U.S. citizens and U.S. residents who are officers, directors or shareholders in certain foreign corporations are responsible for filing Form 5471.
Form 5471 Filing
Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is in an information return that must be filed by U.S. citizens and U.S. residents who are officers, directors or shareholders in certain foreign corporations to report the activity of the foreign corporation. Although it is only an information return, accurate completion is essential as it is an important IRS tool for determining companies that need to be audited or are subject to Subpart F income.
Form 5471 Filing Requirements
The filing requirements for Form 5471 relate to persons who have a certain level of control in certain foreign corporations. Form 5471 is a filing requirement in the following situations:
- U.S. person becomes a director or officer of a foreign corporation
- U.S. person acquires an ownership interest in a foreign corporation in excess of the prescribed limits
- U.S. person disposes of stock in a foreign corporation that reduces his or her interest in the foreign corporation to less than the prescribed limits
- U.S. person is in control of a foreign corporation for an uninterrupted period of at least 30 days in a year
- U.S. person is a 10 percent or more shareholder in a foreign corporation that is a “controlled foreign corporation” for an uninterrupted period of at least 30 days in a year and that person owns that stock on the last day of the year.
In determining the ownership interest, the complex rules of direct, indirect and constructive ownership come in to play as well. Not only that, the category of filers can get confusing. The categories can determine which schedules, statements and/or other information should be part of the Form 5471 filing. To say that the Form 5471 filing instructions are complex and difficult to understand would be an understatement.
The form and attached schedules are used to satisfy the reporting requirements of transactions between foreign corporations and U.S. persons under sections 6038 and 6046 of the Internal Revenue Code. Substantial penalties exist for U.S. citizens and U.S. residents who are liable for filing Form 5471 and who failed to do so.
What if my foreign corporation had no activity during the year?
Unfortunately, there is no exception that will exclude you from having to file Form 5471 if you fall into one of the categories mentioned above. The IRS has not set any income or asset thresholds for having to file Form 5471.
Substantial Compliance or Substantial Penalty
Penalties under sections 6038, 6038A and 6046 may still apply if the filer does not submit a substantially complete return. The IRS has not included a definition of “substantial compliance” in the instructions of Form 5471 or the Code, making it rather difficult for taxpayers to determine if their filing will comply. Luckily, the IRS has given some guidance on the meaning of substantially complete with reference to international information return penalties. Certain obvious errors on Form 5471 will cause the return to be substantially incomplete:
- Omitting the Entity Identification Number (EIN) or Reference ID
- Failure to complete the category of filer section correctly (Item B)
- Omitting the name and address of the foreign corporation
- Failure to complete the total percentage of stock owned correctly (Item C)
- Failure to file any required additional schedule (e.g. schedules J, M or O)
Other than obvious errors, the IRS can deem the return to be substantially incomplete, based on various factors. Such factors include the balance sheet and income statements not being in accordance with U.S. GAAP, the extent of erroneous transactions reported, the significance of such under or over-reporting, and not providing required amounts in both functional and U.S. currencies.
As a result, taxpayers need to ensure that Form 5471 submissions are as complete and accurate as possible, or potentially face significant penalties.
Tax Jobs and Cuts Act of 2017
The Tax Jobs and Cuts Act of 2017, signed into law on December 22nd, 2017 by President Donald Trump has significant implications for those who own foreign corporations, particularly those with smaller businesses. The new law calls for a repatriation of accumulated earnings held in certain specified corporations and is effective for the last taxable year before January 1st, 2018. A specified foreign corporation is any controlled foreign corporation or a foreign corporation in which a U.S. shareholder owns 10 percent or more of the voting stock.
U.S. shareholders that are in this category must include, in addition to Subpart F income, their pro rata share of accumulated post-1986 foreign earnings on their tax return. The income is subject to an 8 percent or 15.5 percent tax, depending on how the earnings are retained. Earnings being retained as cash or equivalents are subject to the higher 15.5 percent rate, while all other undistributed earnings are subject to the 8 percent rate.
Those who have structured their foreign company in a way so that the foreign corporation is owned by a U.S. corporation can potentially benefit from the new legislation. This is mostly because the legislation favors larger multinational corporations and encourages them to repatriate foreign earnings. For the majority of taxpayers, their foreign corporation is owned by themselves or other individuals.
