Controlled Foreign Corporation Reporting – IRS Penalty Mitigation
- 1 Why is Controlled Foreign Corporation Reporting Important?
- 2 U.S. Ownership of a Controlled Foreign Corporation
- 3 Ownership Interest in a non-CFC
- 4 What are the Penalties for an Un-Filed Form 5471?
- 5 Failure to file Form 5471 and Schedule M
- 6 Failure to file Form 5471 and Schedule O
- 7 Criminal Penalties
- 8 Section 6662(j)
- 9 How to Get Into IRS Compliance for Form 5471?
- 10 Golding & Golding – Offshore Disclosure
- 11 The Devil is in the Details…
- 12 What if You Never Report the Money?
- 13 Getting into Compliance
Controlled Foreign Corporation Reporting is a vast and complex area of law. Unfortunately, so are the IRS Penalties associated with CFC Reporting.
One of the fastest ways to land in hot water with the IRS is for them to discover that you have ownership (or an interest in) of a foreign business or corporation (aka Controlled Foreign Corporation) that you have not properly reported to the Internal Revenue Service (Tax Returns) or Department of Treasury (FBAR aka FinCEN 114).
The IRS has the right and authority to issue excessively high fines and penalties for failing to report Subpart F Income and/or failing to file Form 5471 if you fall into the Categories of Filers required to file this forms.
Why is Controlled Foreign Corporation Reporting Important?
Because the IRS wants to believe anybody who has ownership in a foreign business is doing so in order to hide or shelter income offshore.
The penalties for failing to report your foreign business on an annual basis can result in significantly high monetary costs; luckily, these penalties can oftentimes be avoided by getting into compliance before it’s too late — in other words, before the IRS contacts you.
U.S. Ownership of a Controlled Foreign Corporation
When a US person has an interest in a foreign corporation, it can cause a significant tax liability to the US person. Why? Because there are very specific rules required for the reporting and taxation of foreign corporations that are owned by US persons, otherwise known as a Controlled Foreign Corporation (CFC).
Essentially, the test to determine whether a corporation is a CFC is whether more than 50% of the corporation is owned by US persons who have at least a 10% share of ownership. Yes, there are methods to avoiding CFC Status (For example, 11-12 individuals coming together – each with less than 10% ownership) but for the most part, the majority of US taxpayers who have ownership of a controlled foreign corporation usually fall into the CFC category.
**In other words, not all U.S. Interests in Foreign Corporations results in CFC status. Moreover, if there is not Subpart F income, there may be no resulting U.S. tax liability.
Ownership Interest in a non-CFC
Although CFC is a common issue amongst US persons with ownership of a foreign corporation (the concept of CFC is actually very common worldwide) the threshold for having to report ownership or an interest in a foreign company is much lower. There are various forms that may need to be filed, but the most common involving ownership of a foreign corporation (non-partnership) is a form 5471. This form is filed by an individual, when he or she has at least a 10% interest in a foreign corporation. There are various different categories of filers, depending on the level of ownership and control of the foreign corporation – which also determines how many additional “schedules” the filer must file along with the 5471 – but a 10% share in a foreign corporation usually requires you to step up to the plate and begin reporting.
**An argument can be made that you only report a 5471 in the year you acquired a 10% interest (presuming you do not qualify under one of the other “heightened” categories of filers) but to play it safe, it is generally recommended to report each year a 10% interest is held.
What are the Penalties for an Un-Filed Form 5471?
Even though the form is merely a reporting form, the penalties are very severe. Why? Because in recent years and with the introduction of FATCA (Foreign Account Tax Compliance Act) the IRS has been taking a hard-line against individuals who maintain foreign/offshore investments or money but have not been reporting or paying tax on the income or money.
As provided by the IRS:
Failure to file Form 5471 and Schedule M
A $10,000 penalty is imposed for each annual accounting period of each foreign corporation for failure to furnish the required information within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign corporation) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.
Any person who fails to file or report all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901, 902, and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure to the U.S. person, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038(c) (2) for limits on the amount of this penalty.
Failure to file Form 5471 and Schedule O
Any person who fails to file or report all of the information requested by section 6046 is subject to a $10,000 penalty for each such failure for each reportable transaction. If the failure continues for more than 90 days after the date the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period or fraction thereof during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000.
Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file the information required by sections 6038 and 6046.
Note. Any person required to file Form 5471 and Schedule J, M, or O who agrees to have another person file the form and schedules for him or her may be subject to the above penalties if the other person does not file a correct and proper form and schedule.
Penalties may be imposed for undisclosed foreign financial asset understatements. No penalty will be imposed with respect to any portion of an underpayment if the taxpayer can demonstrate that the failure to comply was due to reasonable cause with respect to such portion of the underpayment and the taxpayer acted in good faith with respect to such portion of the underpayment. See sections 6662(j) and 6664(c) for additional information.
How to Get Into IRS Compliance for Form 5471?
If you are already out of compliance for failing to report form 5471 and want to avoid penalties, then one of the most effective ways for getting back into compliance is through IRS Offshore Voluntary Disclosure.
Depending on the specific facts and circumstances of your case, their options and alternatives, including traditional OVDP, Streamlined Program, or Reasonable Cause.
A summary of the procedures is provided below:
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlikes the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
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