1. Inbound Structuring Considerations and Section 199A
UF Tax Course- July 24, 2018
James Barrett, Baker Mckenzie LLP

2. Inbound Planning Estate Tax Income Tax Individual v. Corporate cases
Definition of Domestic Corporation
Based upon where incorporated
Definition of Resident for Individuals
US citizen
US green card holder
Substantial presence test
Closer Connection Test
Treaty-Center of Vital Interests

3. Inbound Planning FDAPI and Trade of Business Income (ECI) Nexus
PE – Treaty
ECI
Independent Agents
Economic and managerial independence
Can have a related independent contractor Treas. Reg. § – 7(d)(3)
Ability to accept offers important [See e.g. US/Mexico Income Tax Treaty at Article 5(5).]
Dependent Agents
Acts generally attributed to principal

4. Inbound Planning Source of Income [Code §§ 61, 862, 864, 865.]
Services
generally where performed
Sales
generally where title passes. Sourced based upon materialfactor test [Treas. Reg. § ]
foreign title passage can be US
Tangible Property

5. Inbound Planning Intangible Property Royalties Interest Dividends
license, sale or service each a possibility
Royalties
generally where rights are
Interest
generally based on obligor
Dividends
generally based on company
Partnerships
If partnership is ECI – foreign partners are ECI

6. Inbound Planning Corporations
Branch profits tax [Code § 884(e); Treas. Reg. § ]
reduction in net equity
cash held for foreseeable short-term need
U.S. sub an alternative that is typically used
qualified resident reduction
year of liquidation exception [See Treas. Reg. § T.]
Resourcing of interest to domestic interest

7. Inbound Planning FIRPTA Nonrecognition requirements USRPI for a USRPI
Outbound distributions
Definition of USRPI includes USRPHC
Code § 897(i) elections
Distribution of USRRPI by a foreign corporation [Code § 897(d).]
Nonrecognition notices

8. Inbound Planning
Partnership Code §1446 withholding tax on ECI of partnership allocated to foreign partners
30% withholding tax on FDAP as reduced by tax treaty
interest, royalties and dividends
Portfolio Debt exception
Registered loans
10% vote and value requirement for corporate borrowers
10% capital or profits requirement for partnership borrowers

9. Inbound Planning
Code § 163(j) anti-earnings stripping – potential deferral of interest deductions
All trade or business interest
No debt to equity safe harbor
30% EBITDA
Exemption for certain transportation income
Sourcing for telecommunications income

10. Inbound Planning
Importance of timely filing U.S. income tax returns – failure to can result in a loss of deductions. [Code §§ 874, 882(d).]
Can elect to have real property income (e.g. rents from US real estate) taxed as ECI (i.e. on a net income basis) [Code § 871(d).]

11. Background – Non-Compliant US Taxpayers
Offshore Voluntary Disclosure Program Update
failure to file the Foreign Bank Account Report ("FBAR").
Second Offshore Voluntary Disclosure Program – Expired September 9, % of the highest amount in the unreported foreign financial accounts during the period, on top of the additional tax, penalties (generally 20% of the amount of tax) and interest for the previous 8 years.
By 2016: 35,000 US taxpayers.
By 2016: $4.4 billion in tax revenue.
Third Offshore Voluntary Disclosure Program announced. IR – , January 9, Penalty percentage raised to 27.5%.
Frequently asked questions are being updated. See 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers.  From IRS website: irs.gov/busineses/international.

12. FATCA: Code Sections 1471 – 1474; Prop. Treas. Reg. § 1. 1471-1, et
FATCA: Code Sections 1471 – 1474; Prop. Treas. Reg. § , et. seq.
Payor FFI
30% Withholding Tax on US Sourced Interest, Dividends, Rents, Salaries, Wages, Gain (from sale of assets generating such income – e.g. stocks and bonds).
Unless: FFI has a qualifying FFI Agreement
FFI is “deemed compliant”

13. Inbound Investment Prior Law
Types of Investment Vehicles: Flow-through and Corporate
U.K. Individuals
U.K. Individuals
U.K. LTD.
U.K. Ltd.
U.S. LLC
U.S. C Corp.
U.S. Operations & USRPI
U.S. Operations and USRPI

14. Inbound 2017 Tax Act: Overview
Applicable tax rates for individuals [Code §1(j)], flow through [Code §1(j)], and corporate taxpayers [Code §11(b)].  
Note that 3.8% ACA tax will continue to not apply to nonresident alien individuals. 
Note 20% flow through deduction that can reduce the effective tax rate from 37% to 29.6% [Code §199A].
Interest deduction limitations (e.g. EBITDA limitation) (becomes more restrictive in 2022) [Code §163(j)]
Other deductible payment limitations  
10% alternative minimum taxes on outbound payments (“BEAT”) (only applies where average annual income of at least $500M for past 3 years), [Code §59A]
As a transitional matter, is 5% for tax year beginning 2018.

