I. If You’re a US Citizen or Resident with Foreign Investments, Beware…and Be Proactive!
Between the very long arms of the IRS and the perils inherent in foreign laws and protections—i.e., tax filing nightmares, damaging currency fluctuation, estate planning snafus, and inadequate protection—foreign investors may be setting themselves up for major losses, huge tax penalties, and even jail time. (Yes, you read that right. The IRS is actively pursuing those with foreign investments who fail to correctly report and/or pay taxes according to very complex regulations. Besides egregious penalties, there is the specter of criminal prosecution if willful disregard of the law is evident!) Whether you have $11,000 or $500,000,000 invested, this is a good time to migrate your foreign assets to the US.
II. Tax Penalties for the Non-Compliant are Severe...and Head-spinning
And that’s on top of currency fluctuation, inadequate investment protection, and foreign inheritance law challenges. US citizens and residents thinking they have escaped the IRS with overseas investments are, unfortunately, living in a fantasy world. The Foreign Account Tax Compliance Act (FATCA) and Bank Secrecy Act are two ways the IRS makes taxpayers accountable for reporting, disclosing and paying applicable taxes on foreign investments—and assesses significant penalties for non-compliance.
III. The Top 7 Reasons US Person Should ONLY Invest in the United States
The US is being called the “New Switzerland,” with a variety of favorable conditions, protections and tax reporting responsibilities. Currently, $800 billion from foreign investors resides in the US, which now provides asset protection from foreign governments as Switzerland once did. There are many investment alternatives in the United States providing stable returns, protecting assets, and hedging against the risks of investing in unstable foreign currencies and economic environments. The key to successfully investing in the United States is to find and understand investments which meet the goals and needs of the client from the myriad of choices available.
IV. How to Invest in the US to Heighten Returns and Lower Risks
When all is said and done, investing in the US is a logical, less perilous, and less stressful alternative to foreign investments. However, most people do not know how to attain the same type of returns as they did overseas. Out of the gate US investments avoid foreign currency fluctuations and/or losing the money tied to a financial institution that goes under. Investors can also achieve the same objectives they had for putting the money overseas in the first place; protecting assets from creditors and ex-wives, secrecy, avoiding probate, getting investments that are backed by insurance and are liquid, and comparable tax deferral they thought they could only get with investment overseas.
V. Fitting All Wealth Management Puzzle Pieces Together
As complex as investment management and tax compliance are, they only comprise two pieces of the entire wealth management puzzle. Tax planning and issue resolution, estate planning, and gift planning are just some of the other pieces that need to be addressed correctly to complete the puzzle. To be properly invested and protected from tax compliance and foreign country pitfalls, it’s important to work with a team that views your entire financial picture in a comprehensive and coordinated way.
VI. About Freeman Tax Law
Freeman Tax Law puts its team to work for clients-it functions like a well-oiled machine. Internally and through strategic partnerships, the firm offers tax law, accounting, estate planning, financial planning, and wealth management services. Depending on the client’s needs and established relationships, Freeman Tax Law can coordinate with the client’s advisors and wrap them into the team structure; rounding out the representation with internal and strategic partnership resources.
VII. Relevant Resources
Between the very long arms of the IRS and perils inherent in foreign laws and protections—i.e., tax filing nightmares, damaging currency fluctuation, estate planning snafus, and inadequate protection—foreign investors are setting themselves up for major losses, huge tax penalties, and even jail time. (Yes, you read that right. The IRS is actively pursuing those with foreign investments who fail to correctly report and/or pay taxes according to very complex regulations. Besides egregious penalties, there is the specter of criminal prosecution if willful disregard of the law is evident!)
Whether you have $11,000 or $500,000,000 invested, this is a good time to migrate your foreign assets to the US.
On the surface, investing outside the US seems enticing. There are many reasons why people like to invest outside the United States (i.e., tax deferral, asset protection, better interest rates). But, as the world changes, so do the rules—and they’re stacked against foreign investment by US taxpayers.
Here are the major challenges of foreign investing:
- Foreign inheritance laws that can thwart estate planning wishes
- Foreign currency fluctuation that can turn that high-interest investment into a major loss in front of your eyes
- Inadequate institutional protection of investments relative to the US (i.e., no protection comparable to FDIC, SIPC)
- Paying US tax on foreign income, and highly-complex tax and regulatory compliance nightmares that can turn your life upside down
There are better alternatives to these investments available in the United States. They provide similar benefits with much less tax compliance, risk, and aggravation.
