Be sure you get competent legal and accounting advice before you set up the typical arrangements to buy that property you fell in love with in some tropical paradise.  Everyone’s facts and circumstances are slightly different, and you need someone who can look at the specifics and provide professional advice.

Many exPats have formed Panamanian Private Interest Foundations (PIF) to hold title to their Panama investment entities.   Most investors who purchase property in Panamá follow the common practice to hold title to the real estate in an SA.  There is nothing unsavory or illegal about doing  that. There are however a couple of “gotch-ya’s” if you are not careful.

So what are the risks?

One is the unintentional creation of a controlled foreign corporation, which is defined in the US Code as any foreign corporation that has officers, directors or shareholders who are US persons.  A CFC must file an annual information return as an attachment to the individual officer, director or shareholder’s personal US Income Tax return which basically lays out every detail of the entity to the IRS incuding a full income statement and comparative balance sheets at the beginning and end of the tax year.  The Form 5471 was revised in Dec 2008 and pdf copies can be downloaded free from the IRS webpage. (http://www.irs.gov/app/picklist/list/formsInstructions.html  ) Be sure to also download the instructions and take note of the disclosure on page 14 of the Paperwork Reduction Notice info – the IRS estimates it takes 16+ hours to learn the law, another 82+ hours to keep the records, and over 24 hours to prepare the return and send it to the IRS.  Note too, on page 3:  Penalties for Failure to File the required information carries a $10,000 per annum penalty which increases incrementally every 90 days to a maximum of $50,000, plus other penalties, including a reduction in the foreign tax credit for any taxes paid by the CFC to its residence country.

Another gotcha, which has even potentially higher unexpected costs is the failure to disclose transfers of assets to a foreign trust.  Most well-trained CPAs with experience in off shore matters believe that the IRS would treat  a PIF as a foreign trust.  The failure to report transfers  to a foreign trust is subject to a 35% penalty on the gross value of the assets transferred to the trust.

So, for example, let’s suppose a US Citzen-taxpayer puts $200k into a PIF to form an SA to buy a beachfront condo.   The citizen names his children as beneficiaries  of the PIF and himself and his wife as President and Secretary of the SA then goes about enjoying the wonderful climate and friendly people of Panamá.  The condo is not a business and is not rented out to friends or strangers, so the taxpayer believes they have no filing requirements.  They may be aware that the SA has an annual registration fee of $300 due to the Registro, but unless they are conducting a business (renting your condo is a business), then they do not have to file an annual Declaración de Renta (Panamanian Income Tax return) with the DGI (the anacronym for the Direccion General de Ingresos, Panamá’s IRS).  There may be property taxes but many new projects are sold with an exemption for 10 or 20 years.

However, it is not enough to just keep the SA alive and pay the property taxes, if any.

So what are the USA  reporting requirements?

o    If the trust is deemed to be a domestic (USA) trust, then  an Annual Trust Return, Form 1041, needs to be filed with the IRS.  A trust will be treated as a Domestic trust if the US courts have jurisdiction and at least one US person has control of the trust.

·       The transfer of the $200k to the PIF requires at least the filing of a Gift Tax Return, Form 709 to comply with the disclosure requirement – and although there is no tax to pay unless the cummulative lifetime gifts have exceeded the combined threshold of $3.5 million (in 2009), there could be a penalty of $70k for failure to disclose the transfer! Depending on whether there is any obligation of the trust to repay the money, then the Form 3520 will be required as well for each year that the obligation exists.

·         And then there is the issue that if a US citizen may be the beneficial owners, i.e., shareholders, of the SA that holds title to the nice beachfront condo, they have inadvertently created a CFC.  If they do not prepare and file the 5471 there could be a nasty surprise lurking in their future.  See above for the costly penalties for failure to file this information return.

·         This is all in addition to the requirement of all US citizens who may have control of offshore investment or bank accounts.  If there is over $10,000 combined in offshore accounts you have the Annual Treasury Department Form 90-22.1 to send to Detroit by June 30, and to check off the box on Schedule B of your Form 1040.  The current US administration has made numerous claims and demands for information about offshore bank accounts, and is in the international courts now over accounts held in Switzerland.

·         That is not the worst of it.  If the exPat is a USA citizen/taxpayer there is the exposure to being lumped into a popular demonized category that the IRS calls an abusive trust.  The IRS description of an Abusive Trust starts with the 1st step:  forming a foreign trust, followed by a second step:  forming an IBC (international business corporation).   

Panamá is on the radar due to the US Congressional resistance to signing an open trade agreement based on the complaint that Panama is a tax haven – which anyone who actually pays taxes in Panama knows is completely wrong.  Panama tax rates are higher than in the USA for the same earnings.  What the IRS is really after is access under what they like to call ‘transparency’. 

So, be  sure to get competent tax counsel before you sign all those papers to make sure you are not putting yourself and your heirs at risk of having to either file expense-to-prepare infomation returns, or face penalties that could result in having to sell that beautiful property to pay the penalites.  Know too, that most US-based CPAs know little of the offshore requirements nor how to legally and easily avoid these traps.