Keeping on Top of Foreign Information Reporting Requirements – Part I
Written by Eric Swerdlow and Hunter Norton
For many years, U.S. persons have been required to report ownership in and transfers to certain foreign corporations, foreign partnerships, and foreign trusts. In addition, U.S. persons have been required to report their ownership of and/or signature authority over foreign bank and financial accounts. Recently, in response to a heightened concern over tax evasion and improper reporting of income earned in foreign jurisdictions, the IRS and the Treasury Department have enfor
ced these reporting requirements more strictly. Congress responded to the concerns over tax evasion through the use of foreign accounts by passing the Foreign Account Tax Compliance Act (“FATCA”) in 2010. FATCA placed additional reporting requirements on U.S. persons to report interests in foreign financial assets and utilized the threat of additional withholding to force foreign financial institutions that receive U.S. source financial payments to report the identity of their U.S. account holders.
The worldwide community has also taken action to combat underreporting of income and improper shifting of profits. Pursuant to the FATCA initiative, more than 110 countries have entered into intergovernmental agreements with the IRS to share information regarding the identity of the other country’s account holders. Separately, the G20 countries (those part of an international forum of the 20 major economies) have directed that an action plan be drafted (referred to as the BEPS project) to address improper shifting of profits among countries by harmonizing international tax rules. The BEPS action plan recommendations are now final, and are expected to be adopted into legislation by the European Commission in 2016. The IRS has already proposed to adopt aspects of the action plan requiring country by country reporting of income and capital for certain multinational groups pursuant to existing statutory authority.
Against this backdrop, it is more important than ever that U.S. persons and others timely and comprehensively file foreign information reporting returns and forms to avoid potential criminal sanctions, substantial penalties, loss of foreign tax credits, and tolling of the statute of limitations. This blog is the first of a two-part series that seeks to bring many of the foreign reporting requirements to the attention of its readers in an effort to help them prepare accordingly to comply with the requirements. Part I of the series will focus on foreign information reporting for business entities, while Part II will focus on foreign information reporting with respect to interests in foreign trusts, foreign accounts and foreign financial assets.
INFORMATION RETURN OF U.S. PERSONS WITH RESPECT TO FOREIGN DISREGARDED ENTITIES (FORM 8858):
A foreign disregarded entity is a foreign legal entity that for U.S. tax purposes is ignored, and the U.S. owner of the foreign legal entity is treated as if they own the assets and liabilities of the entity directly. Revenues and expenses of the foreign disregarded entity are treated as if realized or incurred directly by the owner of the disregarded entity. As such, U.S. owners of foreign disregarded entities and certain persons who are required to file Forms 5471 and 8865 (described below) are required to file Form 8858. Form 8858 is due when the related income tax return or information return is due. A $10,000 penalty applies for each failure to file Form 8858 by the U.S. owner of a controlled foreign partnership or a controlled foreign corporation. In addition, a 10% reduction in available foreign tax credits applies for each failure to file Form 8858.
INFORMATION RETURN OF A 25% OWNED U.S. CORPORATION OR A FOREIGN CORPORATION ENGAGED IN A U.S. TRADE OR BUSINESS (FORM 5472):
U.S. corporations that have foreign ownership exceeding 25% or foreign corporations that are engaged in a U.S. trade or business are required to file Form 5472 if the aforementioned corporations engage in certain related party transactions during the tax year. A separate Form 5472 is required to be filed for each domestic or foreign related party with which the reporting corporation had a “reportable transaction” during the tax year. Form 5472 is required to be filed with the filer’s income tax return and is due on the date the income tax return is due. A $10,000 penalty applies for each failure to file and an additional $10,000 penalty applies for failure to maintain records.
INFORMATION RETURN OF U.S. PERSONS WITH RESPECT TO CERTAIN FOREIGN CORPORATIONS (FORM 5471):
While the IRS does not have jurisdiction over a foreign corporation that is not conducting business in the U.S., it does have jurisdiction over U.S. shareholders of that foreign corporation. A U.S. person who acquires or disposes of stock equal to either 10% of the vote or value of a foreign corporation must file Form 5471 to report the transaction. In addition, if the foreign corporation is a Controlled Foreign Corporation (U.S. shareholders own more than 50% of the vote or value of the corporation) then U.S. shareholders and certain U.S. officers and directors of the CFC must file Form 5471 to report information relating to the foreign corporation. If a taxpayer is required to file Form 5471 and does not do so, there is a $10,000 penalty per foreign corporation per year that the Form is not filed. There are additional penalties for failure to include certain schedules and for failure to properly complete the form. Two common areas of confusion we find are that U.S. officers and directors of a CFC are often not aware that they might have a Form 5471 filing requirement and shareholders who maintain a majority of the voting rights but don’t own a majority of the outstanding stock are not aware of their filing requirements.
