U.S. have the most severe exposure.

Please contact us to discuss any concerns or questions you might have with respect to holding US assets.

The United States tax code presents a labyrinth of rules and regulations, particularly for U.S. residents with investments in foreign corporations. These complexities are magnified when dealing with Controlled Foreign Corporations (CFCs) and the associated immediate taxation of foreign earnings under Subpart F or the Global Intangible Low-Taxed Income (GILTI) regime. This article delves into Section 962 of the Internal Revenue Code (IRC), explaining its significance and utility for U.S. tax residents in managing their foreign investments more effectively.

The Challenge: Immediate Taxation of Foreign Earnings

For U.S. tax residents with investments in foreign corporations, including those held through pass-through entities such as partnerships and S corporations, immediate taxation of foreign earnings is a significant challenge. This taxation arises annually under the Subpart F or GILTI regimes, compelling taxpayers to include foreign income in their U.S. taxable income, often leading to double taxation without relief mechanisms available to corporate taxpayers.

Corporate vs. Individual Taxpayer Treatment

The tax burden disparity between corporate and individual taxpayers under the GILTI regime is stark. U.S. corporations benefit from a reduced federal income tax rate of 21 percent, a Section 250 deduction that allows them to deduct up to 50 percent of GILTI, and the ability to claim up to 80 percent of foreign taxes paid as a foreign tax credit. This combination of benefits significantly mitigates the impact of GILTI on corporate taxpayers.

Conversely, U.S. resident individuals are generally taxed at a federal income tax rate of up to 37 percent on GILTI, without access to the Section 250 deduction or foreign tax credits for GILTI. This discrepancy creates a substantial tax burden for individual taxpayers, necessitating a strategy to level the playing field. This is where Section 962 of the IRC comes into play.

How Section 962 Election Works

A Section 962 election allows U.S. individuals to elect to be taxed on their GILTI and Subpart F income at corporate tax rates. When an individual makes this election, they are effectively treated as if they own their CFC through a hypothetical domestic corporation. This election provides several advantages:

1. Corporate Tax Rate: The taxpayer is subject to the 21 percent corporate tax rate instead of the higher individual rates.
2. Section 250 Deduction: The taxpayer can avail the Section 250 deduction, reducing GILTI by 50 percent.
3. Foreign Tax Credit: The taxpayer can claim an indirect foreign tax credit for taxes paid on the CFC’s net income in the foreign country, up to 80 percent of the foreign taxes paid.

Practical Example Of Section 962 Election

Consider a U.S. individual who wholly owns a CFC in Germany with net tested income of $1,000 for GILTI purposes, having paid $150 in foreign taxes. Without a Section 962 election, the individual faces a 37 percent tax rate on GILTI, resulting in $370 of U.S. tax, without any foreign tax credit or Section 250 deduction.

However, with a Section 962 election:

• The income is taxed at the corporate rate of 21 percent.
• The individual can deduct 50 percent of the GILTI under Section 250, reducing the taxable income to $500.
• Adding back the $150 foreign tax paid (gross-up), the taxable income becomes $650.
• Applying the 21 percent corporate tax rate results in $136.50 of U.S. tax.
• After claiming 80 percent of the $150 foreign tax as a credit ($120), the U.S. tax liability is reduced to $16.50.

Future Distributions And Tax Implications

The tax advantages of a Section 962 election extend to future distributions. In the example above, when the taxpayer eventually receives a distribution of $1,000 from the CFC, it will be taxed at the qualified dividend rate of 20 percent plus the 3.8 percent Net Investment Income Tax (NIIT), resulting in $238 of U.S. tax. Without the election, distributions would typically be subject to ordinary income tax rates, leading to higher tax liabilities.

When To Make A Section 962 Election

Despite its benefits, a Section 962 election is not always advantageous. Some scenarios where the election might not be beneficial include:

1. Same-Year Repatriation: If the CFC’s earnings are repatriated in the same year, the benefits of the election may be negated.
2. State Tax Considerations: Not all states follow the federal tax treatment. States like California do not tax Subpart F or GILTI until a distribution is made, meaning the Section 250 deduction and foreign tax credits may not be available for state tax purposes.
3. Future Tax Increases: Future distributions from previously taxed earnings under a Section 962 election might be taxed at higher rates, potentially offsetting the initial benefits.