15. Tax Rates Individuals Top Rate of 37%
07 November 2018
Tax Rates
Individuals
Top Rate of 37%
Single Individual (taxable income over $500,000)
Married Taxpayers (taxable income over $600,000)
Flow Throughs
Same rates as above
No “flow through rate.” There is a new 20% deduction for certain flow through income that brings the 37% rate down to an effective rate of 29.6% on qualified business income.
Corporations
21%
Capital Gains for Individuals
No changes, still 20% (no 3.8% tax)

16. 3.8% Net Investment Income Tax
No changes
Nonresident aliens are not subject to this tax

17. New 20% Flow Through Deduction- (199A)
Applies to individuals of flow through entities, including nonresident aliens
Qualified Business Income includes only income that is effectively connected with the conduct of a trade or business within the United States

18. Interest Deduction Limitation (163(j))
The deduction for business interest is limited to the sum of (i) business interest income, (ii) 30% of the adjusted taxable income of the taxpayer, and (iii) floor financing interest.
No special rules for nonresident aliens
30% limit
Prior to Jan 1, 2022 (EBITDA)
After Jan 1, 2022 (EBIT)
The interest deduction limitation does not apply to taxpayers with average annual gross receipts for the three-taxable-year period ending with the prior taxable year that do not exceed $25 million.

19. Base Erosion and Anti-Avoidance Tax (BEAT)
The base erosion minimum tax amount is the excess of 10% of the taxpayer's "modified taxable income" over the taxpayer's "regular tax liability" (defined in section 26(b)) reduced by the sum of (1) the credit allowed under section 38 allocable to the section 41(a) research credit, and (2) the portion of the applicable section 38 credits that do not exceed 80% of the lesser of the amount of such credits or the base erosion minimum tax amount
Replace 10% with 5% for 2018—effectively operates as a transition rule
Base erosion payment: Any amount paid or accrued to a foreign related person for which a deduction is allowable, including amounts paid in connection with an acquisition of property subject to the allowance of depreciation or amortization. The tax would not require the add-back of cost of goods sold
But COGS are added back in for companies that invert after 11/9/17

20. BEAT
Do not add back base erosion payments if paid full withholding tax; add back prorated amount if paid partial withholding tax
Applies where base erosion percentage (aggregate base erosion deductions divided by total deductions) is greater than 3% and average annual gross receipts of at least $500 million for the past three years
BEAT increases to 12.5% excise tax for taxable years beginning after 12/31/2025
Increased rates apply for certain banks and securities dealers
Carve-out for certain services payments and qualified derivatives payments

21. BEAT
Treasury is granted authority to issue regulations to prevent taxpayers from avoiding the purposes of the BEAT provision, including through
The use of unrelated persons, conduit transactions, or other intermediaries,
Transactions or arrangements designed to
Recharacterize payments otherwise subject to the BEAT as payments not subject to the BEAT, or
Substitute payments not otherwise subject to the BEAT for payments otherwise subject to the BEAT
Imposes new information reporting requirements

22. Immediate Expensing (168(k))
100% expensing of certain assets
Property acquired and placed in service after September 27, 2017
The asset is no longer required to be new to be eligible for the 100% expensing. Used property will now qualify, as long as it is the taxpayer’s first use of the property.
No special provisions for nonresident aliens

23. Net Operating Loss Deduction (Sec. 172)
NOL 2-year carryback is eliminated
Indefinite NOL carryovers
NOL deduction limited to 80% of taxable income

24. Portfolio Interest
No changes to the portfolio interest or treaty withholding tax rules

25. Section 1031 Section 1031 continues to apply to real estate.
No longer available for other types of property.

26. Changes to Equity Investments
US real estate investments by foreign persons
Previously we tried to avoid the use of corporate form. With the new 21% rate, corporate form may be appropriate in more cases.
Note that foreign corporations can avoid the branch profits tax if the US corp liquidates.
Note also that corporate tax applies at the Florida state level at 5.5%.
20% deduction on flow through income is attractive to foreign persons. They continue to receive favorable 20% capital gains rates. Now their rental income is taxed at an effective rate of 29.6%, provided the W-2 wage limit and 2.5% unadjusted basis limit do not limit the deduction.

27. Estate Tax
The doubling of the estate and gift tax exemption applies to US citizens and residents.
No change for nonresidents with US situated assets. The $60,000 limit still applies.