For those individuals, the law includes a provision that allows the taxpayer to elect to pay the liability in eight installments, rather than in one lump sum. The installment payments can be broken down as follows:
- I. 8 percent of the net tax liability in the case of each of the first five of such installments
- II. 15 percent of the net tax liability in the case of the sixth such installment
- III. 20 percent of the net tax liability in the case of the seventh such installment
- IV. 25 percent of the net tax liability in the case of the eighth such installment
If electing to pay the liability in installments, the taxpayer must make the first installment payment by the due date of their return, without the consideration for any extensions of time for filing the return. Each subsequent installment is due on the due date of the following year’s tax return. Earnings that were already subject to tax can be distributed in the future tax-free.
Global Intangible Low-Taxed Income and Subpart F
Effective for tax years after December 31st, 2017, shareholders of controlled foreign corporations will now have to include their share of income deemed as global intangible low-taxed income on their return. For the purposes of Section 951, the term “global intangible low-taxed income” is the excess of a shareholder’s net tested income from a controlled foreign corporation over the net deemed tangible income for the year. Net tested income is generally considered to be the controlled foreign corporation’s gross income, not including Subpart F income, foreign oil and gas extraction income, and income subject to U.S. tax as effectively connected income. Net deemed tangible income is the excess of 10 percent of the aggregate of such shareholder’s pro rata share of the qualified business asset investment of each controlled foreign corporation, over the amount of interest expense taken into account in determining the shareholder’s net CFC tested income.
Certain rules associated with Subpart Fm as it relates to controlled foreign corporations, were also changed in the Tax Cuts and Jobs Act. The definition of a U.S. shareholder under the pre-act law only included individuals that own 10 percent or more of the voting stock of a foreign corporation. The new definition for tax years after 2017 now includes U.S. shareholders who own 10 percent or more of voting stock or the total value of the foreign corporation’s stock. Further, the new legislation eliminates the 30-day requirement in regard to controlled foreign corporations. Prior to the Act, U.S. shareholders of foreign corporations would have to include Subpart F income on their return if the foreign corporation was adeemed a controlled foreign corporation for at least30 consecutive days during a taxable year.
As a result of the changes from recent legislation, owners of foreign corporations should consider seeking advice from a professional U.S. tax preparer with expertise in this area. Tax Samaritan is here to help guide you through the complex reporting requirements. Get started today with a Free Tax Quote.
Read more about the Tax Jobs and Cuts Act of 2017.
Subpart F Income
This type of income is defined as movable, commonly passive income, such as dividends, interest, rent, and royalties. Subpart F aims to curb foreign corporations from deferring U.S. income tax on these types income. The general assumption is that the movable income is not directly related to business activities in the foreign corporation’s country of incorporation. Subpart F does not tax the foreign corporation, rather the shareholder is required to include their portion of Subpart F income on their tax return. The provisions of Subpart F are complicated and contain numerous general rules, special rules, definitions, exceptions, exclusions and limitations, which require careful consideration.
What if I do not have Subpart F Income?
Many taxpayers may erroneously conclude that Form 5471 is not required if they are not required to report Subpart F Income. Form 5471 is still required whether or not the foreign corporation had Subpart F income. In general, there are not very many exceptions that will exclude the requirement to file Form 5471 if you fall into one of the filing categories.
Form 5471 Filing Deadline
The Form 5471 filing is an attachment to your individual income tax return should be filed by the due date (including extensions) for that return.
IRS Form 5471 Penalties
Penalties for the failure to file a Form 5471 can be very steep, and it’s an important form to file because, if you fail to file the form and were required to file the form, you can be subject to a substantial penalty $10,000 or more for each year.
Additional penalties of up to $50,000 are charged for instances of continued failure. Any person who fails to file or report all of the information required within the time prescribed will be subject to a reduction of 10 percent of the foreign taxes available for credit. Continued cases of failure are also subject to additional reductions. In addition, criminal penalties may also apply for failure to file the requisite information. If you are directly or indirectly involved in a foreign corporation in any of the ways discussed above, we advise you to contact us to determine if you have any filing obligations.
Last but not least, if the form is not filed, your Form 1040 would be considered to be non-filed by the IRS leaving your individual return open for audit and penalties indefinitely. This is a dream come true for the IRS.
Corporate Owned Foreign Bank Accounts
Many owners of foreign corporations do not realize the additional reporting requirements that result if their foreign corporation owns foreign financial accounts. The Report of Foreign Bank and Financial Accounts (FBAR) requires taxpayers to report a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trusts or other type of foreign financial account. This includes accounts owned by the foreign corporation, in which the taxpayer has control over. These financial accounts should be considered when determining whether or not the taxpayer has an FBAR filing requirement. United States persons are required to file the FBAR if the aggregate value of all foreign financial accounts exceed $10,000 at any time during the calendar year.
