Can Form 5471 Be Avoided with a Non-Resident Treaty Election

Can the IRS Form 5471 Be Avoided with a Tax Treaty Election?

Can IRS Form 5471 Be Avoided with a Treaty Election?

Currently, there is no specific tax code section or regulation that unequivocally provides that a taxpayer who makes a treaty election to be treated as a foreign person for tax purposes must file a Form 5471 if otherwise required (see below). But, that is the general position the IRS takes, as recent as 2022, based on Regulation 1.6038. 2(j)(2)(ii). Now, in 2024, with the proposed foreign trust regulations being issued – which proposes that Taxpayers who make a treaty election to be treated as nonresidents for tax purposes may be able to circumvent filing Form 3520 – there is hope that this will ultimately lead to a similar update for Form 5471 reporting as well. This concept is furthered by the recent case of Aroeste, in which the U.S.D.C for the Southern District of California ruled in favor of the Petitioner on the issue of whether Taxpayers who qualify for a treaty election must file the FBAR (the ruling squarely contradicts the IRS position as laid out, by example, in Publication 5569).

26 U.S.C. 6038

• • • Requirement

    • (1) In general

      • Every United States person shall furnish, with respect to any foreign business entity which such person controls, such information as the Secretary may prescribe relating to—

        • (A) the name, the principal place of business, and the nature of business of such entity, and the country under whose laws such entity is incorporated (or organized in the case of a partnership);

        • (B) in the case of a foreign corporation, its post-1986 undistributed earnings (as defined in section 902(c)); [1]

        • (C) a balance sheet for such entity listing assets, liabilities, and capital;

        • (D) transactions between such entity and—

          • (i) such person,

          • (ii) any corporation or partnership which such person controls, and (iii)any United States person owning, at the time the transaction takes place—

            • (I) in the case of a foreign corporation, 10 percent or more of the value of any class of stock outstanding of such corporation, and

            • (II) in the case of a foreign partnership, at least a 10-percent interest in such partnership; and

What does this mean?

It means that according to 26 U.S.C. Section 6038, certain U.S. Taxpayers who have ownership of a foreign corporation(s) are required to report the information annually to the U.S. Government. This is typically accomplished by filing IRS Form 5471.

As provided by the IRS:

• Purpose of Form 5471:

  • • • “Form 5471 is used by certain U.S. persons who are officers, directors, or shareholders in certain foreign corporations. The form and schedules are used to satisfy the reporting requirements of sections 6038 and 6046, and the related regulations.”

Section 1.6038- 2(j)(2)(ii)

• • • (ii) If an individual who is a United States person required to furnish information with respect to a foreign corporation under section 6038 is entitled under a treaty to be treated as a nonresident of the United States, and if the individual claims this treaty benefit, and if there are no other United States persons that are required to furnish information under section 6038 with respect to the foreign corporation, then the individual may satisfy the requirements of paragraphs (f)(10), (f)(11), (g), and (h) of this section by filing the audited foreign financial statements of the foreign corporation with the individual’s return required under section 6038.

What does this mean?

This is where it starts to veer off and requires a deeper reading to connect the dots. Based on this section of the regulation, it implies that Taxpayers who make treaty elections to be treated as foreign non-residents can forego filing Form 5471 if they instead file an audited foreign financial statement of the foreign corporation. Thus, it implies that if the taxpayer who makes a treaty election does not want to furnish the audited foreign financial statements, then they would still have to file Form 5471.

Form 3520 Proposed Regulations 1.6039F-1(f)(1) 

Recently, the Government issued proposed regulations involving 6039F (Foreign trust and gift reporting) which in part aims to reduce the reporting required for Taxpayers making a treaty election:

1. 1. 1. Special Rules for Dual Resident and Dual Status Taxpayers

• • • • “Proposed § 1.6039F-1(f)(1) provides a special rule for dual resident taxpayers (within the meaning of § 301.7701(b)-7(a)(1)).

      • A dual resident taxpayer who, pursuant to a provision of an income tax treaty that provides for resolution of conflicting claims of residence by the United States and the treaty partner, claims to be treated as a resident of the treaty partner as provided in § 301.7701(b)-7 is taxed as a nonresident for U.S. tax purposes for the portion of the taxable year that the individual is treated as a nonresident.

      • The Treasury Department and the IRS are of the view that, because the dual resident taxpayer’s filing of relevant forms pursuant to § 301.7701(b)-7 provides adequate information for the IRS to identify residents in this category in order to ensure their tax compliance, reporting on Form 3520 by such a taxpayer is not essential to effective IRS tax enforcement efforts relating to this category of residents.”

Aroeste Court Ruling

The U.S. Government takes the position that Taxpayers who make treaty elections to be treated as a non-residents must still file the FBAR. In Aroeste, the court disagreed with the U.S. government and ruled in favor of the Taxpayers. Here, the court concluded that the Taxpayer did not have an FBAR filing requirement at the time the penalties were issued against him:

• • • “Specifically, the Court finds Aroeste is a United States person, but ceased to be treated as a lawful permanent resident of the United States because he commenced to be treated as a resident of Mexico under the Treaty, did not waive the benefits of such Treaty, and notified the Secretary of the commencement of such treatment. Thus, Aroeste is not subject to FBAR penalties. The Government must discharge Aroeste’s liability for penalties still outstanding for the non-filing of a FBAR for the years 2012 and 2013 pursuant to 31 U.S.C. § 5321, totaling $21,851.76, and must refund Aroeste’s payment of $3,004.”

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

This resource may help taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.