Evolution Tax & Legal’s Week in Review – August 17, 2020

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For this week’s in review, we are looking into the IRS’s final rules on the foreign dividends received deduction, potential tariffs by Trump, the end of extradition and shipping tax agreements with Hong Kong, and a practitioner’s insight on tax planning for those coming to and leaving the US.

Specifically, we will be covering the following this week—

  • IRS Releases Final Rules on the Foreign Dividends Received Deduction
  • Trump Threatens 2nd Term Tariffs on US Companies That Don’t Move Jobs Back to US
  • Practitioner Insight: Tax Planning for Those Coming into and Leaving the US
  • Practitioner Insight: Tax Planning for Those Coming into and Leaving the US

IRS Releases Final Rules on the Foreign Dividends Received Deduction

Final rules limiting tax code Section 245A deduction for dividends that a U.S. company (the “Foreign DRD”) gets from a foreign company in which it holds at least a 10% stake released August 21.

Generally, the Foreign DRD provides domestic, US corporations a deduction equal to the portion of a dividend received from a foreign subsidiary company (of which it owns 20% or more of) related to its foreign earnings.

The new rules also limit the exception to subpart F income under Internal Revenue Code Section 954(c)(6) for certain dividends received by controlled foreign corporations.

The regulations limit the availability of the Foreign DRD and the Section 954(c)(6) exception in certain limited circumstances where the effect would be contrary to the appropriate application of those provisions in the context of the 2017 Tax Cuts and Jobs Act’s (the “TCJA”) integrated approach to the taxation of income, or E&P generated by income, of a CFC, the IRS outlined.

Information reporting regulations are updated to take into account the new rules, the IRS stated.

There has been criticism that the IRS lacked the authority to issue the regulations by ensuring that the Foreign DRD appropriately operates within the statutory framework to complement, not contradict, the application of new provisions released. However, the IRS refuted this criticism.

The final regulations apply to tax periods ending on or after June 14, 2019, the date the proposed regulations were filed with the Federal Register, the IRS referenced.

https://www.federalregister.gov/documents/2020/08/27/2020-18543/limitation-on-deduction-for-dividends-received-from-certain-foreign-corporations-and-amounts

Trump Threatens 2nd Term Tariffs on US Companies That Don’t Move Jobs Back to US

President Donald Trump threatened this past Thursday that if he’s re-elected, he’ll impose tariffs on U.S. companies that refuse to move jobs back to the country from overseas.

“We will give tax credits to companies to bring jobs back to America, and if they don’t do it, we will put tariffs on those companies, and they will have to pay us a lot of money,” Trump said last week.

“So what are they going to do? They are going to bring the jobs back,” Trump said.

Trump offered no insight on the tariffs referenced in his comments. It is unclear how they would operate or at what stage of policy development the tariffs are sitting at.

“The beauty of the Trump tariffs is that they represent a powerful inducement for investment in domestic production by both American companies that have offshored our factories and foreign companies that want to sell into the U.S. market,” Peter Navarro, a Trump trade adviser said in a statement.

“We have seen this lesson time and again during this administration with the steel and aluminum tariffs, with the threat of auto tariffs, and with the China tariffs,” he said. “Tariffs mean more American jobs and factories.”

Extradition and Shipping Tax Agreements Between United States and Hong Kong Ended

This past week, the U.S. suspended its extradition treaty with Hong Kong and ended reciprocal tax treatment on shipping with the former British colony.

The moves are part of the Trump administration’s efforts to pressure China over the imposition of a national security law that has led to charges against more than 20 pro-democracy activists.

China urged the U.S. on Thursday to cease its “wrong moves” toward Hong Kong, with Foreign Ministry spokesman Zhao Lijian reaffirming Beijing’s position that the city’s affairs were a domestic matter.

The end of the favorable reciprocal shipping tax treatment is likely to impact import/export companies operating between the US and China. It also is likely to continue to affect the perception of a failing working relationship between the US and China, bringing down the price of equities for companies operating between the two countries.

The U.S. decision on fugitives follows a half-dozen other countries — including Australia, Germany and the U.K. — that have suspended extradition agreements with Hong Kong following China’s imposition of the law in late June.

The agreements terminated Wednesday “covered the surrender of fugitive offenders, the transfer of sentenced persons, and reciprocal tax exemptions on income derived from the international operation of ships,” State Department spokeswoman Morgan Ortagus said.

Practitioner Insight: Tax Planning for Those Coming into and Leaving the US

With the recent impact of COVID-19, many questions have arisen with the tax status of persons coming and going from the US. Major thought should be given to getting your affairs in order prior to arriving to the US or leaving from here. Without this, a person coming or going from the US could face seriously negative tax consequences.

