Since 2009, an ever increasing emphasis has been put on international tax compliance, with stiff penalties being imposed by the Internal Revenue Service (IRS) if things are not done correctly, if filings are not made or are not timely. Today's blog post will take a peek at the notoriously difficult and confusing Form 5471, "Information Return of U.S. Persons with Respect to Certain Foreign Corporations" . It will not cover the nuances of the Form (I am not that brave). Instead it will emphasize how getting things wrong with this Form can cost you dearly.
Form 5471 is an extremely complex form. How complex is complex? Well, the IRS estimates it will take over 123 hours to do all that is required for the basic Form itself (prepare proper records in order to complete the form, learn about it and actually prepare it). Heaven forbid you need to add schedules to the Form; for example, if you must complete Schedule M, that will consume another 33 hours of your time. (See page 15). The scope and detail of the information to be reported on Form 5471 is directly linked to the percentage of the US taxpayer's ownership of the foreign (i.e., non-US) corporation. As the degree of ownership increases, the amount of information (and time required) will also increase.
Since 2012, the IRS has become more savvy with respect to tracking taxpayers required to file this Form and the information being submitted. Since tax year 2012, in order to help the IRS detect inconsistencies in a taxpayer's filings with regard to any foreign entity, IRS began assigning a unique reference identification number to each foreign entity. This number allows the IRS to compare the tax forms filed with respect to a certain foreign company, for example, over a several year time span.
Form 5471 seeks to gather information about foreign (that is, non-US) corporations that in any way involve US persons. It provides for four "categories" of US persons who must file the form and lists the information required for each "category" of filer. The categories themselves are tricky. Most (but not all) categories require ownership by a US person. In order to get information about US persons owning stock in foreign companies, however, Category 2 contains a "snitch" provision. A Category 2 filer includes a US citizen or resident who is merely an officer or director of a foreign corporation in which a US person acquires a certain percentage of stock. If you are an officer or director you are presumed to know about ownership of the corporation! So, watch out for any US persons taking on or increasing their stock ownership – you, Corporate Officer or Director, have to snitch on them. If you don't, the IRS can hit you with a $10,000 penalty.
Ownership itself is a slippery concept when it comes to Form 5471. US persons "owning" 10% or more (by "value" or by "voting power") of the stock of a foreign corporation are legally required to provide information about that foreign corporation on Form 5471.
How do you know if you "own" shares in a foreign corporation? Simple as it sounds, this initial inquiry can be very difficult to pin down. Ownership is determined by reference to stock held directly; stock held indirectly through foreign entities (for example, a beneficiary of a foreign trust that itself owns stock in a foreign corporation will be treated as owning some of the stock by virtue of being a trust beneficiary); and finally, stock deemed held through so-called constructive ownership rules when ownership is attributed from others (for example, stock owned by certain family members is treated as owned by other family members).
Penalties may apply when a Form 5471 is filed late, when it is not "substantially complete", or when it is not filed at all. With regard to any of these three types of mistakes, an "initial" penalty of $10,000 per Form 5471 per year may be assessed. See IRC § 6038(b)(1).
In addition, a "continuation penalty" of $10,000 per Form 5471 per year may be assessed for every 30-day period (or part thereof) beginning 90 days after notification by the IRS of the problem. See IRC § 6038(b)(2). The maximum continuation penalty for each Form 5471 per year is $50,000. These penalty amounts can quickly add up since the penalties may apply per Form 5471 as required each year. In addition to monetary penalties, the IRS may also reduce otherwise available foreign tax credits.
The statute of limitations for assessing and collecting the aforementioned penalties ends three years after a "substantially complete" Form 5471 has been filed.
The Foreign Account Tax Compliance Act (FATCA) enacted in 2010 extended the statute of limitations governing the time period for the IRS to examine a tax return if certain foreign-related information returns, including Forms 5471, have not been filed. The statute of limitations will remain open on the taxpayer's entire tax return and not only on Form 5471 if Form 5471 is not timely filed. Only when the form is filed will the statute of limitations "clock" begin to "tick". Due to the complexity of Form 5471, the issue arises as to what it means for the Form to be "substantially complete" and thus, considered to have been "filed". When is Form 5471 "substantially complete"? The IRS has set a pretty high bar. Failing to pass that bar may mean you are not considered as having filed the Form 5471 at all. As a result, the aforementioned penalties and statute of limitations issues will be troublesome.
If a taxpayer has not filed a Form 5471 or the Form filed is not considered "substantially complete", this can cause big problems if the individual has expatriated or is in the process of expatriating (i.e., giving up US citizenship or relinquishing a green card held for a substantial period of time). Such an individual will not be able to certify he has been fully tax compliant for the 5-year period prior to the year of expatriation, as required by the current expatriation tax regime. The issues of what constitutes a "substantially complete" Form 5471 and the impact this may have on expatriations will be examined in the next blog posting. Stay tuned.
The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.
Virginia La Torre Jeker J.D.
Virginia La Torre Jeker J.D., is based in Dubai. Virginia has been a member of the New York Bar since 1984 and is also admitted to practice before the United States Tax Court. She has over 30 years of experience specializing in the international aspects of US tax, including FATCA. She has been quoted in the New York Times and Newsweek, and is regularly quoted in many local news articles and publications."
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