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Form 5472- The Hidden Reporting Requirement for Foreign-Held Disregarded Entities

Form 5472- The Hidden Reporting Requirement for Foreign-Held Disregarded Entities

By Anthony Diosdi

There is a perception by many countries that the United States is the world’s largest tax shelter. This is because unlike many countries, the United States does not require public disclosure of ownership of its entities, (in particular Limited Liability Companies (LLCs)), or publishing of year-end financial statements for public viewing. The lack of transparency has allowed nonresidents of the United States to form a domestic shell to avoid paying foreign income taxes, hide money or commit other acts of wrongdoing. Historically, nonresidents established shell companies in the United States as domestic disregarded entities.

On December 13, 2016, the Treasury Department and the IRS issued final regulations regarding new reporting requirements for domestic disregarded entities wholly owned by a nonresident of the United States. For the purposes of reporting requirements under Internal Revenue Code Section 6038A, a disregarded entity will be treated as U.S. corporations.

In the past, for tax purposes, a foreign-owned U.S. disregarded entity was just that- the entity was disregarded. Prior to the finalization of the new regulations issued by the Treasury Department and IRS, there was no requirement for disregarded entities most of its transactions to the IRS. Under the new requirements, a domestic disregarded entity owned by nonresidents will be required to obtain an Employer Identification Number (“EIN”), prepare a pro-forma Form 1120 and file Form 5472, Information Return of a 25% Foreign Owned US Corporation or a Foreign Corporation Engaged in a US Trade or Business. In filing the Form 5472, the disregarded entity will need to provide information regarding its foreign owners, information regarding related parties, and the dollar amounts of transactions that it entered into during the taxable year. A separate Form 5472 is filed for each foreign or domestic related party with which the disregarded entity engaged in reporting transactions during a tax year.

The IRS believes the regulations governing the Form 5472 reporting requirements will allow them to better enforce the tax laws, increase financial transparency, better combat perceived misuses of U.S. shell companies, share information with treaty partners, and support Bank Secrecy Act regulations.

Penalties for Noncompliance

For tax years beginning after December 31, 2017, the Tax Cuts and Jobs Act increased the penalties for late filing of Form 5472 to $25,000 (previously $10,000). See IRC Sections 6038A(d)(1) and (2). It is important to note that the penalties associated with the late filing of a Form 5472 is on the IRS “automatic” penalty list, subject to possible “reasonable cause” defenses. This penalty can be assessed annually. The failure to timely file a substantially complete Form 5472 can also result in criminal prosecution. A penalty also applies for the failure to maintain records required by Treasury Regulation Section 1.6038A-3.

Compliance and Record Keeping Requirements

Under the new regulations, if a domestic disregarded entity is owned by a nonresident(s), whether the nonresident owner is an individual or an entity, the disregarded entity must timely file an accurate Form 5472. The Form 5472 must be attached to the pro-form Form 1120. Nonresident owners of disregarded entities must also understand that there is now the need to maintain the appropriate records in order to comply with new regulations. In particular, Treasury Regulation Section 1.6038A-3, requires nonresident owners of disregarded entities to maintain records to allow for accurate reporting of transactions. Among the types of transactions that will require disclosure are sales, cost-sharing transaction payments, rents, royalties, leases, licenses, commissions, loans, interest, etc. Disclosure is required for any transaction or group of transactions if any part of the consideration paid or received was not monetary consideration, or less than full consideration was paid or received.

Extending to Time for Filing Form 5472

It is common for foreign owned disregarded entities to need additional time to file a Form 5472. There are special requirements for filing an expansion for a Form 5472. A foreign owned disregarded entity that is required to file a Form 5472 can request an extension of time by filing Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns. The extension must be filed on or before the regular due date of the return. Since a Form 5472 for a disregarded entity is attached to a pro forma Form 1120, “Foreign-owned U.S. DE” should be written across the top of the Form 7004.

Any foreign investor that maintains an interest in a disregarded entity must understand they have an annual Form 5472 and pro-forma Form 1120 filing. There is also a requirement to maintain records. Failure to comply with these compliance and record keeping requirements can be very costly.

We have substantial experience advising clients ranging from small entrepreneurs to major multinational corporations in cross-border tax planning and compliance. We have also  provided assistance to many accounting and law firms (both large and small) in all areas of international taxation.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.