Foreign Loss Audit

[Corduroy Frog]

Client owns 100% of a company in a foreign company. Revenue in US$ 24K, Expenses $ 29K. Company is chartered in its home company, but does not have the machinery to issue a K-1 for this loss, as their tax laws do not recognize 1120S or K-1.

Client does not exercise control, so I filed a schedule C with no active participation, showing $24K revenue and $29K expense. This is a passive loss of $5K and not deductible.

IRS has pounced on the Schedule C and has asked for receipts and substantiation of ALL of the $29K expense. As they were located 12,000 miles away they could not be produced in a timely or meaningful manner. IRS has thus disallowed all the $29K expense, which makes the $24K revenue totally taxable. Had the foreign company filed a K-1 for his ownership, none of the expenses would have been asked for.

Any advice, possibly with the help of the state department?

[Koss]

Foreign Records

I assume that you are planning to seek an audit reconsideration, or take the case to IRS appeals.

I'm not sure the State Department will be much help. It probably won't hurt. But the State Department is not going to tell the IRS to accept the loss. Maybe you're thinking that the State Department can help your client get some data from the company abroad. That's possible, but I wouldn't pin my hopes on it.

If your client has an ownership interest in the company, then the laws of that country, like ours, should give him the right to inspect and copy the company's financial records. He may have to pay for the cost of copying and shipping the records to him.

If the company's management isn't cooperating, he certainly has some options, but all of them will take time and/or money.

The first step would be a strong letter to the company's managers, politely demanding the records he needs. The letter could be on from your client, or from you, on your letterhead, or from an attorney here in the US. Depending on how much time or energy someone wants to put into this, you could try to cite the applicable law in that country that gives him the right to review the records. The letter should state clear expectations about when he expects to receive the records, and he should proactively offer to pay any reasonable copying or shipping costs. He should also request that the records be certified, with the signature of company's secretary or treasurer, and either a notary or the corporate seal. He can also suggest that the records could be provided in an electronic format, either by e-mail or by fax.

If the company doesn't respond promptly, then he has a couple options.

He could explore the possibility of filing a complaint against the company with a regulatory agency in that country. Or he could retain the services of an attorney or an accountant in that country to help him get the records he needs.

How much is at stake in this affair?

If your client is in the 35% tax bracket, then he's looking at a 35% tax bite on $24K? Is the IRS asserting that it subject to self-employment tax?

It might make sense for your client to spend a couple thousand dollars to resolve this, especially if it is likely to happen again in future years.

BMK

[Koss]

Ownership

I overlooked the first sentence of your original post, perhaps because I was reading too quickly.

If your client owns 100% of the company, why is it so difficult for him to get the records that he needs?

Maybe he needs to pay somone over there to scan everything he needs and send him a disk.

Once he has all the relevant documents, audit reconsideration or appeals is the best bet.

Watch the time limit on appeals, though.

As a last option, he can always file a petition in the Tax Court, if he is within the 90-day statutory period.

What country is it, anyway?

BMK

[Golden Rocket]

Country

I think part of the problem is I shouldn't have filed as a proprietorship. The company is 100% owned by the client, and it is chartered in India as a corporation.

But being a corporation doesn't mean they file 1120s or issue K-1s. I filed a passive Schedule C to meet his obligation to report all worldwide income.

Can you imagine the enormity of scanning all records and sending a CD? Bear in mind that a .pdf file is a real hog for memory.