Dateline: Istanbul, Turkey
To say that the US tax code is complicated would be an understatement.
There are forms for every possible situation, income source, and individual. There are even tax forms and filing requirements for individuals who have never set foot inside the US and who are not even considered US persons.
Now, before we get started, a disclaimer:
While I help people plan their offshore tax structures, I am not a US tax advisor and the information on this blog should not be taken as personal financial or tax advice. Not only can and do laws change often, but there may be various interpretations, including for your situation. As such, you should always consult a licensed tax professional before making any decisions in regards to information you read online, including this blog.
Thanks to a recent change in IRS regulations, a new form has been added to this list: IRS Form 5472 – “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.”
Form 5472 is not a new tax form in and of itself. The IRS simply took the existing form and made some modifications to expand its reach.
For years, certain businesses have filed Form 5472 to report information about foreign involvement in a US trade or business. Any enterprise with at least 25% foreign ownership was required to disclose all “reportable transactions” to the IRS.
On December 13, 2016, the IRS made three key changes to the instructions for filing this report that revised definitions and added new requirements – changes that effectually increased the number of entities now required to file the report and complicated the reporting process itself.
The most significant change of all was the inclusion of foreign-owned U.S. disregarded entities. Under the new regulations, these foreign-owned DEs are now regarded as domestic corporations for the filing purposes of Form 5472 meaning that certain foreign individuals and businesses are now required to report to the IRS.
Why Did the IRS Make the Change?
While cumbersome, it is understandable that the US government would request US citizens to report their interest in foreign corporations. But to understand why the US feels that it is within their jurisdiction to make demands on foreign entities takes a bit more explanation.
The IRS utilizes a second form – Form 5471 – to specifically request information from US persons about their interest in any foreign corporations. When I was a US citizen, I would file an annual return for all of my foreign corporations. Whether they held real estate, were an active business, or did absolutely nothing, I had to file a Form 5471 for each one.
Before the new regulations, Form 5472 did much the same, except its main purpose was to communicate the involvement of US businesses with foreign parties (specifically, foreign owners) instead of the involvement of US persons with foreign businesses (as is the case with Form 5471).
With the new regulations, Form 5472 still communicates this information but it has also taken on the function of what is, essentially, a reverse 5471. Whereas Form 5471 requests information from US persons about their interest in foreign companies, Form 5472 now requests information from foreign persons about their interest in US companies.
There are many reasons why a foreign person would own a US LLC, whether it is for convenience in collecting money in a US bank from US customers or part of a holistic international tax structure.
One reason in particular that may have motivated the changes to Form 5472 is that many people favor US LLCs for the greater privacy that they offer. In some US states like Delaware, Wyoming and New Mexico, you can own a totally anonymous LLC.
It’s all held in private documentation.
People would form LLCs in these states to buy property in New York City, for example, and no one would really know who owned it. The US and other western governments are increasingly getting tired of these practices and want to get more information about the money that is flowing through their country.
New regulations like the changes made to Form 5472 are their response to too many privacy measures.
[Side note: I do not necessarily recommend anonymous LLC jurisdictions for use in international business for offshore structures because moving money from an anonymous company to an offshore structure has become increasingly difficult.]
In 2016, the US finally put its foot down and changed the rules so that, beginning in 2017, more people would be required to file Form 5472. Their hope was to put a stop to the abuses of US LLC law that have led to income tax evasion in domestic and foreign transactions between US businesses and their foreign owners.
What Exactly Did the IRS Change?
The IRS made three changes to Form 5472. Below, we will discuss each individual change and the implications of those changes.
1. Part I, Line 3
Change: This section now includes an option (line 3) to report that a foreign-owned US disregarded entity is filling out the form.
Implications: Previously, foreign persons that had partial or full ownership of a US LLC did not have to file Form 5472. Now they do.
Essentially, the US government now treats foreign-owned US disregarded entities (DEs) as US corporations. These entities are no longer exempt from reporting requirements and must inform the IRS of all “reportable transactions” made by their US disregard entity.
2. Part II, Lines 1-4
Change: The form now requests that all foreign persons who own a US DE provide a foreign taxpayer identifying number (FTIN).
Implications: Obtaining a taxpayer identifying number (e.g., ITIN, EIN, SSN) can often take several months of time-consuming paperwork. Not only must a foreign owner of a US DE now file Form 5472 on an annual basis but they must initially apply for and obtain a taxpayer identifying number in order to begin the filing process.
3. A New Part V
Change:The IRS also added a completely new section to Form 5472 (and renumbered all subsequent sections) to identify certain reportable transactions of foreign-owned US DEs that are not reported in Part IV.
According to the IRS, a reportable transaction includes any exchange of money or property with the foreign shareholder, such as:
Payments for rents, sales, royalties, interests, commissions, insurance premiums, etc. (basically, anything that may affect the taxable income of the reporting entity);
Loans between the corporation and the foreign shareholders (in both directions);
Equity-related transactions that cover all amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the foreign-owned US DEs.
