Foreign Business Reporting & U.S. Tax – 10 Basic Facts to Know
- 1 Foreign Business Reporting & U.S. Tax
- 2 Is it a Controlled Foreign Corporation?
- 3 Do You Have Subpart F Income?
- 4 PFIC
- 5 Schedule B
- 6 FBAR
- 7 Form 8938 (FATCA)
- 8 Form 5471
- 9 Foreign Retirement
- 10 Per Se Corporations
- 11 I am out of Compliance, What do I do?
Foreign Business Reporting & U.S. Tax
Reporting Foreign Businesses & U.S. Taxes are complicated issues – and we’re here to help!
Whether it is because you started your own business, or invested in another business — business can be very exciting. With that said, there are very specific tax laws, rules, and nuances that come into play when a person has an interest in, or ownership of a business.
These rules are amplified when the business involves a foreign, offshore or overseas business. Whether it is because the business is located outside of the United States, and/or the business generates U.S. and/or Foreign based source income — issues involving foreign business can be unnecessarily complex and burdensome.
Is it a Controlled Foreign Corporation?
One of the most important preliminary issues is to determine whether the foreign corporation is a . If it is a Controlled Foreign Corporation that means more than 50% of the foreign business is owned by US persons who each own at least 10% of the foreign business (attribution rules apply).
If it is a Controlled Foreign Corporation, then it is subject to very strict rules and regulations in accordance with subpart F and other related laws. From a basic tax standpoint, the idea is that the IRS wants to prevent you from hoarding passive monies in a foreign businesses that are otherwise owned in majority by US persons, and would be presently taxable if the money was located in the United States.
If you have a Controlled Foreign Corporation, and this is the first you are hearing about it, it is very important to speak with an attorney to better understand the ramifications and reporting requirements of your Controlled Foreign Corporation.
Do You Have Subpart F Income?
Even if it is a Controlled Foreign Corporation, that does not mean all of the income being earned abroad by the business is immediately taxable. But, it does mean that any prorated subpart F income in any year in which you had current Earnings and Profit (E&P) may be immediately taxable, even if it is not distributed.
The concept is again, that the IRS does not want you to hide passive income abroad. If you do, the IRS is going to penalize you and they can do so heavily – especially if the IRS determines that your foreign business is a
Typically, these are companies that are foreign holding corporations or other businesses that may or may not conduct any business aside from earning passive income.
For example, if you own a BVI that holds 10 different mutual funds and other types of trading funds, in addition to conducting active business – then you are probably going to have subpart F income on matters involving your passive earnings.
As with any IRS rule, exemptions and exclusions to apply.
A PFIC is a Passive Foreign Investment Company. Typically, unless your PFIC has made the necessary election, chances are your foreign PFIC is going to be taxed so heavily, that it should be considered a penalty.
The IRS truly despises the PFIC. That is because the IRS does not want you to shelter passive income that would ordinarily be taxed in the United States, into one of these offshore investment companies.
Here’s a basic example: Steve owns a foreign mutual fund (yes, foreign mutual funds are almost by default considered to be a PFIC). Steve’s initial investment into the fund was $100,000 and five years later it is worth $200,000. It miraculously earned $20,000 a year in passive income that was never distributed.
In a US version of the mutual fund, oftentimes the fund will have to distribute at least 90% of its income to avoid two layers of tax. Therefore, even if your earnings are distributed and then immediately reinvested, they will be taxed and you will receive a 1099.
The same cannot be said with a foreign investment into a foreign mutual fund, which may sit in the fund indefinitely until it is distributed. From the IRS’ perspective, all the while you should have been paying tax. Therefore you get hit with a monster tax bill in addition to interest payments on the unpaid tax of earnings that were actually never distributed, but to which the IRS believes there should have been distributions, and income tax paid.
PFICs are no fun and if you have one, you should speak with an experienced tax lawyer to figure out the smoothest way to get out of it.
If you have ownership in a foreign business and through this ownership you have access to, or signature authority over foreign accounts — then you must identify this on a schedule B.
will ask you to identify whether you have ownership or signature authority over foreign accounts (whether or not the money is yours) and if you do, it will ask you to identify which countries. It includes signature authority through your foreign business.
Moreover, question seven will also ask you whether you are required to file an FBAR.
