The U.S. Taxation of Foreign Corporations Owned by Taxpayers

Is 5471 Required for All US Persons with Foreign Corporations

A Foreign Corporation’s Filing Requirements

For individuals who have ownership of a foreign corporation, the US tax filing requirements and reporting rules have become extremely onerous and invasive. Even before the introduction of GILTI, the Form 5471 requirements coupled with the complexities of Subpart F income make foreign corporation reporting extremely complicated. And, trying to fit too much information into a single article or blog post may overwhelm the taxpayer (read: you) even more, which is not what we want to do. Instead, we have created a beginner’s guide used primarily for issue spotting to assist taxpayers in determining what issues they may have or what issues may arise involving their foreign corporations. Let’s look at some of the common issues to consider for U.S. taxpayers who own a foreign corporation.

Who has a U.S. Tax Requirement?

First, it is important to note that having to file US taxes and/or report a foreign corporation is not limited to only U.S. citizens who have ownership rights. Rather, it includes United States Citizens, Lawful Permanent Residents, and Foreign Nationals who meet the Substantial Presence Test.

Does the Foreign Entity Operate in the U.S.?

A key consideration of having ownership of a foreign company is to determine whether that foreign company conducts business in the United States. If the business conducts business in the United States, then it will be a much more comprehensive reporting and tax requirement than if it is a foreign company that operates outside of the United States only with non-U.S. clients.

What Type of Foreign Structure is it?

Different foreign countries have different types of structures available that taxpayers can use to create an entity. For example, in the United States, taxpayers would typically choose between an LLC, a partnership, a corporation, or an S-corporation. When it comes to reporting a foreign entity in the U.S., it is also important to determine how that structure will be perceived in the United States under US tax law. For some taxpayers, it may be better for them to try to disregard the entity depending on whether the corporation is earning significant income.

Should You Disregard the Entity?

Many foreign countries have LLC equivalents in which the taxpayer is taxed personally on the income and not the entity structure. But, just because the entity is disregarded in a foreign country does not mean it will receive disregarded entity treatment in the United States. To do so, it typically requires the filing of various forms such as 8832 and 8858.

*Noting, that not all foreign corporations can be disregarded.

Is it a Per Se Corporation?

The US government has a list of different foreign corporations that do not have the right to be disregarded. For example, a Sociedad Anonima — which is common throughout the different Latin American countries — is considered a per se corporation, even though oftentimes it is used for simple estate planning purposes. This means that even if the taxpayer prefers to disregard the entity they cannot do so. Another common example of a per se corporation is a Canadian corporation.

Is the Entity Actually a Trust for U.S. Tax Purposes?

It is important to note, that just because the taxpayer prefers the entity be considered a corporation for U.S. tax law does not mean that the US courts will agree with the Taxpayer’s determination — as was the situation in the recent case in Fairbank, the taxpayer was penalized heavily because they tried to report the company as a foreign corporation instead of a foreign trust and Forms 3520 and 3520-A were not filed which led to significant fines and penalties. 

A CFC or Non-CFC?

One of the biggest concerns for taxpayers who have ownership or interest in a foreign corporation is whether that corporation is considered a controlled foreign corporation. For a corporation to be considered a controlled foreign corporation, it means that the corporation is owned more than 50% by US shareholders. If the company is considered a controlled foreign corporation then there are various other acronyms that the taxpayer must become familiar with, such as GILTI and FDII — along with Subpart F income, section 965, and the section 962 election.

Subpart F (CFC)

The concept behind Subpart F income is the idea that about 50 years ago when the tax rates were much higher in the United States than they are now, many taxpayers hightailed it to foreign countries to avoid U.S. tax. They did not receive a salary but instead received loans from the company and then the loans were forgiven. This increased the tax gap in the United States exponentially and so the United States developed Subpart F income to try to require taxpayers with ownership of certain controlled foreign corporations to pay tax on their ratable share of earnings in any year that generated a positive earning and profit even if that income was not technically distributed.

GILTI (Global Intangible Low-Taxed Income)

GILTI (Global Intangible Low Taxed Income) is a relatively new law that requires certain previously untaxed income sitting in foreign corporations to be taxed — even though the money has not been distributed and even though it is not Subpart F income. It is extremely unfair to taxpayers, especially those who do not have high assets but rather service corporations such as medical professionals who may have many years of saved-up untaxed income that they would use toward retirement. Some various elections and deductions can be made, but still,  for any taxpayer who is under the impression that none of this income would be taxable until it was distributed — and who has no foreign tax credits to offset the US tax liability — it comes as an unwelcome tax surprise.

962 Election

Taxpayers who may become subject to GILTI may make a Section 962 election to be treated as domestic shareholders and allow certain deductions as well as foreign tax credits to be applied to any potential tax liability. Individual shareholders can claim the election as well even though they are not considered a corporation.

