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When there is a disagreement regarding the ownership of funds or other assets, a Disputed Ownership Fund (DOF) established pursuant to §1.468B-9 can provide a formal and secure arrangement to hold and preserve the funds or other assets until a court can resolve the claimants’ conflicting claims of ownership. This article explores various facets of DOFs, in what circumstances it is best to utilize this tool, and when other options, such as Qualified Settlement Funds (QSFs) or traditional escrow accounts, are more appropriate.

Introduction

DOFs refer to amounts under contention resulting in conflicting claims of ownership. These conflicting claims of ownership can arise for numerous reasons, including disagreements over private and commercial transactions or arrangements, invoices, claims, adjustments, estates, divorce, etc.

The IRS has established that all “pooled” Court Interpleader Accounts [aka Court Registry Accounts] (Court Accounts) are DOFs. However, the inherent disadvantage of Court Accounts is that the court imposes a significant fee, typically 10% of income, on the first $240 million.

Likewise, Court Accounts have restrictive operating rules, such as required pooling of accounts and (by way of example) limiting investment options to:

“Funds on deposit with the Court are to be placed in some form of interest-bearing account, or invested in a court approved, interest-bearing instrument...”

Therefore, Court Accounts do not provide flexibility and thus may not be best suited to parties’ needs. Alternatively, when funds or other assets are in dispute, a private trust-based DOF allows the parties to customize the arrangement and benefit from a more comprehensive array of investment options. Unlike Court Accounts, a private DOF does not have investment restrictions.

Finally, FDIC insurance covers only the first $250,000 in a Court Account’s investment pool. In the event of a depositary bank’s default, as we have seen with SVB and others, the Court Account maybe be unable to recover all funds held on deposit in the failed institution. Suppose the Court Account is purchasing government bonds as they may under the rule; in that case, the liquidation of such bonds in a rising interest rate environment can result in market-based losses or a lack of liquidity to fulfill disbursements.

A private DOF can eliminate both of these types of risks.

What Qualifies as a DOF?

The regulations (1.468B-9(b)(1)) define the four simple requirements for an arrangement to qualify and operate as a DOF:

(1) Disputed ownership fund means an escrow account, trust, or fund that—

     (i) Is established to hold money or property subject to conflicting claims of ownership;

     (ii) Is subject to the continuing jurisdiction of a court;

     (iii) Requires the approval of the court to pay or distribute money or property to, or on behalf of, a claimant, transferor, or transferor-claimant; and

     (iv) Is not [emphasis added] a qualified settlement fund under §1.468B–1, a bankruptcy estate (or part thereof) resulting from the commencement of a case under title 11 of the United States Code, or a liquidating trust under §301.7701–4(d) of this chapter (except as provided in paragraph (c)(2)(ii) of this section);

What is Disputed Property (Claims)

The regulations (§ 1.468B-9(b)(5)) also define what is “Disputed Property.”

(5) Disputed property means money or property held in a disputed ownership fund subject to the claimants’ conflicting claims of ownership;

DOFs vs. Escrow Accounts

While an escrow account can be a DOF, not all escrow accounts are DOFs; as traditional commercial escrow accounts are never DOFs. The following are the key differences:

• DOFs require a court order to disburse funds, and escrow accounts may disburse funds upon the parties’ mutual agreement.
  
• Escrow accounts may operate as a Grantor-type trust arrangement - DOFs may not.
  
• Escrow accounts need not be subject to the continuing jurisdiction of any court.
  

When to Utilize a Private DOF vs. a Non-DOF Escrow Account

The requirements of § 1.468B-9 do not apply to traditional escrow arrangements (Non DOFs); therefore, traditional escrow arrangements may operate outside the DOF requirements. Traditional escrow arrangements are typically used when the parties are satisfied that the funds or other assets held under the supervision and custody of an independent trustee or escrow agent are sufficiently controlled and that the ultimate distribution of those assets is safeguarded to the parties’ mutual satisfaction.

On the other hand, when the parties are at such odds or levels of distrust and conflict that they are motivated to prevent the loss of the assets and have a court adjudicate the question of ownership, then a Private DOF is the appropriate solution.

Disputed Ownership Funds vs Qualified Settlement Funds (QSF)

It is also essential to differentiate between a DOF and a QSF, as they are not interchangeable.

• A QSF requires governmental authority approval to establish – a DOF does not.
  
