Sophisticated tax structuring is generally involved in the Investment activities of foreign private and sovereign investors in U.S. private equity and real estate investments, that generate effectively connected income to a U.S. trade or business (ECI). The focus of this structuring generally accomplishes several important tax and non-tax objectives.
Re-characterization of income otherwise it’s subject to taxation at the top corporate rates, into interest and dividend income, that is subject to lower tax rates under applicable tax treaties with the U.S. Professionals tend to be unfamiliar within other technical solutions outside of their own box. The trustee would like to minimize the tax impact of current income to the trust. The income is mostly short-term capital gain income and interest income.
Higher tax rates not only create a problem for high-net-worth individuals, but also trusts – grantor or non-grantor. It seems that not much attention has been given in periodicals on the reduction of the tax burden for trusts such as marital trusts. Use within marital trusts is something that should be strongly considered particularly as trustees make larger allocations to tax inefficient hedge funds and fund of funds.
Case study of foreign owned income as Offshore Investment into the USA:
Michael Chim, age 45, is a managing director of a private equity firm, Acme Asset Management. A recent change in tax law has adversely impacted the taxation of the firm’s carried interest in the firm’s funds. The marginal tax bracket for carried interest for the California-based firm will increase from 25 percent to 53.4 percent.
The fund has significant income due to management fees and performance fees. After bonuses to employees, Acme has $3.5 million of taxable income. An existing fund is expecting to make a distribution to investors. The projected carried interest for the firm is $10 million.
Michael would like to minimize the income tax liability associated with his funds and accumulate funds on a more tax-advantaged basis beyond the reach of his personal and corporate creditors.
Another example foreign owned income as Offshore Investment into the USA:
Juan Valdez, a resident and citizen of Colombia, purchased a three bedroom condo on Brickell Key in Miami for $750,000 in January 2010. Based on rentals within the same condominium, a fair market rental is $4,500 per month or $54,000. The condo is owned within a Florida corporation. The shares of the Florida LLC are treated as a corporation. The LLC is wholly owned by a Cayman corporation which is owned by Juan.
Juan’s children have lived in the property on a full time basis since the purchase while they attend the University of Miami. Juan and his wife have lived in the property when they are in the U.S.- which is approximately half of the year.
The IRS audits Juan’s returns for the following tax years – 2010-2013. They determine that he should have declared income based upon the value of the deemed dividend of $54,000 each year. The withholding liability amount is $16,200 per year in 2010-2013, four years. An estimate of the taxes, interest and penalties for the four years is $60,080.
In both of the above cases, the solution is a Specific Regulated, IRS Recognized and FATCA Registered Retirement Plan.