QUESTION: If HYIP investments are legal in the US, how is it possible
to file and pay taxes on the capital gain obtained by offshore HYIPs?
Form 1040 line 21 or Form 8621? No form 1099 will be ever sent to the
tax payer by any offshore company, as well as any possible
certification stating the difference between the initially deposited
amount of money and the final compound at the end of the investment.

In both case (Form 1040 or Form 8621), what kind of documentation is
required to justify the capital gain as obtained? HYIPs just indicate
the total amount of money one earns on the considered period and the
money that each single investor withdraws, always with no formal
disinvestment.

REPLY: Any kind of gains or profit from a typical HYIP would most
likely be treated as ordinary income by the IRS and could be reported
on line 21 of Form 1040 (Other income) or on line 1 of Schedule B (
ordinary dividends). Form 8621 is used to report income received from
a passive foreign investment company (PFIC) or to report gains from
the diposition of any shares of a PFIC.

Three people have hired me to help them file delinquent returns for
foreign corporations they had formed in order to invest in an offshore
high yield investment program (HYIP). In all three cases, they turned
out to be Ponzi Schemes. In a Ponzi scheme, the early investors often
receive distributions that are called gains and they usually re-invest
those funds so that they are ultimately lost. Later investors receive
account statements showing gains of as much as 50% per month, but
when they try to cash out, the promoter gives them endless excuses for
having to delay the payment and eventually the program ends up in some
kind of legal action or the promoters just close up shop and disappear.

There is no beneficial tax result I can think of with an offshore HYI
program. As you say, there is no information from the promoter to
indicate any distinction between capital gains and interest or
dividend income. In all three of the deals my clients were into, the
client had to first form an international business company (IBC) which
is treated as a foreign corporation for U.S. tax purposes. The
investment income of a controlled foreign corporation (CFC) is passed
through to the U.S. shareholders as ordinary income, regardless of the
actual character of the income. Losses do not pass through.

When the paper gains later turn into a worthless investment, the
taxpayer would have to prove that the investment was worthless in
order to claim a loss. The loss would be treated as a capital loss
that is only deductible against capital gains or $3,000 per year of
other kinds of income.

If a U.S. investor bought into a HYIP directly (without using an IBC),
the IRS would treat the paper gains as ordinary income. It's possible
they could argue that the HYIP is a passive foreign investment company
but that would make the alleged income non-taxable until there was a
cash distribution or a disposition of the shares or until the venture
closed down.

These comments only scratch the surface of the U.S. tax rules relating
to investment losses and does not include a lot of related
information. Also, the rules relating to PFICs are extensive and are
not discussed here.

Richard Duke and I have discussed some of these tax issues in our
book. "Offshore Tax Strategies". Details about the book are at
http://www.offshorepress.com/offshoretax/index.htm

Vern Jacobs

IRS Regulations require that I include the following statement with
any written explanation of the tax law. The comments in this
memorandum are not intended to constitute an opinion regarding any
specific tax issues because additional tax issues may exist that could
affect the tax treatment of the tax issues addressed in this memo.
This memorandum does not consider or reach a conclusion with respect
to those additional issues and was not written and cannot be used for
the purpose of avoiding penalties under code section 6662(d). For
further details see
http://www.offshorepress.com/vkjcpa/disclosurerules.htm