And that’s on top of currency fluctuation, inadequate investment protection, and foreign inheritance law challenges cited above.
US citizens and residents thinking they have escaped the IRS with overseas investments are, unfortunately, living in a fantasy world. The Foreign Account Tax Compliance Act (FATCA) and Bank Secrecy Act are two ways the IRS makes taxpayers accountable for reporting, disclosing and paying applicable taxes on foreign investments; assessing significant penalties for non-compliance.
Those non-compliant generally fall into one of three categories: uninformed, unconscious, unwilling. The uninformed don’t know the rules and requirements; the unconscious have some knowledge but choose to bury their heads in the sand; and the unwilling are fully aware but hoping they will not get caught.
There are two major lines in the sand:
- If you earned it, report it. As a US person, you must report your income on a worldwide basis. This is unique for a major developed country, but is required under US tax laws. Requirements are complicated and often convoluted—frustrating even some seasoned tax experts. There are steep civil penalties and potential criminal consequences for non-compliance.
- If you own it, disclose it. Non-disclosure of foreign assets is subject to the sharp teeth of the Internal Revenue Code and the Bank Secrecy Act. Overseas investments must be fully reported. Don’t try to do this yourself using Turbo Tax or other cheap methods of getting tax returns done. It doesn’t matter if the investment is $14,000 or $100,000,000, the accounting work required is identical. Some of the complexity comes from the fact that US people are taxed on worldwide income. Most other countries assess taxes on a territorial basis (i.e., if you live in Taiwan, you only pay tax on the income earned in Taiwan).
FATCA Proves to be 800-Pound Gorilla
Tax compliance involving foreign investments is complicated, even if you know the ins and outs. For the uninitiated, it’s draconian and depth-defying. With passage of The Foreign Account Tax Compliance Act (FATCA) of 2010, global financial transparency gained X-ray vision. It has emboldened the IRS to aggressively pursue Americans with assets outside the United States who have not complied with the United States tax laws and/or their Bank Secrecy Act reporting obligations.
FATCA has created requirements for foreign financial institutions (banks, brokerages, insurance companies, hedge funds, etc.) to disclose accounts held by US persons, US Green Card Holders or signatories. Failure to understand the basic rules of tax compliance and financial reporting/disclosure requirements can expose a person to financial penalties—not to mention the possibility of jail time.
If a bank doesn’t disclose a US account holder’s name, the bank gets hit with a 30% backup withholding tax on the money in the account that is due to the IRS. A bank withholding information on $1 billion will owe the US government $300 million! The penalties for the failure to report assets can be as high as 50% of the value of the account and for willful situations create criminal penalties of up to 10 years in prison.
Bank Secrecy Act Compounds the Complexity
To comply with the US Bank Secrecy Act requiring disclosure of foreign financial assets, US tax filers must complete FBAR forms. There are two major landmines encircling this filing:
- No one (including banks and insurance companies) tells people what accounts must be disclosed. Foreign accounts can be bank accounts, CD, mutual funds, unsegregated gold accounts, insurance policies, etc.; and,
- Penalties for not filing the form are insane—civil penalties are 50% of the account’s value or $100,000, whichever is greater, for “willful behavior.” But that’s only part of it. Willful failure to disclose can carry criminal sentences of up to 10 years in prison and up to a $500,000 fine. Violators are subject to both civil and criminal penalties.
For starters, know that foreign investments of more than $10,000 require disclosure on a FinCen Form 114 and on Schedule B of a tax return.
What if I Am Not in Compliance with My Financial Account Disclosure and US Tax Obligations?
There are four solutions available to remedy the non-reporting of offshore holdings:
Offshore Voluntary Disclosure Program (OVDP)
This approach is typically for taxpayers that are willfully hiding assets offshore and have done it while avoiding paying US tax
- Max penalty - 27.5% of highest value of non-compliant foreign assets over an 8-year time period
- Requires 8 years of FBAR filings
- Requires 8 years of amended returns
Streamlined Procedure for US Persons Living in the USA
For non-willful taxpayers, likely the solution for most cases
- Max penalty - 5% of highest account balance over a 6-year time period based on highest year-end account balances
- Requires 6 years of FBAR filings
- Generally requires 3 years of amended returns
Streamlined Procedure for US Persons Living Outside of the USA
For non-willful taxpayers, likely the solution for most cases
- Max penalty - 0%
- Requires 6 years of FBAR filings
- Generally requires 3 years of amended returns
- Requires a showing that the taxpayer actually lived outside of the USA for the prior 3 years
Reasonable Cause Letter
Typically only used when we can show that our client relied upon improper professional advice from a CPA or attorney.