Distributions Taxable (CFC vs Non-CFC)

When a person owns a foreign corporation, it is important to determine controlled foreign corporation status to determine whether there is any taxable income. For taxpayers who do not have a controlled foreign corporation, generally do not have to pay tax on the income unless it was distributed to them. Conversely, for taxpayers who have ownership of a controlled foreign corporation even if income was not technically distributed to them they may be taxed in accordance with the Subpart F rules and GILTI.

Foreign Tax Credits

Taxpayers who may have already paid corporate taxes in the foreign country or individual income taxes on income that was distributed to them may be able to claim foreign tax credits on Forms 1116 and 1118. The former is for individual foreign tax credits and the latter is for corporate tax credits. When it comes to GILTI, the former tax credits are considered a separate bucket and there are some limitations in taking the credits and trying to carry unused credits over the year to the next

PFIC/CFC

With all this talk about CFC, it is important to note that there is another type of foreign corporation referred to as a PFIC or a Passive Foreign Investment Company. This is different than a passive foreign holding company (26 USC 552) and primarily deals with individual taxpayers when they have foreign holding companies, foreign mutual funds, or foreign ETFs. Taxpayers who have PFIC may qualify to make certain elections such as the Mark-To-Market Election (MTM) or Qualified Electing Fund (QEF). Likewise, a single company may be both a CFC and PFIC, which leads to crossover issues — and as you may have guessed even more complications. Some owners of PFIC may become subject to excess distributions if they do not make timely elections (income tax at the highest tax bracket available instead of LTCG or QD tax treatment). Still, they may be able to make a late purging election but that requires a purging of the taint — which typically results in a significant tax liability. Taxpayers may try to make a reasonable cause for late filing to avoid the purging taint implication, but it is very difficult and the reasonable cause requirements for this type of submission are very strict.

Section 965 and Moore

Taxpayers who have foreign corporations and previously untaxed, undistributed income may be subject to a one-time repatriation act tax. This was required for 2017 or 2018 depending on the tax year. The IRS has increased enforcement of 965 non-compliance — and even created an enforcement directive to go after taxpayers who have not properly reported this income. Likewise, taxpayers who want to submit to the Streamlined Procedures are required to include the 965 if they did not do so timely and they are not entitled to the eight-year, interest-free payment schedule.

It is important to note, that there is currently a case at the Supreme Court (Moore) challenging the legitimacy of this statute.

Form 5471

Onto the reporting requirements of having a foreign corporation.

Form 5471 is used when a taxpayer falls into one of five different categories of filers. Depending on the specific category of filer, the reporting may be an only one- or two-time ordeal or it may be an ongoing annual requirement. And, depending on the cross-section of the income within the company will determine how complicated the Form 5471 filing is, which schedules need to be included, in which calculations are required.

Late 5471 Filing and Farhy

When it comes to late filing international reporting forms, the IRS loves to issue automatically assessed penalties. But a recent case ruling in the tax court may limit their ability to do so. In Farhy, the Tax Court said that the way that the Form 5471 statute was written, the IRS does not have the right to issue accessible penalties at this time. The IRS signaled that they have every intent to appeal this ruling.

Form 8858/8832

Taxpayers who are considering disregarding the foreign entity to try to avoid the Form 5471 reporting requirement may have to file Form 8858 and Form 8832 (election). There may be some timing issues for late elections so taxpayers should be cognizant of these rules. As mentioned before, there may also be issues with per se corporations that cannot be disregarded.

Form 8938

If the taxpayer is not required to file a Form 5471 because they do not meet the categories of filers necessary to have to file the 5471 Form – but are required to file a Form 8938 because of the total value of their ownership of foreign assets — then the foreign company is reported on Form 8938 instead. Taxpayers will be relieved to learn that Form 8938 is much simpler than Form 5471.

Closing the Foreign Company (Under 10%)

If in any year the taxpayer’s ownership of a foreign corporation dips below 10% may mean that they are also required to file a Form 5471 in that year unless an exception, exclusion, or limitation applies.

FBAR Signature Authority or Ownership

Just owning a foreign corporation does not require a person to file an FBAR. However, many taxpayers may have signature authority over accounts owned by the business, which then would require the taxpayer to include the accounts on their FBAR involving the signature authority. For smaller corporations, the taxpayer may have ownership of foreign corporations in their name which is used by the corporation but still in their name, so this too would be filed on the FBAR.

Foreign Person with U.S Corporation is Different

Finally, for foreign persons who have an ownership or interest in U.S. companies, different reporting requirements may be needed and one of the main forms that they will have to file is Form 5472. This includes foreign persons who have ownership of U.S. disregarded entities. The penalties for Form 5472 are double the penalties for Form 5471.

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. 

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.