For U.S. Tax Residents with Foreign Entities, Taxes & Examples

For U.S. Tax Residents with Foreign Entities, Taxes & Examples

For U.S. Tax Residents with Foreign Entities

When an individual person is considered a U.S. person for tax purposes, they are typically subject to U.S. tax on their worldwide income and required to report their foreign accounts, assets, investments, trusts, and entities on various international information reporting forms. And, with the globalization of the world market, it is very common for taxpayers who are considered US persons for tax purposes to have ownership in a foreign entity. What makes ownership of a foreign entity complicated from a U.S. tax and reporting perspective is that the IRS does not have a different set of rules for each foreign country. While the United States has entered into various tax treaties and FATCA agreements, it does not go into detail about:

• • • Which international forms may be required,

    • Whether the income is taxable or not,

    • Is the income categorized as GILTI or Subpart F, and

    • Will foreign tax credits may apply.

Let’s walk through two examples of the reporting and tax of foreign entities by US persons into perspective.

(Non-CFC) Example of Foreign Entity Ownership

Melanie is a green card holder who recently became a green card holder and relocated to the United States. In the foreign country she is originally from, she is a 25% shareholder of a foreign company that is also owned by her other family members none of whom are considered U.S. persons. This will be the third year that Melanie is required to file a U.S. tax return and in speaking with the tax professional, she realized she had missed the reporting of the foreign entity in prior years.

Is Form 5471 Required for the First Year?

Typically, in this type of situation, Form 5471 will be required in the first year that she became a us person. That is because in the first year she became a U.S. person she acquired 10% or more ownership in a foreign company. Technically, while she received the ownership in her foreign country several years ago, one of the categories of filers for Form 5471 is taxpayers who become a U.S. person and have 10% or more ownership in a foreign entity.

• • • “A person who becomes a U.S.person while meeting the 10% stockownership requirement with respect to the foreign corporation;”

Ongoing Form 5471 Requirement

Generally, Melanie will not have an ongoing Form 5471 reporting requirement at least for this entity. That is because it is not a Controlled Foreign Corporation and she did not acquire any additional ownership since becoming a U.S., person. She does not have any constructive ownership with any other U.S. persons, and the company is not considered a CFC.

Usually what will happen is that in subsequent years, Melanie will file a Form 8938 instead of a Form 5471 to report her ownership.

CFC Example of Foreign Entity Ownership

Brandy is a U.S. citizen who formed a company with another U.S. citizen when they were both living overseas and working as consultants. The company operates as a consulting company and Brandy and the other U.S. citizen are the only two owners of the company. When Brandy was talking with her new tax professional, she learned for the first time that for the past few years that the company has been in existence, she had some reporting requirements that she had to fulfill.

Will a Form 5471 be Required?

This is where it starts to get very complicated for unsuspecting taxpayers.

For Brandy and her friend, this was just a consulting company they operated while living overseas. But, from a U.S. tax perspective, it is considered a Controlled Foreign Corporation because more than 50% of the company is owned by U.S. persons who are each defined as U.S. shareholders (10%). Therefore, unlike Melanie, Brandy will have to file Form 5471 for each year. She will have to include many schedules as is required for owners of controlled foreign corporations.

Likewise, because there is also some investment income through the company, there may be Subpart F or PFIC income attributed to Brandy and her partner. Even though this income was not distributed there were positive earnings and profit which means that her ratable share would be imputed to her on her U.S. tax return. Moreover, there is also a GILTI issue which may result in some additional tax liability.

Should Brandy make an Election?

Since the company was owned by multiple people who were not her spouse, certain elections and default positions would not necessarily be available to her. Otherwise, if an election was available, she could consider filing a Form 8832 to make an election along with an annual Form 8858 to report the FDE.

But, because it is a controlled foreign corporation, there is still a significant amount of paperwork that can be required so making the election may not be the best strategy. This is because she would then be subject to significantly more income taxes on income that was not distributed but would be imputed to both her and her partner if there was no entity in place (and no individual foreign tax credits to apply).

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.