• A QSF is established to receive funds to resolve or satisfy one or more claims by funding a settlement or judicial award liability (§1.468B-1(c)(2)):
  

“Resolve or satisfy one or more contested or uncontested claims that have resulted or may result from an event (or related series of events) that has occurred and that has given rise to at least one claim asserting liability”

• A DOF is not a QSF, and a DOF exists solely to hold assets subject to conflicting claims of ownership; the resolution of said conflicting claims shall occur by future court order.
  
• A QSF does not require a court order to disburse funds, while a DOF does require a court order to disburse funds.
  

Conclusion

Understanding Disputed Ownership Funds, when their use is appropriate, and the alternatives such as traditional escrow accounts are vital in selecting the appropriate instrument to resolve ownership disputes or prevent asset loss risks. By grasping these concepts, stakeholders can better address ownership disputes and navigate the resolution processes more efficiently.

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Tax information reporting is essential to compliance with Internal Revenue Service (IRS) regulations. It ensures accurate income reporting and facilitates the proper allocation of tax liabilities. In this guide, we will explore the requirements for furnishing employer identification numbers (EINs) and the On-Line Taxpayer Identification Number Matching Program (TIN Matching Program) administered by the IRS. We will also delve into how these requirements relate to payments made to a qualified settlement fund (QSF) to gain a thorough understanding of tax information reporting related to a QSF and the related exemptions which eliminate the requirement for 1099-Misc reporting of payments to a QSF.

General Rules Regarding EINs and Information Reporting

Let’s start with the general rules surrounding EINs and information reporting to establish a solid foundation. Section 6109 of the Internal Revenue Code and the Treasury Regulations provide the framework for issuing tax identification numbers and furnishing them to other parties. An EIN is a unique identifier for U.S. persons, which includes domestic trusts and corporations. When making a return, every U.S. person must furnish their own identifying number as required by the IRS forms and accompanying instructions. If another person requires the TIN, you must provide such upon request – utilizing IRS Form W-9 is the preferred method.

Section 6041 of the Internal Revenue Code outlines payment information reporting requirements. This section stipulates that persons engaged in a trade or business making payments over $600 in a taxable year must furnish an information return to the IRS. However, payments made to domestic corporations are generally exempt from the information reporting requirement, with a few exceptions outlined in the IRS’ 2022 Instructions for Form 1099-MISC. For example, businesses or individuals making payments for the purchase of fish for resale, medical and health care payments, substitute payments in lieu of dividends or tax-exempt interests, and gross proceeds paid to an attorney are reportable on Form 1099-MISC.

General QSF Information Reporting Requirements

QSFs operate to resolve or satisfy liabilities, and as previously noted, the amounts transferred to a QSF are not includable in the fund’s gross income. For income tax purposes, a QSF is taxable as a corporation, and payments to a QSF are classified as payments to a corporation[i] for information (1099) reporting purposes.

Considering the general information reporting rules, payments made to a QSF to settle a claim are not reportable on Form 1099-MISC. This reporting exemption is because such payments are excluded from the QSF’s gross income and are not subject to the reporting requirements of Section 6041. Additionally, Form 1099-MISC only requires reporting specific payments to corporations, such as (i) cash payments for the purchase of fish for resale, (ii) medical and health care payments, (iii) substitute payments in lieu of dividends or tax-exempt interests, and (iv) gross proceeds paid directly to an attorney. Therefore, payments made to a QSF do not fall under these categories and do not require 1099-MISC reporting.

In summary, there is no requirement for a payor to consider the payments to a QSF as reportable income or subject to Backup Withholding. Correspondingly, there are no requirements for a payor to issue a 1099-MISC; thus, the TIN Matching Program is not applicable.

Detailed QSF Exemptions From Reporting, Backup Withholding, and TIN Matching Requirements

It’s important to note that there are NO information reporting requirements for payments expressly excluded from the recipient’s gross income. For instance, when a QSF is involved, the QSF administrator is solely responsible for tax reporting associated with such payments and distributions from the QSF. Therefore, the defendant making payments from the QSF to a recipient, such as a claimant or attorney, has no obligation to file an information return; specifically, no 1099-MISC is required. Correspondingly, there is no Backup Withholding, and no TIN Matching is required.

Tip – Settlement Payments into a QSF are not taxable as §1.468B-2(b) excludes from the definition of Modified Gross Income the amounts transferred to satisfy the settlement/order liability.

