Tax Questions and
Answers
about the Panama
Foundation
Since 2001, I have responded
to questions about international tax law and asset protection subjects
from
members of the Jacobs Report group at Yahoo Groups. One of the
most
frequent questions involves the U.S.
tax treatment of the Panama Private Interest Foundation. The following
is a
collection of past questions and answers on that topic. Because
the answers to the questions were made
at different times, there is substantial duplication of some material.
Please
note that this information is not intended to be personal tax advice
and is not
an authoritative source of information about this subject.
(Vernon
Jacobs)
QUESTION: What do you think of Panamanian
foundations?
REPLY: Basically, if a U.S. person establishes a
foreign
foundation, the foundation 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 its
legal
status under the foreign law. The only exception to these
classifications is a
true non-profit charitable entity.
QUESTION:
I have a foreign grantor trust, but from what I have read I have to
file a FBAR
report when I exceed $10,000 a year. Would the same be true if I had a
Panama
Foundation? I was told that since I wouldn't own it then I wouldn't
have to
list it. In fact I could make the PF the beneficiary of my trust.
REPLY: For some reason that escapes
me, there seems to be a huge amount of misinformation about the U.S. tax treatment of U.S.
persons who are the founders
and/or beneficiaries of a Panama Foundation.
As a reminder, the U.S.
and
the IRS do not have any jurisdiction over a foreign foundation, trust
or
corporation -- BUT -- they do have legal jurisdiction over the U.S.
persons or entities that are the founders, investors, grantors or
beneficiaries
of these foreign entities.
Without digressing into a long dissertation about how the IRS and the U.S.
courts
decide on the tax treatment of an entity or its owners/beneficiaries,
they will
use the "duck theory". If it looks like a duck, walks like a duck and
quacks like a duck they will tax it like a duck.
Based on this esoteric legal principle, they will treat a Panama
or other foreign foundation
as a trust if it functions like a trust that has a grantor and
beneficiaries
and a primary function of managing investments. But if the foreign
foundation
is structured so that it resembles a business corporation with
shareholders, a
board of directors and transferability of ownership, they will treat it
as a corporation.
And, in those few cases when a foreign foundation resembles a
charitable
foundation, they will treat it as a foreign charity.
Once they have decided how the foreign foundation should be treated for
U.S.
tax purposes, they then impose various taxes and reporting obligations
on the
shareholders (if it's treated as a corporation) or the grantor (if it
is
treated as a trust.) A failure to comply with their rules results in
penalties
and interest in the event of an audit and a persistent failure could
result in
some time in their free hotel.
If the foreign foundation is treated like a trust, the U.S.
grantor of
the trust will be required to file the Form 3520 and 3520-A and the
FBAR
(Foreign Bank Account Report) report. If the foreign foundation is
treated as a
foreign corporation, the U.S.
officers and directors of the foreign corporation (including certain
owners)
will be required to file the FBAR report and certain shareholders will
be
required to file the Form 5471 and Form 926.
For those who disagree with the IRS on these matters, there are three
basic
choices. (1) Dispute the issue in court if you can find a lawyer
willing to
argue the matter for you. (2) Expatriate so that you are no longer
subject to
the U.S.
tax laws on future income. (3) Take your chances on whether the IRS
will find
you. But with respect to that last alternative, you might want to read
my
article on why secrecy doesn't work anymore. (http://www.offshorepress.com/secrecy-myth.htm
)
QUESTION: I saw your last article about foreign
trust vs
foundation. Do the IRS regs use the terminology "foundation" along
Trusts? If I "founded" a foundation, is it the same as a Grantor and
do I have to report such to IRS?
REPLY: If a foreign foundation
functions as a trust (rather than as a corporation), then the founder
would
most likely be treated the same as the grantor of a foreign trust. If
the
foreign foundation is operated like a corporation, the founder would
most
likely be required to file the same reports as the officer or
shareholder of a
controlled foreign corporation. The classification of a foreign
foundation
would depend on the specific facts and circumstances of the entity.
