Form 8865 - Fundamental Rules on Foreign Partnership Ownership (Golding & Golding)

Form 8865 – Fundamental Rules on Foreign Partnership Ownership (Golding & Golding)

IRS form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships) is filed with the IRS when a person has an interest in a foreign partnership. The 8865 Form can be intense, and oftentimes requires the assistance of a Tax Attorney (especially if it is being filed untimely).

*The Form 8865 should be distinguished (since it is often confused) with Form 5472, which is an information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.

Form 8865 – The Basics

When a person has a qualifying interest in a Foreign Partnership, the information is reported on this form and it is filed along with their tax return (or separately if no tax return is required)

Do I File an 8865 or 8938?

Typically, a person will file a form 8938 (Reporting Specified Foreign Financial Assets) if they have an interest in an offshore investment,  which does not meet the threshold requirement of an 8865 or 5471, and/or it is not the year of acquisition. But, if the ownership is in the year of acquisition and/or the the value/percentage of the ownership increases, the person may have to file a form 8865 instead of the 8938 for the particular asset. This is especially true when it involves a foreign partnership.(a person does not file the same form 8938 and 8865 for the same interest...although if accounts are involved, an FBAR may be required)

Why Do I Not File 8938?

The form 8938 is used to report specified foreign assets. Typically, the scenario will include a foreign bank account or foreign stock ownership. When a person owns a percentage of a foreign partnership, they may also need to report it on a form 8938… unless they meet the threshold requirement of having to file form 8865. In that case, individual will file a form 8865 instead of a form 8938 as to that particular interest in the foreign partnership.

Similar to Form 5471, but…

While the form is similar to a form 5471 involving foreign corporations, and the 5471 is more common (for the simple fact that more individuals have interests in foreign corporations than they do in foreign partnerships), there are important distinctions regarding these two forms.

Who Has to File Form 8865?

A person will file form 8865 when they qualify as one of the four (4) categories of filers indicated in the instructions. There are four categories of filers, and depending on which category a person falls into, it may be required to file form 8865 along with certain schedules detailing more information about the foreign partnership.

What are the Four (4) Categories of Filers?

Category 1 (aka Control)

When a person has control of a foreign partnership, which typically means ownership of more than 50% of the partnership, then they will qualify as a category 1 Filer.

Category 2 (U.S. Controlled Partnership)

This category of filing requires an individual to have at least 10% interest in the foreign partnership when the foreign partnership is controlled by US persons each have at least 10% ownership. If this sounds familiar  you, it is similar to a controlled foreign corporation in which more than 50% ownership must be had by US persons each have at least 10% ownership (attribution rules apply).

Category 3 (Contributing Property)

When a U.S. person contributes property during the individuals tax year to foreign partnership, and in exchange receives an interest in the partnership, they will also have to file this form when the person either owns 10% or more immediately following the contribution or when the value of the property (along with any other property attributed by the individual or related person during the 12 month period ending on the transfer) exceeds more than $100,000.00

Category 4 (General Catchall)

This is the most common scenario for most individuals. Why? Because often times the foreign partnership will not be owned by at least 50% of US persons who each own 10%, the individual will not control the Partnership, nor contribute any property. That brings us to the fourth category in which a person acquires at least 10% or greater interest in the foreign partnership. A typical example would be when the individual purchases a 15% share or inherits a 12.5 percent share.

How do I File Form 8865?

Form 8865 is generally not the type of form that you will find included in tax software used by non-tax professionals such as TurboTax or TaxAct. Rather, if you are not utilizing a tax professional, you would have to download the PDF form and complete the form yourself. Thereafter, you would attach the form 8865 to your income tax return when you submitted to the IRS.

But I am Not Required to File a Tax Return?

Unfortunately, the Internal Revenue Service does not let you off the hook that easily. Rather, you will still have the complete and submit the form separately to the location you would otherwise have to submit a tax return — in order to make sure you are in compliance. In other words, if you are the only US person in the Foreign Partnership, and the only person filing this form on behalf of the partnership — even if you do not have to file a tax return, you still have the file this form.

Key Definitions of Terms Used in the 8865.

The IRS provides the following summary of the different key terms used in preparing form 8865:

Partnership

A partnership is the relationship between two or more persons who join to carry on a trade or business, with each person contributing money, property, labor, or skill and each expecting to share in the profits and losses of the business

whether or not a formal partnership agreement is made. The term “partnership” includes a limited partnership, syndicate, group, pool, joint venture, or other unincorporated organization, through or by which any business, financial operation, or venture is carried on, that is not, within the meaning of the regulations under section 7701, a corporation, trust, estate, or sole proprietorship. A joint undertaking merely to share expenses is not a partnership. Mere co-ownership of property that is maintained and leased or rented is not a partnership. However, if the co-owners provide services to the tenants, a partnership exists.