Conclusion

Section 962 of the IRC offers a powerful tool for U.S. tax residents with investments in foreign corporations to manage their tax liabilities more effectively. By allowing individuals to be taxed at corporate rates and claim deductions and credits typically available only to corporations, this election can significantly reduce the tax burden associated with GILTI and Subpart F income. However, the decision to make a Section 962 election should be based on a careful analysis of individual circumstances and potential future implications. Consulting with a tax professional is essential to navigate the complexities and determine the best tax strategy.

The US has similar payroll tax requirements to Australia. From withholding taxes on wages, to payment of payroll taxes assessed on wages paid, and lodgement of employee forms, there is a range of compliance requirements that your company must fulfill.

There are a wide variety of payroll tax considerations, including tax withholding and taxes payable on the amount of wages. These taxes are levied to fund social security, Medicare, unemployment and disability benefits, and other State and Local requirements.

Withholding Taxes

• Employers are responsibility for withholding taxes from wages and paying this to the Federal government.
• Some States also require withholding taxes to be withheld in relation to the income taxes on employee wages.
• Employers must typically make regular payroll tax deposits and file quarterly payroll tax returns with the IRS.
• State and Local tax agencies often have their own reporting and payment requirements.
• Withholding taxes go towards the individual employee’s income tax obligations.

Payroll Tax Requirements

Federal Insurance Contributions Act (FICA) Taxes

• Funds social security and Medicare.
• Social security tax rate is 6.2% for the employee plus 6.2% for the employer.
• Medicare tax rate is 1.45% for the employee plus 1.45% for the employer.
• Additional Medicare is payable at 0.9% for the employee when their wages exceed $200,000 in a year.

Federal Unemployment Tax Act (FUTA) Taxes

• Funds state workforce agencies and unemployment insurance.
• FUTA is payable by the employer and is calculated at 6% on the first $7,000 paid to each employee.
• Payment of state unemployment taxes can often be used as a tax credit to bring the FUTA tax rate down to as low as 0.6%.

State Payroll Taxes

• State Payroll Taxes may apply depending on the location of your business.
• The most common State tax is State Unemployment Tax (SUTA), which is payable by the employer.

Local Payroll Taxes

• Additional payroll taxes may be payable based on the zip code, county or municipality where your business is located.

Employee Forms

• At commencement of employment, employees fill out a Form W-4. This guides employers on how much income tax to withhold.
• At the end of each year, employers must provide employees with Form W-2, which reports the employee’s annual wages and tax withholdings.
• On commencing employment, employers are required to verify an employee’s eligibility to work in the US. This is typically done through the I-9 Form.

Other Payroll Considerations

• Workers Compensation Insurance
• State Disability Insurance
• Paid Leave
• Health Care Costs for Employees
• Retirement Plan Contributions 
• Reimbursements and Stipends

Penalties For Missed Or Late Payments

The IRS may charge a late fee for employment taxes that are not paid on time. This is called a “Failure to Deposit Penalty”.

Payroll tax penalties are:

• 1-5 days late: 2% of the overdue payment
• 6-15 days late: 5% of the overdue payment
• Over 15 days late: 10% of the overdue payment
• More than 10 days from first notice: 15% of overdue payment

Other Employee Benefits

Other Employee Benefits you may be required, or choose, to pay, can include:

Retirement Plans

One of the tax advantageous retirement savings plans is known as a 401(k). Under this plan you would pay a percentage of each paycheck into your employee’s retirement savings account instead of directly to them.

Health Insurance

Employers must offer affordable health insurance that provides minimum value of 95% to full time employees (working 30hrs or more a week) and their children (until they turn 26).

Stock and Stock Options

Stock and stock options can be offered as a form of equity compensation.

The US has a complex tax system, with multiple taxes, including income taxes, often being imposed on a State level as well as a Federal level. Some types of taxes also apply locally, meaning that even within the same State you can pay very different taxes to other parts of the State.