- Typically no penalty; however, penalty could be more if it is determined that you were willful
- Requires 6 years of FBAR filings
- Generally requires 3 years of amended returns
We assist our clients with the entire disclosure process including the preparation and filing of the FBARs, amending tax returns, and handling the voluntary disclosure representation before the IRS. At no time will you need to be in direct contact with the IRS, we will handle all communication and negotiation on your behalf.
The IRS tends to disregard the fact that in the United States, approximately 40 million people or 13% of the US population, are foreign-born. According to the Wall Street Journal, “The U.S. State Department recently raised its estimate of the number of U.S. citizens living abroad to 8.7 million from 7.6 million, not including military personnel—yet fewer than one million people a year file forms that are often required for routine foreign accounts.” That means there are upwards of 9 million Americans living outside the United States who have been exposed to the government’s offshore compliance initiatives.
Here’s the tax bottom line: You can run, but you can’t hide…forever. The IRS views tax reporting and collection on foreign investments as a top-tier source of revenues. Now that they have the teeth to follow through on their threats, the time to run and hide is growing short.
Read our Offshore Disclosures ebook to learn more.
The US is being called the “New Switzerland”, with a variety of favorable conditions, protections and tax reporting responsibilities. Currently, $800 billion from foreign investors resides in the US, which now provides asset protection from foreign governments as Switzerland once did.
A February 1, 2016 Bloomberg Businessweek article addresses the influx of money rushing to the US as part of this phenomenon.
According to this article, “The World’s Favorite New Tax Haven Is the United States…Moving money out of the usual offshore secrecy havens and into the U.S. is a brisk new business…Some are calling it the new Switzerland…After years of lambasting other countries for helping rich Americans hide their money offshore, the U.S. is emerging as a leading tax and secrecy haven for rich foreigners…‘how perverse—that the USA, which has been so sanctimonious in its condemnation of Swiss banks, has become the banking secrecy jurisdiction du jour,’ wrote Peter A. Cotorceanu, a lawyer at Anaford AG, a Zurich law firm…‘That “giant sucking sound” you hear? It is the sound of money rushing to the USA.’”
Following are the 7 reasons:
- Inherent currency fluctuation in other countries can impact returns. Initially, investors liked fixed deposits in foreign countries because of a higher rate of return. While India, for example, may offer 8-9%, the rupee has deflated 30-40%. Investors using rupees in India are losing right off the bat—which a higher rate of return does not make up for, at least near-term.
- Strong US safety net. The US provides such safety net protection as FDIC coverage up to $250,000, and SIPC protection for US brokerages up to $500,000. Foreign countries may not carry the same protection. A high-return investment quickly loses its luster if the company holding it defaults, and there is no way to recover the money. For example, initial sunny expectations of Caribbean investments with high interest rates have left investors snowed under when the bank fails—unlike in the US, where recovering money under these conditions is the rule, not the exception.
- Estate planning minus the money. Foreign countries often impose draconian rules that make it difficult for US heirs to recover assets. So, while they are entitled to certain moneys under US law, foreign obstructions can lead to drawn-out battles or worse, inability to ever collect. One all-too-common scenario is investors from a foreign country such as India who live in the US and have US-born kids. The kids can’t get on a plane to India to probate their dead parents’ estates. Also, US wills and trusts do not work in foreign countries -- because some countries do not provide full faith and credit to our laws (e.g., if you have a will in the US, it will not work in France). So the money will go through probate in France and may wind up with the sister of the person who died rather than his/her US kids. Most people do not have dual wills to deal with this issue. In the US you can simply put a beneficiary on the account and it gets paid to this person upon death of the owner.
- Robust asset protection. The US provides a variety of ways to maximize tax benefits and protect assets through such vehicles as annuities and insurance. There also are alternative investments with a fixed rate of return, such as Real Estate Investment Trusts (REITs), corporate and municipal bonds, preferred stock investments, and modified endowment contracts that use an insurance policy as a bank account, providing instant liquidity and a fixed rate guaranteed by insurance. There are US alternatives to fixed deposits, including smaller investments sold by Series 7 brokers that carry less risk in the US than elsewhere.
- Greenlighting a Green Card. Foreign investors who invest at certain income thresholds in the US can get Visas and Green Cards more easily, along with accruing the tax advantages.
