Reminder about Requirements for Foreign-Owned U.S. Disregarded Entities

The Internal Revenue Service ("IRS") and the Department of the Treasury ("Treasury") issued final regulations on December 13, 2016 for the Internal Revenue Code ("IRC") Sections 6038A and 7701. These regulations take effect for tax years beginning after January 1, 2017 and make way for additional filing requirements for domestic disregarded entities (DREs) that are wholly owned by foreign persons.

Under the new rules, foreign-owned Disregarded Entities (DREs) are required to file Form 5472, Information Return of a 25 percent Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. For many foreign-owned DREs, this new requirement has added implications. In order to file Form 5472, these entities are now required to obtain an Employer Identification Number (EIN) if they have not yet established one. When applying for an EIN, the foreign-owned DRE must identify the owner or name of a responsible party. If the foreign owner or responsible party does not have a Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN) potential complications can arise.

Another nuance under these regulations is a requirement for foreign-owned DREs to maintain books and records that would allow them to accurately file Form 5472 and follow US tax treatment with respect to reportable transactions. Reportable transactions under these regulations include sales, assignments, leases, licenses, loans, advances or any other transfer that constitutes a right to use property or money in addition to the performance of any services for the benefit of or on behalf of another taxpayer. In addition, contributions and distributions are also considered reportable transactions under IRC 6038A.

To facilitate compliance with the additional requirements of Section 6038A and the required reporting under Form 5472, a foreign-owned DRE that has a U.S. filing requirement is required to have the same taxable year as the foreign owner; and similarly, if the foreign owner has no U.S. filing requirement, the taxable year of the entity is the calendar year unless otherwise indicated.

The penalties for failure to file are steep. Not filing Form 5472 could cost a taxpayer $10,000. This penalty can also be assessed for failure to maintain proper records. In fact, filing a substantially incomplete Form 5472 would constitute a failure to file Form 5472 and the $10,000 penalty can be assessed. However, there is no guidance provided by the IRS or any other regulatory agency as to what constitutes filing a substantially incomplete Form 5472. Criminal penalties may also apply for failure to submit information or for filing false or fraudulent information. Lastly, foreign-owned DREs cannot electronically file Form 5472.

If you have any questions regarding the new filing requirements, please reach out to a member of the Tax Advisory Group (TAG) at HBK.

About the Author(s)

Sarah Nicole Gaymon, CPA is a Manager in the Naples, Fl office of HBK CPAs & Consultants. She has several years experience in the field of taxation. Her background includes tax compliance and tax consulting for high net worth individuals, family groups, trusts, estates, and gift tax issues. Sarah aids her clients in the year-end planning process as well as the preparation and review of individual, trust, gift, estate, small family owned partnerships and small S-Corporation returns. She also has experience in foreign trust and individual return preparation and tax planning. Sarah has completed extensive research in the gift and estate tax area and has contributed to the publication of an international estate and gift tax planning handbook for the DFK group. Sarah is a graduate of St. John’s University in Queens, NY, where she received both her Bachelor of Science degree in Accounting and her Master of Science degree in Taxation. She is currently licensed to practice accounting in Florida, New York and New Jersey.

Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.