FIRPTA WITHHOLDING

RECENT DEVELOPMENTS

AND THE USE OF NON-FOREIGN CERTIFICATES

Thomas C. Roberge, CPA

March 14, 2008

Thomas C. Roberge & Company

St. Petersburg and Sarasota

Telephone: (727) 822-9393

Contact: Info@RobergeCo.com 

Copyright, 2008, Thomas C. Roberge & Company

All Rights Reserved

The sale of U.S. real estate by a non-U.S. person is subject to a withholding tax of 10% of the gross sales price which the seller can get refunded in various ways if the actual tax obligation is less.

The seller of U.S. real estate is exempted from this withholding tax if he or she signs what is commonly referred to as a “Non-Foreign Certificate” or “Non-Foreigtn Affidavit”.  A variation from the wording suggested by the Internal Revenue Service for Non-Foreign Certificates has been used recently in Florida by closing agents, modifying the IRS language, to state that the seller is exempt from withholding because he or she meets the Substantial Presence Test of the Internal Revenue Code.  It is our opinion that the use of the Substantial Presence Test in Non-Foreign Cerificates is potentially very dangerous from a liability standpoint to the closing agent and the buyer.

The following is an article by Jason Warner, a prominent tax attorney in the U.S.  Mr. Warner is the former chairperson of the Tax Section of the Florida Bar Association and the recipient of the  Tax Section’s 2007-2008 Outstanding Tax Lawyer award.  Mr. Warner was instrumental in drafting the original FIRPTA withholding legislation in 1984.  He is most familiar with the Congressional intent that went into the original legislation.  The following is his article.

FIRPTA WITHHOLDING 

Non-Foreign Certificates:  A Matter of Form

Jonathan H. (Jason) Warner

Law Offices of Jonathan H. (Jason) Warner, P.A.

Miami, Florida and Spruce Pine, North Carolina

jasonwarner@warnertax.com

Recently, the author became aware of the use in Florida real estate closings of non-foreign certificates that vary from the simple form suggested in the FIRPTA regulations.  These more elaborate certificates attempt to pinpoint the basis for the claim of non-foreign status, distinguishing between U.S. citizens, green-card holders and aliens who are U.S. tax residents under the “substantial presence” test of Internal Revenue Code section 7701(b) and the regulations.

While the obvious compliance motivation for the more complex form is admirable, in the author’s view a closing agent would be better off using the simple, commonly used format provided in the FIRPTA regulations.  In situations where the closing agent may have serious doubt about the seller’s claim of non-foreign status, some edited version of the more elaborate form might serve as an additional document to be kept in the closing agent’s file should it be necessary to show additional diligence, but it should not be the primary non-foreign certification..

To illustrate the reason for this suggestion, a bit of historical background might be in order.  When FIRPTA was enacted in 1980, it was obvious that a withholding mechanism would be needed.  The IRS naturally followed the model of the established withholding rules of Code Sections 1441-1443 that impose  a 30% withholding tax on dividends, interest and other passive income paid to foreign recipients by U.S. persons.  These rules focused on the party actually making the payment, usually a financial agent who might properly be charged with the task of determining whether the recipient of a passive income item was a foreign person subject to withholding and whether a tax treaty or exception applied to reduce the withholding rate or eliminate withholding.

But this old model was perceived (correctly) as a threat to the U.S. real estate industry, particularly since the IRS version would have imposed the traditional “reason to know” standard for determining whether the seller was foreign.  Under the IRS proposal,  anyone connected with the closing would have been liable for the withholding tax if the seller proved to be foreign and, in the clear light of hindsight, they had “reason to know.”  Since the determination would have to have been made by closing personnel who might not deal with foreign persons or withholding issues on a regular basis, there was a reasonable concern about this degree of liability exposure.

The Florida Bar Tax Section’s legislative proposal that became the basis for FIRPTA withholding recognized these problems, and solved them by making only the buyer liable for FIRPTA withholding tax and replacing the “reason to know” standard with virtually absolute reliance on certifications.  Code Section 1445 and the regulations allow the buyer to forego withholding in reliance on a simple written statement by the seller that the seller is not a foreign person, provided the statement gives the seller’s U.S. taxpayer identification number and is signed under penalty of perjury.  A buyer receiving a false statement is liable for the withholding tax only if the buyer had actual knowledge of the seller’s foreign status or was advised in writing by specific persons involved in the closing that the statement was false.  Except in the case of a “transferor’s agent” representing a foreign corporation, closing agents also enjoy the actual knowledge standard. 

While any foreign seller obviously could give a false statement and even a phony U.S. tax identification number, there is no indication from the IRS of rampant abuse of this system.  In fact, the IRS now uses the Tax Section’s model for new federal tax withholding requirements, such as that in Code Section 1446 and the revised Section 1441-1443 withholding rules (although the reason to know standard lives on in the latter).