- Simpler tax compliance. Tax compliance for US assets is relatively uncomplicated compared to dealing with international compliance that can involve both US and foreign country taxation. When an investor makes a foreign investment, s/he isn’t typically thinking about taxation consequences in the US. Such countries as France tax investments on top of US obligations; India makes the account tax-free for non-residents, but that doesn’t mean it’s US-tax-free. (More about tax ramifications and reporting there and here in the next section.)
- The PFIC problem. PFICs are simply “pooled investments” registered outside of the United States encompassing mutual funds, hedge funds, insurance products and non-US pension plans. A bank account might also be a PFIC if that account is a money-market fund rather than simply a deposit account, because money market accounts are essentially short maturity fixed income mutual funds. Furthermore, PFIC rules can and generally do apply to investments held inside foreign pension funds unless those pension plans are recognized by the U.S. as “qualified” under the terms of a double taxation treaty between the United States and the country in which the investment is located. Due to FATCA, the consequences of this mistake have become very significant. Most clients never heard the term PFIC before, or even knew they had one.
When all is said and done, investing in the US is a logical, less perilous, and less stressful alternative to foreign investments. However, many people do not know how to get the same type of returns as they did overseas. Out of the gate they avoid foreign currency fluctuations and/or losing the money tied to a financial institution that goes under. Investors can also achieve some of the same objectives they had for putting the money overseas in the first place, such as protecting assets from creditors, ex-wives, secrecy, avoiding probate, getting investments that are backed by insurance and are liquid, and tax deferral they thought they would get with investment overseas.
The good news is that there are many possibilities. This also can be the bad news, as people struggle to understand and find the right investments from myriad choices. Following are a few options to consider as part of a well-constructed overall plan:
Insurance, Annuities and Endowment Contracts Create Interesting Opportunities
Insurance, Annuities, and Endowment contracts are a tax lawyer’s best friend due to the tax benefits they provide if used properly in an investment portfolio. Many clients use these vehicles because they create an interesting opportunity for the holder, even though many people are wary of them. Structured correctly, however, they provide a safe place to protect money, provide stable growth, and have many other tax advantages such as tax free growth and tax free benefits upon death. Many products can actually provide better returns than CDs or Fixed Deposits.
According to a forbes.com article, life insurance can benefit you in six ways: 1) Access to Cash; 2) Asset Protection; 3) Consistent, Safe Accumulation; 4) Flexibility with Less Restriction; 5) Long-term Financial Security for You and Your Family; 6) Protected Insurability. Read More
Below are a few interesting options effectively used by clients.
Indexed Universal Life Insurance Can Be a Powerful Tool
What if you could get the flexibility of adjustable premiums, face value, and an opportunity to increase cash value; would you go for it? What if you could get this without the inherent downside risk of investing in the equities market? All of this is possible with an indexed universal life insurance policy. These policies aren’t for everyone, so you really need to examine whether the combination of flexibility and investment growth is the right fit for you.
What’s Universal Life?
Universal Life Insurance (UL) comes in a lot of different flavors, from fixed-rate models to the variable ones; where you select various equity accounts to invest in. Indexed Universal Life (IUL) allows the owner to allocate cash value amounts to either a fixed account or an equity index account. Policies offer a variety of well-known indexes such as the S&P 500, the Nasdaq 100, or the Dow Jones Industrial Average (DJIA). IUL policies are more volatile than fixed ULs, but less risky than variable universal life policies because no money is actually invested in equity positions.
IUL policies offer tax-deferred cash accumulation for retirement while maintaining a death benefit. People who need permanent life insurance protection but wish to take advantage of possible cash accumulation via an equity index might use IULs as key person insurance for business owners, premium financing plans or estate-planning vehicles. IULs are considered advanced life insurance products in that they can be difficult to adequately explain and understand. They are generally reserved for sophisticated buyers.
What’s Good About a UIL Policy?
- Low Price: The policyholder bears the risk, so the premiums are low.
- Cash Value Accumulation: Amounts credited to the cash value grow tax deferred. The cash value can pay the insurance premiums, allowing the policyholder to reduce or stop making out-of-pocket premium payments.
- Flexibility: The policyholder controls the amount risked in indexed accounts vs. a fixed account; the death benefit amounts can be adjusted as needed. Most IUL policies offer a host of optional riders, from death benefit guarantees to no-lapse guarantees.
- Death Benefit: This benefit is permanent.
- Less Risky: The policy is not directly invested in the stock market, thus reducing risk.
What’s Bad about a UIL Policy?
- Caps on Accumulation Percentages: Insurance companies sometimes set a maximum participation rate that is less than 100%.
- Better for Larger Face Amounts: Smaller face values don’t offer much advantage over regular universal life policies.