My previous Q&A memo was a very BRIEF summary of the subject. It
would take
me many hours of research to determine if there is any section of the
tax code
or regulations that specifically distinguishes between a trust and a
foundation. If there is an answer to your question, I suspect it will
be found
in Revenue Rulings or in Private Letter Rulings by the IRS.
The section of the tax code and regulations that define various types
of
entities is section 7701 but I find no reference to either foundations
or
trusts in that section.
The rules for tax exempt (charitable) foundations are generally found
in tax
code sections 507 through 509 and the related regulations would be
found in
sections 1.507 through 1.509. Exempt foundations in the U.S.
can be
organized under state law as either a trust or a not-for-profit
corporation.
A foundation will either be classified by the IRS as a trust or as a
corporation,
depending on how it is organized and operated. When a foundation is
organized
to operate a business for the benefit of the beneficiaries the IRS will
treat
it as a corporation and the beneficiaries will be treated as
shareholders.
Where a foundation is organized like a trust it will be treated as a
trust. If
it is organized and operated for a tax exempt purpose, it will be
treated as a
tax exempt foundation.
There is an 18 page commentary on the Panama Foundation by Richard Duke
which
is available on my paid subscribers' web site at
http://www.offshorepress.com/subscribers/duke/papanamafoundationt.htm
QUESTION:
A client claims if he sets up an offshore corporation that is owned by
a Panama
foundation that the tax burden does not flow through to him. He is
simply a
"signer" on the corporate account and providing a "service"
for the company over yonder. What are your thoughts?
REPLY: There is a mystique about the
Panama Foundation that often results in a lot of horse manure being
spread
about by the promoter of the deal. Because you put a couple of key
words in
quotes, I will assume that your client is the beneficial owner of this
arrangement.
First, any US citizen or resident who has signature authority or an
interest in
a foreign financial account (or accounts) in excess of $10,000 during
any
calendar year must report that on their tax return (Form 1040 for
individuals)
and must file a form TD F 90-22.1 with the Treasury Department. A
failure to
comply will cause the taxpayer to be subject to a MINIMUM penalty of
$10,000 --
without regard to any excuses, no matter how compelling. That's a
result of the
latest tax law (The American Jobs Creation Act of 2004).
Second, the IRS will treat a foreign foundation as either (1) a trust,
(2) a
corporation or (3) a charity -- depending on how it is used. Those who
might
disagree with the IRS on how they categorize a foreign foundation can
pay for
the cost of a court dispute -- and they are not likely to win.
If the foreign foundation is treated as a trust, and if there is any
present or
future US
beneficiary of the foundation, then it will probably be treated as a
foreign
grantor trust and the taxpayer will be subject to income taxes on the
income of
the trust. The taxpayer will be required to file a Form 3520 each year
and the
trustee will be required to file a Form 3520-A each year. A failure to
file
these forms is subject to significant penalties. Because the trust will
be
deemed to be the owner of the stock of the foreign corporation, the U.S.
taxpayer
will be considered to be the controlling shareholder of the foreign
corporation
and subject to personal income tax on the passive investment income of
the corporation.
The shareholders of a controlled foreign corporation are required to
file a
Form 5471 each year and a Form 926 when they transfer assets to the
corporation. Other forms may also be required.
If the foundation is deemed to be a foreign corporation by the IRS,
then the
taxpayer is probably the controlling shareholder -- even if someone
else acts
as a nominee shareholder to hide the ownership. The US
shareholder of a controlled
foreign corporation is subject to current income tax on passive
investment
income of the corporation. The
corporation that is owned by the foundation would be treated as the
subsidiary
corporation of the foundation that is treated as a corporation for tax
purposes. This would require filing a Form 5471 for each of two foreign
corporations.
In the very unlikely event that the IRS concludes that the foreign
foundation
is a genuine charity (because none of the income from any assets owned
by the
foundation will ever be available for the personal benefit of the
person who
created the charity or for any relatives of that person), then the
taxpayer who
set up this arrangement may not be subject to any income tax but would
still be
required to file the foreign account disclosure Form TD F 90-22.1.
This is just conjecture on my part because I don't know the specific
facts and
details of this arrangement. It just happens to look like some of the
scams
that Richard Duke and I have exposed on the Offshore Press web site at http://www.offshorepress.com/offshoretax/otscams.htm
For those who are motivated by a desire to save taxes, there are a lot
of legal
ways to save taxes with methods that don't involve convoluted offshore
structures. See http://www.offshorepress.com/legalways2save.htm For those who are mostly motivated to have
offshore asset protection and/or to have access to foreign investments,
there
are ways to do that without getting into a dispute with the IRS that
the
taxpayer is nearly certain to lose.
QUESTION:
An offshore trust must be reported to the U.S. gov't along with the
beneficiaries. Isn't a Panama
foundation better; no reporting requirements? Also you can have IBC
shares
owned by the foundation. This over rides the cfc status.
REPLY: That might be possible if a
lot of very technical tax obstacles can be avoided -- and if the person
who
provides the funds for the Panama
foundation is making a gift of those funds to a foundation formed for a
purely
charitable purpose. But there are a lot of promoters who are telling
people
that they can put money into a Panama
foundation, protect those assets from creditors, avoid US taxes and
still have
access to the assets and control over the structure. The IRS does not
agree
with the claims of these promoters.
Most commentators on this subject describe the Panama
private interest foundation
as being like a family foundation, which is used for asset protection.
For US
tax
purposes, that entity would be treated as a foreign trust. When a
foreign trust
owns shares in a foreign corporation or IBC, the US
person who provides the funds to the trust (or foundation) is deemed to
be the
owner of the corporation for US
tax purposes.
If the Panama
foundation is
organized like a genuine charitable foundation and the founders have no
residual interest in the foundation income or assets, nor any
prohibited
transactions with the charitable foundation or with any entities owned
by the
foundation, then it is likely that the IRS would treat the entity like
a charitable
foundation in the US.
However, US taxpayers would not be able to deduct contributions to a
foreign
charitable foundation unless the contributions are made via a domestic
charity
or foundation.
Even if the Panama
foundation functions as a charitable foundation, any US
person who is an officer or
director of a foreign corporation is required to file the tax return
(Form
5471) for the foreign corporation -- even if that person is not a
shareholder
of the corporation.
It appears that if a US
taxpayer organizes a foreign foundation in a manner similar to a US charitable foundation, there would
be no reporting
requirements to the US
government other than to file a gift tax return when funds are gifted
to the
foundation. If a foreign charitable foundation establishes and owns a
foreign
corporation, then a US
person who is only an employee of the corporation would not be required
to file
the foreign corporation tax Form 5471 -- BUT – that person can't be an
officer
or director or have any indirect control over the foundation or the
officers or
directors of the corporation. And, if any US person has the authority
to
direct the use of funds in any foreign financial account, they must
file the
Form TDF 90-22.1.
It is a very common desire to find some simple way to protect assets
from
creditors and to also avoid U.S.
taxes on investment income. While there are ways to do this with
domestic
structures, a lot of people seem to think that they have to use an
offshore
structure. But the U.S.
tax law has numerous traps and pitfalls regarding foreign structures
that can
have devastating results for the unwary and the uninformed.
It seems there are a lot of promoters who are making false (or
uninformed)
claims about the tax treatment of a Panama foundation. While
the IRS
has no legal jurisdiction over a foreign foundation as an entity, it
does have
jurisdiction over the U.S.
taxpayers who provide the funds for the foundation and direct its
activities.
QUESTION:
I've set up a Panama Foundation and do not have any authority to sign
checks
for the foundation. The foundation only benefits my children and
grandchildren.
Do I have to file the FBAR report or do my children have to file it?
