Foreign Investment - Qualified Dividends



Foreign Investment and U.S. Taxes

What are the tax consequences of investing in a foreign business? In this post I will consider if dividends received from a foreign corporation can qualify for the preferred tax treatment that qualified dividends receive. In later posts I will consider if double taxation (both the U.S. and the foreign country) can be avoided, and reporting requirements for investments in foreign corporations, foreign partnerships, and foreign LLCs.

First, if you are a U.S. person all worldwide income is required to be reported on your tax return. However, all income is not treated the same. Since qualified dividends are taxed at favorable rates you, as an investor, want to know if dividends from your foreign investment qualify. According to IRS publication 17 here are rules for qualifying for qualified dividend tax treatment.

Qualifications for the dividends.

To qualify all of the following requirements must be met:

  • The dividends must have been paid by a U.S. corporation or a qualified foreign corporation.
  • The dividends aren't the type listed under Dividends that aren't qualified dividends.
  • You meet the holding period.

Qualified Foreign Corporation

So what is a qualified foreign corporation? A foreign corporation is a qualified corporation if it meets any of the following conditions.
  1. The corporation is incorporated in a U.S. possession.
  2. The corporation is eligible for the benefits of a comprehensive income tax treaty with the United States that the Department of the Treasury determines is satisfactory for this purpose and that includes an exchange of information program. 
  3. The corporation doesn't meet (1) or (2) above, but the stock for which the dividend is paid is readily tradable on an established securities market in the United States. 

Exception

Of course there is an exception and it is an important exception. A corporation isn't a qualified foreign corporation if it is a passive foreign investment company during its tax year in which the dividends are paid or during its previous tax year. 

Passive Foreign Investment Company

What is a Passive Foreign Investment Company (PFIC)? 
According to IRS Instructions for Form 8621, A foreign corporation is a PFIC if it meets either the income or asset test described next.
  1. Income test. 75% or more of the corporation's gross income for its tax year is passive income (as defined in section 1297(b)).
  2. Asset test. At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the tax year are assets that produce passive income or that are held for the production of passive income. 
So if you invest in a PFIC and receive a distribution then it will not qualify as a qualfified dividend so the distribution will be taxed at the higher ordinary income tax rates. In addition the tax and reporting requirements for a PFIC are strict and extremely complicated.

Summary

If you invest in a qualified foreign corporation that is not a passive foreign investment company and receive a qualified dividend from that investment you may be able to receive the favorable tax treatment afforded to qualified dividends.

When considering an investment through another business like a mutual fund company or some other investment firm, make sure you determine if it is PFIC. You can probably find the same or a similar investment from an american firm that will allow you to receive distributions that would be taxed at the more favorable capital gains tax rates via a qualified dividend. 

I tried to make this as simple as possible but there are still some complicated issues here. In addition, this is only part of the issue for an investor in a foreign corporation. Another issue is the potential double taxation from the U.S. and the country where the corporation resides. So I will plan to address that issue in a coming post.



Jeff Haywood, CPA
The CPA Superhero
jeff.jhtaxes@gmail.com
217-923-8007
twitter.com/thecpasuperhero




References:

IRS publication 17 

IRS Instructions for Form 8621

Planning for Qualified Dividend Income When Taking Foreign Companies Public - Pepper Hamilton LLP

Understanding taxation of foreign investments - Investopedia

Passive Foreign Investment Company - Investopedia


Be careful when reading about tax law and its application, including my articles, because the wording and definitions are such a challenge and are influenced by writers perspective, specifically his own clients situations that he is mindful of and other situations the writer is not thinking of. The point is talk to your CPA about your situation and circumstances and don't rely on or make conclusions based on articles you read, including articles form irs.gov, because concepts and definitions are not very clear, and of course, they are subject to change. Now is the time to be having discussions about your situation and developing strategies for you and your business. Again, contact me using my information above to discuss your situation. I help business owners all over the U.S. and in foreign countries with their tax returns.

It's what I do. What do you or your business do?

It's Complicated

What Do I Do?

We just finished the 2019 "tax season", sort of, and I have a question: What is it that I do?  From time to time it is good to take a look at a business and ask what do we do, what is the identity of this business. Businesses need to keep in touch with the ever changing world that we live in and make adjustments accordingly.

The 2019 Tax Season

This was a tax year was unlike any other tax year. Between the new tax law, new tax clients, and new situations I found myself spending more time researching issues and explaining them than I did actually preparing returns. Several clients could not understand why they had so much tax because they could not see clearly on the new tax forms how much income they had and how much their taxes were. Once they were able to see it most of them realized their TAXES were actually relatively low. Others had low or reasonable TAXES but had either a healthcare penalty or a return of the premium healthcare credit, neither of which are TAXES and dealing with those made me irritable because I do taxes not healthcare penalties and return of premium credits. Errgh.

What Happened?

