IRS Foreign Business Reporting – Offshore Entity International Tax
- 1 IRS Foreign Business Reporting
- 2 Offshore Entity Tax Basics
- 3 Offshore Business – Better for Conglomerates Than You
- 4 IRS Offshore Enforcement
- 5 Foreign Business Reporting
- 6 Who Has To Report?
- 7 Form 8938
- 8 Form 5471
- 9 Form 8865
- 10 Form 8621
- 11 Continuing Reporting vs. First Year Reporting
- 12 IRS Compliance – What Happens if I do not Report?
- 13 IRS Offshore Voluntary Disclosure
IRS Foreign Business Reporting
So…you thought having your business offshore meant no taxes, no IRS meddling, and secrecy — and now you learned the truth, and regret ever taking your business abroad?
Whether it was because you received a FATCA Letter, learned about FATCA Reporting through the grapevine, informed about your requirement to file Forms 5471, 8865, and/or 8621, or your CPA’s questionnaire now asks you to disclose your foreign bank accounts, you are ready to get into IRS compliance for your Offshore, Foreign and Accounts abroad?
Offshore Entity Tax Basics
While having a foreign business or offshore business sounds like a great idea from the beginning – chances are, whichever seminar you attended, or friend who convinced you about all the benefits of putting your money offshore probably — didn’t fully explain the IRS tax aspects of it to you properly. Moreover, since the IRS has made offshore compliance a key enforcement priority, it is much easier these days to get stuck in the IRS crosshairs than it may have been 20-years go.
Offshore Business – Better for Conglomerates Than You
It is very tempting to want to move a business offshore. Having your business abroad in a foreign country conjures up ideas of limiting and minimizing tax just like you read about with Apple and other companies. The reality is, the way those companies are structured is usually very complex (whether it appears so from the outside or not) and typically does not involve simply picking up and moving a small business offshore).
IRS Offshore Enforcement
In recent years, the Internal Revenue Service has ramped up enforcement of tax and reporting requirements against for businesses. It turns out, it was not just you that moved their business offshore, and the IRS wants to cash in (Read: Payback)
When it comes to offshore and foreign businesses, it is important to make the distinction between reporting and tax. It is also important to make a distinction between a foreign corporation/foreign business vs. a controlled foreign corporation or controlled foreign partnership in which more than 50% of the ownership is held by US persons who each have at least a 10% share of the business (attribution rules apply – which typically means if your spouse or another family member has ownership, then the ownership interest is “attributed” to you).
Why? Because otherwise the entire family can each own 9% of a multi-million dollar corporation and would not be considered a Controlled Foreign Corporation, because none of the shareholders on at least 10%. As you will see, the rules involving a controlled foreign corporation are much different than a regular corporation.
This blog entry will focus on the reporting aspects of a foreign business.
Foreign Business Reporting
Aside from filing your tax return, if it turns out that you have significant ownership of certain foreign businesses or assets, there are additional – and somewhat extensive – reporting requirements. in other words whether or not there is any tax liability, or whether or not you received an income or not will impact your taxes, it does not impact the reporting requirements.
Who Has To Report?
This can get very complex, but will do our best to keep it relatively simple.
A Form 8938 is a reporting of specified foreign financial assets. It is one of the more simpler forms to complete aside from other sister forms such as a 5471, 8865 or 8621. Essentially, a person has to report ownership of certain specified interests, such as ownership of stock.
Take David, who files married filing jointly and resides within the United States. He owns 100 shares of Foreign Stock X, which is now worth $120,000. The company has issued millions of shares, and David owns less than a fractional percentage 1% of the business.
Moreover he does not control the business and or have any managerial responsibilities; David is just a shareholder. As a shareholder, David will have to report his interest on a form 8938. David will also have to identify whether or not he received any interest, dividends or other passive income from this investment — as well as any other investment that qualifies as a specified foreign financial Asset.
Penalty for Failing to File Form 8938
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. 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.
It turns out, David also owns five small rental properties in Costa Rica. David has literally no management or control over the business but the businesses are in the structure called a Sociedad Anonima. As a result, David is the 90% owner of the business – with the other 10% being owned by a local resident.