As it now stands, a buyer of a U.S. real estate interest is protected from failure to withhold even if the seller resembles a character from the bar scene in Star Wars, provided the seller gives the simple non-foreign certification statement as provided in the Code and regulations and the buyer does not have actual knowledge that the certification is false.   The regulations do not mandate a particular form for the certification, instead providing  brief, simple suggested language..  The regulations also specifically provide that a buyer does not have to use a certification form to determine if the seller is non-foreign, but the buyer is exposed to liability for withholding tax, interest and penalties if another method is used and the seller turns out to be foreign.

So why tamper with a good thing?  Remember the old logic rule: all other things being equal, the simplest solution is the best.  And there is a very good practical reason to continue using the simple form.  If an IRS agent were to audit the closing file, doesn’t it make more sense to show the agent exactly what he or she expects to see, a format that uses the language suggested in the regulations, rather than an alternative form that might require explanation?

Here is the simple version provided in the regulations for an individual seller::

Section 1445 of the Internal Revenue Code provides that a transferee (buyer) of a U.S. real property interest must withhold tax if the transferor (seller) is a foreign person. To inform the transferee (buyer) that withholding of tax is not required upon my disposition of a U.S. real property interest, I, [name of transferor], hereby certify the following:

1. I am not a nonresident alien for purposes of U.S. income taxation;

2. My U.S. taxpayer identifying number [Social Security number] is ----------------, and

3. My home address is:  ________________________

I understand that this certification may be disclosed to the Internal Revenue Service by the transferee and that any false statement I have made here could be punished by fine, imprisonment, or both.

Under penalties of perjury I declare that I have examined this certification and to the best of my knowledge and belief it is true, correct, and complete. [Signature and Date]"

There is nothing wrong, though, with requiring additional documentation for the closing file.  The author long has suggested that closing agents also request a Form W-9 from U.S. parties and a Form W-8BEN from foreign parties.  Obtaining these forms facilitates compliance with Form 1099 requirements as well as providing a FIRPTA backup.  It also is suggested that the closing agent obtain reliable post-closing contact information for all parties to facilitate FIRPTA compliance and response to the IRS in case any issue develops.  If the seller has a U.S. passport, that should be conclusive.

As noted above, the alternative form delves into U.S. income tax residency issues.  This is indeed a slippery slope.  While the 1984 revision of the residency rules brought a great deal of objective certainty to the area, there are a number of unanswered questions about the rules.  Trying to make a determination of residency on a form may seem attractive, but tax attorneys who deal with the issues on a regular basis will attest that things are not a simple as they may seem. 

For example, even an alien with a “green card” might be living and working abroad (at least temporarily), and might be entitled to use the residency tie-breaker of a particular treaty to avoid U.S. tax resident status despite holding a green card.  The “substantial presence test,” particularly the version that applies a formula to the number of days present over the course of two or three years, leaves open the issue of days exempt as a teacher or student, for example, or “medical days,” or the possibility that the alien can avoid U.S. tax residency by showing that he or she has a “closer connection” to a foreign country (one in which the alien has a tax home) than to the United States.  And if the closing is early in a year, is an alien who intends to be in the United States for more than 182 days that year entitled to claim he or she is a U.S. tax resident before those days have passed?

It is easily understandable how a buyer or counsel might grow concerned about accepting a non-foreign certificate from a person whose primary residence is in a foreign country, whose name is not Joe Smith, and whose primary language might not be English.  But I just described a U.S. citizen I know who has worked and lived abroad for many years.  And are you sure that the seller sitting in front of you, who the broker swears has spent most of his time in South Florida for the last twenty years, who speaks perfect, unaccented English and might be named Joe Smith, isn’t an expatriate U.K. or Canadian citizen scoffing at all revenue laws?  These indicators do not add up to “actual knowledge” of the seller’s tax residency status, and you are not the Blade Runner.

The point is, the new form simply won’t resolve the question of U.S. tax residency in at least some cases.  If not, then why use it rather than the simple, commonly-accepted form provided in the FIRPTA regulations?  In the author’s view, a buyer overly concerned about a seller’s claim of U.S. tax residency should withhold the FIRPTA tax unless contrary to the sales contract (which usually is silent on the matter).  If the seller is a U.S. taxpayer, the withholding is only an advance payment of tax, refundable to the extent exceeding the actual tax due.  But withholding from a U.S. citizen may provoke a closing dispute (if not litigation), and in the current real estate market there may not be sufficient seller proceeds after paying off mortgages and closing expenses to cover the withholding tax.

The right answer is that FIRPTA withholding matters ought to be resolved in the contract, but like many right answers that may be wishful thinking.  Brokers generally choose the contract form and are unlikely to encourage attorney involvement in negotiating FIRPTA issues while a contract is pending.  As my N.C. mountain neighbors advise, try not to come between a mama bear and her cubs.

And in the absence of a uniform Florida sales contract, it is unlikely that a suitable form will be used.  In writing this article, the author was furnished a contract form in use in southwest Florida that seems written by someone only vaguely familiar with FIRPTA withholding, but with all its errors and bad nuances (including the erroneous implication that the $300,000 personal residence so-called “exemption is mandatory), it probably is the most thorough approach to FIRPTA withholding that the author has seen in a Florida form contract.  Imagine what it is like in states that don’t have the volume of foreign investment in real estate that Florida has enjoyed.