Foreign-owned domestic companies, including U.S. LLCs, that are disregarded as separate entities for federal tax purposes (disregarded entities) are subject to a new disclosure obligation. Treasury regulations promulgated back in 2016 require such entities to file Form 5472 - Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, disclosing certain transactions between the reporting entity and its foreign owner and other affiliates. The new reporting requirement administered by the Internal Revenue Service (IRS) is due for the first time in early 2018 and is subject to substantial non-compliance penalties.
1) Which entities are subject to the new Form 5472 filing requirements?
The new regulations treat foreign-owned, domestic disregarded entities as foreign-owned, domestic corporation for purposes of the Form 5472 reporting requirements. Single-member U.S. LLCs that are owned by foreign entities or individuals and have not elected to be treated as corporations for federal income tax purposes are subject to the reporting obligation. Other U.S. legal entities, such as limited and regular partnerships, may in certain instances be treated as disregarded entities for federal income tax purposes and be required to file Form 5472.
2) What transactions are reportable on Form 5472?
Reportable transactions are monetary and certain non-monetary transactions between the reporting entity and the foreign owner or the reporting entity and any U.S. or foreign party related to the foreign owner. These include, but are not limited to, sales, purchases, rents, interest, and loans between the disregarded entity and its owners and affiliates. In contrast to the Form 5472 currently filed by U.S. corporations, the Form 5472 disclosure applicable to disregarded entities includes among reportable transactions contributions by, and distributions to, the foreign owner. A U.S. disregarded entity that has no reportable transactions during a given year is not required to file form 5472 for such year.
3) Do single-member LLCs and other reporting entities need a U.S. tax ID?
Yes, LLCs and other U.S. disregarded entities need to apply for a federal Employer Identification Number (“EIN”), unless they already have one. The foreign owner may or may not possess a federal tax ID, depending on its tax and immigration status. Current IRS instructions contain conflicting information as to whether a foreign owner is required to obtain a tax ID number for the only purpose of complying with the Form 5472 disclosure obligations of its wholly owned U.S. LLC or disregarded entity. While it is possible that foreign owners will not be required to obtain a U.S. tax ID in those instances, official clarifications are expected from the IRS on this point.
4) When is the Form 5472 due?
The new Form 5472 filing requirement applies to tax years of entities beginning on or after Jan. 1, 2017 and ending on or after Dec. 13, 2017. This means that most single-member U.S. LLCs will have to file their first Form 5472 with respect to the year 2017 sometimes in early 2018.
The Form 5472 currently filed by U.S. corporations is submitted as part of their annual federal income tax return. Conversely, LLCs and other entities subject to the new filing rules are not typically required to file a federal income tax return. Accordingly, guidance is expected from the IRS on the due date and the procedure for the submission of Form 5472 by those entities.
It would appear likely that the deadline prescribed by the IRS will not be earlier than the due date for individual and corporate income tax returns. In general, federal income tax returns for U.S. individual and corporations will be due on April 16, 2018 for 2017 calendar year taxpayers.
In an attempt to reduce the compliance burden, the regulations outline that the reporting entity is considered to have the same tax year as its foreign owner, that is, if the foreign owner has a US income tax filing obligation. If the foreign owner does not have a filing obligation, then the entity must report on a calendar year basis.
5) Do the new regulations impact the taxation of U.S. LLCs or its foreign owners?
No, the new reporting requirements do not affect the federal income tax treatment of U.S. LLCs. Similarly, there is no change to the U.S. tax liabilities and filing obligations that may arise for foreign individuals and corporations in connection to their ownership in U.S. LLCs. However, the new requirement is intended to provide the U.S. tax authorities with a clearer map to identify foreign LLC owners that are not currently in compliance with their U.S. tax obligations.
6) Are U.S. LLCs required to maintain separate accounts under the new rules?
Yes, in addition to filing Form 5472, the reporting entity is also required to maintain records sufficient to establish the accuracy of the information presented on its federal filings. This means that foreign owners need to maintain a separate book of accounts on a stand-alone basis for the disregarded entity sufficient to properly track income, expenses, and balance-sheet transactions between the entity, its owner and other related parties. This may be a new task for many foreign owners who were not used to think of a U.S. LLC as a stand-alone entity. There is no requirement that the books and records be maintained, geographically, in the United States.
7) What are the penalties for failure to file Form 5472?
Failure to file Form 5472 by its due date, and providing all information as prescribed in the form instructions, may result in a penalty of $10,000. If the failure continues for more than 90 days after notification by the IRS, an additional penalty of $10,000 will apply. In addition to the failure to file penalty, a penalty can also be assessed for failure to maintain sufficient records. When warranted by the specific circumstances, criminal penalties may also apply for filing false or fraudulent information.
As year-end focus is on tax reform and its consequences, foreign investors and their advisors should not forget about the new Form 5472 reporting obligation that will effect foreign-owned, single-member LLCs and other U.S. entities that are disregarded for U.S. federal income tax purposes. Substantial guidance is needed from the IRS to clarify the due date and the procedures for the submission of the form. Updates to forms and instructions should be closely monitored to ensure he affected entities are not exposed to major penalties.
By Pietro Stuardi, tax partner and Brian Malecki, senior accountant, Baker Tilly Virchow Krause