If you are a US person (ie a US citizen or green card holder) and own 10% or more of a foreign corporation (a corporation organized and operating outside the US) you are responsible to file Form 5471 every year. If you own part of a partnership you must file Form 8865.
Any U.S. Person who received a distribution from a foreign trust, was a grantor of or a transferor to a foreign trust must also file Form 3520. A trustee of a foreign grantor trust with a U.S. grantor must file Form 3520-A. Annuitants and Beneficiaries of Passive Foreign Investment Companies (PRIC) may be required to file Form 8621.
If you want the gory details in thick legalese – here is the link to the IRS Website on filing requirements.
We are one of the few tax preparation firms who are real experts in this field and can help you prepare this form. The article below provides more information on this issue.
What Information Must be Provided?
The required information starts by listing the identity of the US shareholder and details about the foreign corporation. It must also include data on transactions between you and the foreign corporation, original capital contributions and other relevant data. It is 4 pages long. Several other schedules are required, which can make it a total of 6-7 pages. Among the schedules to be filled are the balance sheet for the corporation and income and expense sheet for the current year of operation.
Depending on which of the five categories apply to the taxpayer (in fact, there are four categories because category one has just been repealed), different schedules must be completed. An officer or director of a CFC who is not an owner of the CFC will be required to file under category 2 where certain U.S. persons have acquired additional stock in the corporation. A category 2 filer is only required to complete page one and schedule G. Where a U.S. corporation is the 100% owner of a foreign corporation that is not a Foreign Personal Holding Company (FPHC), the filer could be classified as a category 3, 4 or 5. Quite often, more than one category can be applied to one filer – all that applies must be checked and required,. schedules for each category filed.
When is it Due?
The form is due with the income tax return of the affected shareholder. For most corporations, that would March 15th or the extended due date. For most individuals, that would be April 15th or, if you are an expat, June 15th. This form is filed along with your personal tax return (or your business corporation / LLC tax return if it is the owner of the foreign corporation).
How Long Does it Take to Prepare?
The IRS estimates that it takes approximately 38 hours on average to prepare Form 5471 (aside from the record keeping time and the time required to learn about the relevant law and instructions). The learning time could be much longer for someone who is not familiar with the pertinent sections of the tax law. IRS estimates that the average time required for record keeping to prepare the form is 82.5 hours and that the average time required for learning about the form is 16 hours. And that does not include the separate time estimates for schedules J, M, N and O.
What Happens if You Don’t File Form 5471 or File it Late?
The penalties for a failure to file the return are severe – and it is not necessary for the corporation to have any profits for the penalties to apply. A return must be filed even if there is no taxable income to report.
Until recently, it was rare even to get a response from the IRS about the filing, even in the event that the for was filed late. However – as of late, the IRS has been vocal about the automatic penalties assessed by the computer for late filing of the Form 5471. The penalty under IRC Section 6038(b)(1) is $10,000 for each late or incomplete Form 5471.
You must remember that this is mostly an informational form, that does not result in any tax due for the taxpayer. So the $10,000 penalty is a “disclosure penalty”, unrlatd ot the actual tax tax consequences of the information provided on the Form 5471. If the failure continues for more than 90 days after the date the IRS mails notice of failure, an additional $10,000 penalty will apply for each 30-day period. The additional penalty is limited to a maximum of $50,000.
Controlled Foreign Corporation
If you, along with other US persons, own more than 50% of a foreign corporation, it is then defined as a Controlled Foreign Corporation (CFC). Then certain types of income (called Subpart F Income) may be taxed and flow through to the US shareholders. This would cause them to pay tax on that income on their US personal tax returns. The rules for determining which types of income are considered Subpart F are rather complex.
Certain types of corporate income such as dividends, interest, rental income, insurance income, offshore shipping income and personal service income are treated as Subpart F income. Subpart F income is taxable on the US shareholder’s personal return (or corporate return if a US corporation is the owner) in the year it occurs as ordinary income. This happens regardless whether the income was distributed.
Dividends paid to shareholders of Foreign Corporations are occasionally eligible for reduced qualified dividend rate (same rate as capital gains) when paid from the foreign corporation that is located in a country with which the US has a tax treaty.
Should a US Corporation with Net Operating Losses Still be Concerned?
With current tough economic climate, many US companies have accumulated significant Net Operating Losses (NOLs). Therefore, their managers may not be concerned about filing of Form 5471 – since they expect that the firm’s NOLs would protect from potential problems with the IRS. However – because the failure to file Form 5471 results in a penalty (and not a tax), NOLs would not offer any protection.
In addition, the three year statute of limitations that applies to normal tax returns (we discuss it in more detail here: Statute of Limitations for Tax Returns) does not start counting until Form 5471 is properly filed. This is because failure to file Form 5471 renders the personal tax return as incomplete at the time of original filing.
Preparation of Form 5471 is one of the most complicated and formidable challenges faced by tax preparers. Unfortunately even most professionals do not know how to handle it and may require help. If you believe that you need assistance with this particular form, we would be glad to help out, even if the rest of your personal tax return is prepared by your existing accountant. We can certainly handle your personal tax return as well. Either way – please talk to us to find out how we ca help