§1.468B-2

(b) Modified gross income. The “modified gross income” of a qualified settlement fund is its gross income, as defined in section 61, computed with the following modifications—

(1) In general, amounts transferred to the qualified settlement fund by, or on behalf of, a transferor to resolve or satisfy a liability for which the fund is established are excluded from gross income. However, dividends on stock of a transferor (or a related person), interest on debt of a transferor (or a related person), and payments in compensation for late or delayed transfers, are not excluded from gross income.

Accordingly, as the settlement payments are not taxable to the QSF, there are no circumstances whereby any 1099-Misc reporting requirement or any associated applicable Backup Withholding is applicable. Thus, there is no need for any TIN Matching in any circumstances associated with QSFs.

Tip – It is improper for the transferor (payors) into a QSF to perform any look-through 1099-Misc reporting requirement or associated applicable Backup Withholding. To perform such would result in willful inaccurate/double income reporting violating the code.

The TIN Matching Program and Why It Does Not Apply to QSFs

There is no TIN Matching requirement for QSFs as there is no tax liability to the QSF for the defendant’s settlement/award payment as provided for in §1.468B-2(b).

Since the IRS’ TIN Matching Program only applies to assist payors filing Form 1099 associated with taxable income, a QSF payor has no Backup Withholding or payee certification via TIN Matching obligations. As stated, the payments received by a QSF are not taxable income, and there is no 1009-MISC reporting requirement. Therefore, a QSF is not subject to Backup Withholding as the settlement/award payment is not taxable income to the QSF; and hence, there is no 1099-MISC or payee certification via TIN Matching obligation.

Tip – Caution should be given to not confuse the requirements of other types of payments as opposed to payments to QSFs. Note that in addition to the stated exemptions for QSFs, Backup Withholding and payee certification via TIN Matching are moot for payments arising from personal injury claims (§104(a)(2)) as the underlying settlement/claims are non-taxable and, as such, there could never be any applicable 1099-MISC reporting requirement or Backup Withholding in any circumstances.

Defendants asserting the requirement for 1099-MISC reporting or payee certification via TIN Matching are operating outside the applicable code. Such payors are implementing unnecessary and undefendable processes, which only serve the purpose of delaying funding the QSF and fulfilling their payment obligations.

Additionally, for payments to a QSF, the TIN Matching Program is not applicable since the QSF administrator (§1.468B-2(l)(2) see endnotes), is responsible for the entirety of the tax reporting, including but not limited to all applicable 1099 reporting and Backup Withholding associated with payments from a QSF to claimants.

Summary

To avoid bad faith payment delays, payors should understand the rules and requirements surrounding EINs, W-9s, information reporting, the TIN Matching Program, and the exemptions applicable to QSFs. By adhering to these regulations, businesses can ensure compliance and not gratuitously impose processes outside the code’s requirements which artificially delay payment of settlement/award obligations and which may result in additional liabilities.

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Financial institutions have the ability to ask for KYC and KYB information from clients at any time as part of the financial institution’s Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) obligations and policies.

A common misunderstanding is that financial institutions need to ask the client’s permission or seek the agreement of the client to request the information, and that the financial institution is required to justify its ongoing and additional information demands. This is not so. Continuing and additional information demands may stem from ongoing reviews as part of the financial institution’s ongoing CDD and AML audits/examinations or arise from EDD triggered by unusual or suspicious transactional activity, changes to the entities structures, ownership, or control, or negative news or information that comes to the attention of the financial institution. Financial institutions do not need to ask the client’s permission or seek the agreement of the client to request information, and financial institutions are not required to justify their ongoing additional information demands.

Some believe they can object to CDD or EDD requests or intentionally hide, withhold, or misrepresent KYC/KYB information. Such actions, especially if done intentionally, can violate several laws. Here are some of the most relevant ones:

Bank Fraud: In many jurisdictions, including the United States, intentionally deceiving a bank, credit union, or trust company to gain monetary benefits constitutes fraud. Bank Fraud is usually a felony punishable by fines and imprisonment.

False Statements: Under United States federal law, knowingly making false statements to federally insured banks, credit unions, and broker-dealers may be a crime.

Identity Fraud or Identity Theft: If a person hides information about their identity or uses someone else’s identity without their permission, it’s considered identity fraud or theft. This may include using a web of shell companies, trusts, fictitious entities, or strawmen to conduct financial transactions in the name of another for one’s benefit.

Money Laundering: A person hiding information may be part of a money laundering scheme if it is in furtherance of a conspiracy or facilitation to disguise the origins of money or for tax evasion.

