# IRS:IOUs and Patnerships



## cescolar

I am a US citizen living in Brazil, married to a Brazilian woman. I had shares in a business in Spain that was in the red and causing me to have to fill all kinds of forms for the IRS.

There was no money to buy me out, so I came up with a creative solution: I sold my shares to the business, in exchange for an IOU worth $X. The IOU says that when some real estate that the business owns gets sold, I will get my money. In the meantime, if the real estate generates income, the business will return part of my money with it.
When the real estate gets sold, I will have a capital gain or loss, my cost basis beeing the $X minus all the principal returned.

My first question: will the IRS consider this IOU a partnership? 

Since I might have to pay capital gains to 3 countries, I thought it would be a good idea to give this IOU to my wife, and avoid having to pay US taxes.

My second question: I know that there is a yearly limit on gifts to non-us spouses.
($140,000 a year? was is less in past years?) I would like to give her part of the IOU year by year, until it is all hers. Do I need to fill any IRS forms notifying them of the yearly gifts?

Thanks in adavance!


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## BBCWatcher

And/or a PFIC.

Why didn't you keep things clean and simple?


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## cescolar

BBCWatcher said:


> And/or a PFIC.
> 
> Why didn't you keep things clean and simple?


I thought this would be simple...I think it could be considered a partnership because as defined in 26 USC § 761 - Terms defined, as:

"the term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a corporation or a trust or estate"

My understanding is that a PFIC is a CORPORATION. All I have is a contract.
Am I wrong?


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## cescolar

The IRS does not like PFICs because of all the monkey business that they could do.
Here is a simple contract, specifying exactly what is going to happen: I am going to be getting my original money back, little by little and the rest (with a possible taxable capital gain) when the sale of the property takes place.

The filling of the partnership form, 1065, should be very simple: all empty except for the return of capital item each year.

Can you think of a simpler solution or with lower taxes due?


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## Bevdeforges

I'm not sure that the IRS recognizes the terms of an IOU such as yours. They may conclude that what you have done is to sell your business interest but having taken back a loan (i.e. you are financing the buyer for the money s/he "paid" for the business).

You probably need to consult a tax attorney on this one. It could get complicated.
Cheers,
Bev


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## BBCWatcher

Or that it isn't a loan because it doesn't have fixed and determinable repayment. In other words, it looks like selling without selling, i.e. a tax dodge.

I do recall cautioning you about this.


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## cescolar

Bevdeforges said:


> I'm not sure that the IRS recognizes the terms of an IOU such as yours. They may conclude that what you have done is to sell your business interest but having taken back a loan (i.e. you are financing the buyer for the money s/he "paid" for the business).


I know that there is no such thing as an IOU, as far as the IRS is concerned...I was just speaking in common terms...I believe that what I have is what the IRS calls a partnership.

I am not making a loan to the buyer. I am making a bet that the price of the company to be liquidated will be higher that what I am "buying" it now for.



> You probably need to consult a tax attorney on this one. It could get complicated.


I did consult a lawyer in Spain, since it is where the corporation is located, and where the sale takes place.
What the call it there is "Contrato de Cuenta en Participacion". (See Cortés, Pérez y CIA Servicios Jurídicos: EL CONTRATO DE CUENTA EN PARTICIPACIÓN)


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## cescolar

BBCWatcher said:


> Or that it isn't a loan because it doesn't have fixed and determinable repayment. In other words, it looks like selling without selling, i.e. a tax dodge.
> 
> I do recall cautioning you about this.


I agree that it is not a loan. That I sold, there is no question, because Spain will recognize that I am no longer the owner of the shares of the corporation. That eliminates all the headaches of reporting the finances of a foreign corporation.

The only questionable item, in my mind, is what I was payed with.
I believe it fills the IRS definition of a partnership. 
("means of which any business, financial operation, or venture is carried on".)
I am taking a risk that the asset will appreciate. If it works out and there are profits, the IRS will get its share of the profits. I don't see a tax dodge here...


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## BBCWatcher

The IRS will not necessarily be persuaded by a Spanish determination. They make their own rules about what constitutes a sale (or not).


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## cescolar

cescolar said:


> there is a yearly limit on gifts to non-us spouses.
> ($140,000 a year? was is less in past years?) I would like to give her part of the IOU year by year, until it is all hers. Do I need to fill any IRS forms notifying them of the yearly gifts?


