U.S Tax Challenges of Foreign Personal Holding Entities

U.S Tax Challenges of Foreign Personal Holding Companies

U.S Tax Challenges of Foreign Personal Holding Companies

Depending on which country a U.S. Taxpayer wants to acquire investments in, it may benefit the Taxpayer to form a holding company to oversee the investments. This may help protect the assets if the Taxpayer is sued or involved in litigation. Unfortunately, from a U.S. tax perspective, forming a foreign personal holding company can have several unintended tax and reporting consequences. Especially with the introduction of the Tax Cuts and Jobs Act (TCJA), U.S. Taxpayers who previously may have kept income sheltered overseas may become subject to tax on that income –even if it is not so part of income — in the year it is generated and not simply in the year it is distributed. In addition, there are harsh corporate rules in the United States that may limit a Taxpayer’s ability to disregard a foreign entity. Let’s look at some of the common foreign personal holding company tax challenges for U.S. persons who want to create foreign companies.

Per Se Corporation

One of the first complications a Taxpayer must consider is that certain foreign corporations cannot be disregarded for U.S. tax purposes. For example, it is common for a U.S. person to form a single-member LLC (SMLLC) in the United States but only have to file a Schedule C and not any corporate tax forms. The U.S. government limits which foreign entities a Taxpayer may disregard. For example, if the Taxpayer forms a Canadian corporation or a Sociedad Anonima then the Taxpayer is unable to disregard these entities and thus may be subject to unexpected U.S. tax and reporting.

CFC

Oftentimes, personal holding companies will consist of just one person or two family members operating together, managing their foreign investments. In a situation in which U.S. persons own more than 50% of the foreign corporation and each shareholder owns at least 10% (attribution and constructive ownership rules apply), the company will be considered a controlled foreign corporation. As a controlled foreign corporation, the Taxpayer may have to file a Form 5471 each year in addition to several additional schedules as well as include certain undistributed income as taxable income even though the Taxpayer has not received that income yet.

GILTI

GILTI refers to Global Intangible Low Tax Income. If a U.S. Taxpayer has ownership of a controlled foreign corporation, then they may become subject to GILTI. Unfortunately, in practice, GILTI is all-encompassing and not limited to the terminology used to define this acronym.

Form 5471

Form 5471 is used to report foreign corporations. There are multiple categories of filers, and the Taxpayer may qualify under multiple categories to have to report to the US government on this form. When the foreign corporation is a controlled foreign corporation then there is an extensive amount of reporting, and it is required each year as opposed to other categories of filers which are only required in a year in which for example the Taxpayer may acquire 10% ownership. Form 5471 is not for the faint of heart, so Taxpayers who may have an otherwise simplified tax return should review the form before considering whether or not they want to form a foreign personal holding corporation and what the fees would be to hire a firm to manage that annual filing requirement.

Form 926

When a U.S. Taxpayer forms a foreign corporation and they want to make transfers to that foreign corporation, they may have to file a Form 926 in addition to Form 5471. Form 926 is used to describe certain transactions in which the U.S. owner is transferring money and other assets to a foreign corporation. The IRS requires these forms to be filed to ensure Taxpayers are not circumventing any U.S. tax rules and that the IRS is not missing out on any income.

PFIC

Another common issue is that the foreign corporation may be considered a Passive Foreign Investment Company. When the foreign investment is a Passive Foreign Investment Company then there may be significant reporting on Form 8621 as well as very harsh income tax implications because the income is taxed at a much higher tax rate than its domestic counterpart. Whereas oftentimes qualified dividends in the United States may be taxed at a 15 or 20% tax rate, most dividends and other distributions from a PFIC will be taxed at the highest tax rate available for most years in addition to interest.  There are specific CFC and PFIC crossover rules to consider as well.

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.