REPLY: Without knowing a lot more
details about your foundation, it seems likely that the IRS would treat
it as a
grantor trust and would treat you as the trust grantor. That means that
you would
be required to file the FBAR Form TD F 90-22.1 if the total funds in
the foreign
checking account and any other foreign financial accounts were more
than
$10,000 in the preceding calendar year.
QUESTION:
An offshore promoter has told me that it is very unlikely the IRS would
ever be
able to find out who the beneficial owner is of a Panama
foundation as no documents
have to be filed with the government. They are kept in private hands.
What are
your views on this? I should add I am a New
Zealand Citizen and resident so my only concern is
the NZ
IRS, however we have similar CFC laws as the USA.
REPLY: I'm not familiar with the tax
laws in New Zealand.
If the NZ tax laws are similar to those in the U.S.,
there are probably some
serious penalties for an intentional attempt to evade taxes. The mere
attempt
to hide assets and income makes it easy for any government to prove
that there
is a willful intent to evade taxes. But your question is, how can they
discover
the hidden assets and income. I've
devoted a large article to that subject called "The Secrecy Myth" and
it is on my web site at http://www.offshorepress.com/secrecy-myth.htm
Here are some additional web sites that deal with the subject --
although most
are in the context of the U.S.
tax laws. Readers may need to combine any broken segments of a long web
site
address.
http://www.assetprotectionbook.com/hide_offshore.htm
http://www.quatloos.com/traps/hideoff.htm
http://www.sovereignsociety.com/vmembers.php?nid=1203
http://www.ustreas.gov/press/releases/po366.htm
http://www.strasburgerandprice.com/calendar/articles/tax/cjm_tax01.htm
http://www.expat.ca/offshore_art.htm
(Canada)
http://money.independent.co.uk/personal_finance/tax/article207871.ece
(U.K.)
QUESTION: Can I use a
Panama Foundation to postpone U.S. taxes on
my investment income?
REPLY: The short
answer is “No”. If it is used to invest
money and to make
distributions of investment income and/or principal to beneficiaries,
it will
be treated as a foreign trust by the IRS. That means the person who
forms the
trust and puts money into it will be liable for paying taxes on any
income
earned by the trust – regardless of whether that income is distributed
or
accumulated.
If the Panama
Foundation is
used for the purpose of generating a profit from a business enterprise
(rather
than from passive investments), and if there are certificates that
represent
ownership by various people and if those people can exchange their
certificates
for their money value, then the foundation will be treated as a foreign
corporation by the IRS. Any investment income will be currently taxable
even if
it is not distributed. A number of other unpleasant tax results will
occur if
the foundation is treated as a foreign corporation that is controlled
by U.S.
persons.
===================================================
QUESTION: It is interesting that you claim Panama
foundations aren’t legal. They are being marketed for thousands or tens
of
thousands of dollars. The airline sky mall catalog" has ads for forming
offshore banks and " rabbi trusts" by a man in Vancouver for about
$40,000 and someone in Panama who says they have 14,000 clients who do
these
foundations which they claim are 100% legal . Both them and others
claim you
do not understand the law of the USA. (Emphasis added).
REPLY: You seem to presume that because
something is being sold to a lot of
people it must be legal or that when something is advertised in a large
circulation magazine it must be authentic. There is no U.S.
law that
says a Panama Foundation is inherently illegal. What is illegal is the
way it
is often being used to evade U.S.
taxes.
Of course the promoters claim we
don't
understand the law. Our advice is costing them serious money because
potential
prospects are not buying their package deal after they talk to us.
However,
some of these promoters don't live in the U.S.
and are not subject to the U.S.
laws so they can say whatever they want. As for the “man in
Vancouver”, his
business was persuading people to put their money into private foreign
banks (also
known as brass plate banks) that were not treated as banks by the tax
law. The
last I heard of him he agreed to cooperate with the IRS in exchange for
a shorter
jail sentence.
===================================================
QUESTION:
The U.S. tax law
permits a U.S.
foundation
to be funded with pre-tax dollars. Is this also the case if one funds a
foreign
foundation?