Implications: The list of qualifying “reportable transactions” is two pages long, but the bottom line is that you must report any cash going in or coming out of the foreign-owned US disregarded entity and attach a short description of the transactions to Form 5472.
Form 5472 Definitions
Up to now, we have used several different terms to discuss the changes made to Form 5472. As with anything the IRS does, the exact definition of those terms is extremely important to understanding the full implications of the new regulations.
You can find the full list of definitions on the instructions for IRS Form 5472, but I have included the most important definitions below accompanied by brief explanations of how those definitions may affect you.
A disregarded entity is an entity that the IRS disregards as an entity separate from its owner for U.S. income tax purposes. This definition is generally assumed to apply to US LLCs, which are tax-transparent companies whose profits simply flow to the shareholder.
If you are a US citizen and you own a US disregarded entity, you may not need to file Form 5472 unless it has “foreign ownership”.
A foreign person can be any one of the following:
This is an important definition to pay attention to because “person” according to the IRS can also mean a foreign company. If you are a US person who has set up an offshore company and that offshore company owns a US LLC, that company is now considered a foreign person and must file Form 5472.
Foreign-owned US LLCs
The IRS covers several different definitions to clarify exactly what they mean by terms such as ‘25% foreign owned,’ ‘25% foreign shareholder,’ ‘direct 25% foreign shareholder,’ and ‘ultimate indirect 25% foreign shareholder.’
The also state that a ‘foreign-owned US disregarded entity’ is specifically defined as a domestic disregarded entity that is wholly owned by a foreign person and is treated as an entity separate from its owner and requires an informational filing.
You should work with a tax professional to determine which definition applies to you, if any. However, the basic rule is that if you own 25% or more of a US entity, you need to file Form 5472.
Reporting Requirement vs. Tax Return
Form 5472 is not necessarily a tax return. For many people, the form is merely an informational return meant to communicate to the IRS the types of transactions your corporation has made throughout the tax year with foreign parties.
If you are a foreign person and you have used a service similar to Stripe Atlas to set up a Delaware LLC to get a merchant account and bank account in the US as a non-US person, you now need to file Form 5472 for your US LLC – not necessarily because you have to pay tax but because the IRS wants more information about who is doing business in the US.
Who Is Required to File Form 5472?
The reporting entity is either:
1. Any single foreign person who owns at least 25% of a US DE
Anyone who directly or indirectly owns at least 25% of a US company and has reportable transactions with that company must submit Form 5472.
If there are multiple foreign owners with more than 25% ownership each, they must each file a separate Form 5472.
If various foreign persons hold an aggregate of 25% or more of the US company, they are not required to file Form 5472. A foreign person only has to file if they own 25% or more of the company on an individual basis.
This form will request the foreign shareholders’ name, address, country of citizenship, organization or incorporation, and all reportable transactions made with each foreign shareholder.
2. A foreign corporation engaged in a trade or business within the United States
If a foreign corporation conducts economic activities in the US or has a reportable transaction with an American or foreign-related party, they must file Form 5472.
This applies to any foreign company that has income derived from any economic activity in the United States. If this company makes any reportable transaction with a related foreign or US party, this also requires the submission of Form 5472.
The bottom line is foreign ownership. If you are a US citizen and your foreign company owns a US DE, you have to file. If you are not a US citizen and you or your foreign company own a US DE, you have to file.
When to File Form 5472?
If a foreign owner has no other obligations to file a US tax return, the IRS has determined that their default tax year is the calendar year.
Otherwise, the form can be filed with the US corporation’s income tax return, including any filing extensions.
Penalties For Not Filing
If you are required to file Form 5472 and you either fail to file or file a substantially incomplete return, the IRS could apply a penalty of $10,000 USD per year. Your company will also be under greater scrutiny from the IRS with possible audits and follow-ups in subsequent years.
Other sources have noted that, while the form instructions state that the penalty is $10,000, the Tax Cuts and Jobs Act recently increased the applicable penalty in Section 6038A(d)(1) from $10,000 to $25,000 beginning in 2018.
The change extends to any reporting required under Section 6038A(b), which is the basis for all filing requirements applicable to Form 5472.
As always, I recommend being completely transparent with all your offshore dealings. If you are required to file, file. Countries are increasingly sharing information thanks to FATCA and other information-sharing laws around the world. If you don’t file, it is likely the US will find out that you should have filed, subjecting you to expensive penalties.
New Implications in the Face of Change
Many people are marketed on the ease of doing business in the United States for their offshore business and they end up making big mistakes that cost them a lot of money. I’ve had those people come to me in the past to clean up the mess.
It’s better to get a properly laid out plan from the beginning to avoid these situations. If you’d like some help, click here to work with me.
Using US companies as part of your offshore structure may be beneficial to you at some point and it’s worth considering. However, in my opinion, services like Stripe Atlas got it wrong. There are a lot of tax ramifications – like Form 5472 – that make it vital that you receive professional help before including the US in your international tax strategy.