Minding Your P’s and Q’s in the English language is an idiomatic expression that language experts have speculated means either you should mind your manners, mind your language, be on your best behavior, or watch what you’re doing. No matter the definition of this idiomatic expression, it remains clear that P’s and Q’s are a reference to your behavior and the comporting of that behavior to the appropriate protocols expected of a civilized citizenry. No one really knows the exact true origin of the expression. But, one theory is that it harkens back to the English pubs of the mid-17th century when bartenders would keep a watchful eye on the alcoholic consumption habits of patrons. A tipsy patron may be warned that he or she should mind the number of pints and quarts of alcohol consumed before the bartender cuts him or her off due to drunkenness. No activity ever goes unseen whether it is in an English pub or in international taxation. There is ever always a mindful eye keeping track of activities, whether they are victuals, transactions, or records. In some venues, it is a bartender, in others, the IRS.
Prior to December 2018, informational reporting of activities by US persons on Form 8858 Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs), applied only to foreign disregarded entities. Since then, the IRS has expanded the requirement to include reporting of foreign branch operations of US persons, controlled foreign corporations and partnerships. With this change, some US citizens and residents doing business overseas will be surprised by the extra reporting requirements that have been thrust upon them. The consequences of not reporting these activities or of filing late are steep. The penalties range from $10,000 per missed form per tax year, losing the ability to claim certain foreign tax credits, and in some situations, the imposition of criminal penalties.
Pursuant to the new rules, a taxpayer US person falling into certain categories must not only file the form 8858, but must also attach a Schedule M to the return. The schedule M is an information reporting schedule that shows the activities engaged in between FDE’s or FB’s and the filer or other related entities. The Internal Revenue Code defines US person as citizens or US resident aliens, domestic corporations and partnerships, and domestic estates and trusts.
A foreign branch needs to be an operation that is integral to the business and operated outside the US by a US person. However, to be defined as a foreign branch necessitates engaging in certain actions such as the foreign branch maintaining its own set of books and records. Further, the foreign branch must maintain its own office or have a fixed place of business with employees and/or officers reporting to the US person. Tax treaties between countries also provide guidance in this area in that the respective parties to the treaty define a permanent establishment, which is a characteristic that majorly contributes to the reporting requirement in the US.
Code regulations abound in this area of tax practice and provide a significant resource for the practitioner and taxpayer. One of the definitions contained in the regulations is for a QBU, or qualified business unit. These are separately identified units of a trade or a business that, as mentioned above, maintain their own set of records. Excluded from this definition are those activities carried on by an individual in the capacity of employee. Nonetheless, the regulations have a caveat to the rule applicable to individuals in that a QBU may arise if the activities make up a separate trade or business and those activities are tracked separately in books and records apart from the principal US domestic owner.
In essence, the regulations direct taxpayers to look at all the facts and circumstances of the business structure. Namely, one must consider the specific group of activities and whether those activities on their own give rise to an independent economic enterprise. Some other factors to consider in attributing independent activity to a foreign branch are the motivation to produce revenue and make a profit. One should consider the types of expenses and deductions taken by the FB. All in all, the sum of the activities cannot be merely ancillary to the trade or business.
The downside of a facts and circumstances test is that it can leave room for an interpretive and broad understanding of business activity. For instance, the IRS may widen the statute’s reach from its applicability to US ownership of tiers of foreign partnerships or controlled foreign corporations (CFCs) to mere individuals whose actions fit the qualifications for a QBU. Consider that a professional who owns a business that normally reports its income on Schedule C may have an additional 8858 reporting requirement. This is because the professional living and working abroad is running affiliated businesses that also file on separate Schedule C’s each maintaining its own respective books and records.
In evaluating the necessity for an 8858-reporting requirement, a taxpayer must take into consideration the length of time in the performance of business activities. Included with this time element of evaluating facts and circumstances is again, whether separate books and records are maintained. Further, a comparison is made between the significance of the work in relation to other activities conducted by the business. Moreover, a fixed place of business is also adjudged from the perspective of the facts and circumstances test whether that fixed place is a separate business office, a home office, or a space reserved exclusively for the conduct of business.
The variety of business ventures overseas necessitates a subjective application of the facts and circumstances test that is exclusive to the nature of the venture. For example, a business engaged in the marketing and sale of product abroad should consider, among the other factors mentioned above, product ownership, the leasing of office space abroad, and the employment of salespeople overseas to sell product. In contrast, however, meeting the facts and circumstances test is less apparent when leasing warehouse space to only store product and having that product sold and distributed by independent salespeople living in the host country.
In a similar vein, a business engaged in investment activity may necessitate an 8858-filing based on the engagement of a broker to manage the investments and incurring expenses to produce the income from those investments. This may be the case even when those investments are managed by a foreign broker wherein the expenses incurred are ordinary and necessary. Likewise, the facts and circumstances test would be applicable when reporting the expense of the engagement of a property manager whose purpose is to increase the production of income.
Bar hoppers and digital nomads alike share many characteristics. They can move from place to place and reinitiate activity at their new locale. That activity may involve running up a new tab in another bar necessitating a new-fangled mindfulness of “p’s” and “q’s” or it may be establishing a home office in a remote destination and starting up a foreign branch of a domestic US business. In either event, both the bar hopper and the digital nomad are hard pressed to evade the watchful eye that regulates activity. In reality, no one is ever immune from the watchful eye because we are all held accountable to laws, rules, and regulations. It befits taxpayers and drinkers alike to be heedful to the compliance requirements expected of them because to do otherwise tempts fate and has negative pecuniary consequences.
About the Author
Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high net worth families and their advisors. Alicea has more than 17 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm. Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates and foundations that have a U.S. connection.
Alicea also specializes in foreign investment in U.S. real estate property, and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, FATCA registration, and foreign companies wanting to do business in the U.S. Alicea is fluent in Spanish and has a working knowledge of Portuguese.
Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPAs), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).
Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA Forty Under 40 Award. She was selected as someone that has notable skills and is visibly making a difference in the accounting profession.
In 2021 and 2022, Alicea was the Gold and Silver Winner, respectively, of Citywealth's Powerwomen Awards in the category USA - Woman of the Year - Business Growth (Boutique). In 2023, she continued her winning streak by receiving the Gold award for Company of the Year Female Leadership (Boutique). Furthermore, Alicea is currently listed in the Global Elite Directory 2023, which is an annual exclusive directory of the world's elite lawyers and outstanding wealth advisors advising ultra-high net-worth clients.
Please note: This content is intended for informational purposes only and is not a replacement for professional accounting or tax preparatory services. Consult your own accounting, tax, and legal professionals for advice related to your individual situation. Any copy or reproduction of our presentation is expressly prohibited. Any names or situations have been made up for illustrative purposes — any similarities found in real life are purely coincidental.
Alicea Castellanos, CPA, TEP, N.P.
CEO & Founder
Global Taxes LLC
Tax Advisory & Compliance Services
Tel: 212 803 3327
Cell: 917 834 9307
WhatsApp: 917 834 9307