28. Inbound- Additional Issues
Taxability of sale of partnership interest where partnership has effectively connected income [Code §864(c)(8)]
Inbound investors impacted by change in controlled foreign corporation rules [Code §958(b)(4), §§951(b), 951(a)]
Family business with NRA owners and US owners

29. Types of Investment Vehicles: Flow-through and Corporate
Inbound Investment How current common ownership and operational structures have been changed by HR 1
Types of Investment Vehicles: Flow-through and Corporate
U.K. Individuals
U.K. Individuals
U.K. Ltd.
U.K. LTD.
U.S. C Corp.
U.S. LLC
U.S. Operations and USRPI
U.S. Operations & USRPI

30. Overview
New Section 199A Deduct 20% of Qualified Business Income From January 1, 2018 to December 31, 2025 (8 years) Applies to individuals (including non resident alien individuals) and trusts and estates Deduction available to both non-itemizers and itemizers

31. Qualified Business Income (QBI)
Income from a “Qualified Trade or Business”
Income from a partnership, S corporation or sole proprietorship
Net amount (i.e., you take into account items of deduction and loss)
Only applicable to income that is effectively connected with the conduct of a trade or business within the United States
Does not include Specified Investment-Related Income

32. Qualified Trade or Business
Any trade or business except:
A Specified Service Trade or Business
health, law, consulting, athletics, financial services, brokerage services or
where the principal asset is the reputation or skill of one or more of its employees or owners. (service providers; not selling goods)
Being an Employee

33. Example
You own 30% of an S corp that pays you $40,000 of wages and allocates you $80,000 of income. Your QBI from the S corp is ONLY the $80,000 of income. The $40,000 of wages does not count.

34. Specified Investment-Related Items
Qualified income does not include Specified Investment-Related items:
Capital gains/losses
Dividends
Interest
Gains from commodities transactions
Foreign currency gains
Income from notional principal contracts
Annuities

35. Thresholds
The exclusion from the definition of a qualified business for specified trades or businesses phases in for a taxpayer with taxable income in excess of a threshold amount:
$157,500 (single taxpayer)
$315,000 (joint return)
Thresholds are indexed for inflation.
Purpose: Deter high-income taxpayers from attempting to convert wage income to income eligible for the 20% deduction.

36. Limitation Based on W-2 Wages and Capital
Wage limit applies when taxable income is above the threshold
Limit based either on
Wages paid, or
Wages paid plus a capital element

37. Wage Limit Limitation is the greater of: 50% of the W-2 wages paid, or
the sum of 25% of W-2 wages plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property.
Qualified property means tangible property subject to depreciation.

38. Example: Wage Limit
Widget Making Sole Proprietorship subject to the limit
Buys a widget-making machine for $100,000
No employees
Limitation is the greater of
50% of wages (0) or
the sum of 25% of wages (0) plus 2.5% of the $100,000 machine ($2,500).
The amount of the limitation on the taxpayer’s deduction is $2,500.

39. Example
A is the 30% owner of ABC, LLC. The LLC produced a total ordinary income of $3,000,000. The LLC paid total W-2 wages of $1,000,000, and the total adjusted basis of the property held by ABC, LLC is $100,000. A is allocated 30% of all items of the partnership.
A is entitled to a deduction that is the Lessor of:
$180,000 (30% of $3,000,000 x 20%) and
Greater of:
$150,000 (50% of allocable share of W-2 wages of $300,000 or
$75,750 (25 of allocable share of W-2 wages of $300,000 ($75,000) plus 2.5% of $100,000 (2,500))
A is entitled to a deduction of $150,000.

40. Why the 2.5% Adjusted Basis Complication
Added at the last hour to help real estate companies that typically do not have a large number of employees or who hire out a management company.

41. 2.5% Adjusted Basis Complication
A owns a 50% interest in a commercial rental properties through an LLC. A’s share of the rental income of the LLC is $1,500,000. The LLC pays no W-2 wages, rather, it pays a management fee to an S corporation A controls. The management company pays W-2 wages, but also breaks even, passing out no net income to A. A’s share of the total unadjusted basis of the commercial rental property is $10,000,000.
Until mere days before the final legislation was agreed upon, A would not have been entitled to a 20% deduction against his $1,500,000 of QBI, because he ran up against the 50% of W-2 wages limitation ($0). After the 11th hour change, however, A is now entitled to a deduction – assuming the rental activities rise to the level of a 162 business – equal to the Lesser of:
$300,000 (20% of QBI of $1,500,000) or
$250,000 (2.5% of the unadjusted asset basis of $10,000,000)
A receives a $250,000 deduction that was very nearly nil.