• The US Corporate tax system operates on a Federal, State and Local system. This means taxes and other compliance costs may be charged from all three levels.
• Filing requirements, lodgement deadlines, and available deductions or credits often differ between locations.
• Due to the complexity of Local variances, compliance with the Local tax laws requires specialised Local knowledge for the area or areas in which your business operates.
• To optimise your corporate tax strategy, it is recommended that you consult with experienced tax professionals who have a Local understanding of US taxes, as well as international taxes.
• Tax returns are typically based on a calendar year.

Choosing Your State

Since every State has different laws, it can be important to select the right State for your business operations. You will be required to register in every State that you operate in, however if you have no particular business requirement for which State or States you operate in, then it can be advantageous to select a State that has more well known and simple tax laws.

For instance, Delaware has no state income tax, a fairly straight forward tax system, and well-known corporate laws across the US.

Types of Taxes

Income Taxes (Federal And State)

• The Federal tax rate for companies is 21% 
• 44 States levy corporate income taxes. These taxes vary from 0% to 11.5%, with some states assessing taxes on a flat rate and others using tax brackets in the same manner that individual income taxes are assessed.
• 43 States levy state income taxes, 41 tax wage and salary income, New Hampshire exclusively taxes dividend and interest income and Washington only taxes capital gains income. Seven states don’t impose any individual income taxes. Some states use a flat income tax rate, while others have a graduated tax rate depending on the individual’s income.

Sales Taxes (State And Local)

• Sales taxes are similar to GST or VAT in certain parts of the world. However, as sales taxes are only imposed on a State level, the rates vary between 0% and 7.25% depending on the State.
• There are also various Local governments within 35 States that impose an additional sales or use tax, which ranges from 1% to 5%.

Property Taxes (State And Local)

• Local authorities such as cities, counties, and school boards, typically impose property taxes on the value of the property, including the land and the structure on the land.
• Each State imposes different parameters on property taxes.
• Property taxes can also be payable on purchase and/or sale of property.
• Most States have a “homestead” exemption which reduces or eliminates the cost of property tax on your primary residence, subject to a variety of qualifications or limits, which vary State to State, or even within States.

Payroll Taxes (Federal, State And Local)

• Federal payroll tax is paid by both the employer and the employee.
• Some States and Local authorities also require some form of payroll tax to be paid. The most common type is State Unemployment Insurance (SUTA tax), which is payable by the employer.

Franchise Of Privilege Tax (For Doing Business In A State)

• Some States require certain business organisations to pay a franchise tax, otherwise known as a privilege tax, for doing business in the State.
• This tax is typically calculated on the net worth of capital held by the entity.
• Some States use an economic and physical presence test to determine whether a business is taxed, while others have no written interpretation of the basis of their test for determining who is required to pay the franchise tax.

Gross Receipts Tax (State)

• Some States apply a gross receipts tax on a company’s gross sales, without consideration of deductions for expenses.
• Gross receipts tax applies to businesses, regardless of whether sales relate to business-to-business transactions or business-to-consumer transactions.

Business Licenses (State, Local, With Some Federal Regulations)

• Business licences or permits may be required on a Federal, State, or Local level.
• Business licenses can take some time to be processed, and they should be completed prior to commencing operations. The complexity of the application depends on your industry, as well as the locality managing the license.
• Licences and permits typically need to be renewed on a regular basis.

Due to the complexity of the wide variety of Local, State, and Federal taxes, it is important that you obtain qualified advice regarding your business. If your business expands into additional locations you will need to get updated advice regarding the new location in which you are operating.

Expanding to the US means you are entering a complex tax system. From international tax concerns, to different Local, State, and Federal requirements, there are many factors to consider. The type of legal structure you choose will impact your compliance and tax considerations obligations.

Type Of Entities

C Corporation (C Corp)

• Separate Legal Entity that works like an Australian private company does.
• Offers some asset protection due to legal structure.
• Taxed at the corporate level and when profits are distributed as dividends, these are taxed in the hands of shareholders.
• Has Directors, shareholders (stockholders) and a separate tax identity to the shareholders.
• Federal income tax rate is currently 21%. State income taxes may also apply.
• In some instances dividends may have a reduced withholding rate of 5% when paid to foreign shareholders.
• Allows for capital raising, new shareholders or selling the business completely by selling shareholdings to new investors.
• High compliance requirements including meetings, quorums, minutes, and other management formalities.