For example, 18 USC §1956 is a United States federal law that pertains to money laundering. Money laundering refers to the process of making illegally-gained proceeds appear legal. Here’s an analysis of the critical provisions of the law:

Financial transactions: This section of the code makes it illegal to conduct or attempt to intentionally conduct a financial transaction involving proceeds from specified unlawful activities to promote the carrying on of specified criminal activity or to engage in tax evasion or tax fraud by actions intended to engage in conduct constituting a violation of section 7201 or 7206 of the Internal Revenue Code of 1986 as amended.

International and interstate commerce: The law also applies to transactions involving the movement of funds by wire, or other means that either cross state lines or national borders.

“Knowing” nature of the transaction: A critical aspect of the law is that the person involved in the transaction must know that the property involved represents the proceeds of some form of unlawful activity.

Penalties: Violations of 18 USC §1956 can result in severe penalties, including fines of up to $500,000 or twice the value of the property involved in the transaction, whichever is greater, or imprisonment for up to twenty (20) years, or both.

Conspiracy: This law also makes it a crime to conspire to commit any of the offenses defined in this section.

This law is one of the main tools used by federal prosecutors in the United States to combat organized crime, drug trafficking, tax evasion, and financial fraud, because it allows them to prosecute the illegal activities that generate large sums of money and the subsequent efforts to conceal these activities.

Tax Evasion: Hiding income or assets or conducting transfer payment(s) through a shell company(ies) to evade taxes can also be a criminal offense.

Know Your Customer (KYC) Violations: Financial institutions must implement KYC procedures to prevent identity theft, financial fraud, money laundering, and terrorist financing. If a customer provides false or misleading information or intentionally omits essential information, they could be implicated in a KYC violation, resulting in penalties, account closure, and various potential legal consequences.

Please note that the preceding are only general explanations. The actual laws are detailed and nuanced, and their application can vary depending on the case’s specifics.

Also, it’s worth noting that even if a person’s actions don’t amount to a criminal offense, they could still face account closures, negative news, and civil penalties, such as lawsuits or fines, for providing false information to a bank. It’s always best to be entirely truthful and transparent when dealing with financial institutions and seek the advice of competent legal professionals.

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In the context of federal legislation in the United States, 18 U.S.C. § 1956, often referred to as the Money Laundering Control Act, constitutes a critical piece of legislation pertaining to the laundering of monetary instruments [1][2]. Given its intersection with tax laws, particularly sections 7201 and 7206 of the Internal Revenue Code of 1986, it offers a comprehensive legal framework to combat the menace of money laundering and associated tax evasion. This article delves into an in-depth consideration of these provisions and their interplay [2][3]. This following discussion aims to provide a comprehensive overview of the law, its various elements, and the penalties involved.

Understanding the Premise

18 U.S.C. § 1956 et seq. primarily criminalizes financial transactions that involve proceeds from specified unlawful activities. Essentially, this implies that if a person, with knowledge that a property involved in a financial transaction represents the proceeds of some form of illegal activity, conducts or attempts to conduct such a financial transaction, he or she would be violating this law. Accordingly, United States prosecutors frequently use 18 U.S.C. § 1956 accompanied with linked allegations of mail or wire fraud, tax fraud, tax evasion and bank fraud.

Key Components of the Legislation

The law is applicable to scenarios where the individual conducts a financial transaction with the intent to either promote the carrying on of specified unlawful activities or to engage in conduct constituting a violation of certain sections of the Internal Revenue Code of 1986 [1][2].

Furthermore, it is applicable in instances where the individual knowingly designs the transaction, in whole or part, to either conceal or disguise the nature, location, source, ownership, or control of the proceeds of specified unlawful activity, or to avoid a transaction reporting requirement under state or federal law. 18 U.S.C. § 1956 makes it unlawful for anyone knowing that the property involved in a financial transaction represents the proceeds of some form of unlawful activity, to conduct or attempt to conduct such a financial transaction [2]. Two main intentions are identified under this law. The first pertains to the promotion of the carrying on of specified unlawful activity. The second deals with the intent to engage in conduct constituting a violation of section 7201 or 7206 of the Internal Revenue Code of 1986, effectively bridging the gap between money laundering and tax laws.

Violations of Sections 7201 and 7206 of the Internal Revenue Code of 1986

Section 7201 of the Internal Revenue Code deals with tax evasion, where an individual willfully attempts to evade or defeat any tax imposed by the federal laws [3]. The potential defenses for tax evasion can be insurmountable evidence of the taxpayer's ignorance of a due tax liability or an honest belief that the taxpayer was not violating any of the provisions of the tax laws.

