Dangerous Liaisons: Foreign Assets and the US Nominee

We’ve known for some time that the Internal Revenue Service (IRS) has been mining heaps of data provided to it by financial institutions that were the subject of non-prosecution agreements, as well as examining treasure troves of financial information from various leaks (think “Panama Papers”) looking not only for tax dollars, interest and penalties but also for individuals (including “enablers”) to serve as “examples” to others who may flout the tax laws.  Add to this data, the information coming to the IRS from foreign (that is, non-US) financial institutions under the “Foreign Account Tax Compliance Act” (“FATCA”) and you have a recipe for some serious problems as the tax noose keeps tightening.

A US tax issue gaining momentum particularly for many non-US families in Asia, the Middle East and North African (MENA) regions (jurisdictions in which I deal extensively), involves the use of so-called nominees to hold legal title to foreign (non-US) assets.  This troublesome issue affects many very innocent parties and will continue unabated as financial transparency becomes the new normal.

Let’s learn more about the problem of the “nominee” when it comes to US tax.  First, some basics.

What is a Nominee?  How Does a Nominee Relationship work?

A nominee is a person or entity named by another party (called a “nominator”) to hold title to a certain property. The nominee is the registered owner of the property but he is not the beneficial owner. All rights and incidents of true ownership belong to the beneficial owner and essentially, the nominee stands in a position of trust to follow the orders of the beneficial owner with respect to the asset.

For example, if a parent registers stock in the name of his son, and the parties understand that the son holds bare legal title to the stock, the parent is the party with the right to vote the stock.  Further, the payment of dividends by the company to the son does not mean the son can keep the funds so paid. He has the duty to turn over the dividend income to the parent.  Following these lines, the parent (who is the true beneficial owner of the dividend), and not the son, is the party to pay tax on that dividend income.  This example illustrates how the use of nominees does not alter the obligations of the beneficial owner with regard to paying tax and meeting any reporting requirements with respect to the stock.

In my tax practice in the MENA and Asian regions, it is very common for family members to make use of nominee relationships. For example, it is common for a parent to have the eldest son hold legal title to property in which the child has no beneficial interest whatsoever.  In cases with which I am familiar, sometimes the nominee relationship is entered into in an attempt to circumvent forced inheritance shares of Sharia law, or in order to avoid probate. Other times it is simply a method to protect aging parents who have become uncomfortable dealing with their financial affairs, or who have become incapable of effectively handling them.

Properly Document the Nominee Relationship

In the real world, most people in family or close relationships do not document the existence of the nominee relationship.  This is a big mistake for various reasons. What if the son turned against his parent and decided to disregard the nominee relationship, voting the shares as his own and keeping the dividend income?  Perhaps the son may decide to sell the shares and keep the proceeds. While the parent may have recourse in a court of law, it may be very difficult to prove the parent gave the stock to the son to hold as a nominee, rather than giving it as a true gift.  If the parent has died, and other siblings claim their share of the stock, what messy situation will result?  A legal wrangle may also be inevitable in the case of a divorce – that is, when the other spouse is demanding a share of assets.

It is obvious that nominee holdings can result in unanticipated problems. As such, all nominee relationships should be properly documented. If you need help in properly documenting a nominee relationship, I am happy to assist.  This can still be done even if the nominee relationship has been ongoing for some time.

US Persons As Nominees – Can They be Replaced?

The situation is worsened from a US tax perspective if the nominee is a US person holding foreign  assets for a foreign (non-US) nominator.  With FATCA now in full swing, questions will arise once the IRS starts receiving information from a foreign financial institution about a US account holder who, for example, has not reported income from the foreign account or reported ownership of the foreign asset on the various US tax forms mandated for this purpose (e.g., reporting duties on Form 5471, Form 8938 or FBAR etc.).  Certainly the IRS will not know the US person is a mere nominee; in fact, the financial institution will similarly be in the dark.

When a US person acting as a mere nominee holds stock in  a foreign corporation for a non-US person, or holds a bank account as a nominee for such a person, do the US reporting duties simply disappear because of the nominee status? How should this matter be handled for the foreign family and the US nominee?  For example, the so-called FBAR must be filed if the $10,000 aggregate accounts threshold is met. This remains so, for example, even if a US person holds interests in a foreign financial account(s) only as a nominee for a non-US person. Foreign families with whom I work loathe the idea that the US government will have detailed information about their financial affairs when the family and activities have nothing to do with the United States, “but for” the existence of the pesky US nominee. My response to such comments is very simple: “Get rid of that US nominee”.

When FATCA was enacted I saw these problems on the horizon.  Sadly, many practitioners are still blissfully unaware of the huge pitfalls that lie ahead.  Foreign families with US persons must be aware of the problem and take heed with proper solutions. Such solutions include terminating nominee relationships with US persons and replacing them with non-US persons, documenting the nominee relationship and making clear when it began even if the document itself is only being very recently prepared.  In addition advice should be taken from a US tax professional about how the reporting issues might be addressed, including past reporting deficiencies.

Posted December 5, 2019

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