I found the answer: for 2013 the limit is $143.000. You need to file form 709 to notify the IRS. (Gift Taxes, Gift Tax, Are Gifts to Your Spouse Taxable?)

If you exceed the limit you don't have to pay until all the excess reach one million dollars.


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## cescolar

BBCWatcher said:


> The IRS will not necessarily be persuaded by a Spanish determination. They make their own rules about what constitutes a sale (or not).


I can prove to them that I am no longer the owner by showing them the records that show the owners of the property, in the "Junta Comercial" of Madrid.
But as far as to what the heck I own now, I can see that the IRS has a say in it...


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## cescolar

cescolar said:


> If you exceed the limit you don't have to pay until all the excess reach one million dollars.


Correction: the "lifetime gift tax exclusion" is now a whoping $5.34 million!

So the simpler solution would be for me to sell my shares, give my brazilian wife the proceeds and let her be the one entering into the Spanish "Contrato de Cuenta en Participación", so the IRS will not have anything to say about it...
I will have to file a form 709 to let the IRS know about the gift, so they know that my "lifetime gift tax exclusion" has been reduced a little. I should not have to pay any gift taxes, right?

Does anybody see any problem with this?
(PS I am waiting to hear from a Spanish lawyer, to make sure there are no taxes due at that end either...)


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## BBCWatcher

There are two limits. Yes, there's a total limit (now over $5 million), but there's also an annual limit for nontaxable gifts to nonresident alien spouses while you're still alive. The 2013 tax year limit is $143,000. In general you do not need to file Form 709 if your gift(s) to your spouse are below that limit, but check the form instructions.


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## cescolar

BBCWatcher said:


> There are two limits. Yes, there's a total limit (now over $5 million), but there's also an annual limit for nontaxable gifts to nonresident alien spouses while you're still alive. The 2013 tax year limit is $143,000. In general you do not need to file Form 709 if your gift(s) to your spouse are below that limit, but check the form instructions.


Let me see if I understood this. I have 2 options:

- I can transfer ownership little by little, by giving her up to the $143K limit every year and not have to report the gifts
- or give it to her all at once, fill form 709 and since it is bellow the 5 million not owe any taxes?

Right?


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## BBCWatcher

Wrong. You would owe gift tax on the amount over $143,000 (tax year 2013 limit). As I posted, the $143,000 annual limit applies while you're still alive, and you're still alive.


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## cescolar

BBCWatcher said:


> Wrong. You would owe gift tax on the amount over $143,000 (tax year 2013 limit). As I posted, the $143,000 annual limit applies while you're still alive, and you're still alive.


I guess I don't understand how the 5 million limit comes into play then...


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## jbr439

BBCWatcher said:


> Wrong. You would owe gift tax on the amount over $143,000 (tax year 2013 limit). As I posted, the $143,000 annual limit applies while you're still alive, and you're still alive.


So you could gift $5M to a perfect strange, fill out form 709, and owe no taxes. But if you gift more than $143K to your NRA wife, you are on the hook for taxes?

If that's correct, it sounds bizarre. Is there a rationale for it?


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## BBCWatcher

No, and this really is quite simple. There's a lower annual gift limit to arbitrary individuals of about $14,000. Give more than that in any year and you owe gift tax.

The $5M+ numbers are lifetime limits normally only relevant to the size of your estate after you die. Though if you give the annual maximum to a nonresident alien spouse for roughly 37 years of your life then that lifetime limit can become relevant before you die.

You've still of course got the problem of valuation. What is that exotic "IOU" worth?


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## cescolar

BBCWatcher said:


> No, and this really is quite simple. There's a lower annual gift limit to arbitrary individuals of about $14,000. Give more than that in any year and you owe gift tax.
> 
> The $5M+ numbers are lifetime limits normally only relevant to the size of your estate after you die. Though if you give the annual maximum to a nonresident alien spouse for roughly 37 years of your life then that lifetime limit can become relevant before you die.


I am still confused. I found at 5 Common Tax Myths About Gifts - Forbes the following quote:

"_The $13k is also per person so you can theoretically give $13k gifts to a virtually unlimited number of people each year tax-free. (If this is your intention, don’t forget the person you heard this from.) You and your spouse can also combine your $13k exemptions to give a $26k tax-free gift.

