Death of the Straw Man: Foreign Owners of U.S. LLC's Face Additional Reporting Requirements - IRS Form 5472

U.S. Government Takes Steps Towards Full FATCA Reciprocity

Since the inception of the Bank Secrecy Act of 1970, the United States has considerably advanced and succeeded in its efforts to combat offshore tax evasion and other financial crimes. Metaphorically, no country is an island; Intergovernmental agreements (IGA) with more than 100 governments enabled collection and remittance of information on U.S. owners of foreign financial accounts to the IRS & Treasury. These agreements have been instrumental in the implementation of the Foreign Account Tax Compliance Act (FATCA).

Background and Reasons for New Reporting Requirements

Up until recently, the aforementioned agreements on the exchange of financial information worked mainly in one direction: from the partner countries to USA. There was no legislation in place allowing the Treasury Department to fully reciprocate the information exchange. There were even discussions amongst members of the Financial Action Task Force (FATF), the global organization combating money laundering, as well as members of the European Union, about designating the United States as a tax haven.

With global interest rates at record low rates, money needs to be parked somewhere (preferrably safe & stable). As a result enormous flows of money from all over the world have gone into the U.S. real estate.

On Jul 18, 2017 the National Association of Realtors released a report showing that the amount of properties bought by foreign buyers surged 32% YoY. The total dollar value of purchases by foreign buyers and recent immigrants totaled $153 billion; 10% of the total dollar value of existing home sales. This value is up 49% from 2016. Half of all foreign sales were were in three states: Florida, California, and Texas.

Foreign nationals have placed large amounts of cash into limited liability companies (LLCs) in U.S. states such as Delaware or Nevada that have minimal disclosure requirements.

These LLCs would then purchase real property in the United State. Foreign buyers mainly use the wholly owned U.S. LLCs for liability protection and for estate planning reasons. These transactions did not require disclosure of the “real owner” of the LLC, and phantom buyers all over the world purchased tremendous amounts of real estate.

The absence of IRS reporting obligations, in addition to the lack of public disclosure of legal entities ownership, has created opportunities to hide copious amounts of wealth using the LLCs as money-laundering vehicles. These properties would usually remain disregarded entities in the eyes of the IRS, and without being rented out, the foreign owner would remain outside of the U.S tax system.

For example - a foreign owner could purchase a $10MM property in Manhattan through a Delaware LLC, thus achieving complete anonymity of the property’s natural owner.

Three Mechanisms to Enable FATCA Reciprocity

The IRS and Treasury Department have implemented new mechanisms to stem the tide of money laundering, allowing financial information to be obtained and stored in IRS databases and transmissible to a foreign country partner with the click of a mouse.

The protocols put in places fulfill reporting requirements from two complementary sides. On the one hand the onus is placed on the responsible corporate entities enabling the transactions - such as title companies and financial institutions. These institutions will now be required to report data to the IRS & Treasury. On the other, the individuals who are the foreign owners, must equally self-report their U.S. holdings.

The mix of reporting sources proved to be a success in achieving global financial transparency with regard to U.S. citizens. The FATCA paradigm comprises self-reporting of foreign financial assets owned by US citizens/permanent residents in conjunction with information on US account holders collected by foreign banks. With the additional disclosures outlined in this article, the U.S.Treasury Department expects such a mix to be as successful in implementation of the reciprocal FATCA information exchange.

Step 1 - U.S. Title Insurers Required to Identify and Disclose High-End Cash Buyers in Six Major Metropolitan Areas

On Jul 27, 2016 the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) announced the Geographic Targeting Order (GTO) that will require U.S. title insurance companies to identify the natural persons behind shell companies used to make cash purchases of high-end residential estate in selected metropolitan areas.

The following major U.S. geographic areas are covered. The threshold purchase price subject to reporting varies by area.
 

The GTO brings reporting of cash transactions to a new level by adding three new requirements.

• When the purchaser is a limited liability company (LLC), the title company must disclose the name, address and tax identification numbers of all of its members, thus putting an end to the anonymity of the cash transaction involving certain legal entities.
• Another new requirement is the inclusion of partially cash transactions to the scope of reported transactions. A reportable purchase, called a Covered Transaction, is a transaction made, at least in part, using currency or a cashier’s check, a certified check, a traveler’s check, a personal check, a business check, or a money order in any form.

Elimination of the “de minimis exception”. If any part of the purchase price was paid using a method of payment specified above, then the transaction is considered a Covered Transaction (assuming the location and threshold purchase price criteria are met).

The title insurance company shall report the “Covered Transaction” real estate transactions meeting the monetary threshold for that area by filing FinCEN Form 8300 within 30 days of closing. This is the same form that has been in use for years to report to the IRS cash transactions in excess of $10K.