What happened to doing a bunch of relatively easy returns? When I took a position working for another CPA, many years ago, he assigned me to take care of a bunch of personal returns from a tax practice he had just purchased. This was not a book of CPA clients but there were a significant number of clients with fairly simple personal returns for me to take care of. At the time I had conversations with the CPA I worked for and we discussed what we do and how that relates to what we charge. For example what do I charge these new clients who previously paid less to a non-CPA tax preparer. These new clients needed to somehow fit with what we did and what we charged. I was given freedom to set their prices and I chose to significantly increase the fees to be on par with what a CPA charges. I advised these clients that we would charge them more and discussed some options for them. In reality our fees for many of these clients were comparable to what the franchise tax businesses charged. That first year a majority of the clients stayed with us and paid the higher prices. So that first year I did a lot of simple returns but over the next few years the mix grew increasingly towards business returns and tax returns for business owners.

What I Do Now

So now how did I get to my own practice preparing what are mainly more complicated returns and what type of clients am I targeting now. Keep in mind I once heard in a seminar to be careful about the type of people you do business with. The reason being that you will attract more of the same. So when someone asks if I will do their returns or asks what I do I am really careful to define that according to what I want to be doing. What I do is complicated tax returns or returns for people or businesses that are complicated.

Complicated tax returns are what I do now. I do a few simple personal returns but most of those are a favor to someone else like a return for a client's kid or their employees. Most of my clients are business owners or investors who are dynamic people and most of them tend to be complicated - the people,  the business, and/or their situations. I have a lot of tech businesses, restaurants, entrepreneurs and investors. I have some clients with cryptocurrencies and many with residency issues both international (they reside in foreign countries) and between states (they move around). I also have a group of clients that are basically digital nomads. Additionally, I have several clients that reside abroad.

Also, now that I am residing back in Illinois, after returning from living in Acapulco for six years, I am taking on estate returns. Most of these estate returns are for people that have died with assets that will eventually be sold and dispersed to the beneficiaries but because the assets generate income for the estate an estate income tax return needs to be filed. I have also done and I am sure I will be doing the other type of estate tax return where there is a tax based on the value of the estate at death if the value of the estate is over $11.4 million for 2019. Those returns are whoppers and have to be filed within 9 months after the date of the decedent's death. I am sure I will be doing some of those again soon. There are a lot of wealthy elderly farmers in this area. But mostly I am doing estate income tax returns for estates with income producing assets. The demographics here in central Illinois make that a growing market, and these returns are typically interesting and complicated. 

To give you a better idea of what I do, this past year I had one client that sold a commercial building for over a million dollars. This year I have a few clients that are looking to sell businesses for several million each. So we are having discussions about structuring the sales and planning for the taxes and other opportunities. One of these is developing several businesses that they will turn around and sell once the businesses are established.

This year I have had many complex tax issues to deal with, including residency issues, cryptocurrencies, alimony and not just alimony but alimony from a pre January 1, 2019 agreement between an alien resident and a (now) non-alien resident (that could be another post all on its own). There have been stock options > RSOs and ISOs. There has also been issues with income from foreign corporations, S Corporation Compensation and Medical Insurance Issues.

Finally, I have three clients that I am helping to get in compliance with the IRS. These clients have not filed tax returns in many years. One lives in another country and did not realize they needed to file. Another needs ten years of returns done and I still don't know the whole story but I will find out in the next month. There is yet another that asked for my help but I still need to help them get everything together. Often these clients have some major issue that kept them from filing. I am refining my processes for helping these clients to move forward. I anticipate writing a new article about helping people who need to file several years of back tax returns.

Don't even get me started about the issues with the healthcare penalty and the reconciliation of the healthcare premium tax credit. Between these issues and trying to explain to clients what their tax situations were using the new tax forms I have realized I did not charge my clients enough this year. I charged more this year because I have not raised my fees in a few years and I could see that with the new tax law there would be much more involved with preparing business returns and the returns of the business owners. I just did not anticipate the additional work and stress associated with explaining the new tax forms and the healthcare related  issues. 

This gives you an idea. It's complicated. That's what I do. 

How Did I Get Here? What About This Year?


How did I get here, in this situation? It was actually my choice. Years ago I decided I did not want to compete with the mainstream tax preparer but I wanted to develop a business doing returns that were out of the ordinary. I made this choice for two reasons. One is there is much more value and appreciation for my work since these are specialized returns. And two, I am not just charging for a tax return but for the specialization and the conversations about these unique situations. Now I am assessing my current position and deciding what areas to focus on growing for my practice. There are issues with simple returns and that is not what I do. What I do is complicated. So if you have one of these unique situations or something else that is complicated then contact me using my information below. 

There is more to this story and but be assure it is complicated. 


What Do You Do?


For your business, the question is: what do you do? I would be happy to discuss it with you and help you develop plans and strategies.


Jeff Haywood, CPA
The CPA Superhero
jeff.jhtaxes@gmail.com
217-923-8007
twitter.com/thecpasuperhero



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