Limited Liability Company (LLC)

• This is a simplified form of a company. In operation it is similar to an Australian partnership where control is in the hands of the members and profits flow through to the owners rather than being taxed at the entity level.
• Provides similar protection, and more flexibility than a C Corp.
• LLCs are not managed by Directors. They are managed by the members or an appointed Manager.
• It is possible for an LLC to have a sole member.
• Members do not need to be US residents.
• Tax returns need to be filed if there are two or more members, however the profits are distributed to the members who pay tax on their share of the profits.
• Can elect to be taxed as a C Corporation instead of being taxed in the hands of the members.
• Can elect how profits are distributed to members. For instance, profits may be split equally between members, based on capital contributions, or in other agreed ways.
• If foreign tax is paid on the profits to an Australian member, they can claim the foreign tax paid as a tax credit on their own assessment of profit distribution received.

Branch (No New Entity)

• No separate legal entity, meaning Australian entity is directly responsible for tax and compliance requirements.
• Branch profits may be subject to US tax as well as Australian tax, depending how the branch is established in the US. In this instance the Australian company can typically claim the foreign tax paid as credits to reduce the impact of double taxation.
• As there is no additional entity there may be less compliance issues to consider with transferring profits from the US to Australia. 
• Whether you need to establish a US entity or not, will depend on the nature of the business you are operating.

Taxation Issues To Consider With Your Chosen Legal Structure

Both Australian and US tax laws need to be considered regardless of the legal structure used to establish the US business operations. International tax issues will also need to be considered where members, Directors or owners remain residents of Australia.

Australian Taxation

• If the US entity is controlled in Australia it may be treated as an Australian tax resident.
• The Australian parent company will need to consider how the fees paid between the US and the Australian entities are taxed in Australia.
• US generally imposes a 30% withholding tax on payments to foreign entities.

US Taxation

• The US may tax income earned from any business established in the US, regardless of whether the operating company is a US or Australian resident.
• Australian resident members or Directors may be subject to US taxes before considering Australian taxes on income generated from the US branch or entity.

Fees Between Entities

1. US transfer pricing rules require transactions between related parties to be at arm’s length. This means that the value of fees may be adjusted where it is not arm’s length.
2. Proper documentation is essential for consulting or management services between entities, including basis for fees charged. This can assist in ensuring that fees paid between the US and Australian entities are treated as required for tax purposes.
3. Fees must be ordinary and necessary business expenses in order to be tax deductible to the paying entity.

If you or any of your key employees will be moving to the US when expanding your business, they may have unique tax considerations.

With both Australia and the US taxing their residents on their worldwide income, and taxing non-residents on income that is sourced within the respective country, it is important to be aware of double taxation provisions that help ensure an individual isn’t taxed twice on the same income.

Tax Residency

It is important to determine which country an individual is a tax resident of, as this will impact how that individual is taxed in each country.

When an Australian resident moves to the US for work purposes they will typically become a US tax resident if they establish a home in the US and reside there on a “permanent” basis. Factors that will be considered in determining whether residency changes include whether family is brought overseas with them, if they buy or rent a home to live in, and if they disconnect with ties back in Australia. 

Conversely an individual who lives in the US on a short-term basis, staying in temporary accommodation, and leaving their family back home in Australia, is more likely to remain an Australian tax resident.

A US resident who moves to Australia will face a similar situation. However, the US is fairly unique in taxing citizens on their worldwide income, even if they change their country of residency for tax purposes.

Expatriate Taxation Rules

It is important that you familiarise yourself with both the Australian and US tax rules related to expatriates, so that your key employees who travel from one country to the other have the right information to manage expatriate taxation concerns.

Foreign Earned Income Exclusion

When certain conditions are met, individuals from the US may qualify for the foreign income exclusion. This applies for individuals who reside in a foreign country and earn foreign income. As US citizens are typically taxed on their worldwide income, regardless of their tax residency status, this allows eligible individuals to exclude certain income from their US federal income tax return.

Foreign Tax Credit

Both Australian and the US allow provision for foreign tax credits to be claimed in their resident tax return.

This ensures they are not taxed twice for the same income from both the source country and their country of residence.

