Family Attribution and Constructive Ownership for Form 5471 & CFC
Contents
Family Attribution & Constructive Ownership
Form 5471 Family Attribution & Constructive Ownership: While IRS Form 5471 is a difficult form to begin with, the family attribution and constructive ownership rules make it even more complicated. The concept of Family Attribution is the idea that when certain family members (individuals or other related business) own shares in a business, the ownership interest is attributed to the other family member. The other family member does not have direct ownership, but rather indirect or constructive ownership of the entity.
We will summarize the basic concepts of constructive ownership and attribution for a U.S. Person, as it impacts ownership in a foreign corporation and annual filing of Form 5471.
Constructive Ownership & Attribution
When a person has attribution, but neither has direct ownership shares and/or less than 10% direct shares, do they still have to file the form 5471?
Maybe.
Example of Family Attribution
Let’s assume for the moment that the individual contemplating filing a 5471 for in this particular situation does not own any direct shares of the Foreign Entity.
But, his family members own shares – upwards of 90% – as it is a family business located in a foreign country.
For example, Darren is originally from Hong Kong but now resides in the United States.
His parents own a company in Hong Kong, of which they own 90%.
Darren does not own any direct portion of the company. Even though Darren does not own any portion of the company, under IRS rules he may be considered a constructive owner through attribution.
In other words, even though Darren does not have actual ownership of any shares, he is considered to have “constructive” ownership of the shares that are attributed to him through family members.
What is Attribution?
Attribution means a person has ownership of something as a result of being related to another person – usually a relationship such as a spouse, sibling or parent (or subsidiary, sister or brother corporation).
The main reason behind it, is to avoid hiding income and other tax purposes.
The typical situation is designating one spouse or family member as the 100% owner of the foreign business, which the other spouse or other family members are actually benefiting or operating – but avoiding any reporting or income tax related issues because they do not have actual ownership.
1.958-2 Constructive ownership of stock.
(1 ) In general. Except as provided in subparagraph (3) of this paragraph, an individual shall be considered as owning the stock owned, directly or indirectly, by or for –
– His spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance); and (ii) His children, grandchildren, and parents.
(2) Effect of adoption. For purposes of subparagraph (1)(ii) of this paragraph, a legally adopted child of an individual shall be treated as a child of such individual by blood.
(3) Stock owned by nonresident alien individual. For purposes of this paragraph, stock owned by a nonresident alien individual (other than a foreign trust or foreign estate) shall not be considered as owned by a United States citizen or a resident alien individual.
**However, this limitation does not apply for purposes of determining whether the stock of a domestic corporation is owned or considered as owned by a United States shareholder under section 956(b)(2) and § 1.956-2(b)(1)(viii). See section 958(b)(1).
Family Attribution
If the constructive ownership of stock of a family member involves the spouse, children, grandchildren, and parents, the other family members are attributed ownership.
Non-Resident Alient Exception to Family Attribution
An important limitation is that if the stock is owned by a nonresident alien, it should not be considered owned by a US citizen or resident Alien.
In other words, if the stock is owned by a nonresident alien individual that will not be attributed to a US person for that US person to determine whether they have constructive ownership.
What is a CFC?
A CFC is a controlled foreign corporation. Oftentimes, the catalyst for Family Attribution and Constructive Ownership is interest in a CFC entity.
Form 5471
Unfortunately, unlike this code section and accompanying regulations which are general — Form 5471 is more specific.
When dealing with form 5471, it provides that individuals (scoring categories 3,4, or 5) must file a form 5471 when they have constructive ownership, unless they meet all these requirements
- The U.S. person does not own a direct interest in the foreign corporation,
- The U.S. person is required to furnish the information requested solely because of constructive ownership (as determined under Regulations section 1.958-2, 1.6038-2(c), or 1.6046-1(i)) from another U.S. person, and
- The U.S. person through, which the indirect shareholder constructively owns an interest in the foreign corporation files Form 5471 to report all of the required information.
Let’s review the elements under 5471:
The U.S. Person Does Not Own a Direct Interest in the Foreign Corporation
Assuming that the person has attribution with another US person which would otherwise require filing form 5471, if the potential filer does not have any direct ownership in the foreign corporation, then he or she has met prong one.
The U.S. Person is Required to File Solely Because of Constructive Ownership
Building upon prong 1, the IRS goes on to say that if the person does not have any other independent need to file form 5471 beyond the mere fact that they have constructive ownership through attribution, then they do not have to file.
This can get a bit confusing, because it presumes that if a person has very minor direct ownership (not sufficient to file a Form 5471) but has constructive ownership sufficient to file, then the person has to file. Thus, as a result, even minimal or fractional ownership, when combined with constructive ownership may require a person to file — which does not seem to follow the spirit of the intended exception.
The U.S. Person Through, Which There is Constructive Ownership Files Form 5471
All this means, is that the person of which are filing has attribution/constructive ownership group must file a form 5471. Something else to keep in mind, is typically only one 5471 must be filed per Corporation (although typically all US persons seem to want to file their own form 5471).
Under this particular exclusion, it would still require the person of which there is attribution/constructive ownership through to file a form 5471 – even if another form 5471 for the same corporation had already been filed by another person.
IRS Offshore Voluntary Compliance
If you are considering getting into IRS offshore compliance through voluntary disclosure, this gives you a glimpse into how hard it can actually get. It is important to use an experienced offshore disclosure attorney to bring you into compliance.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance.