Disregarded Entities with Foreign Ownership Face Challenges and Opportunities Filing 2017 Tax Returns by Andrew Leonard, CPA
Posted on February 28, 2018 by Andrew Leonard
While the media is rightfully paying significant attention to the U.S.’s new tax laws effective for the 2018 tax year, foreign persons with direct or indirect ownership in certain U.S. entities and structures should not forget that they have a significant new filing requirement effective for the 2017 tax filing season.
For taxable years beginning in 2017, foreign-owned domestic disregarded entities, including single-member limited liability companies (SMLLCs) must, 1) maintain a set of permanent financial records, 2) obtain from the Internal Revenue Service (IRS) an employer identification number (EIN) and 3) file both a U.S. corporate income tax return and IRS informational reporting 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 Sections 6038A and 6038C of the Internal Revenue Code). Failure to file the return or maintain proper records could result in a penalty of $10,000 for each violation of the law.
Generally, the Internal Revenue Code (IRC) treats SMLLCs as disregarded for all tax purposes. This means that a SMLLC would not have any U.S. income tax or information-reporting requirements separate from its foreign owner. However, under the new rules, such disregarded entities owned by a foreign person are treated as a domestic corporation that must meet all of the reporting and recordkeeping requirements applicable to domestic corporations with foreign owners. This includes filing an income tax return even if the foreign owner is already filing a U.S. tax return to report the SMLLC’s activity. The tax return will provide only general identifying information, but the Form 5472 that must be attached includes disclosure of the SMLLC’s direct and indirect foreign owners and any transactions that occurred between the SMLLC and a related party (including but not limited to the owner). For this purpose, a foreign owner includes a nonresident alien individual, foreign corporation, partnership, trust or estate.
It is likely too late for applicable taxpayers to avoid the domestic disregarded entity filing and recordkeeping requirements in 2017. However, taxpayers do have an immediate opportunity during the first few months of 2018 to plan ahead and change their structures.
For example, a SMLLC may elect to be treated as a corporation for U.S. income tax purposes in order to take advantage of the reduction in the U.S.’s corporate income tax rate from a high of 35 percent to 21 percent beginning in 2018. While this option may be acceptable and easy for some foreign owners of SMLLCs to do, it is not really a solution since it will not eliminate the need for filing a tax return, and Form 5472 may still be required. If the SMLLC owns U.S. real property there may be FIRPTA issues.
Or, if the SMLLC is owned by a foreign corporation and holds personal use property, the LLC may be liquidated and avoid a U.S. corporate tax return filing requirement going forward until the property is sold. However, this option may also yield future tax implications, including foreign tax consequences, depending on the SMLLCs activities and whether the foreign corporation owns other assets.
Before making any decisions, it is vital that taxpayers engage the expertise of accountants and advisors to conduct a thorough review of their unique circumstances and a careful analysis comparing the options available to them.
The advisors and accountants with Berkowitz Pollack Brant work with domestic and foreign individuals and businesses to comply with international tax laws, maximize tax efficiency and reduce unnecessary compliance costs.
About the Author: Andrew Leonard, CPA, is an associate director with Berkowitz Pollack Brant’s International Tax Services practice, where he focuses on pre- and post-immigration tax planning for individuals from South America, Asia and Europe and helps U.S. residents with foreign interests meet their filing disclosure requirements. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.