In recent years, many Americans have formed offshore private interest foundations (OPIFs), mainly in Panama. However, if you establish this entity without expert tax advice, you could be in for a rude awakening from the IRS.
The gist of the problem is that no legal framework for OPIFs exists in U.S. law. For that reason, the IRS relies on the person that forms an OPIF to tell the agency how it should be taxed. Despite claims by some promoters that you aren't taxed on the interest, dividends, and earnings of OPIFs, they generally have no U.S. income tax advantages, unless set up for charitable purposes.
When a U.S. person establishes an OPIF, it must be classified for tax purposes as a trust, a corporation, a partnership, a charitable foundation or a disregarded entity. This classification is determined under IRS regulations, not on the OPIF's legal status under foreign law. The only exception to these classifications is a true non-profit charitable entity.
Treasury regulations require that you make this election within 75 days of the foundation's creation. If you fail to do so, you lose the opportunity to have the foundation taxed as anything other than an offshore trust or offshore corporation.
Many Americans who form an OPIF intend to use it as a substitute for an offshore trust. But, if the IRS disagrees with your classification, it can elect to tax the OPIF as an offshore corporation. This can lead to potentially disastrous tax results.
Even if you persuade the IRS to tax the OPIF as an offshore trust, you are subject to voluminous reporting requirements with stiff penalties for non-compliance. Case in point: Treasury regulations require that the trustee of an offshore trust (or the trust grantor) file IRS Form 3520A annually. The form provides the IRS financial information about the offshore trust (or OPIF taxed as an offshore trust). And if you fail to file Form 3520A by the deadline (generally the same as your personal tax return), there’s a 5% penalty of the entire value of the offshore trust or OPIF.
It's even worse if you formed an OPIF years ago and funded it without reporting the transfer of assets to it on Form 3520. You must file this form when you fund an offshore trust (or an entity taxed like one). You must also file Form 3520 when the trust makes loans, distributions, or you make additional contributions. The penalty for failing to file—or filing late—is a whopping 35% of the loan, distribution, or contribution. Generally, Form 3520 is also due at the same time as your personal tax return.
With a new administration ready to assume power in Washington, D.C. that is overtly hostile to offshore investments and jurisdictions, I don't see the IRS becoming "kinder and gentler" in regard to these requirements. Instead, I expect the IRS will ratchet up enforcement efforts dramatically.
For that reason, if you're considering forming an offshore foundation (or any other offshore entity), get assistance from a qualified tax professional before you do so. And, if you've already formed an offshore structure, and suspect you're not fully compliant with IRS reporting requirements, obtain professional assistance before the IRS alerts you of the problem.
Copyright © 2008 by Mark Nestmann
(The information herein is not intended to constitute personal tax advice. It does not constitute a “covered opinion” and may not be used to avoid potential tax penalties.)
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