The GTO is being renewed every 180 days with additional modifications, the latest extension is through Aug 22, 2017.

During his last visit to Miami, Dennis Ivanov, a Russian citizen, was impressed by an exquisite mansion at Indian Creek Island. Dennis offered $3M to the owner, all-cash. The owner countered with $3.5M. The counter offer was accepted. Dennis paid $3.5M with a cashier’s check issued by the National Bank of Panama. Dennis received title to the house.

The title insurance company will now report this cash purchase to FinCEN on form 8300. No actions taken against Dennis. Information is stored at the FinCEN database and may be retrieved per request by FATCA partners from any country.

Step 2 - U.S. Financial Institutions and Individual Brokers Required to Identify Owners of LLC Involved In Financial Transactions

The new rules issued by the Financial Crimes Enforcement Network (FinCEN) include a new requirement for Financial Institutions (Banks, Federally Insured Credit Unions, Mutual Funds, and other dealers in securities) to identify and verify the identity of the owners of legal entity customers (anonymous LLC-type entities).

Financial institutions are not presently required to know the identity of the individuals who own or control U.S.-organized legal entities (LLC). The new requirement will address this weakness and provide information that will assist law enforcement in financial investigations, improve the ability of financial institutions to facilitate tax compliance, and advance U.S. compliance with international standards and commitments.

The financial institution may comply either by obtaining the required information from clients on a standard FinCEN Form (Certification Regarding the Beneficial Owners of Legal Entity Customers) or by any other means that comply with the substantive requirements of this obligation.

Financial institutions and individual security brokers must comply with these rules by May 11, 2018.

John Blake, a UK citizen, established a revocable trust in Malta. The Maltesian trust is the sole member of an LLC in Nevada. The LLC aggressively invests in the U.S. stock market. Capital gains attributable to the trust are tax-exempt in the U.S. through Article 13(5) of Tax Convention between U.S. and Malta.

Maltese tax law does not tax income of non-resident trust beneficiaries. Thus, this income is also tax exempt in Malta. The new requirement for Financial Institutions will identify and reveal John Blake, the UK citizen, the real person in receipt of the trading income.

Step 3 - New Reporting Requirements for Foreign Owners of U.S.LLC

U.S. citizens and legal permanent residents must file information returns, such as Form 5471 & Form 3520-A, to report business entities outside of the United States in which they have financial interest. Under the principle of reciprocity, foreign owners of U.S. disregarded entities will be required to file Form 5472 information returns with the IRS.

This form is not new; the prior application of this form was limited to disclosure of the natural owners of a Foreign-Owned U.S. Corporation; now it’s use is expanded beyond corporations and covers foreign owners of disregarded entities (LLC).

The new reporting requirements apply whether the disregarded entity is owned directly by the foreign owner or through one or more foreign or domestic disregarded entities or grantor trusts.

The new reporting requirements go into effect on January 1, 2018 for taxable years beginning on or after Jan. 1, 2017.

New Tax Identification Number Requirements Bring Foreign Owners of U.S. LLC’s Into the U.S. Tax System

To file form 5472, the LLC is now required to obtain the EIN (employer identification number) by filing form Form SS-4.

The Form SS-4 requires the applicant to identify a "responsible party'' for the entity. For a typical Delaware LLC, this could be the owner or manager (or both). In order to complete form SS-4 a “responsible party”, i.e. foreign owner of the LLC, will be required to obtain a U.S.Individual Tax Identification Number (ITIN).

This will naturally bring the real owner into the sights of the IRS. The U.S.tax identification number will also make foreign owners easily identifiable by their resident country tax authorities.

Paul Dubois, citizen of France, is the single owner of Delaware LLC. The LLC holds the title to a condominium in New York with a purchase price of $900,000. Since the time of purchase in 2010, the value of the property has almost doubled and reached $1.75M. The property was never rented. Paul stays there when he visits New York.

Over those 7 years Paul was never required to file a U.S. tax return because the property did not generate any income. It is unknown whether he includes this asset on his French tax declaration for calculation of French wealth tax (ISF).

The new reporting requirements now require Paul to apply for a U.S. personal tax identification number in order to request an EIN for his LLC. The EIN is necessary to file form 5472 in 2018. On the form, Paul will report his beneficial interest in the property and its current market value. He will have to indicate the country (France) under whose laws he files an income tax return as a resident.

We anticipate that Delaware registered agents are likely to add a new service to their foreign clients. They will act as a “responsible party” for the LLC, thus keeping the owner off the radar. In such an arrangement, Paul may circumvent applying for personal tax ID and have his Delaware agent fill the role. Sooner or later, the government will identify and change the regulations to prevent that too.