- Based on an Equity Index: If the index goes down, no interest is credited to the cash value. (Some policies offer a low guaranteed rate over a longer period). Investment vehicles use market indexes as a benchmark for performance. Their goal is normally to outperform the index. With the IUL, the goal is to profit from upward movements in the index.
While not for everyone, indexed universal life insurance policies are a viable option for people looking for the security of a fixed universal life policy and the interest-earning potential of a variable policy.
The Modified Endowment Contract (MEC)
Another life insurance policy that provides both tax and estate planning benefits is the Modified Endowment Contract (MEC). A MEC is a tax qualification of a life insurance policy where the policy has been funded with more money than allowed under federal laws. If the cumulative premium payments exceed certain amounts specified under the Internal Revenue Code, the life insurance policy becomes a modified endowment contract.
Taxation under an MEC is similar to taxation under an annuity (discussed below). Under an MEC, the death benefit payable to the beneficiary is not subject to income tax. A life insurance policy that becomes an MEC is no longer considered life insurance by the IRS; MECs are essentially treated like non-qualified annuities for tax purposes. This reclassification to an MEC changes the ways in which the IRS taxes money withdrawn, and can result in penalties for a life insurance owner if the owner makes a withdrawal before the age of 59.5. If structured properly, however, distributions from these policies can be done tax-free.
Tax implications of an MEC
As a tax lawyer, I find it very interesting when I see how a client uses the MEC as a financial tool in their arsenal of assets. Some policies can actually be structured to be a very close cousin to Certificates of Deposit (CDs), but have more flexibility and provide access to the cash almost immediately after the policy has been set up. An MEC is an insurance product with liquidity. It can also be indexed to a stock exchange. The excess cash in a policy can grow based on the higher fixed-rate of return (minimum) and the indexes. Some pay as much as 12%. The IRS considers MECs non-qualifying annuities versus life insurance, changing how withdrawn funds are taxed (including penalties before 59.5 years of age). Because MECs have death benefits accruing tax-free to beneficiaries, they can be a valuable estate planning tool. If structured correctly, and given the right circumstances, this is one product where a licensed insurance professional can really add tremendous value to an overall investment portfolio, and provide awesome tax and estate planning opportunities.
An Annuity Contract is a method of converting wealth into a stream of income. An investor gives money to an insurance company, which agrees to provide the investor with a benefit at a future date. Many annuity contracts offered by insurance companies can be structured to mimic pensions. There are two basic types of annuities: deferred and immediate. With a deferred annuity, money is invested for a period of time until you are ready to begin taking withdrawals, typically in retirement. If you opt for an immediate annuity, you begin to receive payments soon after you make your initial investment.
A forbes.com article points out, “Annuities have become big business…When chosen carefully annuities can protect consumers against outliving their money and protect against stock market volatility–features which are not available in traditional stock or mutual fund accounts.” For more information about the advantages and disadvantages of annuities, click here.
Important Gross Income Exclusions for Amounts Received Under Life Insurance, Annuity, and Endowment Contracts
The labyrinth of rules governing these contracts can be summarized as follows:
1. Death benefits. Amounts paid under a life insurance contract on the death of the insured are ordinarily excluded from the recipient’s gross income. Internal Revenue Code (IRC) Section 101(a) covers both lump-sum and installment payments, but the latter are ordinarily apportioned between the amount that would have been paid at the date of death, which is excluded from income, and post-death earnings, which are ordinarily taxed. Under IRC Section 101(g), enacted in 1996, the exclusion for life insurance proceeds is extended to payments before death if the insured is terminally or chronically ill.
2. Exemption or deferral of inside buildup. Life insurance policies frequently have a cash surrender value that accumulates while the policy is outstanding and can be obtained from the insurer during the insured’s lifetime by cashing in the policy. Annuity and endowment policies nearly always have cash surrender value. Under a policy with cash surrender value, a portion of each premium payment is allocated to cash surrender value, and cash surrender value also increases by the addition of interest on accumulations.
Cash surrender value, in other words, is like a savings account buried within the policy. During the insured’s lifetime, the savings element in cash-surrender-value life insurance grows without being currently taxed to the policyholder. The same is true of income accruing on the cash surrender value of an annuity prior to the time payments to the annuitant begin. For life insurance, this income often escapes income tax permanently because the proceeds, payable at death, including the portion representing income accumulated on cash surrender value, are excluded from the recipient’s gross income. For annuities, tax on income accruing on cash surrender value is more commonly “deferred” rather than exempted because a portion of each annuity payment, representing accrued income, is taxed to the annuitant. The exemption or deferral of inside buildup is a gift from the Insurance Industry Lobbyists and is a departure from the principles applied generally to investment income.