The ’s bark is usually much worse than its bite. Be careful what you read online about this form, since unscrupulous attorneys, CPAs and other tax professionals will try to scare the living daylights out of you regarding penalties that can be issued involving this form. Yes, the IRS may issue penalties, which far exceed any ‘crime’ you may have committed, but there’s a few things to keep in mind.
First, oftentimes (though usually through an attorney) you can submit late FBARs through one of the approved voluntary disclosure programs or with reasonable cause and avoid (or severely reduce) any penalties the IRS issues. Moreover, the IRS may issue a warning letter in lieu of penalties. Finally, the burden the IRS must meet in order to issue the worst of the worst penalties is a very heavy burden.
If you did not file FBARs for accounts you have with a form business then you should do so, but don’t let these individual scare you unnecessarily.
Form 8938 (FATCA)
is a relatively new form that was introduced by the IRS in about 2011. The form is similar to the above referenced FBAR, except it is filed directly with the IRS and assets the IRS wants more information. They want to know if these accounts generated any income and if so, the type of income and the amount of income.
Moreover, unlike the FBAR, form 8938 requires you to identify specified assets. For example, if you own a foreign business then you may have to file this form (although usually do not have duplicate it with a form 5471) in order to identify the asset. This will include the value of the asset, the date of acquisition, the address, and any income was earned through this particular asset.
Like the FBAR, the failure to file this form may result in very high penalties-but please see above for the different options you will have to try to avoid these penalties.
is required by individuals who meet one of four categories of individuals owning foreign corporations. Generally, it will include anybody who has ownership of, or has acquired more than 10% ownership of voting rights in a foreign business. Alternatively, they may have had control over the business for 30-days and therefore would also still have to report. Depending on which categories you fall into, a person may have to file one or more schedules to accompany the form 5471.
The IRS takes form 5471 very seriously. In fact, in which the IRS issued extensive fines and penalties against an individual who failed to properly file the form.
It should be noted that, while the facts show the individual may have been reckless or exhibited willful blindness in failing to file the form, it does show that the IRS is serious about ensuring individuals who have the requirement to file this form do so timely.
Foreign Retirement is a key issue that seems to upset individuals the most – understandably so. Let’s say you own a foreign business or have an interest in it and also work for that business in that business set aside certain money for you in retirement. If the money was set aside in a US-based 401(k) there are a few rules that normally apply: the employer’s contributions are not taxable with your current income tax return, your contributions as an employee are deductible, and the annual growth or accumulation of income that is not yet distributed is not taxed until it is distributed.
The IRS sees it differently. Unless you have a foreign pension or retirement through an approved tax treaty countries such as the UK or Canada, the opposite applies. In other words, you have to report your employer’s contributions as current income, you do not receive a deduction for your contribution, and the annual growth may he currently taxed (although you receive a tax credit against future tax).
This is common in countries in which the United States does not have a tax treatment but in which Provident funds are common-such as Singapore, Thailand or Malaysia.
Per Se Corporations
As you may be aware, with Domestic LLC’s in the United States you can oftentimes disregard an entity to avoid current Tax reporting requirements. For example, let’s say David lives in California and owns an LLC, that owns three rental properties. David is the only member of the LLC and the main purpose (if not only purpose) of the LLC is to protect David in a lawsuit. In other words, there is no tax purpose to the LLC.
Under current IRS laws, David may be able to disregard the single-member LLC (married couples in California who own a business together also enjoy this benefit) and not have to file the necessary forms such as 1120S – if it elected to be an S corporation. Rather, they would just use a 1040 Schedule C
Even with foreign corporations, a person may also get the benefit of disregarding the entity, but it should be noted that there are certain foreign corporations in which a form must be filed because it is considered a per se corporation. In other words, the IRS will not allow the individual to disregard the entity.
This is very common in Latin American countries with the sociedad anonima. Even though the S.A. is often used as an estate planning tool for individuals living abroad, from the IRS perspective –it makes you a per se corporation and you cannot disregard the S.A. at this time.
I am out of Compliance, What do I do?
If you are out of compliance because you failed to properly file the necessary forms in one or more prior years, you may qualify for one of the IRS offshore voluntary disclosure programs.
The following is a summary of the different programs:
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)
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