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Owners of Foreign Corporations Must Beware Form 5471

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Monday, 08 October 2018 10:40 AM Current | Bio | Archive

A U.S. taxpayer whose interest in a closely-held foreign corporation meets a specified threshold must file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, with his U.S. income tax return reporting his interest in the foreign corporation.

Significant penalties may be assessed for failure to file Form 5471. More importantly, the assessment statute of limitations as to a tax return—the entire tax return, not limited to the penalty for failure to file an information return—does not expire until three years after all Forms 5471 and like information returns due with the tax return have been filed.

What Is Form 5471?

Form 5471 is the primary means by which the Internal Revenue Service identifies (1) controlled foreign corporations that are subject to the anti-deferral regime of Internal Revenue Code Subpart F; and (2) foreign corporations availed of to disguise U.S. persons’ beneficial ownership of foreign investments. Form 5471 requires information about the filer and the foreign corporation.

Form 5471 also requires a set of financial statements for the foreign corporation, prepared in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”). For this reason I involve a CPA in preparation of all but the simplest of Forms 5471.

Form 5471 is filed with the filer’s U.S. income tax return for the tax year.

Who Must File Form 5471?

Form 5471 filers include Category 2 filers, Category 3 filers, Category 4 filers, and Category 5 filers (Category 1 has been repealed). A Category 2 filer is a U.S. citizen or resident who is an officer or director of a foreign corporation in which a U.S. person meets the “10% ownership requirement." A person meets the 10% ownership requirement with respect to a foreign corporation if he has acquired, in one or more transactions, (1) 10% or more of the foreign corporation’s outstanding stock, or (2) an additional 10% or more of the foreign corporation’s outstanding stock. A citizen or resident of the U.S. remains a Category 2 filer for as long as these two tests are satisfied: (1) he remains an officer or director of the foreign corporation, and (2) a U.S. person meets the 10% ownership requirement with respect to the foreign corporation. A “U.S. person” is a citizen or resident of the U.S., or a domestic (U.S.-based) corporation, partnership, estate, or trust.

A Category 3 filer includes (1) a U.S. person who acquires stock in a foreign corporation which, when added to stock already owned on the acquisition date, meets the 10% stock ownership requirement; (2) a U.S. person who acquires stock in a foreign corporation which, without regard to stock owned on the acquisition date, meets the 10% stock ownership requirement; (3) a person who becomes a U.S. person while meeting the 10% stock ownership requirement with respect to the foreign corporation; and (4) a U.S. person who disposes of stock in the foreign corporation reducing his interest to less than the 10% of the corporation’s stock, by vote or value. A person is a Category 3 filer only for the year in which he (1) acquires stock in a foreign corporation which, when added to stock already owned on the acquisition date, meets the 10% stock ownership requirement; (2) acquires stock in a foreign corporation which, without regard to stock owned on the acquisition date, meets the 10% stock ownership requirement with respect to the foreign corporation; (3) becomes a U.S. person while meeting the 10% stock ownership requirement with respect to the foreign corporation; or (4) disposes of in the foreign corporation reducing his interest to less than 10% of the corporation’s stock, by vote or value.

A Category 4 filer is a U.S. person who owned, at any time during the tax year, (1) more than 50% of the total voting power of the foreign corporation’s outstanding stock, or (2) more than 50% of the total value of the foreign corporation’s outstanding stock.

A Category 5 filer is a person who is a U.S. shareholder of a controlled foreign corporation at any time during the tax year. A “U.S. shareholder” is a U.S. person (defined above) who owned at least 10% of the voting power of the foreign corporation’s stock. A “controlled foreign corporation” is a foreign corporation at least 50% of the stock of which, by vote or value, is owned by U.S. shareholders.

In practice, Categories 4 and 5 are the ones most often met by U.S. persons.

What Is A “Foreign Corporation”?

Form 5471 applies only to foreign “corporations.” A business entity is classified as either a corporation or a partnership for Federal tax purposes. The analog to Form 5471 for partnerships is Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. The Form 5471 filing requirement has been in effect since 1963, but the Form 8865 requirement has been in effect only since 2000. I will examine Form 8865 in a separate post.

