A Foreign-Owned US Disregarded Entity Tax and Reporting

Foreign Owners of US Disregarded Entities and Form 5472

Foreign Owners of US Disregarded Entities and Form 5472

Oftentimes, when tax attorneys refer to international information reporting forms, they are focused on the reporting requirements of US persons such as US Citizens, Lawful Permanent Residents, and Foreign Nationals who meet the Substantial Presence Test. In general, when a US person has an ownership or interest in foreign assets, accounts, entities, and trusts — they may have one or several reporting requirements to the US government on various IRS foreign reporting tax forms. Form 5472 is different in that it is a Form designed for foreign persons  (non-resident aliens) who have ownership of US entities. This form catches many foreigners by surprise, because not only does it include U.S. entities, but it also includes disregarded U.S. entities. And, since outside of the United States, the US is known as one of the easiest tax systems to manipulate and hide money (aka ‘Tax Haven’), it is important for foreign nationals to avoid missing the reporting — especially since penalties start at $25,000 per violation.

Common Example 

A foreign person wants to invest in the United States and their customers prefer to deal with a US-based company. Therefore, the foreign person opens a US business. In order to avoid potential taxation, the foreign person disregards the entity so that the foreign person is directly responsible for the tax. Then, the foreign person (who is only subject to US tax on US-sourced income) does not report any of the income to the US government — claiming it is a foreign company with foreign-sourced income because it is disregarded. The United States may disagree as to the source of some of the income, but how was the United States to learn of this business based on these facts?

The answer is to require Foreign Taxpayers to not only include entities in the United States that they have ownership over, but also to include disregarded entities as well.

Section 6038A

• • (a) Requirement

    • If, at any time during a taxable year, a corporation (hereinafter in this section referred to as the “reporting corporation”)—

      • (1) is a domestic corporation, and

      • (2) is 25-percent foreign-owned, such corporation shall furnish, at such time and in such manner as the Secretary shall by regulations prescribe, the information described in subsection (b) and such corporation shall maintain (in the location, in the manner, and to the extent prescribed in regulations) such records as may be appropriate to determine the correct treatment of transactions with related parties as the Secretary shall by regulations prescribe (or shall cause another person to so maintain such records).

Section 6038C

• • • (a) Requirement

      • If a foreign corporation (hereinafter in this section referred to as the “reporting corporation”) is engaged in a trade or business within the United States at any time during a taxable year—

        • (1) such corporation shall furnish (at such time and in such manner as the Secretary shall by regulations prescribe) the information described in subsection (b), and

        • (2) such corporation shall maintain (at the location, in the manner, and to the extent prescribed in regulations) such records as may be appropriate to determine the liability of such corporation for tax under this title as the Secretary shall by regulations prescribe (or shall cause another person to so maintain such records).

26 CFR 1.6038A-1 – General requirements and definitions.

• • (c) Reporting corporation –

    • (1) In general.

      • For purposes of section 6038A, a reporting corporation is either a domestic corporation that is 25-percent foreign-owned as defined in paragraph (c)(2) of this section, or a foreign corporation that is 25-percent foreign-owned and engaged in trade or business within the United States. After November 4, 1990, a foreign corporation engaged in a trade or business within the United States at any time during a taxable year is a reporting corporation. See section 6038C. A domestic business entity that is wholly owned by one foreign person and that is otherwise classified under § 301.7701-3(b)(1)(ii) of this chapter as disregarded as an entity separate from its owner is treated as an entity separate from its owner and classified as a domestic corporation for purposes of section 6038A. See § 301.7701-2(c)(2)(vi) of this chapter.

Form 5472 Instructions

• • Reporting corporation.

    • A reporting corporation is either:

      • A 25% foreign-owned U.S. corporation (including a foreign-owned U.S. disregarded entity (DE)), or 

      • A foreign corporation engaged in a trade or business within the United States. 25% foreign-owned. A corporation is 25% foreign owned if it has at least one direct or indirect 25% foreign shareholder at any time during the tax year.

  • Also Still Must be a Reportable Transaction

    • Reportable transaction.

      • A reportable transaction is: 

      • Any type of transaction listed in Part IV (for example, sales, rents, etc.) for which monetary consideration (including U.S. and foreign currency) was the sole consideration paid or received during the reporting corporation’s tax year;

      • Any transaction listed in Part V; or

      • Any transaction or group of transactions listed in Part VI. Transactions with a U.S. related party, however, are not required to be specifically identified in Parts IV, V, and VI.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and how the Substantial Presence Test works.

Contact our firm today for assistance with getting compliant.