IRS, Treasury Department Finalize Reporting Regulations for Foreign-Owned U.S. Disregarded Entities
For years, limited liability companies (LLCs) in America with a single foreign owner were not subject to U.S. tax reporting requirements. However, final regulations recently issued by the Internal Revenue Service (IRS) and the Treasury Department have effectively closed that loophole, significantly raising the tax filing complexity and record-keeping burden on these entities.
Under the new rules, domestic LLCs that are wholly owned (directly or indirectly) by a foreign person will now be treated as a U.S. corporation and required to disclose “reportable transactions” via Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Under previous regulations, the disclosure requirement applied only to 25 percent foreign-owned (not wholly owned) domestic corporations.
While direct ownership by a single foreign person is easily defined, the new regulations define indirect single ownership as:
- Ownership by one person entirely through one or more other entities disregarded as entities separate from their owners, or
- Ownership through one or more grantor trusts, regardless of whether any such disregarded entity or grantor trust is domestic or foreign.
What are reportable transactions? In a newly-added section of Form 5472, the IRS defines reportable transactions as “amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the entity.” This is a much broader definition of transactions that must be reported and, since the new regulations do not provide a de minimis exclusion, virtually all transactions within the scope of this definition must be reported.
While the new regulations do not necessarily mean new tax obligations for foreign single owners of domestic LLCs, they do make it harder to remain compliant with tax reporting rules. For example:
- These LLCs are now required to file Form 5472 each year, creating a greater annual recordkeeping burden for those entities.
- The filing of Form 5472 requires either an Employer Identification Number (EIN) or other U.S. tax identification, which foreign owners are not likely to have. Thus, these LLCs must take additional time to append a pro forma Form 1120, U.S. Corporation Income Tax Return with their filing, denoting “Foreign-owned U.S. DE” across the top.
- At this time, the IRS does not allow these forms to be electronically filed, which means these LLCs must spend more time with paperwork and mailings to ensure tax compliance.
The filing requirements for these new regulations took effect for taxable years beginning on or after January 1, 2017 or ending on or after December 31, 2017. Keep in mind that the penalty for not filing a timely Form 5472 in tax years after December 31, 2017 starts at $10,000 and can increase from that point, depending on certain filing circumstances or lack of compliance with IRS notifications.
For more information on these new foreign ownership filing and recordkeeping requirements, contact our Business Entity Planning and Compliance team.