A taxpayer can file Form 8832, Entity Classification Election, electing to classify an entity, even a foreign entity, as either a partnership or a corporation for U.S. tax purposes. But Form 8832 generally cannot be effective more than 75 days before it is filed.

If Form 8832 is not in effect with respect to an entity, the default rule determines the classification of the entity for Federal tax purposes. Under that rule, an entity is classified as a corporation if no member (owner) may have personal liability for debts of the business, and as a partnership if at least one member may have personal liability for the debts of the business. The law of the jurisdiction in which an entity is organized determines whether members may have personal liability for the entity’s debts.

Dire Consequences for Failure to File Form 5471

The penalty for failure to file Form 5471 is $10,000. A taxpayer must file a Form 5471 with respect to a foreign corporation for each year the taxpayer meets a Form 5471 filing threshold as to that corporation. As noted above, the Form 5471 filing requirement was first effective for 1963.

Internal Revenue Code Section (“IRC §”) 6501(c)(8)(A) provides that, in the case of information required to be reported on Form 5471 and like information returns, the assessment statute of limitations with respect to any tax return, event, or period to which such information relates shall not expire before three years after the IRS is furnished the required information. Ordinarily, the assessment statute of limitations with respect to an income tax return expires three years after the return is filed.

Thus, according to IRC § 6501(c)(8)(A), at least, the failure to file Form 5471 or like information return suspends the assessment statute of limitations not only as to the penalty for failure to file the information return, but as to the taxpayer’s entire income tax return for that year.

A law suspending the statute of limitations on assessment of with respect to an income tax return for failure to file an information return does not seem to comport with traditional notions of fundamental fairness implicit in the concept of Due Process of Law. IRC § 6501(c)(8)(A) may well violate the Due Process Clause of the Fifth Amendment to the U.S. Constitution.

I have a case in which the IRS has proposed assessing against a taxpayer penalties for failure to file Forms 5471 for several foreign corporations going back nearly 30 years.

File Delinquent Forms 5471 As Soon As Possible

In keeping with its policy of encouraging voluntary compliance with tax laws, the IRS will not assess the penalty for failure to file Form 5471 provided the taxpayer files the delinquent Forms 5471 before the IRS discovers the deficiency and brings it to the taxpayer’s attention. But if the IRS discovers the failure to file Forms 5471 before the taxpayer corrects it, the IRS will propose the penalty for failure to file Forms 5471. Therefore, a taxpayer who owns or owned interests in foreign entities should ascertain whether he failed to file Forms 5471 that were due, and file any delinquent Forms 5471, as soon as possible.

Reasonable Cause for Penalty Relief

If the IRS does propose a penalty for failure to file Form 5471, the taxpayer should ask the IRS to refrain from assessing the penalty, on the ground of reasonable cause. The classic articulation of reasonable cause is that the taxpayer exercised reasonable care but due to factors beyond his control was unable to comply with the law. For example, a taxpayer who was advised by a tax professional that he need not file anything with the IRS concerning his interest in a foreign corporation, when the taxpayer was actually required to file Form 5471, has reasonable cause for not filing Form 5471. A taxpayer could also have reasonable cause for failing to file Form 5471 if the taxpayer’s tax advisor knew or should have known of the taxpayer’s interest in a foreign corporation, and failed to advise the taxpayer to file Form 5471, where the taxpayer did not otherwise know that he was required to file Form 5471.

Stephen J. Dunn is a tax attorney in Troy, Michigan. He is the author of the treatise Foreign Accounts Compliance (Thomson Reuters 2017) and Foreign Accounts Compliance Blog. He is also an adjunct professor at Michigan State University College of Law.

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StephenJDunn
A U.S. taxpayer whose interest in a closely-held foreign corporation meets a specified threshold must file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, with his U.S. income tax return reporting his interest in the foreign corporation.
taxpayers, closely, held, foreign, corporations
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2018-40-08
Monday, 08 October 2018 10:40 AM
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