Amid the flurry of tax reform activity that’s consuming taxpayers and their advisors, it may be easy to miss some new reporting obligations beginning in 2018 that were not part of the tax reform legislation. This article focuses on a particularly unusual reporting obligation that applies to business entities that were not required to file tax returns in the past. Beginning in 2018, any domestic business entity that is wholly owned by a foreign person and that is otherwise classified under the check-the-box regulations as a disregarded entity separate from its owner (a “foreign-owned DRE”) must complete Form 5472, Information Return of a 25 Percent Foreign-Owned Corporation or a Foreign Corporation, and report transactions with its owner and related parties. With the April 15, 2018 filing deadline on the horizon and an applicable $10,000 penalty for failure to file the required form, it is important to identify the entities in your structure potentially subject to the new rules as well as the transactions that will need to be disclosed.
On December 13, 2016, the Internal Revenue Service (IRS) and United States Treasury (“Treasury”) issued final regulations (“the Regulations”), Treasury Decision 9796,1 requiring domestic disregarded entities (DREs) that are fully owned, either directly or indirectly, by a foreign person, to be treated as a domestic corporation to comply with Internal Revenue Code Section 6038A. The final regulations generally require foreign-owned DREs to do the following:
- File Form 5472;
- Maintain records to prove the accuracy of Form 5472; and
- Obtain an employer identification number (EIN) to report on Form 5472
As provided in the entity classification regulations, DREs are eligible business entities with only one owner and not recognized for tax purposes as an entity separate from its owner (i.e. single member LLC).2
A foreign person is defined as “any person who is not a United States person.”3 A foreign person includes individuals who are not residents or citizens of the United States, as well as a partnership, association, company, or corporation that is not created or organized in the United States. Likewise, any foreign estate or foreign trust described in section 7701(a)(31) is also a foreign person. Furthermore, a foreign person will be considered to wholly own a DRE if the foreign person has direct or indirect sole ownership of the entity. Indirect sole ownership is defined as “ownership by one person entirely through one or more other entities disregarded…or through one or more grantor trusts.” The regulations do not affect the entity’s classification for other purposes.4
Filing the Form
Once you determine that your structure has foreign-owned DREs, you will need to identify the transactions with the owner of the DRE, as well as with related parties, during the reporting period. The related party rules get particularly difficult to apply in the case of a trust or members of a family. Therefore, it is important to carefully consider the extensive attribution rules applicable to identify related parties to report the transactions in Form 5472.
Depending on the type of structure in which the foreign-owned DRE is inserted, the list of transactions captured by Part IV of Form 5472 may apply. This list includes loans, compensation, royalties, rents, and many other transactions that are common for operating businesses. However, the Regulations expand the definition of transactions captured by Form 5472 in the case of foreign-owned DREs. Part V of the Form requires the reporting entity to also list any other transactions with the foreign owner or related parties not listed in Part IV and that meet the broad definition of a “transaction” under the transfer pricing regulations.5 The transfer pricing regulations provide that a “transaction” also includes any contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented.
Unlike the case for corporations, the Regulations do not provide a de minimis exception for transactions to be reported. The first reporting period is the tax year that began on or after January 1, 2017 and ended on or after December 13, 2017. If a proper liquidation of the DRE was done before December 13, 2017, then the Form may not be required. Likewise, if the DRE was converted to a partnership or corporation before December 13, 2017, then other reporting requirements applicable to such entities will apply including possibly filing a Form 5472 if it became a corporation.
Newly revised instructions to Form 5472 were issued to provide guidance, amongst other things, on how to fill out the form, obtain an EIN, and determine who is the direct owner and the ultimate indirect owner. A foreign-owned DRE will be required to file a pro-forma Form 1120, U.S. Corporation Income Tax Return, attaching the Form 5472. The Form 1120 will only need the name, address, EIN and date of formation of the foreign-owned DRE. The instructions provide that the following text needs to be added at the top of the Form 1120 -- “Foreign-owned U.S. DE,” and the forms need to be faxed or mailed in accordance with the instructions.
For most foreign-owned DREs, the tax year will be the calendar year, unless the foreign owner has a different tax year. Accordingly, these returns will be due with the April 15 deadline. The foreign-owned DRE will need to maintain books and records to demonstrate the accuracy of the information reported.6
What must be done now?
Identify the entities in the structure that are disregarded and wholly-owned by a foreign person. Second, identify the foreign owner and related parties under the attribution rules applicable to the Form 5472. Finally, review the transactions between the foreign-owned DRE and the owner or related parties to determine the transactions required to be disclosed.
If the foreign-owned DRE does not already have an EIN, then file Form SS-4, Application for Employer Identification Number with responsible party information, including the party’s SSN, ITIN, or EIN, to obtain the number. Note that these regulations do not impact the obligation to file Foreign Bank Account Reports (FBAR) by certain domestic DREs on certain financial accounts located outside the United States.
- T.D. 9796 (Dec. 13, 2016).
- See Treas. Reg. §301.7701-2.
- See section 6038A(C)(3).
- See Treas. Reg. §301.7701-2(B)(1).
- See Treas. Reg. §1.482-1(i)(7).
- See Treas. Reg. §1.6038A-3 and the exceptions in Treas. Reg. §1.6038A-1(h) and (i)(1).