Reporting common foreign transactions of U.S. clients.

• Author: Jacobs, Vernon K.

Many activities give rise to international reporting obligations. This article provides examples of common activities and identifies the various forms to be filed in each situation.

U.S. persons with international transactions or investments need to file a winery of special tax forms. (1) Noncompliance can be costly. Besides any tax due, not filing some information returns can result in the loss of a benefit or a monetary penalty. Some reporting failures may result in criminal sentences. No tax adviser wants to have a current or previous client receive a notice demanding penalties.

This article highlights common client activities (2) that give rise to an international reporting obligation, offers a number of examples and identifies the tax forms that need to be filed ha each case. Some common international reporting forms are listed in Exhibit 1 on p. 735. It will be helpful for tax advisers who do not specialize in international tax, but whose clients have international transactions, investments or business activities.

The International Reporting Minefield

While it is a cliche to say the world is getting smaller, it is true that national borders are becoming less of an obstacle to cross-border transactions. Small businesses create websites and soon receive orders from all over the globe. Investors look for investments all over the world using the Internet. Employees of U.S. multinational companies work abroad, get married and raise a family outside the U.S.

Below are some examples of the many ways in which U.S. clients get involved (or entangled) in various offshore or cross-border arrangements with tax ramifications different from similar transactions in the U.S.

The Publisher

Example 1: P, a small specialty publisher, advertises on the Internet; potential customers from around the world respond and submit orders via credit card. Dealers in other countries inquire about discounts and shipping terms. Reporters and editors worldwide call for background on a "hot" new book or request review copies. An acquaintance suggests that P could save taxes with a company in a tax haven and defer income taxes on all of his sales to foreign buyers. A lawyer in the Bahamas creates an International Business Company (IBC) and P begins to route orders from foreign countries to the Bahamas IBC. The lawyer also suggests that P establish a foreign trust to own the IBC, for asset protection from potential litigation. The lawyer agrees to serve as the trustee of the foreign trust, but P continues to serve as the IBC's chief executive officer.

Had P consulted with an attorney who specializes in international tax, it would have learned that its activities give rise to a number of return and reporting requirements:

1. P should be declaring all of the profits from the IBC as current taxable income on Form 5471, Return of U.S. Persons with Respect to Certain Foreign Corporations, because the IBC is a controlled foreign corporation (CFC) and the IBC's income is currently taxable to its shareholders.

2. P is the grantor of a foreign trust and is required to file Forms 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, and 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner.

3. Form 926, Return by U.S. Transferor of Property to a Foreign Corporation, should have been filed in the year the IBC was funded.

4. Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, should be filed to disclose foreign account information.

   U.S. Persons Working and Living Outside The U.S.

   Example 2: J was sent to England to manage a branch office of a U.S. distributor of medical equipment. He was single and looked forward to the opportunity to live in another country. The earned income exclusion (3) (Form 2555, Foreign Earned Income) appeared beneficial. He began to invest some of his income in foreign mutual funds.

   England imposes higher taxes on earnings than...