TAXPAYERS SHOULD USE IRS FOREIGN WITHHOLDING AUDIT PROCEDURES TO CHECK THEIR OWN COMPLIANCE

Absent the application of a treaty or other exception, U.S. payors of U.S. source dividends, interest, rents, royalties, compensation, and other fixed or determinable annual or periodical gains, profits, and income (FDAPI) are required to withhold 30% of such payments and pay them over to the U.S., and file appropriate withholding tax returns. A recent supplement to the Internal Revenue Manual signals increased future audit activity in this area, both as to U.S. financial institutions in connection with their brokerage and custodial activities, and non-financial institutions that may not be focused on withholding tax compliance. Non-financial institutions that can expect enhanced scrutiny include professional services firms (law, accounting, and architecture), high-tech medical equipment and computer hardware and software companies, intellectual property providers such as entertainment and publishing, pharmaceutical companies, and companies in the real estate industry.

One method to reduce penalty exposure is for taxpayers to adopt the same examination techniques of their own operations that IRS agents are being advised to use on audit. Thus, taxpayers (or their accountants) should consider:

a. Developing procedures for identifying payment recipients that are subject to withholding and procedures for determining exemptions from withholding and for reporting, which procedures are implemented and ready to be handed over the IRS if an audit arises. It would be all the better if such procedures are in writing and implemented in operating procedure manuals or similar training materials for employees;

b. Review Schedule M of Form 5471, which reports payments made by the taxpayer to controlled foreign corporations, and includes payments of commissions, rents, royalties, license fees, interest, and dividends, and Forms 5472, to determine that payments to all related parties on such forms are being subjected to withholding and reporting when required;

c. Reviewing accounts payable lists for accounts that indicate foreign ownership by reason of name, address, or taxpayer identification number, and assure withholding tax compliance for payments to such payees;

d. Doing the same review as to recipients of corporate dividends and interest payments to the extent not managed through the accounts payable department;

e. Confirming that all withholding is being properly included on Forms 1042 and 1042-S filings;

f. Confirming that copies of Forms W-8 and 8233 are being properly retained to substantiate no withholding based on such forms.

Since it is the payees that suffer the economic cost of withholding, there is no reason for payors not to comply, other than the marginal costs of compliance. Following the foregoing procedures should go a long way towards reducing or eliminating penalties for inadvertent noncompliance, and should further reduce the risk of being held responsible for taxes that are not withheld.

DO THE WEALTHY PAY THEIR FAIR SHARE OF INCOME TAXES?

Much political hay is made over making sure that the wealthy pay their fair share of income taxes, that the wealthy avoid paying income taxes through tax "loopholes," and that tax relief should be restricted to the less wealthy. One has to wonder how much sense any of that makes, and how much more progressivity the system can bear as a practical matter or under equitable principles, when the IRS in its most recent Statistics of Income advises us:

a. Taxpayers in the group that includes only the top 1% of adjusted gross income filers pay 39.9% of the income taxes paid by all individual taxpayers; and

b. Taxpayers in the group that includes only the top 5% of adjusted gross income filers pay an astounding 60.1% of the income taxes paid by all individual taxpayers.

This, according to the most recent year for which compiled information is available - 2006. The information is available online at http://www.irs.gov/pub/irs-soi/09winbulinincome.pdf.

POSSESSION STILL ONLY 9/10ths OF THE LAW

Ronald Griem at one point in time held shares in a British Virgin Islands company (the “BVI”). The BVI held a substantial securities account through a U.S. brokerage house.

Ronald passed away, and to the surprise of his family, they learned that Ronald had married before his death, and that his new wife held all of the bearer shares of the BVI. A dispute arose whether the BVI (and its securities account) belonged to the company or the new wife. The new wife claimed that her husband had gifted the shares to her before he died, that possession is “ten tenths of the law” for bearer shares in offshore companies, and thus she was the owner. She also cited provisions of Florida UCC law (673.2011(1), Florida Statutes) that the possessor of an “instrument” payable to bearer is the owner, even if the instrument was stolen. The trial court agreed with the wife, and granted her petition for summary judgment in her favor.

Not so fast, says Florida 3rd District Court of Appeal. First, shares of stock are not “instruments” under the UCC, but are “securities” and thus the cited UCC provision is not applicable. Analogizing to probate issues as to who is the owner of personal property of an estate after the death of a decedent, the appellate court indicated there are still some issues to be investigated to determine whether the wife is the owner of the shares, and that the personal representative should be allowed to avail itself of discovery to assist in such determination.  Possession, while important, is not alone determinative of ownership. Instead, the ownership issue must be resolved under BVI law, which includes numerous provisions and requirements for documentation that may nullify or support the wife's claim that mere possession of the bearer shares is dispositive.

The appellate court particularly noted that additional discovery should be allowed so that the parties can disclose to each other Mr. Griem's and the  spouse’s federal income tax returns (to determine how ownership was reported for income tax purposes), communications with the BVI registered agent or any custodians, and any pertinent communications with the stock brokerage house regarding the company, the shares, and the wife’s alleged ownership of the shares.

Of course, the wife may still prevail in her claim of ownership, but it will not be as easy as merely claiming that possession is 10/10’s of the law.

INGRID DIANA GRIEM, etc., Appellant, vs. ANITA BECKER, Appellee, 34 Fla. L. Weekly D449d, 3rd District. Case No. 3D07-2320. L.T. Case No. 05-4456. Opinion filed February 25, 2009.