RESIDENCY TESTS – IN GENERAL

For purposes of determining U.S. tax residency, the tax law provides for two objective tests: the green card (lawful permanent residence) test, and the substantial presence test. The holder of a green card is automatically treated as a U.S. tax resident. Under the substantial presence test, an individual is a U.S. tax resident in the current year if he or she is present in the current year at least 31 days and the sum of such days, plus one-third of the days present in the preceding year, plus one-sixth of those in the next preceding year equals at least 183. There are a number of exceptions and exemptions.

Even if the general test is met, a person coming or going to the US can be treated as a resident/non-resident for a single tax year. This framework has allowed for implementing basic pre-arrival and post-departure tax planning. Determining the proper residency starting date or residency termination date is critical to assessing whether and when a person should accelerate income, defer deductions, undertake basis step-up transactions, dispose of stock in foreign or U.S. entities, make check-the-box elections, or engage in various tax planning techniques on departure.

RESIDENCY CONSIDERATIONS WHEN FIRST ARRIVING TO THE US

For first-year residency, if an alien is a resident in the current year under the green card test or substantial presence test, but was not a resident at any time in the preceding year, then the individual is treated as a resident only for the portion of the current year beginning on the residency starting date.

The residency starting date of an alien who meets the substantial presence test in the calendar year is the first day the individual is physically present in the United States. Thus, the individual is treated as a resident only for the portion of the year beginning on that date.

In the case of an individual who is a lawful permanent resident (green card) at any time during the calendar year, but who does not meet the substantial presence test, the residency starting date is the first day physically present in the United States while a lawful permanent resident.

If the individual meets both the green card and substantial presence test, the residency starting date is the earlier of the two dates referred to above.

RESIDENCY CONSDIERATIONS LEAVING THE US

In terms of the last year of residency, an alien will not be treated as a resident for the portion of the year which is after the last day of physical presence in the United States so long as the individual had a closer connection to a foreign country than to the United States and the individual is not a U.S. resident at any time during the next calendar year. If the individual meets both the green card and substantial presence tests, then the residency termination date is the later of the two dates referred to herein.

However, for purposes of determining the residency starting date of an alien meeting the substantial presence test, and for purposes of determining the last year of residency, the individual is not treated as present in the United States for any period during which he or she had a closer connection to a foreign country than to the United States but only for no more than 10 days of “nominal” presence in the United States. Nevertheless, the nominal 10 days of presence in the United States still counts as days present in the United States for purposes of the general substantial presence test.

As it affects tax planning for the last year of residency, a few things should be noted. First, if an alien seeking to terminate U.S. residency in the current year and is a U.S. tax resident at any time during the following year, they will be treated as a U.S. tax resident for the entire current year. In other words, there will not be a “lapse” in U.S. tax resident status. This means that former U.S. tax residents must monitor and restrict their days of presence in the United States in the year after they seek to terminate their tax resident status.

PLANNING AROUND RESIDENCY RULES WHEN LEAVING THE US

Limit Time in the US. The simplest way to avoid meeting the substantial presence test is to limit days of presence in the United States during the following year to 30 or fewer. If that is not possible, an individual must track days of presence to ensure falling below the 183-day threshold of the three-year look-back formula of the substantial presence test.

Wait Until the Following Year to Engage in Nonresident Transactions. Depending on the relative split in the number of months between the residency and non-residency periods in the last year of residency, it may be preferable to wait until the following year to engage in transactions as a “nonresident” in order to be able to document that the individual has truly maintained a closer connection to a foreign country for a sufficient period of time.

Consider Planning Around Income Still Subject to Tax in the US. It should not be forgotten that nonresidents are themselves also subject to U.S. tax on certain types of income, e.g., U.S.-source, fixed and determinable annual and periodical income (FDAP) as well as income effectively connected with the conduct of a U.S. trade or business.  Non-resident will need to take this into consideration when leaving the US to ensure that they are still not generating this type of income.

Capital Gains for Non-Residents. Finally, nonresidents are also subject to tax on the sale of U.S.-source capital gains if they are present in the United States for 183 days or more in the year of sale. If the individual properly terminates residency as described above which requires establishing and maintaining a tax home and closer connection to a foreign country after leaving the United States, the individual should be considered a nonresident for purposes of the gain sourcing rules and the gain should be treated as nontaxable foreign-source capital gains. Thus, non-residents should plan around recognizing capital gains until they meet the “non-resident” status for US tax purposes.

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