I know. Talking about an IRS form is just about guaranteed to generate snores or, worse, inspire visitors to click away. But mention the $10,000 penalty imposed for failure to file this two-page form, and I think that might be enough to get readers’ attention. There are new rules governing who must file this form, and ignore those new rules at your own peril. Do I have your attention now? I hope so.
Previously, only corporations, or limited liability companies that elected to be taxed as corporations, and which were 25% or more owned by non-U.S. parties, had to file this form. But in a parting shot, the Obama Administration, working hand-in-glove with the IRS to make doing business in the U.S. as onerous as possible, put new regulations into effect at the end of 2016. Pertinent to tax filings beginning with the 2017 tax year, these new regulations require all disregarded entities (DEs) with a non-U.S. member or beneficial owner to file Form 5472.
A disregarded entity is one that does not file its own tax returns – it is disregarded by the IRS for tax purposes – and the taxes pass through to the member/owner. The leading example of a DE is a single-member LLC. While foreign-owned single-member LLCs that had not elected to be taxed as a corporation or association previously did not have to worry about Form 5472, beginning with current tax filings they do. There are other types of DEs, too, like some kinds of limited partnerships, and they also are covered by the new regulations, but most of the new burden falls on single-member LLCs.
LLCs with more than one member, such as those owned by a husband and wife, or by multiple entities, or by an individual and an entity, do not come under the new requirement to file a Form 5472 since they file partnership returns, and these returns indicate the LLC’s taxable income. That was deemed to be too difficult or impossible to determine where the taxable income from a single-member LLC is merged with the filing party’s taxable income, and thus the new requirement. While LLCs, single- or multi-member, that have elected to be taxed as a corporation always had a requirement to file Form 5472, now the requirement has been extended to all single-member LLCs, including those that have not elected to be taxed as a corporation.
It’s bad enough to have an added tax filing requirement, but the downside of ignoring this requirement is designed to send fear and loathing into the heart of any filer. Failure to file a Form 5472 when required carries a $10,000 penalty (yes, you read that right). Incomplete or inaccurate filings count as not being filed and thus incur a $10,000 penalty. And allowing time to go by without filing the form incurs additional $10,000 penalties for every 90 days the filing is not done. The penalty also applies to each Form 5472 that is not filed, so if a group of companies must file four Forms 5472, that equates to $40,000 in penalties. It is reported, further, that the IRS is diligent about pursuing penalties for failure to file Form 5472 when the form is required.
There also is a record-keeping requirement that goes with Form 5472, and if a reporting company is deemed not to have maintained adequate records to verify the transactions reported on a Form 5472, that, too, carries a separate $10,000 penalty.
A DE filing Form 5472 would check the box on Line 3 of the form.
I had a client write me recently and ask if this was some sort of joke. Granted, like many things related to U.S. tax law, this one seems so ludicrous that it might well be a joke. But Form 5472 and the penalties attached to it are not jokes. So sit up and take notice if these requirements pertain to you.
A 25%-or-more foreign shareholder is deemed to be any party that is not a U.S. citizen or U.S. legal permanent resident that, directly or indirectly, owns or controls 25% or more of the reporting entity. Obviously, with a single-member LLC, that includes the foreign member, and the rule applies whether the member or the ultimate beneficial owner is an individual, a trust, a corporation, an association, a government agency, or some other entity.
Reportable transactions include any distributions, whether in cash or in kind, to members, as well as rents, sales, or other income received by the entity, whether in a single transaction or group of transactions.
All DEs filing Form 5472 must have their own Employer Identification Numbers (EINs) and must also file Form 1120, the corporate tax return, though the Form 1120 does not have to be complete. It must just cover and explain the items reported on Form 5472.
There are a couple of exceptions to the requirement, and it’s advisable to read carefully in the instructions as well as on the form itself what is required or might fall under an exemption. A foreign person who files a joint tax return with their U.S. citizen spouse is exempted. There also is an exemption for members of what is called a “consolidated group,” where the parent of that group is a corporation filing a consolidated return for the group. It’s hard to tell definitively, but I interpret that exemption to mean that single-member LLCs that report to a single parent LLC or corporation would not have to file individual forms 5472, but the parent is required to file them and also is required to list in an attached schedule all the entities and their names, addresses, and EINs included in the consolidated reporting.
The new requirement covers the tax year beginning January 1, 2017. As the IRS says, “for tax years beginning on or after January 1, 2017, and ending on or after December 13, 2017 (sic), a foreign-owned U.S. DE is treated as an entity separate from its owner and classified as a corporation for the limited purposes of the requirements under section 6038A that apply to 25 percent foreign-owned domestic corporations.”
A tax payer with a tax year different from the calendar year may use that tax year for reporting purposes. Otherwise, the calendar year tax year applies.
Supposedly accountants and tax advisers have been notified of the new rules, but I’m a bit skeptical of that. Remember, if you fail to file properly, you will be assessed the penalties, not your accountant, so be sure to stay on top of this issue and be sure to file these forms if you are required to.
I’ll be covering a wide range of topics relevant to doing business, holding assets in entities like LLCs and corporations, buying and selling real estate, and tax matters, in this blog, so be sure to subscribe via the subscription box that appears in the right navigation. Subscription is free, and that way you won’t miss out on any new postings here. I also welcome readers to share blog postings and to contribute and participate through their comments and questions. And if you have a key topic you’d like covered, either ask me to cover it or you might be invited to submit a guest posting about it.
Welcome to the AlphaBiz! blog!