Finally, even if you go over the exclusion limit, you still probably won’t owe anything to the IRS, at least not yet. That’s because the amount you go over the limit just reduces the $5 million (going up to $5.12 million in 2012) that you can give tax-free over your entire life or at death. Even if you don’t owe anything right now, you still have to file a gift tax return for going over the limit though."_

I interpret that to mean that if you go over the yearly limit you just report it, don't pay and deduct it form the lifetime 5 million limit. When you die, then your estate might have to pay some taxes. 
Is that right?
I don't know what the article means by _you still *probably *won’t owe anything_


> You've still of course got the problem of valuation. What is that exotic "IOU" worth?


I started with the current vaule of the building in question. Then I add a little for the chance to get more money when it gets sold. This IOU can be looked at as a bet that the building will appreciate in value. When the building gets sold, then the IRS will get its money. If I got a bargain when I bought the IOU, there will be more money for the IRS. Why should they object?


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## BBCWatcher

Yes, and we're talking past each other, so let me try again.

1. Gifts within the annual gift limit are tax free and do not count against your lifetime tax free limit.

2. Gift amounts above the annual gift limit are _potentially_ taxable. They reduce your lifetime tax free limit (currently $5.25 million) dollar for dollar. That's generally no problem for big gifts from a small estate, but be careful otherwise. You do have to file Form 709 when making big gifts.

I'm trying to imagine a hypothetical IRS auditor buying the argument you've made about that "IOU." I'm not imagining that.

If I sell stock in Shell Class A shares and use the proceeds to buy stock in Shell Class B shares, that's a sale, and capital gains taxes are owed at that moment in time, not later. There are myriad potential complications if you get "fancy," and that's just one of them. I don't know if the IRS would deem that "IOU" as a sale or not, I don't know how they'd value it, and I don't know how they'd view the ownership structure itself (if ownership exists), e.g. whether it's a PFIC or not. If you've got professional advice that has figured out all those complexities and resolved them consistent with what the IRS would most probably determine, great.

Note that there are certain gift rules about gifts of future interests, so that's another potential layer of complexity here.


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## cescolar

BBCWatcher said:


> I'm trying to imagine a hypothetical IRS auditor buying the argument you've made about that "IOU." I'm not imagining that.
> 
> If I sell stock in Shell Class A shares and use the proceeds to buy stock in Shell Class B shares, that's a sale, and capital gains taxes are owed at that moment in time, not later. There are myriad potential complications if you get "fancy," and that's just one of them. I don't know if the IRS would deem that "IOU" as a sale or not, I don't know how they'd value it, and I don't know how they'd view the ownership structure itself (if ownership exists), e.g. whether it's a PFIC or not. If you've got professional advice that has figured out all those complexities and resolved them consistent with what the IRS would most probably determine, great.


I am structuring the operation first as a sale of my current ownership and then a purchase of the partnership. (Do you agree that the IRS will consider what I had informally called an "IOU" a partnership?)
The sale is at a loss, to my brother's controlled corporation, so I won't be able to claim a loss. The purchase of the partnership has a clear cost basis (the proceeds from the first sale.)
I have gotten in touch with a lawyer who is in private practice now, but that used to work for the IRS - he created form 8938. I will be getting, hopefully, good advice, but not free, like yours!:smile:


> Note that there are certain gift rules about gifts of future interests, so that's another potential layer of complexity here.


I am aware about the rules on gifts of future interests. I think I am OK here. 
I believe a future interest is something that you don't own now. Ex: I give you my house when the tenant living there dies. The gift is considered given when the future event takes place. I am giving the gift of the partnership now. The fact that the partnership will (hopefully) have a capital gain in the future does not make it a gifts of future interests. I believe the crucial test is if the receiver of the gift has control of the gift now or not. In my case, my wife could sell the partnership right away.

Did I convince you?


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## BBCWatcher

No.


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## cescolar

BBCWatcher said:


> No.


Boy, you are gabby today! 

So let's say that I can give it all to my Brazilian wife, fill form 709 and not owe any taxes because of it. Then the IRS will not have any interest (other than the FMV of the gift beeing right) in the future, so I won't have to declare anything more about it,, fill any more forms 8938s (starting on the 2014 return), etc. for anything that my wife owns? I am afraid that the IRS might have some sneaky rules where they attribute me ownership of my foreign wife's property, and then we would be back to square one!


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