The IRS continues its efforts to increase financial transparency, especially in the context of cross-border transactions. This time, pursuant to new regulations, they are treating disregarded entities wholly owned, directly, or indirectly, by foreign persons as domestic corporations, but solely for the purpose of making such entities subject to the reporting requirements of Internal Revenue Code Section 6038A. Prior to this new regulation, Section 6038A only applied to domestic corporations that were 25% foreign-owned, and to related parties of such foreign corporations.
Who does this mean exactly? It is not uncommon for foreign individuals or foreign entities to invest in U.S. businesses or real estate, by creating a Limited Liability Company. If such corporation or individual owns that LLC 100%, and does not make an election with the IRS to treat the LLC as a corporation for tax purposes, the LLC is “disregarded” for tax purposes. Prior to the new regulation, such entities had no filing requirement in the U.S. unless it engaged in a U.S. trade or business or derived certain types of U.S. source income. Under the new rules, such foreigners now have to file a Form 5472, “Information Return of 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business”, even if there was no business activity. Previously, such entities with no business activity didn’t even have to obtain an EIN (Employer Identification Number). Under this new law, in order to file Form 5472, an EIN will have to be obtained for the LLC.
This new filing requirement will apply to tax years of entities beginning on or after January 1, 2017, and ending on or after December 13, 2017. This means that in most cases, the new filings will be made during the 2017 tax filing season (in 2018).
The importance of such filing is that, as is the case with most other international related informational forms, the IRS can assess a penalty of $10,000 for failure to file Form 5472 in a timely and complete manner.
So while there has been quite a bit of commentary in Washington about simplifying the tax code and tax filings, this form adds one potential additional reporting obligation.
If you think you have a filing requirement or would like more information about the new regulation, please contact a member of our firm’s international tax team using the form below.