But for U.S. persons doing business overseas, IBCs usually are not the best good choice. IBCs came under attack in the 1990s by high-tax countries because of their use as a vehicle for tax evasion and money laundering. Today, U.S. citizen or resident shareholders are required to comply with extensive reporting obligations:
• The transfer of assets to the IBC is reportable on IRS Form 926.
• If you acquire more than a 10% interest in the IBC (by vote or value), you must file IRS Form 5471. This form requires an income statement and balance sheet calculated in accordance with U.S. accounting standards. You must file the form annually if you own 50% or more of the corporation’s stock.
• If you have signature or “other” authority over the IBC’s bank account, you must file Treasury Form TD F 90-22.1 each year and separately acknowledge this authority each year on Schedule B of Form 1040.
for starters. If you own 50% or more of the IBC’s shares, the IRS
will categorize it as a “controlled foreign corporation” (CFC). And if
a CFC earns passive income, U.S. shareholders of the IBC can not defer
tax on the income. Even if you find a way to overcome the CFC rules,
if more than 50% of your IBC’s assets are considered passive investments,
or 75% or more of its income comes from passive sources, the IRS has another
trap. It’s called the “passive foreign investment company,” or PFIC rules.
That means more paperwork, more forms to file, and very unpleasant tax
consequences for the shareholders.
And there are even more shortcomings. The 15% income tax rate on long-term capital gains and dividends isn’t available. Losses on investments cannot be allocated against gains until the IBC is liquidated. Any U.S. investments result in double taxation. Plus, the basis of the stock does not step-up to its fair market value at the death of a shareholder for estate tax purposes.
The bottom line: Generally, it’s not possible for U.S. persons to defer tax on income from passive investments using an offshore structure unless you use a variable annuity or life insurance policy. And with these structures, you lose the ability to manage the underlying investment portfolio. Plus, IBC’s don’t even provide as much asset protection as their promoters claim. Creditors can simply seize the stock you own in the IBC, and even liquidate it. That’s hardly “bulletproof” asset protection.
“There’s Got to be a Better Way…”
…I can hear you saying. And there is. It’s called an offshore limited liability company (LLC).
are taxed as partnerships (if there are multiple owners) or disregarded
entities (if there is one owner) under U.S. tax rules. In both cases,
the profits or losses of the LLC simply “flow through” to the individual
owners (members) in proportion to their ownership interests.
1. Fewer tax traps than in an IBC: An offshore LLC doesn’t suffer the unfavorable tax treatment of an IBC, so long as you elect to have the LLC taxed as a “disregarded entity” (for one owner) or a partnership (for two or more owners). However, U.S. members of offshore LLCs are subject to similar reporting requirements as shareholders in foreign corporations. And, neither IBCs or LLCs help you avoid the disastrous tax consequences if you invest in offshore funds. That’s why U.S. persons should ONLY purchase offshore funds through an IRS-qualified life insurance policy, variable annuity, or a retirement plan.
2. Estate Planning Options: LLCs can also be used as estate planning tools in the same manner as limited partnerships. If the LLC is properly structured, LLC interests should be discounted for estate and gift tax purposes for lack of marketability and lack of control.
3. Much more asset protection against the debts of the owners: This is the result of the charging order concept, which generally prohibits creditors from seizing a debtor’s interest in a LLC. A creditor is only entitled to future distributions from the LLC. Nor can the creditor demand a distribution or dissolve the LLC.
It’s best if the LLC is managed by a non-U.S. resident manager. That makes it virtually impossible for a U.S. court to obtain jurisdiction over the LLC’s management. Also, beware of using single-member LLCs for asset protection. The primary purpose of the charging order is to protect non-debtor members from being forced into a partnership with the creditor of a debtor member. If there’s only one member in a single-member LLC, then there aren’t non-debtor members to protect.
It’s possible to have an IBC taxed as a disregarded entity (if there is
only one owner) or a partnership (if there are multiple owners).
This is accomplished by filing Form 8832 with the IRS to make the election.
This avoids the tax disadvantages I referred to, but doesn’t provide the
asset protection of an offshore LLC.
There are a few situations, however, where an IBC may be a more suitable entity than a LLC, with respect to its U.S. owners.
• If your company is engaged in a capital-intensive activity like manufacturing. In this situation, the IBC’s profits would generally be re-invested in expanding production, upgrading manufacturing capacity, etc., rather than being invested in a portfolio of passive assets. A foreign LLC could also be used in this situation by filing Form 8832 and electing to have the LLC taxed as a foreign corporation. In this manner, both tax deferral and asset protection could be achieved.
• If you’re purchasing real estate in a country where a LLC isn’t recognized as an independent entity. This would potentially subject the property to a probate proceeding upon the death of one of the members of the LLC.
• In a holding company situation, where the relevant foreign legislation requires the use of a corporation.
• If you need free transferability of ownership interests – lacking in a LLC. This might be the case, e.g., if the entity might be publicly traded in the future.
Well…there you have it. Obviously, the selection of an offshore business entity requires a substantial degree of advance planning and expert tax advice. Two members of The Sovereign Society’s Council of Experts are prepared to assist members with selecting the proper offshore business entity.
You can contact Michael Chatzky from Chatzky & Associates. He’s located at 6540 Lusk Boulevard, Suite C121 San Diego, CA 92121. You can reach him by phone at +1 (858) 457-1000 or email at MGChatzky@aol.com.
You can also
contact Gideon Rothschild at Moses & Singer LLP. He is located
at 405 Lexington Avenue, New York, NY 10174. Contact him at +1 (212) 554-7806
or email him at firstname.lastname@example.org.