On the other hand, section 7206 pertains to 'tax perjury' and covers fraudulent activities such as making false statements on a tax return or providing fraudulent information [3]. The critical element of this violation is the intent to defraud, where the accused knowingly provides incorrect information.

Intersection of Money Laundering and Tax Laws

18 U.S.C. § 1956 effectively incorporates violations of tax laws as a predicate offense for money laundering. If an individual knowingly engages in a financial transaction involving proceeds obtained from violations of sections 7201 or 7206 of the Internal Revenue Code, they may be found guilty of money laundering under 18 U.S.C. § 1956. This intersection provides a robust mechanism for law enforcement agencies to combat tax evasion schemes that employ sophisticated money laundering techniques.

Involvement of Monetary Instruments and Funds

The legislation also addresses situations where an individual transports, transmits, or transfers, or attempts to transport, transmit, or transfer a monetary instrument or funds from a place in the United States to or through a place outside the United States or vice versa. This is subject to the condition that the monetary instrument or funds involved in the transportation, transmission, or transfer represent the proceeds of some form of unlawful activity.

Significance of the Legislation

In essence, the law not only contributes significantly to the fight against organized crime, drug trafficking, tax evasion and other financial fraud but also serves as a deterrent to entities that might be tempted to engage in such illegal activities. It facilitates the prosecution of illegal activities that generate large sums of money and the subsequent attempts to conceal these activities.

In conclusion, 18 U.S. Code § 1956 is a pivotal piece of legislation that serves to discourage and penalize money laundering activities. The law is comprehensive and detailed, embodying a series of nuanced interpretations and applications that significantly contribute to its efficacy as a tool against financial crime.

Penalties and Sentencing

Violations of 18 U.S.C. § 1956 carry severe penalties, including a fine of not more than $500,000 or twice the value of the property involved in the transaction, imprisonment for not more than twenty years, or both[2]. Sentencing for tax crimes is guided by the U.S. Sentencing Guidelines. The base offense level generally corresponds to the amount of tax loss, which equals the amount of taxes evaded by the taxpayer, excluding penalties or interest for the period in question [3].

Legal Procedures and Constitutional Considerations

Prosecuting tax and money laundering offenses involves intricate procedures, often entailing comprehensive investigations by the Internal Revenue Service (IRS) and other law enforcement agencies. Important constitutional considerations are at play, especially those surrounding self-incrimination, due process, and the statute of limitations for violations. In addition, section 371 of Title 18 of the U.S. Code, dealing with criminal conspiracy, often comes into play in cases involving large-scale tax fraud and money laundering.

Conclusion

In essence, the provisions of 18 U.S.C. § 1956, in combination with sections 7201 and 7206 of the Internal Revenue Code of 1986, form a robust legal framework for curbing money laundering and tax evasion. These laws underscore the seriousness of these offenses and their impact on society at large. By integrating tax violations into the ambit of money laundering, these provisions provide a comprehensive approach to combatting financial crime, deterring potential offenders, and maintaining economic integrity.

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[1] Tax Crimes Handbook - Internal Revenue Service
https://www.irs.gov/pub/irs-utl/tax_crimes_handbook.pdf

[2] 18 U.S. Code § 1956 - Laundering of Monetary Instruments
https://www.law.cornell.edu/uscode/text/18/1956

[3] Tax Violations | Office of Justice Programs
https://www.ojp.gov/ncjrs/virtual-library/abstracts/tax-violations-5

The Internal Revenue Service (IRS) plays a crucial role in determining tax obligations and regulations within the United States. For individuals and businesses operating in the country, it is essential to understand how the IRS defines "doing business" in the United States. This article aims to provide a comprehensive explanation of the IRS definition and its implications.

Definition of “Engaged in Trade or Business Within the United States”

According to the IRS, the term "engaged in trade or business within the United States" is outlined in Part I (Section 861 and following) and Part II (Section 871 and following) of the Internal Revenue Code (IRC). The IRS considers certain activities as falling within this definition, unless otherwise specified [1].

Exceptions to the Definition

The IRS provides exceptions to the definition of "engaged in trade or business within the United States." These exceptions exclude specific activities described in paragraphs (c) and (d) of the IRS regulations [1]. However, it is important to note that the performance of personal services within the United States at any time within the taxable year is generally considered as being engaged in trade or business within the country [1].