- Current taxation is also avoided by other investments whose growth in value consists of unrealized appreciation rather than taxable interest or dividends. The growth in a policy’s value resembles unrealized appreciation in one sense: If the policyholder realizes growth in cash surrender value by cashing in the policy, the benefits of keeping it in force are relinquished, and this entails a significant change in investments and perhaps a substantial sacrifice if the insured is no longer insurable at standard rates; cashing in a policy, in other words, is a closing out of an investment similar to a sale of a stock or bond.
- Most policies, however, entitle the owner to take out policy loans on terms that resemble withdrawals from savings accounts. Interest continues to accrue on cash surrender value for the benefit of the policyholder, but interest also accrues to the company’s benefit on the policy loan. Because these interest accruals roughly cancel each other out and because the choice of whether and when to repay the loan is largely left to the policyholder, the effect is essentially that the amount of the loan has been withdrawn, subject to the policyholder’s right to reinvest it in the insurance contract. The preferential treatment of the loan feature is most obvious in the case of a policyholder who takes out a policy loan. The policyholder is generally allowed a deduction for interest on the loan from the company, but is not taxed on the compensating interest accrual on cash surrender value.
- The broader issue, however, is whether the availability of policy loans under such circumstances should cause all inside buildup to be taxed to policyholders as it accrues. Under the doctrine of constructive receipt, income is taxed when “it is credited to his account…so that he may draw upon it at any time.” Under current law, this doctrine is not applied to increases in cash surrender value because policy loans are treated as loans, not as withdrawals of the taxpayer’s own money, a treatment that some find formalistic and not reflective of economic substance.
- Further, the favorable treatment of inside buildup encourages insurers to devise contracts that are meant primarily as investment vehicles, but are cloaked in the garb of life insurance to give buyers the tax advantages provided for life insurance. The attractiveness of this garb, in other words, leads taxpayers to try to fit as much as possible within it, including some contracts that vary greatly from those envisioned when the life insurance rules were developed. Congress responded to this development in 1984 by enacting rules that tax inside buildup on life insurance as it accrues when investment features predominate over insurance features. A somewhat broader approach was taken for annuity contracts, where a series of rules was enacted to channel benefits into the annuitant’s retirement years.
3. Sales and dispositions. The exclusion of life insurance benefits from gross income applies only to payments by reason of the insured’s death. If the policy is cashed in during the insured’s lifetime, the amount received is taxed to the extent that it exceeds the owner’s cost unless the insured is terminally or chronically ill. The method used to measure this gain provides another advantage for policies with cash surrender. When life insurance protection is provided by term insurance (that is, by a policy without cash surrender value), the unlucky insured who survives the end of a policy year has nothing to show for the premium paid and gets no loss deduction or other tax allowance for the premium. A purchaser of term insurance, in other words, must pay the premium from after-tax income. Under a policy with cash surrender value, a portion of each premium payment goes to purchase current life insurance protection and is not unlike a term premium; the remainder is added to the cash surrender accumulation. If the policy is later cashed in, however, the policyholder’s gain is the excess of the amount received over the sum of all premiums paid, including the portions of the premiums used to pay for pure insurance protection for periods now elapsed. The inclusion of these portions of the premiums in the policy’s cost basis has the effect of allowing the insurance protection to be paid for with pretax income.
4. Ratable cost recovery for annuities. When payments are received on an annuity, each payment is split between income and a recovery of the taxpayer’s investment in the contract, the former being taxed and the latter being excluded from gross income. This is accomplished by prorating the taxpayer’s investment among the payments expected to be received under the annuity. As pointed out later in this chapter, the ratable cost recovery regime has the effect of deferring tax on some of the income accruing to the annuitant during the early years of the payout period. The deferral of tax on inside buildup thus continues for part of the income accruing after the payout period begins.
REITs and Real Estate-based Securities
Securitized real estate-related investments generally consist of clients lending money for a stable rate of return if chosen properly. A Real Estate Investment Trust (REIT) is a security that invests in real estate through property or mortgages, and that may trade on major exchanges such as stocks. REITs provide extremely liquid real estate investments, and are subject to special tax considerations. They can be a good alternative to traditional bonds in a well-diversified portfolio. Another option is mortgage-backed securities (MBS), assets secured by a mortgage(s). Once securitized, investors can buy them through licensed security professionals. And, of course, there are investment properties such as apartment buildings or other types of commercial/industrial properties, which generate returns through regular revenues (e.g., rentals), leveraging appreciation, and/or sale.
