By Bethany Bouw, CPA
The fact that there are filing requirements to disclose foreign businesses often come as a surprise to many taxpayers. If you are familiar with the basics of international business, you may know this is true of foreign corporations. The same goes for partnerships, sole proprietors, other foreign disregarded entities and more. In many cases, taxpayers assume that if they keep most aspects of their business abroad, that the IRS will have no interest in them. Unfortunately, they are incorrect.
Even if you organize the business abroad, did all the work abroad, and kept the profits abroad – the IRS will still care greatly about your entity. It is best to have a basic understanding of the lesser known forms and reporting requirements to ensure you do not get caught in thinking the IRS has no authority over your businesses. Specifically, taxpayers tend to overlook Form 8865 (Foreign Partnerships) and Form 8858 (Foreign Disregarded Entities).
Foreign Partnerships – Form 8865:
- Make sure you have determined what the default treatment of the foreign entity is – Form 8832 has instructions about how to determine the default treatment of a foreign entity. Some entities are “per se” corporations based on the entity type and, therefore, are not eligible for the IRS to treat as a different entity type. Hence, it is important to reach out to a qualified tax professional when organizing to make sure you do tax planning with regards to entity type and that you make elections in a timely manner.
- Form 8865 often reports:
- Controlled foreign partnerships
- Transfers to foreign partnerships
- Acquisitions/changes/dispositions of foreign partnership interests
- Consider all the categories for filing as there are multiple you could qualify for – Filers could fall into multiple categories, with each category having different filing requirements for the various schedules. When reading the instructions, do not just stop at the first category that fits your situation. It is possible to meet the definition for multiple categories and you do not want to miss a required form.
- Where to file – File with your income tax return by the income tax return’s due date. File it separately, however, if you do not have a required income tax return using the date/location you would have if you had been required to file an income tax return.
- Penalties– Like most foreign related informational filings, the penalties are steep and can escalate quickly. If a category 1 or 2 filer does not file the information required, there is an automatic penalty of $10,000. Please note that both time and completeness are factors here. It does not allow for timely filing an incomplete form to game the system. In other words, you should file your forms both on time and complete. The penalties, furthermore, can be even greater if there are issues for category 3 or 4 filers.
Foreign Disregarded Entities – Form 8858
- Again, make sure you have determined the default treatment of the entity and if elections need to be made. There is a means of late relief should you require it. However, you do need to be eligible for such relief.
- The IRS may require Form 8856 even if a person owns a foreign disregarded entity (FDE) indirectly or constructively. Generally, the IRS requires this form if the taxpayer has a controlled foreign corporation (CFC) or controlled foreign partnership (CFP) that is an FDE tax owner. Many times, those with a foreign business set up different tiers of entities for various reasons (taxation, liability, members). As a result, this can lead to tiered ownership that might feature a CFC owning a FDE.
- Line 5 page 1 requires an organizational chart to show specific relationships and information about those relationships. Such a chart needs to include:
- The chain of ownership between the tax owner and the FDE, AND
- The chain of ownership between the FDE and all entities that the FDE has a 10% or greater interest in. To properly complete the chart, the taxpayer needs to have information on names, percentages, entity classifications, and countries.
- Where to file – File with your income tax return or related information return (such as Form 5471 or Form 8865) by that return’s due date. Do not file Form 8858 separately.
- Penalties? Similar to Form 8865, the penalties are steep and can escalate quickly. Timeliness and completeness are major factors related to the penalties. There is an automatic penalty of $10,000 which can increase to $50,000 if the failure continues after notification of delinquency by the IRS. Additionally, there can even be criminal penalties that come into play regarding this form.
The IRS may require additional forms related to foreign entities. Some forms not listed in this article may still apply given individual taxpayer’s situations. Please check out Ryan & Wetmore’s list of major international tax forms (this list is not all-inclusive and is ongoing). For many of the foreign forms, the statute for the year may not start running if there was an incomplete or unfiled required form. For this reason, it is very important to engage qualified tax professionals to assist with these forms.
The International Tax Team
The International Tax Team at Ryan & Wetmore is well-versed in foreign informational filings. For questions or concerns regarding your international accounts and assets, click here to email our foreign tax team. Please be aware that tax issues are very complex and may vary based on the details of your situation. For this reason, we generally require an initial phone call to obtain the facts and address the questions.
Bethany Bouw CPA, is a manager at Ryan & Wetmore and has been with the firm for over eight years. She has experience with offshore voluntary compliance and assisting taxpayers with foreign asset and entity reporting requirements.
Traci Getz CPA, is a partner with Ryan & Wetmore, P.C. Traci has over fifteen years of experience providing accounting, tax, and consulting services to small and medium-sized business owners. She works with clients to understand their accounting and tax issues while specializing in international tax, healthcare, and construction.
Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who is knowledgeable all pertinent facts relevant to your particular situation.
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