INFORMATION RETURN BY A SHAREHOLDER OF A PASSIVE FOREIGN INVESTMENT COMPANY (FORM 8621):
If 75% or more of a foreign corporation’s gross income is passive income (i.e. interest, dividends, rents, royalties, etc.) or at least 50% of its assets held during the year are passive, the corporation is deemed to be a passive foreign investment company (“PFIC”). U.S. shareholders of a PFIC are subject to a harsh taxation regime on certain distributions from PFIC’s and on a gain realized on the disposition of PFIC shares. There are also elections out of the PFIC taxation regime by either treating the PFIC as pass-through entity or, if the PFIC is publicly traded, marking to market the stock of the PFIC each year. A U.S. shareholder of a PFIC must file a separate Form 8621 for each PFIC each year to report the stock they own, to make any of these elections (if applicable), and to report their earnings. Typically, U.S. partners in a partnership that owns PFIC stock must file Form 8621, although limited exceptions to filing apply in the case of U.S. partnerships. The IRS may impose penalties for not filing Form 8621. Unlike the rules discussed above for Form 5471, which defines a U.S. shareholder as one who owns at least 10% of the vote or value of a foreign corporation, there are no such ownership requirements under the PFIC rules and therefore the PFIC rules may apply to U.S. shareholders who own a negligible amount of stock.
RETURN BY A U.S. TRANSFEROR OF PROPERTY TO A FOREIGN CORPORATION (FORM 926):
When certain assets that were used in the U.S. are transferred overseas, it may create a taxable event for the U.S. transferor. In order to determine if this exists, the IRS requires Form 926 to be filed when assets are transferred to foreign corporations. If cash is the only property transferred, Form 926 is not required if less than $100,000 is transferred within a 12-month period, and immediately after the transfer the transferor owns less than 10% of the vote or value of the foreign corporation. It is important to note that if a partnership is the transferor, the U.S. partners of that partnership are responsible for individually filing Form 926. Also note that even if Form 5471 is completed to report the transfer, Form 926 is still required to be completed as well. The penalty for failure to file Form 926 is equal to 10% of the fair market value of the property transferred, limited to $100,000.
RETURN OF U.S. PERSONS WITH RESPECT TO CERTAIN FOREIGN PARTNERSHIPS (FORM 8865):
U.S. persons are taxed on their share of flow-through earnings from foreign partnerships. A U.S. person who either controls a foreign partnership or has at least a 10% interest in a foreign partnership that is controlled by U.S. persons each owning at least 10%, but less than 50%, will be required to file Form 8865. Form 8865 is also required of a U.S. person who contributes property to a foreign partnership in excess of $100,000 in a 12-month period or who owns 10% or more after the contribution. The rules also apply when a U.S. person indirectly owns an interest in a foreign partnership through their ownership of another entity, such as a U.S. partnership. There is a $10,000 penalty per foreign partnership per year for failure to file Form 8865. Additional penalties may be assessed for failure to complete the form properly or for omitting schedules.
For more information on foreign reporting requirements or our services, please contact us at firstname.lastname@example.org or (212) 245-5900.
Eric Swerdlow, CPA, MST is a Tax Manager who has been with FF&F for 10 years. He specializes in corporate and partnership taxation, with a strong background in consolidated corporations, business planning, provisions for income tax, international operations, foreign tax credits, partnership basis step-up and special allocations, fixed assets, and capitalization. Eric’s focus industries include shipping, transportation, oil and gas services, energy, and manufacturing and wholesale.
Hunter Norton, J.D.L., LL.M., CPA, is an accomplished Tax Director with FF&F. Prior to joining the firm, he spent 7 years as an attorney at Withers Bergman LLP, a tax-oriented law firm, and 8 years in the Tax practice with Deloitte. His areas of expertise include business and investment partnerships, cross-border tax matters, high net worth individuals, and family offices. Hunter’s experienc
e also allows him to advise clients in income tax matters related to trusts, estates and grantors, and taxable gifts, as well as estate planning.