Performance of Personal Services for Foreign Employers

The IRS has specific rules regarding the performance of personal services for foreign employers. For a nonresident alien individual, foreign partnership, or foreign corporation that is not engaged in trade or business within the United States during the taxable year, the performance of personal services in the United States does not constitute being engaged in trade or business within the country [1].

Similarly, an individual who is a citizen or resident of the United States or a domestic partnership or corporation maintaining an office or place of business in a foreign country or U.S. possession can perform personal services in the United States for a total of 90 days or less during the taxable year. As long as their compensation for such services does not exceed a gross amount of $3,000, they are not considered engaged in trade or business within the United States [1].

Determining Engagement in Trade or Business

To determine whether an individual or entity is engaged in a trade or business within the United States, the nature of their activities plays a significant role. The IRS considers the regularity of activities, transactions, production of income, and ongoing efforts to further the interests of the business [2].

Nonimmigrants on "F," "J," "M," or "Q" Visas

Nonimmigrants temporarily present in the United States on "F," "J," "M," or "Q" visas are considered engaged in a trade or business within the country. The taxable part of any U.S. source scholarship or fellowship grant received by nonimmigrants in these visa categories is treated as effectively connected with a trade or business in the United States [3].

Partnerships Engaged in Trade or Business

Members of partnerships engaged in trade or business within the United States at any time during the tax year are considered engaged in trade or business within the country [3].

Effectively Connected Income (ECI)

When a foreign person engages in a trade or business in the United States, the income from sources within the United States connected with that trade or business is considered Effectively Connected Income (ECI). This applies regardless of any connection between the income and the trade or business conducted in the United States during the tax year [3].

Conclusion

Understanding the IRS definition of doing business in the United States is essential for individuals and businesses to comply with tax regulations. The IRS considers various factors such as the nature of activities, exceptions for specific situations, and the concept of effectively connected income (ECI). By familiarizing themselves with these guidelines, taxpayers can navigate their tax obligations effectively and ensure compliance with the IRS regulations.

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FATCA stands for the Foreign Account Tax Compliance Act. FATCA is an information-sharing agreement, created via a 2010 U.S. federal law, between the United States and more than 100 foreign countries. The goal of FATCA is to identify non-U.S. financial accounts opened or controlled by U.S. citizens or businesses for the purpose of avoiding U.S. taxes—for instance, in tax havens, tax-free countries, or countries with lower corporate tax rates to avoid taxation.

FATCA does not require reporting related to non-U.S. citizens. So, if you are not a U.S. Citizen (or company) and have an account in one or more U.S. financial institutions, FATCA does NOT apply. However, foreign companies controlled by U.S. citizens are subject to FATCA reporting.

FATCA Objective

The objective of FATCA is to identify U.S. persons who may evade U.S. taxes by placing assets in foreign (non-U.S.) accounts -- either directly or indirectly through certain foreign entities such as corporations or trusts.

Who or What Is a U.S. Person for U.S. Tax Purposes?

• A citizen of the U.S., including an individual who was born in the U.S. but resides in another country, who has not renounced U.S. citizenship
  
• A lawful resident of the U.S., including a U.S. green card holder
  
• A person residing in the U.S.
  
• Certain persons who spend a significant number of days in the U.S. each year. (For example, some Canadian "snowbirds" may be considered U.S. persons. However, the Canada-U.S. tax treaty allows them to claim benefits to be treated as Canadian rather than U.S. taxpayers. Similar relief is provided under many other treaties with the U.S.)
  
• U.S. corporations, U.S. estates, and U.S. trusts

FATCA Fundamentals and International Tax Compliance

For foreign (non-U.S.) financial institutions (FFIs) in countries that have not entered into an intergovernmental agreement with the U.S., FATCA requires FFIs to either:

• Enter into agreements with the United States' Internal Revenue Service (IRS) and report information about financial accounts held by U.S. taxpayers -- or held by foreign entities in which U.S. taxpayers hold an ownership interest -- directly to the IRS, or
  
• Face punitive U.S. withholding tax on U.S.-source payments
  

To address privacy and regulatory concerns related to FATCA, many countries negotiated intergovernmental agreements (IGAs) with the U.S. These IGA "partner countries" entered into one of two standard model agreements, and implemented laws to require financial institutions to collect and report information required by FATCA.

