QUESTION: I recently had a client ask about forming (a private) foundation (in Panama) and keeping it up from year to year. The client is interested in having the private foundation set up as the sole shareholder of an offshore corporation and having the corporation engage in various investment opportunities offered through certain offshore banks that have already been identified by the client. Any information would be helpful.

REPLY: A detailed legal analysis of the U.S. tax classification of the Panamanian foundation is in Richard's article "The Use Of The Panamanian Foundation In Asset Protection Planning And Related Tax Issues" Asset Protection Journal, vol. 1, no. 4, a Panel Publication, Aspen Publishers, Inc. (New York, NY)

A foreign foundation is classified for U. S. tax purposes as either a corporation or a trust. If it's deemed to be a trust, then a form 3520 is due for funding; and if a corporation, then a form 926 is due for funding.

If the foreign foundation is classified as a trust and no powers are reserved by the grantor, then a completed gift is made, which will usually require the filing of a Form 709. Whether or not powers are retained by the settlor, if income can be paid to or accumulated for the benefit of a U.S. person, the settlor is taxed on all income earned, whether distributed or not, and a form 3520-A is due each year for the trust operations. If the foreign foundation is classified as a corporation for tax purposes, the settlor is deemed to be the sole shareholder of a controlled foreign corporation and an annual form 5471 is due for its operations.

Regardless of whether the entity is a corporation or a trust, Schedule B Part III of form 1040 must be checked "yes" where it asks whether the filer has a beneficial interest in (or authority over) a foreign account. Also a TD F 90-22.1 ($10,000 currency report) must be filed (June 30). It is a crime not to answer properly on the 1040 and to fail to send in the currency report. There is an article in the September, 1999 issue of the Journal of Taxation re failure to check the box on 1040 and send in the currency report. The consequences are scary.

Richard Duke

Normally, I don't have or take the time to engage in extended correspondence with people who send me questions by email, but this one sort of caught my "hot button" and prompted me to reply. I'm reprinting the exchange because it's a variation of a question that both Richard and I have received many times.

QUESTION: What do you think of Panamanian foundations? (Name withheld)

REPLY: Richard Duke has discussed that in previous issues of Offshore Tax Strategies (Presently availablefrom Offshore Press as a book). Basically, if a U.S. person establishes a foreign foundation, the foundation must be classified, for tax purposes as a trust, a corporation, a partnership, or a disregarded entity. This classification is determined under U.S. regulations, not on its legal status under the foreign law. The only exception to these classifications is a true non-profit charitable entity.

RESPONSE: It is interesting that you write that because these foundations are being marketed for thousands or tens of thousands of dollars. The airline sky mall catalog" has ads for forming offshore banks and " rabbi trusts" by a man in Vancouver for about $40,000 and someone in Panama who says they have 14,000 clients who do these foundations which they claim are 100% legal . Both them and others claim you do not understand the law of the USA. (Emphasis added).

REPLY: Of course they say we don't understand the law. Our advice is costing them serious money because potential prospects are not buying their package deal after they talk to us. However, these promoters don't live in the U.S. and are not subject to the U.S. laws so they can say whatever they want. Also, one of the promoters of offshore banks and Panama Foundations (Mark Harris) has been convicted of tax fraud by the U.S. Government.

RESPONSE: Are there correct legal structures that you can set up that will also do what they say theirs do and if so what does it cost? If what they do doesn't work and the IRS is after their clients, why is it not public? If they are U.S. citizens, they are still subject to U.S. law.

REPLY: Many of the more aggressive promoters do not reside in the U.S. These illegal schemes have proliferated due to only a few attacks by the internal revenue service against promoters, thus far. However, the most prominent U.S. promoters are on an IRS hit list as discussed above by Richard. The IRS may not be able to get the client lists of the promoters who live offshore unless it's an "accident" -- like the Mathewson case involving a Cayman Islands banker. Briefly, Mathewson was a U.S. person who had established a bank in the Cayman Islands that apparently catered to tax evaders and money launderers. He was nabbed (while in the U.S.) on money laundering charges and he agreed to give the U.S. Treasury Department a list of his 1,500 bank customers (mostly U.S. persons) in exchange for a more lenient sentence. Thus, the IRS accidentally got his records and are auditing his customers. The IRS will probably have more difficulty finding a way to get the client records of former U.S. citizens who are now promoting illegal tax schemes from outside the U.S. but it won't be for any lack of effort.

Most U.S. international tax professionals who really know the international tax law don't work in the consumer market. They work for huge international corporations. There are only a few international tax professionals in the consumer and small business market who know that these schemes are not compliant with the tax law. However, we have little financial incentive to spend huge amounts to advertise in the airline magazines (or offshore publications) in order to convince people they can't legally do something they want to do. People who are selling a promise of huge tax savings for a big fee can always afford to spend more to promote their packages than the professionals who are asked whether these deals are legal. It's a little bit like the hucksters who are selling a phony cure for cancer versus the medical professionals who can only offer sympathy.

I do not know of any structures that will legally do what they say theirs will do, or they would be using them and so would we. There are legal ways to arrange an offshore trust, an offshore corporation or to own an offshore bank. We have discussed many of them in previous issues of this newsletter. There is nothing inherently wrong with a Panama foundation if it's used in a manner consistent with the U.S. tax laws. Owning an offshore bank isn't illegal, but using it to avoid U.S. taxes is illegal unless it meets the IRS requirements for a bone fide bank that can conduct business in the country where the bank is chartered.

Some persons enter into improper structures hoping they will not be audited or caught by the IRS or other governmental agencies. Others take the position that most civilized countries do not consider tax evasion to be a crime. Discussions of other countries' laws or philosophies may be interesting, but it is useless if the IRS has brought a case of tax fraud and/or tax evasion against you. Our primary objection is toward promoters who prey upon persons who are desperately looking for some magic elixir to reduce their U.S. taxes. We object to these promoters because they are causing their clients to commit potential criminal and/or civil fraud or, at the least, become subject to serious and substantial tax penalties that are associated with offshore transactions and structuring.

Vern Jacobs
July, 2000 Offshore Tax Strategies