REPLY: No. A U.S.
charitable foundation can be
funded with tax deductible dollars, but the deduction is limited in a
variety
of ways. Contributions to a foreign charity are not deductible, unless
there is
a treaty that permits residents of each country to deduct contributions
to
charities in the reciprocal country, The U.S. and Canada
have such an arrangement,
but there are significant limitations and restrictions. I’m not aware
of a
similar provision in any other treaties.
===================================================
QUESTION: Do you possibly have a web
site that would explain the benefits of an IBC, foreign foundation and U.S.
foundation?
REPLY: See http://www.offshorepress.com/vkjcpa/articlesindex.htm
for a variety of articles about offshore tax matters. However, there
aren't any
articles about foundations. You can do a search on the Jacobs
Report Yahoo Groups site to find some previous comments about IBCs,
foreign
corporations, foundations and in particular the Panama foundation.
QUESTION:
I established a Family Foundation and IBC in Panama
in 2006. I have the legal
incorporation documents sent to me by the company I worked with in Panama City. I
have not
placed even one dollar into assets for either corporation. I only paid
to have
the corporations formed. I have not done any business in either. Do I
have to
disclose the foundation and IBC to the IRS, and if so, why?
REPLY: The tax law permits the IRS
to impose a penalty of $10,000 for mere failure to file an information
return
for a controlled foreign corporation. If the family foundation is
functionally
like a trust, the penalties for non-filing or late filing of the Forms
3520 and
3520-A are based on the amount of asset owned by the trust or
transferred to
the trust. If the foundation is functionally like a corporation, it
would be subject
to the same penalty that applies to a controlled foreign corporation.
As far as
I can determine, these penalties can also be imposed for a delinquent
filing.
That's the bad news and the best reason I can think of for filing the
required
returns.
I have not found any clear answer as to whether it is necessary to file
any
returns for a foreign corporation or foreign trust when there are no
assets
within the entity. An argument could be made by the IRS that the cost
of
forming a corporation is an asset that would be called "organization
costs". However, the instructions for the Form 5471 include a provision
for an abbreviated filing procedure for a dormant foreign corporation
as
detailed in Revenue Procedure 92-70. Only the information on page one
of the
form is required if the corporation has less than $100,000 in assets
and less
than $5,000 in income and less than $5,000 of expenses and no
transactions
involving the stock of the corporation. If the foundation is deemed to
be functionally
equivalent to a corporation it would be subject to the same filing
rules.
If the IBC is owned by the foundation and if the foundation is deemed
to be a
trust, then the cost of forming the corporation would be deemed to be
an asset
of the trust. I have not been able to find any exception or abbreviated
filing
procedure for filing the foreign trust returns (Form 3520 and 3520-A),
but as
mentioned above, the penalties for non filing are based on the value of
the
assets in the trust.
If the foundation is treated as a trust and does not own the stock of
the IBC,
then it would have no assets and would not be subject to any penalties
for
non-filing. Whether the foundation is deemed to be a trust or a
corporation
will depend on its structure and purpose.
CAUTION: The information herein is
not intended to be personal tax or financial advice
and may not be appropriate or applicable for every recipient of this
message.
If personal advice is needed, the services of a qualified legal,
investment or
tax professional should be sought.
IRS
Regulations require that
I include the following statement with any written explanation of the
tax law. “The
comments in this memorandum are not intended to constitute an opinion
regarding
any specific tax issues because additional tax issues may exist that
could
affect the tax treatment of the tax issues addressed in this
memo. This
memorandum does not consider or reach a conclusion with respect to
those
additional issues and was not written and cannot be used for the
purpose of
avoiding penalties under code section 6662(d)”. For
further details
see http://www.offshorepress.com/vkjcpa/disclosurerules.htm
Vern
Jacobs
Copyright,
2007, All rights
reserved
http://www.vernonjacobs.com
http://offshorepress.com
http://finance.groups.yahoo.com/group/JacobsReport/