FFIs comply with FATCA in one of three ways:

1. In countries with Model 1 IGA, FFIs comply under local legislation and report to their local tax authority; in turn, the local tax authority exchanges information with the IRS
   
2. In countries with a Model 2 IGA, FFIs comply with local legislation to enter into agreements with, and report directly to, the IRS
   
3. In countries without an IGA, FFIs enter into agreements with, and report directly to the IRS. (A 30% withholding tax will be deducted from U.S. source payments received by FFIs in non-IGA countries if they do not enter into agreements with the IRS.)
   

U.S. financial institutions are automatically required to comply with FATCA.

Note: the term U.S. Reportable Account is an account owned by a U.S. individual (person), U.S. entity, or a non-U.S. entity that has U.S. controlling persons -- regardless of the currency of the account itself. FATCA applies to all types of financial accounts, including insurance, investments, trust, assignment, escrow, and other business accounts.

EPTC complies with FATCA regulations in all jurisdictions in which it operates.

What Is the Difference Between a FATCA Model 1 Country and a Model 2 Country?

In general, the countries that are included in FATCA have entered into either a Model 1 or Model 2 agreement. In a Model 1 country, financial data about United States citizens is collected by the partner country's various financial institutions and sent to that country's governmental tax authority. That authority then passes the information on to the IRS, which uses it to ensure the person is paying the amount of tax they legally owe. A total of 94 countries fall under the Model 1 agreement.

In a Model 2 country, the partner government's tax authority is removed from the transfer chain and information is passed directly from the country's financial institutions to the IRS. 14 countries have entered into a Model 2 agreement. Both models also include variants in which the US would reciprocate by providing similar information about any of the partner country's citizens residing in the U.S.

What Countries Are FATCA Model 1 Countries?

Note: Countries marked with ** have a signed agreement or an agreement in substance, but the agreement has not yet entered into force.

What Countries Are FATCA Model 2 Countries?

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Note: Countries marked with ** have a signed agreement or an agreement in substance, but the agreement has not yet entered into force.

In 2021, reported fraud losses experienced a significant increase, reaching $5.8 billion, which represented a surge of over 70 percent within a single year [1]. To combat the rise in financial fraud and money laundering, one effective strategy is to reduce the prevalence of anonymous bank accounts and closely monitor suspicious activities. Financial organizations, including banks, credit unions, and Fortune 500 financial firms, need to adopt measures to know their customers and continuously monitor for risk factors. This process is known as KYC or "Know Your Customer" [1].
 
While the specific programs to meet KYC requirements are developed by individual organizations, financial institutions must comply with complex regulations to verify customer identity, known as KYC [1]. It is essential for businesses in various industries to prioritize KYC compliance; non-compliance can result in steep fines, increased fraud risk, and reduced consumer trust [1].
 
KYC, which stands for "Know Your Customer," is a due diligence process employed by financial companies to verify the identity of their customers and assess and monitor their risk [2]. The purpose of KYC is to ensure that customers are who they claim to be [2]. Complying with KYC regulations plays a crucial role in preventing money laundering, terrorism financing, and other types of fraud [2]. By verifying a customer's identity during the account opening process and continuously monitoring transaction patterns, financial institutions can more accurately identify suspicious activities [2]. To meet KYC requirements, clients are typically required to provide proof of their identity and address, such as ID card verification, face verification, biometric verification, and document verification [2]. Examples of KYC documents include a passport, driver's license, or utility bill [2]. KYC is not only essential for determining customer risk but also a legal requirement to comply with Anti-Money Laundering (AML) laws [2].
 
The importance of KYC in banking lies in its role as a legal requirement for financial institutions and financial services companies to establish the identity of their customers and identify risk factors [3]. KYC procedures help prevent various financial crimes, including identity theft, money laundering, financial fraud, terrorism financing, and other illegal activities [3]. Failing to meet KYC requirements can lead to severe consequences, including substantial fines and penalties [3]. The implementation of KYC regulations gained momentum after the 9/11 attacks, leading to stricter requirements under the Patriot Act [3].
 
Under the Patriot Act's Title III, financial institutions are required to fulfill two core components of KYC: the Customer Identification Program (CIP) and Customer Due Diligence (CDD) (CDD may also include Enhanced Due Diligence (EDD) for high risk or suspicious activity clients.)[3]. The current KYC procedures embrace a risk-based approach to counter identity theft, money laundering, and financial fraud [3]. KYC helps establish proof of a customer's legal identity, preventing the creation of fake accounts and identity theft through forged or stolen documents [3]. Additionally, it limits the ability of criminal sectors to use dummy accounts for illegal activities such as narcotics, human trafficking, smuggling, tax fraud and racketeering [3]. KYC also helps prevent fraudulent financial activities, such as sham loans or fraudulent loan applications using fake or stolen IDs to obtain funding through fraudulent accounts [3].
 