Alternative Investment Products
Other options, both traditional and more avant-garde, include: good ol’ US CDs, credit market funds (lending money to corporations with a security interest in the asset), corporate and municipal bonds, preferred stock investments, and alternative investment products sold by Series 7 licensed investment professionals are highly regulated by the Securities and Exchange Commission (SEC). By virtue of the regulation in the United States, many of these alternative investments can carry less risk in the US than in other countries with poor regulation.
As complex as investment management and tax compliance are, they only comprise two pieces of the entire wealth management puzzle. Tax planning and issue resolution, estate planning, and gift planning are just some of the other pieces that need to be addressed correctly to complete the puzzle.
To be properly invested and protected from tax compliance and foreign country pitfalls, it’s important to work with a team that can view your entire financial picture in a comprehensive and coordinated way. Seek out a team that can provide both birdseye and detailed perspectives at the same time. Look for:
1. Global and microscopic insights working hand in hand
In some ways, it’s similar to a surgical procedure. The patient needs both the big-picture perspective of a coordinated team and a detailed follow-through to ensure that everything is addressed. Handling big-picture and minute details together is critical to developing the most effective strategy, creating and maintaining a safety net, and instilling peace of mind.
2. Insightful interpretation of the issues, coupled with clear communication
Most people don’t have the stomach to learn codes and regulations filled with legal and tax gobbledygook. They want, and deserve, a team that can explain everything in clear terms and offer accompanying insights about how to proceed, based on its years of experience and expertise. (It’s not just the number of years; it’s what you do with those years.)
3. Technology that streamlines processes
This is especially critical when dealing with foreign governments and offshore entities. Incompatible systems, breakdowns, slow performance, “misplaced” files and inadequate security all create nightmares when working in a complicated wealth management arena that can span the globe. Verify that current systems that consistently provide accurate and reliable interactions and transactions involving foreign institutions, languages, and the like are in place and working properly. Pay special attention to security measures in place to protect sensitive information from hackers and unauthorized personnel.
4. World-class bedside manner
That surgeon in #1 above who needs to be so skilled and attentive to the operation itself also must practice kind and caring bedside manner. Let’s face it, too many professions, industries, and companies are filled with people who don’t connect with their stakeholders. There is no excuse in healthcare for arrogance and indifference when dealing with people’s lives. The same is true in the tax law and wealth management realms. People can get anxious, scared, angry, frustrated and overwhelmed with all the complexities and pitfalls. Work with a team that knows and shows how to care, will take the time to make sure that understanding is complete, and work to establish that comfort to the greatest extent.
5. Clear direction and guidance about pricing
No one, from the most modest to high-rolling investor, should have to endure the scourge of unclear pricing structure and payment terms. While there are typically variables that can’t be fully predicted at the outset, the team should be able and willing to explain how charges accrue, conveying appropriate estimates and ranges, and payment terms and timeframes in a straightforward and easily understood manner. When unexpected issues or complications arise, the team should be timely and complete in notifying the client about what’s going on, and options available.
The biggest challenge in building a wealth management and tax team is cohesion and a common playbook. Too many investors have a corporate attorney, CPA/tax advisor, financial planner, investment advisor, estate planning advisor and other advisors as separate entities. Besides lacking a common plan and understanding, this approach carries the omnipresent threat of “viewpoint tunnel vision.” An attorney will provide one perspective, a CPA another, and the financial planner may be on an entirely different page—and so forth. Then, it becomes incumbent on the client to weave all this disparate information together and try to make sense of it all.
In contrast, Freeman Tax Law puts the team in place for clients; it functions like a well-oiled machine. Internally and through strategic partnerships the firm offers tax law, accounting, estate planning, financial planning, and wealth management services. Depending on the client’s needs and already-established relationships, Freeman Tax Law can coordinate with the client’s advisors and wrap them into the team structure; rounding out representation with internal and strategic partnership resources. Bottom line, a well-coordinated team with agreed-upon objectives and clear direction will set out to cover all the bases—from managing money to meeting tax obligations.
In terms of core specialties, Freeman Tax Law is dedicated to its longstanding mission: Working predominately with individuals and businesses across the country on all domestic and international tax law matters. The firm has helped resolve a wide range of complex tax controversies dealing with delinquent filings, audits and criminal tax investigations, offshore banking taxation, estate challenges, wealth management, gift planning, bankruptcy and more.