These rental properties do not generate much income, and at the end of the day there are no distributions made to David. Nevertheless, since David is the owner of this foreign business, he meets the qualifications of being a category filer in accordance with form 5471.
Form 5471 has five categories of filers, although the first category is no longer used. Now, David must go through the accounting and financials of his foreign business to determine the balance sheet, translate it (or hire a foreign Accountant) and then take that information and use it to prepare form 5471. While it does not take a brain surgeon complete the form, it does require an understanding of accounting principles and GAAP.
**There is a side issue as to whether this company is a holding company that generates nothing but passive income and therefore may be considered a PFIC (Passive Foreign Investment Company). That discussion is beyond the scope of this introductory article, but you can find more about PFICs in prior blogs we’ve written in the past:
Penalty for Failing to File Form 5471
A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. 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.
David also owns a partnership with his sister in Hong Kong, which required filing an IRS Form 8865. The partnership owns a small business, and David sister handles all of the management and other business aspects of the company. David was an early investor, and now owns a significant share of the partnership.
While David’s sister resides in Hong Kong and is a resident of Hong Kong, she’s a citizen of the United States because their birth mother was a US citizen. Even though David’s sister literally has no ties to the United States other than her younger brother living there, the US will see her as a US person, and therefore it makes this partnership a controlled foreign partnership.
As a controlled foreign partnership, the rules are much more complex and considerations such as the unnecessarily complicated Subpart F income issue , come into play. Moreover, since it is a controlled foreign partnership the IRS will be taking a much deeper look into the business as opposed to just being a foreign business that operates outside of the United States and is not owned in majority by US persons.
Penalty for Failing to File Form 8865
A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. 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.
A form 8621 is one of the most complicated forms in US tax law. That is not say actually completing the form is super difficult, but the analysis to determine whether a company is considered a PFIC and thus required to file a form 8621 is a very detailed exercise.
In addition, if it is considered to be a PFIC and there have been excess distributions along the way, which were not properly reported and taxed, than the individual will have to prepare a very detailed spreadsheet regarding the excess distributions. Not to get into too much detail, but an excess distribution occurs when a person receives a distribution from a PFIC, in which the current year distribution exceeds the average of the prior three years (or less than three years if it is a newer PFIC) by 125%.
Typically, if you have had the PFIC for a long time, then your first distribution is going to be excess distribution because in the prior year you have zero distributions, and therefore anything would be considered an excess distribution.
Penalty for Failing to File Form 8621
While there is no specific monetary penalty for non-filing of form 8621, it does leave your tax return open for audit in perpetuity…not a good thing as it leaves your return ripe for audit at any time in the future (far long after you thought you were already in compliance)
Continuing Reporting vs. First Year Reporting
Once you have reviewed the instructions for some of these forms, you may find that there is a distinction in many of the categories for when a person acquired a certain amount of stock or shares or interest, and maintains that same ownership.
As an example, if a person acquires more than 10% of the foreign partnership in year-one, then they will have to report the partnership interest on a form 8621. Any subsequent year, if the individual did not acquire any additional interest in the business but still maintains ownership, and it is not a controlled foreign partnership, then the person would usually start reporting on a form 8938 and not an 8621.
IRS Compliance – What Happens if I do not Report?
Here’s the deal: there is no way to know whether you will be one of the unlucky ones the IRS audits. The IRS is understaffed and underfunded – which is a double edged sword.
On the one hand, the chances of being audited are relatively slim – although this does increase based on factors such as foreign income, foreign accounts and highly compensated earners, but overall many people will go their whole life without ever being audited.
On the flip-side, if you are audited, it can become a very arduous process and very difficult to negotiate with the IRS when they are only operating at 20 or 30% capacity. In other words, trying to get somebody on the phone could take hours upon hours of your time. The IRS is a major bureaucracy, and trying to make your way through the different levels is very difficult.
Compounded by this time issue, is the fact that the IRS has the right to issue various means of recovery against you (against both your US and foreign property, income, accounts, etc.), such as:
IRS Offshore Voluntary Disclosure
Before making any affirmative representation, or past filing to the IRS it is important to speak with an experienced offshore disclosure where to learn the pros and cons of each different approach.
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.)