AML (Anti-Money Laundering) and KYC (Know Your Customer) are closely related but distinct concepts. AML refers to the framework of legislation and regulations to which financial institutions must adhere in order to prevent money laundering, while KYC is a key component of the overall AML framework, requiring organizations to know their customers and verify their identities [3]. Financial institutions are responsible for developing their own KYC processes and ensuring compliance with specific AML standards dictated by any applicable jurisdiction or country [3].
 
Financial institutions that deal with customers while opening and maintaining financial accounts are required to have KYC processes in place [3]. This includes banks, credit unions, wealth management firms, broker-dealers, finance tech applications (fintech apps) depending on their activities, private lenders, and lending platforms [3]. KYC regulations have become increasingly critical for almost any institution involved in financial transactions due to the need to limit fraud, as well as the requirements imposed by banks on organizations with whom they conduct business [3].

The taxation of plaintiff litigation recoveries is confusing. But it’s important to know the right answers. This is because the income tax consequences are so significant, especially where there are “double tax” issues.

10 things to know:

1. Recoveries in connection with personal injuries are not always tax-free.

2. Many other types of individual plaintiff recoveries are taxable.‍

Compensatory and emotional distress damages for physical injuries are tax-free, but the related punitive damages and interest are taxable.

These include non-physical injuries and related emotional distress, mental anguish, defamation, breach of contract, malpractice, fraud, securities law violations, intellectual property and more.

3. Many individual plaintiffs receiving taxable recoveries CANNOT DEDUCT their legal fees.‍‍

Personal attorney fees are “miscellaneous itemized deductions,” which are nondeductible. IRC §67(g). There are limited exceptions (e.g., employment discrimination, whistleblower). It’s important to know whether the IRC permits the deduction of your attorney fee.

4. The U.S. Supreme Court held that plaintiffs must include the attorney fee portion of their taxable recovery in income – creating the double tax.‍

This is the 2004 ruling in Commissioner v. Banks. As a result, in taxable cases where the attorney fee is not deductible, both the plaintiff and lawyer pay tax on the attorney fee portion of the recovery – hence the “double tax.”

5. In “double tax” situations, plaintiffs in high-tax jurisdictions end up with little or nothing.

A plaintiff might keep 10% after paying 40% to their lawyer and 50% in taxes. (Looking at you California!) And if their lawyer had significant expenses that are not covered by the contingent fee, the plaintiff may end up with nothing.

6. Defendants are subject to huge 1099 penalties in taxable cases if they don’t issue a 1099, or if they exclude the attorney fee portion.

The penalty can be 10% of the unreported amount, without limit. IRS Regulation 1.6041-1(f); IRC §6722(e).

7. Plaintiff lawyers must consider client tax issues.

American Bar Association (ABA) materials advise that “competent representation” of plaintiffs requires “considering the tax implications of the settlement.” ABA, Ethical Guidelines for Settlement Negotiations (August, 2002). Ethics rules require that personal injury lawyers tell clients the consequences of not addressing taxes or seeking competent tax advice.

8. Many suggested ways of reducing plaintiff recovery taxes don’t work.

These include reporting to the IRS only the portion of the recovery received by the plaintiff (excluding the attorney fee portion), treating the attorney-client relationship as a partnership or business, or excluding the structured portion of the attorney’s fees. Not only do these not work, they subject the plaintiff to massive penalties and interest if the IRS finds out.

9. Plaintiffs with taxable recoveries can increase their after-tax recovery if they act before a final resolution of the claim.

One way to do so is to draft the complaint or settlement agreement to consider the taxes (to the extent the facts allow). Another way to avoid taxation on the attorney fee portion of the recovery is to contribute the claim to a Plaintiff Recovery Trust (PRT). A PRT uses a traditional charitable trust planning arrangement, modified to the litigation context to achieve this result. There are other methods to reduce the taxes associated with a taxable recovery, such as selling the claim.

10. Addressing taxes after settlement is hard.

Tax planning to reduce plaintiff taxes on their recoveries is possible while the case is contingent and doubtful, i.e., not finally resolved. Careful planning is required. There are limited opportunities once the claim resolves. In this regard, few accountants are familiar with plaintiff recovery taxation matters and they tend to get involved only after the recovery, when it’s too late.

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