Within the firm, Freeman Tax Law offers the services of attorneys, former IRS Agents, CPAs, consulting professionals, and professional staff that collectively have vast experience handling and resolving tax controversies. This team is well-versed in knowledge of IRS procedures, reconstructive accounting, white collar criminal defense, bankruptcy and estate planning. From this wealth of resources, the firm assembles a tailor-made team to address client needs.
Freeman uses a process that makes sure to cover all bases, and provides the client a clear picture of what we’re doing and where we’re going. Fundamentally, this process includes:
1. Information gathering
This is where we collect pertinent documents to get an initial view of the situation and assess where the client stands presently. A state-of-the-art, secure portal enables efficient and safe sharing of information. From the compiled data, we develop initial ideas about scope and timing of needed services—from disentangling foreign investments and associated complicated tax compliance challenges and/or non-compliance consequences to recommending US investments that will meet desired client criteria and moving foreign deposits into the appropriate silos.
2. Succinct workplan
Based on analysis and a good in-depth understanding of the client’s situation, Freeman develops a workplan. The outline of an appropriate investment plan addresses such cornerstone issues as risk tolerance level and desired income—ensuring full tax reporting and compliance every step of the way. By employing this comprehensive approach, Freeman helps ensure that a successful wealth management program reaches its potential instead of being thwarted by the ominous long arms of the tax authorities.
In the tax law arena specifically, Freeman develops a straightforward strategy that covers every aspect of the client’s tax plan [e.g., to file returns and other needed forms (e.g., 8865, FBAR)] and address associated issues. These issues can be very complicated, from having to deal with treaty issues to determining what income can be excluded from taxation. Everything is double-checked with the IRS to ensure full compliance and to avoid later unpleasant surprises.
3. Assembling the puzzle
After the comprehensive workplan has been assembled, it is vetted among the team to tighten, fill in any blanks, and reassess and revise as necessary. The resulting plan should feel strong, tight, and doable to all team members (e.g., the recommended investment strategies align with the client’s desired outcomes and ensure full and timely handling of all tax-related issues and requirements). The plan will be made available to the client and all team members in an easily accessed format for easy reference and review as desired.
4. Moving forward
The plan is implemented, with the appropriate team members overseeing their portion of the process. To ensure staying on track, regular reviews and evaluations will be conducted. Besides providing the obvious continuity, this can spot potential trouble spots or conflicts (e.g., a tax problem) before they blossom into real problems with substantial consequences.
About the author
Jeffrey S. Freeman, J.D., LL.M.
Jeffrey S. Freeman, Esq. has personally represented and counseled hundreds of clients throughout the United States on tax matters. Jeff’s objective is handle complex tax matters efficiently, creatively and strategically, and provide his clients complete, cost-effective representation and resolution.
Jeff represents clients with a variety of backgrounds and professions. He has successfully negotiated and resolved complex tax controversies for his clients before the IRS and in the Federal Court system, U.S. Tax Court, State Tax Courts, and the U.S. Bankruptcy Court. Further, Jeff has skillfully handled audits with various taxing authorities, the settlement of tax liabilities with the IRS, negotiation of installment agreements, Offer in Compromises, removal of tax liens and levies, sales tax and payroll trust fund tax assessments, innocent spouse relief claims and the removal of penalties and interest for his clients.
Jeff holds a Masters of Law in Taxation (LL.M.) from Georgetown University Law Center in Washington, D.C. and Juris Doctor, Cum Laude, from the Michigan State University College of Law and a Bachelor of Arts in Accounting, with honor, from Michigan State University where he was a member of the Beta Gamma Sigma Business Honor Society and the Phi Kappa Phi Academic Honor Society.
Further, he is a member of the Taxation Section of the American Bar Association and Michigan Bar Association, where he served as a past chair of the Tax Practice and Procedure Committee. In addition to the state courts in Michigan, Jeff is admitted to practice before the United States Federal Court, United States Court of Appeals and in the United States Tax Court.
With national recognition for his work and commentary, Jeff has appeared on the Frank Beckman Show, Fox News, and has been quoted in Newsweek, The Motley Fool, Business Week, the Detroit News, Detroit Free Press, Crain’s Business, and Detroit Business. Over the years, he has authored numerous articles for various professional journals.
He has been named a “Top Lawyer” by Detroit’s dbusiness magazine; and has been the keynote speaker about the Foreign Account Tax Compliance Act (FATCA) at the American Chamber of Commerce in Shanghai, China.
Following are links to additional resources to help address the myriad issues, questions and concerns around foreign and US investments, from promises to pitfalls: