This topic originated with Karl,
who owns a condo in Puerto Vallarta, Mexico.
Karl was incredulous when I
had him file a foreign trust tax return for his Mexican condo a couple of years
ago. Why? Because the IRS was increasing their attention to foreign matters (think
FBAR and FATCA, for example), and the penalties for failure to file had marched
full-throated into extortion territory – at least for my clients, as I do not
represent P&G, Toyota or their executives.
Under the Mexican
constitution, noncitizens cannot directly own real estate within 50 kilometers
of the coastline. This means that a U.S. citizen (Karl for example) has to use
an agent to purchase the real estate. This agency is called a fideicomiso. Mind
you the fideicomiso does nothing other than hold title – there is no bank
account to pay taxes or insurance or repairs or anything.
The tax issue with the
fideicomiso is whether or not the IRS would consider it to be a foreign trust.
For many years practitioners (including me) considered it the equivalent of an
Illinois land trust. The IRS treats the Illinois land trust as though it
doesn’t exist; a technical way to say it is that the owner has a direct
interest in the real estate and reports accordingly.
When the IRS tightened up its
foreign reporting, it became unclear how they would treat fideicomisos. I
called the National Office, for example, but received no clear-cut answer or
leaning. This put me in a difficult spot, as the penalties for failure to file
a return when assets are transferred to a foreign trust are the greater of
$10,000 or 35% of the assets transferred. There is also an annual filing
requirement (it is assumed that the trust is not funded annually), and those
penalties are the greater of $10,000 or 5% of the value of the trust assets.
You can see how this gets
very expensive.
So I had Karl file a tax
return to report the funding (Form 3520) as well as an annual tax return (Form
3520-A). I am uncertain what the IRS got out of this, but Karl racked up
additional tax compliance fees.
The IRS has recently published
a Private Letter Ruling (PLR 201245003) stating that a fideicomiso is not a
trust as that term is intended in IRS Reg. 301.7701-4(a), and that the
beneficiary of the trust is to be treated as the direct owner. In other words,
the fideicomiso is “invisible” to the IRS.
There are issues with PLRs, primarily
that the IRS does not consider them as precedent to anyone other than the
person to whom the PLR was issued. That means that – while tax advisors can
look to them for markers as to IRS positions – they are not a failsafe if the
IRS goes against you. Karl is not
completely protected unless he obtains his own PLR. Those cost money, of course.
The filing fee alone can be several thousand dollars. Then you have my fee.
Don’t get me wrong: I have
used PLRs in IRS representation before, and I have gotten greater or lesser
traction depending on the examiner, manager or appeals officer and the
magnitude of the specific issue to the exam. I suspect that, in the case of
fideicomisos, the IRS is waving the flag and giving advisors a clue on their position
and enforcement intentions. But one cannot be sure, and there’s the rub.
So how would you have me advise Karl? Would you advise him/her to get his/her
own PLR (for thousands of dollars), would you rely on the issued PLR or would
you have Karl continue filing Forms 3520/3520-A?
And remember: all we are
talking about is a condo. A nice one, granted, but this "trust" has never even been near Switzerland.
