Almost Everything About Form 8865 to Know (with Examples)

Form 8865 & Foreign Partnership Ownership

IRS Form 8858 with Examples 

IRS Form 8865 is a very important international information reporting form. It is required to be filed by U.S. persons who have an ownership interest in a foreign partnership. In many foreign countries, it is common to form a partnership instead of an entity to manage a business, oversee rental properties, or facilitate other specific types of joint ventures that would qualify as a partnership under U.S. tax law. IRS Form 8865 is comparable to Form 5471 (which is more common and used to report foreign corporations) but has its own set of tax requirements, complications, and headaches. For Taxpayers who are required to file Form 8865, it is important to understand which category of filer they qualify as, and whether they meet the threshold to file Form 8865 every year — or are they only required to file Form 8865 in some years (sometimes Form 8865 may be required in the initial year but the Taxpayer can file the less complicated IRS Form 8938 in subsequent years). Let’s look at Form 8865.

What is a Foreign Partnership?

In general, a partnership occurs when two or more persons work together to operate a trade or business, with each person contributing something of value to the partnership — such as property money, or skills. Many different types of relationships can qualify as a partnership, such as a joint venture, syndicate, or group. IRS Form 8865 makes it clear that just agreeing to co-own a property does not qualify the co-owners as partners — just as merely sharing expenses does not qualify as a partnership either. In addition, to make the partnership foreign, it requires that the partnership not be formed or organized under U.S. law.

• • • Example 1: Frank is a U.S. Citizen who forms a foreign partnership to operate a rental property business in a foreign country. Frank contributes money to the partnership and owns 25%.

    • Example 2: Jennifer, Maxine, and Lisa are Lawful Permanent Residents who join together to form a foreign partnership. They each contribute their skills to the partnership, resulting in each having a15% ownership of the foreign partnership. The foreign partners contribute money to the partnership, with a combined 55% ownership of the foreign partnership.

Who Has to File Form 8865?

There are several different categories of filers who may be required to file Form 8865. This is similar to how it works for Form 5471 as well, in that the different categories of filers have different filing requirements — and based on which specific category of filer(s) the U.S. Taxpayer qualifies as will determine which schedule the Taxpayer must file. For example, if a U.S. Person controls the foreign partnership (which means that they own more than 50% interest in the partnership) then the filer usually qualifies as a Category 1 filer and will have many different Form 8865 schedules to file. Meanwhile, if the Taxpayer qualifies as a Category 2 filer (owns 10% or more of the foreign partnership which is controlled by U.S. persons who each own 10% or more) they are required to file significantly fewer Form 8865 schedules. Essentially, the IRS wants individual Taxpayers who control the foreign partnership to report in more detail than partnerships with less ownership (and control).

• • • Example 1: In the current year, Peter is a U.S. citizen who contributes 12% into a foreign partnership. This Taxpayer may be categorized as a Category 3 filer since the foreign partnership is not controlled by US persons.

    • Example 2: Michelle is a U.S. citizen who has 62% ownership of a foreign partnership. Even though Michelle did not make any contributions in the current year, since she controlled the foreign partnership during the year, she may qualify as a Category 1 filer and complete several schedules as part of her Form 8865 filing.

What is Constructive Ownership for Form 8865?

Constructive ownership means a person does not directly own an interest in the partnership, but based on a relationship the Taxpayer has with one of the partners they are attributed ownership of the partnership. For example, when a family member owns an interest in a partnership, other family members may be considered owners as well. A very common example is where one spouse has a direct interest in a foreign partnership. Under the constructive ownership rules, the non-direct owner spouse may be attributed to an ownership in the foreign partnership for reporting purposes — only because the Taxpayer is married to one of the partners.

Constructive Ownership Exception

There are some exceptions to the reporting rules for certain Taxpayers who are only filing because they have constructive ownership. For example, Taxpayers who do not have a direct interest in the partnership may avoid filing Form 8865 — if they meet certain requirements — even though they have constructive ownership in the foreign partnership.

When is Form 8865 Due?

In general, Form 8865 is due when the tax filer’s tax return is due. If the Taxpayer files for an extension for their underlying tax return, then IRS Form 8865 goes on extension as well. Unlike some other international information reporting forms such as Form 3520-A, a Taxpayer is not required to file a separate extension on Form 7004 to extend the time for reporting a foreign partnership on Form 8865.

Civil and Criminal Penalties for Failing to File Form 8865

When a Taxpayer fails to file Form 8865, they may be subject to a $10,000 penalty for each tax year in which they fail to file. If the Taxpayer receives notice of the failure to file from the IRS and still does not file Form 8865, the Taxpayer may become subject to a continuing failure to file penalty — up to $50,000 for failure. In addition, if the Taxpayer does not file the form completely, it may result in a reduction of foreign tax credits available.  Finally, a Taxpayer may also be subject to criminal penalties — but it is important to note that the chance of the IRS pursuing criminal penalties for simply failing to file Form 8865 is rare. Typically, the IRS only pursues criminal penalties when there are other issues as well such as fraud, evasion, money laundering, etc.

Late Filing Penalties May Be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.