Form 5471 Filing Instructions
The instructions to Form 5471 state that it could take over 32 hours to complete this form. The form requires that you supply the IRS with the corporation’s income statement, balance sheet and data on its loans, operations and other shareholders. It also requires information on dividends and managerial payments made to shareholders, officers and directors.
The financial information must be presented using U.S. generally accepted accounting principles (U.S. GAAP), which generally differ from those used to produce foreign financial statements. So, there is some work required in converting financial statements to the required format.
If you own part or all of a foreign corporation, and have not done your form 5471 filing, you should start filing it immediately to avoid the $10,000 penalty. While in the past, it has been difficult to secure ownership information on foreign corporations, in the future, it will become easier. The IRS is actively involved in securing more information of U.S. citizens’ finances overseas through FATCA and other methods, and will only increase its efforts in the future. And, of course, there are many US-Foreign Country tax treaties that provide for complete cooperation between the two nations with respect to the exchange of tax information on citizens domiciled in each.
For more information about the Foreign Corporation information return, please read more in the IRS instructions for the Form 5471.
Options to Get Into Compliance
Owners of foreign corporations who have a requirement to file Form 5471 should not hesitate to come into compliance. In general, there are a few options available to taxpayers depending on the circumstances of their situation.
Streamlined Filing Compliance Procedure
One of the more popular programs, the Streamlined Filing Compliance Procedure, allows taxpayers to come into compliance, resolve their tax obligations and file delinquent or amended returns through one procedure. It is available to taxpayers that live in the U.S. or in a foreign country. The program allows taxpayers to come into compliance by filing the last three years of delinquent or amended returns, and six years of delinquent or amended FBAR reports. To qualify, you must meet the following criteria:
- Taxpayers must certify that conduct was not willful
- IRS has not initiated a civil examination of taxpayer’s returns for any taxable year
- Taxpayers eligible to use streamlined procedures who have previously filed delinquent or amended returns must pay previous penalty assessments
- Taxpayers who want to participate in the streamlined procedures need a valid Taxpayer Identification Number
Tax returns submitted under either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures will be processed like any other return submitted to the IRS. Returns submitted under either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures will not be subject to IRS audit automatically, but they may be selected for audit under the existing audit selection processes applicable to any U. S. tax return, and may also be subject to verification procedures in that the accuracy and completeness of submissions may be checked against information received from banks, financial advisors and other sources.
Offshore Voluntary Disclosure Program
The Offshore Voluntary Disclosure Program (OVDP) is a voluntary disclosure program specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report foreign financial assets and pay all tax due in respect of those assets. The IRS began an open-ended OVDP in January 2012 and may end the 2012 program at any time in the future. In general, the main requirement is that the individual or entity entering into the program is not under any IRS examination.
The OVDP submission should include the previous eight years of amended or delinquent tax return filings, previous eight years of FBAR (FinCEN Report 114) reports, penalty computation worksheet and various other documents necessary to be included. Taxpayers are required to pay any additional tax liability and interest for the previous eight years. The taxpayer must also pay a 20 percent penalty on the amount of unpaid tax. Each unreported account for each of the eight years will receive a maximum penalty of 27.5 percent. The maximum value for each year can be computed by aggregating the highest balance of each account during the year. A 50 percent penalty is imposed if any of the accounts are held in an institution on the list of “Foreign Financial Institutions and Facilitators” published by the IRS.
Taxpayers holding undisclosed foreign accounts and assets, including those held through undisclosed foreign entities, should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties, and generally eliminate the risk of criminal prosecution for all issues relating to tax noncompliance and failing to file FBARs. Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of significant penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution. The IRS remains actively engaged in identifying those with undisclosed foreign financial accounts and assets.
Statement of Reasonable Cause
This option is available to taxpayers who do not need to use the Offshore Voluntary Disclosure Program or the Streamlined Filing Compliance Procedures but do need to file delinquent or amended tax returns for failure to include international information forms (e.g. 5471, 3520, 3520A). Taxpayers must have reasonable cause for not filing the information returns, not be under civil examination or criminal investigation by the IRS, and not be in contact with the IRS about the delinquent information returns.
Submitted returns under regular procedures must have an attached statement of reasonable cause. In the statement of reasonable cause, the taxpayers must certify that any entity for which the information returns are being filed were not engaged tax evasion along with all other relevant facts that establish reasonable cause. Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.
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Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog, where Enrolled Agents write all of the articles. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. We design our articles to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.
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Randall Brody is an enrolled agent, licensed by the U.S. Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation. They must also fulfill continuing education credits and adhere to a stringent code of ethics.
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