Tax Equalisation Policies

Tax equalisation policies are policies that aim to neutralize the impact of an individual’s tax liability when they are working on a global assignment. The objective of these policies is to ensure that the tax burden on an individual is similar to what the individual would have faced if they had merely remained living in their home country.

Australian Help Debts

In the event that you move an Australian employee to the US on a permanent basis, they may become a US tax resident. Ordinarily this would mean that they only need to lodge an Australian tax return to declare any Australian sourced income.

However, if the individual has an outstanding HELP, TSL or VSL debt, they will need to declare their worldwide income. While a foreign resident is not liable for Australian taxes on foreign sourced income, they are still liable for HELP debt repayments based on the value of their worldwide income.

Individual Tax Obligations In The US

As the employer you should be prepared to provide guidance to any key employees that you relocate from Australia to the US. This helps ensure that they aren’t caught unaware of their obligations and tax requirements while residing in the US.

Familiarise your employees with US filing requirements, which are not only different, but can be significantly more complex than Australian requirements.

• The US tax return is based on the calendar year and the filing deadline is mid-April.
• In the US, Individual tax brackets vary from 10% to 37%. The US does have a tax withholding system, that is similar to Australia, to help individuals manage their tax obligations.
• Unlike Australia, where each individual must always file their own return, individuals in the US can file as a single person or jointly as a married couple, or separately as a married couple.
• The US requires individuals to lodge a Federal Tax Return. However, depending on the State in which the individual resides, they may need to file a State income tax return as well.
• Non-residents who receive US income are also required to file a tax return. This means that any employee who is only in the US on a temporary basis will need to file a US return as a non-resident.
• Local Income Taxes may also need to be considered.

Employee Benefits

The US has similar benefits and options for employees as Australia does, however there are some key differences that an individual employee should be aware of so that they can make appropriate plans and decisions for their individual care.

Retirement Plans

US employers are not obligated to contribute towards retirement in the way that Australian employers are required to pay the Superannuation Guarantee. Most employers voluntarily provide retirement benefits through a 401(k) plan (similar to Superannuation).

Health Insurance

While the US has a federal health medical system, Medicaid, to provide free or low-cost health coverage, this is typically limited to low income and disadvantaged individuals. Without a universal healthcare system it is important to consider health insurance, which is commonly provided as an employee benefit.

As an Australian business expanding into the US you will need to consider US, Australian and international taxation issues. Depending on how your business is structured it may be required to pay taxes in both the US and in Australia. As a shareholder, you may also face tax obligations in both the US and Australia.

Residency

The first issue to address with International Taxation is the issue of residency. Your residency, and the residency of your company, is the primary factor in determining which tax jurisdiction has taxation rights over your income.

Both Australian and US residents are taxed on their worldwide income, which means it is important to understand the ways in which double taxation is mitigated.

If you set up a US structure to operate in the US, you will face Australian taxation consequences if the owners and/or managers of the business are Australian residents, and for any interactions you have between your US company and your Australian company.

Conversely, if you use your Australian company to operate a business within the US, you will need to consider the US taxation consequences due to the source of that branch income being in the US.

Tax Treaty

The primary way that double taxation issues are mitigated is through the International Tax Treaty between Australia and the US. When it comes to an Australian business operating in the US, some of the key factors that this Tax Treaty covers include:

• Business profits of an Australian enterprise are only taxable in Australia unless the enterprise carries on business in the US through a permanent establishment there. This means if you establish a permanent presence in the US, your business will be taxed under US regulations. A permanent place of business can be a broad term and may include:

1. A physical place of business including offices, factories, branches, workshops, stores, a place of management, or other physical presence for business operations. 
2. A sales representative of your business who has a permanent establishment who conducts business deals for your business.
3. A permanent provision of services in a specified location, even without a physical presence in that location.

• Transfer Pricing Rules mean that if you have a US entity and an Australian entity, any fees paid between these two entities must be paid on an arm’s length basis. This means there must be a business reason for the fees and a market value basis for calculation of these fees.
• Double taxation is mitigated by both countries typically allowing foreign tax credits to be applied against local taxes.
• The treaty also includes provisions for exchange of information and mutual agreement procedures to resolve disputes.
• A non-discrimination clause ensures that nationals of one country are not subject to taxation in the other country that is more burdensome than that imposed on nationals in the same circumstances.

