United States

FATCA and the net investment income tax creating an atmosphere for change


Foreign tax considerations under the Foreign Account Tax Compliance Act (FATCA) including how to classify income and ensure proper withholding, topped the list of tax concerns during the tax update workshop at RSM's Sixth Annual Investment Industry Summit, held in New York City. Issues involving how to classify fixed, determinable, annual, periodical income (FDAP) and effectively connected income (EIC) are under close IRS scrutiny, creating a challenging tax compliance environment for firms and investors.

"The world is getting harder to manage in terms of foreign tax considerations," said RSM partner and panel moderator Richard D. Nichols. "From the perspective of the IRS, more examinations of withholding and tax documentation are coming. The Department of the Treasury thinks it's going to be able to get more revenue by going after withholding."

In essence, the two classifications subject foreign persons that generate income in the United States to a 30 percent or greater tax rate, and this income can include income derived from derivatives and securities. Whether that person is entitled to reduce that amount and by how much depends on which type of income–FDAP or ECI.

"There are about 35 to 40 tax treaties that the United States has with other governments out there that could allow individuals and entities to claim exemptions and/or get lower rates," Nichols explains. In most cases, when it comes to withholding, parties will save more money and cut down on headaches if they withhold and make deposits in a timely manner, rather than waiting until all other processes have been exhausted. Ultimately, he says, with FATCA and corporate inversions, the "Service is looking."

Yaakov Tambor, a senior manager at RSM, provided an update on the section 1411 net investment income (NII) tax. The NII tax was a source of confusion for many taxpayers when it first came out and remains an issue for financial services industry participants, as it will impose a nearly 4 percent tax on most individuals, estates and trusts within the industry.

"Most people in the financial services industry and most trusts are going to be subject to the NII tax," he explained. "In some cases, it may be worth considering a restructure from an LLC to an LP. The general partner of section 475 mark-to-market funds, for example, can get hit with the highest rate here, but if the partners pay the incentive as a fee to an LP and not as a reallocation, then those rates can come down." NII is essentially investment income that is not subject to self-employment tax.

It is important to note, Tambor adds, that once a partnership has elected to have passive foreign investment company income included in income for NII purposes at the same time the income is recognized for "regular" tax purposes, "that election is irrevocable, even if you sell the security and buy it back at a later time. So partners will want to consider this when deciding to make that election."

Irina Kimelfeld, a senior manager at RSM, provided an update on the next set of FATCA compliance deadlines, which begin Jan. 1, 2015. A significant portion of the world has entered into an intergovernmental agreement with the United States. Taxpayers will have to comply with guidance provided in the agreements and U.S. regulations to ensure FATCA compliance.

The next step for financial firms is account holder due diligence and reporting. The new W-8 forms are complex, and since there is a significant possibility for error, review and validation of the forms could pose challenges for financial firms.

"Additionally," Kimelfeld added, "you must also search for U.S. indicia, which means that firms will have to look through their investor files, and if files contain information that suggests the investor may be a U.S. person, such as a U.S. phone number or other U.S. indicia outlined in the regulations, additional steps have to be taken to document an investor as foreign."

Finally, Moshe Metzger, a partner at RSM, followed with an update on estate tax considerations and how individuals might use their gift allowances through the use of intrafamily loans and grantor retained annuity trusts (GRATs) in order to leave a legacy without running up against the estate tax.

Metzger also spoke about the potential to gift carried interests under the current estate and gift tax laws. He cautioned that although this can be done, such an approach should be exercised with great caution.