Foreign partnership

A foreign partnership is a partnership that is not created or organized in the United States or under the law of the United States or of any state or the District of Columbia.

50% interest

A 50% interest in a partnership is an interest equal to: 50% of the capital, 50% of the profits, or 50% of the deductions or losses. For purposes of determining a 50% interest, the constructive ownership rules described below apply.

10% interest

A 10% interest in a partnership is an interest equal to: 10% of the capital, 10% of the profits, or 10% of the deductions or losses. For purposes of determining a 10% interest, the constructive ownership rules described below apply.

Constructive Ownership

For purposes of determining an interest in a partnership, the constructive ownership rules of section 267(c) (excluding section 267(c)(3)) apply, taking into account that such rules refer to corporations and not to partnerships. Generally, an interest owned directly or indirectly by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its owners, partners, or beneficiaries. Also, an individual is considered to own an interest owned directly or indirectly by or for his or her family. The family of an individual includes only that individual’s spouse, brothers, sisters, ancestors, and lineal descendants. An interest will be attributed from a nonresident alien individual under the family attribution rules only if the person to whom the interest is attributed owns a direct or indirect interest in the foreign partnership under section 267(c)(1) or (5)

Penalties for Not Filing Form 8865

The penalties for failing to file form are intense, and vary depending on which category a person would have to file:

Failure to timely submit all information required of Category 1 and 2 filers.

A $10,000 penalty is imposed for each tax year of each foreign partnership 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 partnership) 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 furnish 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, 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 (and the underlying regulations) for the maximum reduction, the exception due to reasonable cause, and for limits on the amount of these penalties.

Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file or for filing false or fraudulent information. Additionally, any person that files under the constructive owners exception may be subject to these penalties if all the requirements of the exception are not met. Any person required to file Form 8865 who does not file under the multiple Category 1 filers exception may be subject to the above penalties if the other person does not file a correctly completed form and schedules. See Exceptions to Filing, earlier.

Failure to file information required of Category 3 filers.

Any person that fails to properly report a contribution to a foreign partnership that is required to be reported under section 6038B and the regulations under that section is subject to a penalty equal to 10% of the fair market value (FMV) of the property at the time of the contribution. This penalty is subject to a $100,000 limit, unless the failure is due to intentional disregard. In addition, the transferor must recognize gain on the contribution as if the contributed property had been sold for its FMV. See section 6038B for the exception due to reasonable cause.

Failure to file information required of Category 4 filers.

Any person who fails to properly report all the information requested by section 6046A is subject to a $10,000 penalty, in addition to the section 7203 criminal penalty, unless it is shown that such failure is due to reasonable cause. If the failure continues for more than 90 days after 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 shall not exceed $50,000.

Section 6662(j).

Penalties may be imposed for underpayment attributable to undisclosed foreign financial asset understatements. The term “undisclosed foreign financial asset” with respect to any tax year includes any asset with respect to which required information was not provided. An “undisclosed foreign financial asset understatement” means for any tax year, the portion of the understatement for that tax year which is attributable to any transaction involving an undisclosed foreign financial asset. 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 Compliance

If you are out of compliance, for not filing form 8865, one of the best ways to get back into compliance is by entering the IRS offshore voluntary disclosure program. Programs to seek means getting to compliance while reducing or forewarning penalties.

We Specialize in Safely Disclosing Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

Examples of areas of tax we handle

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Sean M. Golding, JD, LL.M., EA (Board Certified Tax Law Specialist)

Our Managing Partner, Sean M. Golding, JD, LLM, EA  earned an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)

Mr. Golding and his team have successfully handled several hundred IRS Offshore/Voluntary Disclosure Procedure cases. Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.

Less than 1% of Tax Attorneys Nationwide are Board Certified Tax Law Specialists 

Out of more than 200,000 practicing attorneys in California, less than 400 attorneys have achieved this Certified Tax Law Specialist designation.

The exam is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys. 

Beware of Copycat Law Firms

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IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

A Penalty for failing to file Form 8938

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 3520

The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

A Penalty for failing to file Form 3520-A

The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 5472

The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

A Penalty for failing to file Form 926

The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

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