42. REIT Dividends, Cooperative Dividends, Qualified Publicly Traded Partnership Income
Deduct 20% of aggregate:
Qualified REIT dividends
Qualified cooperative dividends
Qualified publicly traded partnership income
Special rules apply to specified agricultural or horticultural cooperatives.

43. Qualified REIT Dividends, Cooperative dividends and Publicly Traded Partnership Income
Qualified REIT dividends do not include any portion of a dividend received from a REIT that is a capital gain dividend or a qualified dividend.

44. Example – Small Business
You earn $150,000 from a small business LLC, but the business pays only $10,000 of wages and has no significant property. Are you limited to taking only a $5,000 deduction, equal to the lesser of:
$30,000 (20% of QBI of $150,000) or
$5,000 (50% of W-2 wages of $10,000)
If your taxable income is less than the threshold amounts of $157,500 (single) and $315,000 (married), the limitations do not apply.
Note that the thresholds are indexed for inflation.

45. Example -
A has QBI of $200,000 from an S corp that paid a total of $30,000 of W-2 wages and has no qualified property. A’s spouse has $50,000 of W-2 income, and A and B have interest income of $20,000. Thus total taxable income is $270,000.
Normally, A’s deduction would be limited to $15,000, the lesser of:
$40,000 (20% of QBI $200,000) or
Greater of
$15,000 (50% of W-2 wages of $30,000) or
$7,500 (25% of W-2 wages of $30,000 plus 2.5% of 0)
While normally, A’s deduction would be limited to $15,000, because A’s taxable income is $270,000 (less than $315,000), the two limitation are disregarded, and A simply takes a deduction equal to 20% of QBI.

46. Example – Phase In
W-2 limitation is “phased in” over the next $100,000 (Married) or $50,000 (single) A and B are married. A earns $300,000 from an S corp. A’s share of W-2 wages paid by the S corp is $40,000. A’s share of the unadjusted basis of qualified property held by the S corp is $0. B earns wages from her job, so that the taxable income from A and B is $375,000. Step 1: If A’s taxable income had been less than $315,000, A would take a deduction of 20% of QBI of $300,000, or $60,000.

47. Example: Phase In (continued)
Step 2. How does the $60,000 deduction compare if the W-2 limits had applied? A’s $60,000 deduction would have been limited to the greater of:
$20,000 (50% of W-2 wages of $40,000) or
$10,000 (25% of W-2 wages of $40,000 plus 2.5% of $0)
If taxable income had been less than $315,000, the new law would have given A a break in the form of $40,000 of additional deduction ($60, $20,000). This is known as the “excess amount.”
Once you exceed the threshold amount, the benefit of the $40,000 benefit is reduced over the next $100,000 (married) or $50,000 (single).

48. Example: Phase In (Continued)
Step 3: A receives a total range of $100,000 of taxable income – from $315,000 to $415,000 – before his $40,000 “excess amount” is totally eliminated. It works as follows: Excess taxable income: $60,000 ($375,000 income - $315,000 threshold) Percentage of benefit A should lose: 60% (60,000 excess taxable income / $100,000 total phase In range)

49. Example: Phase In (Continued)
Step 4: A started with a benefit of $40,000: a $60,000 deduction when a $20,000 W-2 limit would have otherwise applied. Now that A has burned through 60% of that phase-in range, he should lose 60% of that $40,000 benefit, or $24,000. Thus, as a final step, we reduce A’s $60,000 deduction by the amount of the excess benefit that he has lost because his income is too high: $60,000 (20% QBI deduction) -$24,000 (reduction in $40,000 benefit because income is over $315,000) $36,000 (final deduction)

50. Example: Specified Service
Same as the previous example, except A’s taxable income is $300,000, his share of the income of the law firm LLC is $200,000, his share of the W-2 wages is $60,000, and his share of assets of the LLC is $40,000. Even though A is a lawyer, he may take the deduction because his taxable income is below $315,000. As a result, A can take a deduction of 20% of $200,000, or $40,000. But wait…50% of A’s share of W-2 wages is only $30,000. Shouldn’t his $40,000 deduction be limited to $30,000 under the W-2 limitation? No. When taxable income is less than $315,000, the W-2 limitations do not apply.

51. Example
Step 1. If A’s taxable income had been less than $315,000 he would have received a 60,000 deduction. Step 2. How much of the $100,000 “phase in” was exceeded? Taxable income was $375,000, thus we have excess income of $60,000. In other words, A is 60% through his phase in range. Step 3. A should thus lose 60% of his benefit. His “applicable percentage” is 40% (100% less the percentage from step 2). A is entitled to only take his applicable percentage (i.e., 40%) of QBI ($120,000 (40% of $300,000)) and W-2 wages ($16,000 (40% of $40,000)) and basis in assets ($0)