Withholding Taxes

The Tax Treaty also deals with withholding tax requirements for certain types of income. In some cases, these withholding requirements limit the amount of foreign tax that can be paid on the specified income types.

Dividends

If a US corporation pays dividends to an Australian company that owns 10% or more of the voting stock of the corporation, the rate of US tax on the gross amount of the dividend generally cannot exceed 5%. For other dividends, the rate generally cannot exceed 15%.

For any Australian resident shareholders, this means you will pay either 5% or 15% in US taxes on any dividends distributed to you from your US company. This income is then included in your Australian tax return and you claim the tax paid as a foreign tax credit to offset the Australian tax assessed on this income.

Interest

Interest arising in one of the countries and paid to a resident of the other country generally may be taxed in both countries. However, the rate of tax imposed by the source country generally cannot exceed 10% of the gross amount of the interest.

As an Australian resident any interest income you receive from a US source will be taxed in the US at 10%. The US sourced income then needs to be included in your Australian tax return and you can claim the 10% tax paid as a foreign tax credit to offset the Australian tax assessed on this income.

Royalties

Royalties arising in one of the countries and paid to a resident of the other country generally may be taxed in both countries. However, the rate of tax imposed by the source country generally cannot exceed 5% of the gross amount of the royalties.

As an Australian resident any royalties you receive from a US source will be taxed in the US at 5%. The US sourced income then needs to be included in your Australian tax return and you can claim the 5% tax paid as a foreign tax credit to offset the Australian tax assessed on this income.

International Tax Planning Strategies

Due to the potential complexities involved in dealing with taxes from multiple countries, and the rules and regulations of managing income from multiple countries, it is important to seek appropriate tax advice. International tax planning strategies allow you to optimise your global tax position by factoring in your options around the types of structure, business, and interactions that your business has in the US and in Australia.

As an Australian expat living in the USA you may have to contend with the impact of taxes on property that you own in Australia or in the USA.

The types of taxes relating to property that you may need to consider include:

• Income taxes
• Capital gains tax (CGT)
• Local taxes such as land tax in Australia or Property Taxes in the USA
• If you inherit property in the USA you may also be subject to inheritance taxes

Since your country of residence will have an impact on how you are taxed for income and capital gains purposes, this article assumes you are a USA tax resident. You can read more about US tax residency in our article ‘Managing Dual Tax Residency as an Expat‘.

Australian Property Taxes

Once you cease to be an Australian resident for tax purposes the taxes you pay on income generated from Australian owned property changes, in potentially significant ways.

Income Generated From Your Property

As a non-resident for Australian tax purposes, any income generated from Australian real property will need to be declared and taxed in your annual tax return on a non-resident basis. This means there is no tax free threshold and your income is taxed at foreign tax rates.

When you lodge your Australian tax return, any tax paid to the Australian Taxation Office (ATO), can be claimed as a tax credit in your USA tax return.

This will apply to any property you retain in Australia as an investment property, or any new property you invest in that is located within Australia.

Changes To The Way CGT Applies When You Move To The USA

Your Main Residence

As an Australian tax resident your main residence is exempt from capital gains tax (CGT).  However, when you move overseas and become a non-resident, this exemption ceases to apply, except in limited circumstances. 

If you have already moved to the US, but intend to return to Australia at some point, your main residence exemption will again be accessible, but only on a pro-rata basis, as long as you are once again an Australian resident at the time you sell your former main residence.

CGT Discount

Australian residents are ordinarily given a 50% CGT discount on assets that are sold after 12 months of ownership. This discount is not available to foreign residents for assets acquired after 8 May 2012. For any property that you acquired after this date you will only be able to utilise the 50% CGT discount on a pro-rata basis for any period that you were an Australian resident.

Note that the discount cannot be applied for any period of ownership where you are or were a non-resident. This means that even if you return to Australia as an Australian tax resident, you will be unable to apply the CGT discount for your time as a non-resident.

Land Taxes

As land tax is applied on a state-by-state basis, the rules and calculations for this tax will vary depending on the location of your property.

It is important to note that some states apply a foreign surcharge on the taxable value of land. This means that your land tax costs may be more expensive while you are a non-resident of Australia.

Transfer Of Property (Stamp Duty)

When you purchase property in Australia you are subject to stamp duty on the value of the property. Stamp duty is applicable on a state level which means that the assessment criteria and rate of calculation, including any exemptions or reductions, varies between states.

Declaring Australian Sourced Property Income

You will need to declare any income you earn from your Australian investment property on your US tax return. You can also claim a credit for any tax paid on the income to the ATO. 

USA Property Taxes

The USA has a lengthier range of taxes and a generally more complex tax system. This is because taxes may be applied on a Local government level, as well as State and Federal levels. With the USA being a much larger country than Australia, taxes can be quite complicated.

Income Taxes

If you hold investment property in the USA you will be taxed on the income generated from renting the property. Unlike Australia, income is taxed on both a Federal and a State level in the USA. This means you are required to lodge both a Federal and a State tax return, unless you are in a state that does not apply income tax.

Capital Gains Tax

The US has a Capital Gains Tax regime that is similar to Australia’s Capital Gains Tax regime.

There are exemptions for primary residences, provided certain conditions are met, and long-term capital gains, defined as assets that are owned for more than a year, are taxed at a preferential rate.

Whereas Australia gives a flat 50% discount after 12 months of ownership, the US applies a progressive, preferential rate of tax which depends on your total taxable income. The rate of tax that is applied to long-term capital gains may be 0%, 15% or 20%.

Local Property Taxes

Property Taxes are imposed by Local governments, which means they vary widely depending on the location of your property. The Local governments that impose these taxes includes counties, cities, and school districts.

The closest comparison in Australia would be land tax. However, while land tax in Australia is assessed on just the value of the land, Property Tax in the USA is assessed on the overall value of the home, including both the land and the property structure. Also, while Australians typically find that their main residence is exempt from Land Tax, US property owners are usually subject to Property Tax, even on their main residence.

The assessed value of your property will determine how much property tax you are required to pay, and this assessment is periodically reviewed, including when there are significant changes made to the property. Assessment is based on a unit known as “a mill”, which is the equivalent of one-thousandth of a dollar.

Some jurisdictions offer exemptions or deductions that can reduce your property tax liability. Exemptions and reductions may cover factors such as the property being your primary residence, or personal factors, such as age, disability, or veteran’s status.

For states that have a “homestead exemption”, Property Taxes are reduced on your main residence. Most states allow between $5,000 and $500,000 of your main residence to be exempt from Property Tax, with larger exemptions for married couples or joint owners. Conversely, some states do not have this exemption at all.

These taxes are ordinarily due annually or semi-annually, depending on the jurisdiction. Penalties and interest can apply for late payments, so it is important to be aware of your local property tax requirements.

Transfer Taxes (Conveyance or Deed Taxes)

When you transfer property between one person or entity, to another, you will also be assessed for transfer taxes, otherwise known as conveyance or deed taxes. Since transfer taxes are administered by the Local government, who pays these taxes, and how much they are, varies significantly between States, and sometimes even between counties within a State. Transfer taxes may be payable by the seller, the buyer, or both.

Estate and Inheritance Taxes

Unlike Australia, most States of the USA have a specific estate and inheritance tax.

Estate taxes are levied on the total value of a deceased person’s estate, before it is distributed to the beneficiaries of the estate. Conversely, inheritance taxes are imposed on the heirs who take ownership of the assets.

These taxes are also applied on a State level, which means the rules and tax rates can vary significantly, and not all States impose them.

Australian Tax Resident

Note that there may be different outcomes if you only are living in the USA on a short-term basis and remain an Australian tax resident instead of becoming a US resident.

It would also mean that you are required to lodge a US tax return as a non-resident. You would then lodge an Australian tax return as a resident, declaring worldwide income, including the foreign income and foreign tax credits from the US.

Understand Your Property Tax Obligations

Taxes on Property, from Property Taxes imposed on ongoing ownership of property, through to taxes on rental income from investment property and CGT, can be extensive. When you are contending with holding property overseas and required to deal with international taxes, it can be even more complex.

Since tax legislation can vary significantly, even between States within the same country, and laws are often adjusted and updated, it is important that you always seek the most up to date tax advice for your situation.