Disregarded Entities with Foreign Ownership Face Immediate Challenges and Opportunities Filing 2017 Tax Returns by Arthur J. Dichter, JD, LLM
Posted on January 22, 2018 by Arthur Dichter
The media is rightfully paying significant attention to the U.S.’s new tax laws effective for the 2018 tax year. However, foreign persons with direct or indirect ownership in certain U.S. entities and structures should not forget that they have an important and immediate new filing requirement effective for the 2017 tax-filing season, which begins in January 2018.
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 an 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, an SMLLC may consider electing to be treated as a corporation for U.S. income tax purposes and take advantage of the U.S.’s new corporate income tax rate, which was has been reduced significantly 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 an ideal solution, since it will not eliminate the tax return filing requirement or, in some instances, the requirement to file Form 5472. In addition, if the SMLLC owns U.S. real property, there may be Foreign Investment in Real Property Tax Act (FIRPTA) issues.
Alternatively, 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 all of 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: Arthur Dichter, JD, is a director of International Tax Services with Berkowitz Pollack Brant, where he works with multi-national businesses and high-net worth foreign individuals to structure their assets and build wealth in compliance with U.S. and foreign income, estate and gift tax laws. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.