Is your company doing business in the US market? If you’re not filing IRS Form 5472, you could face large penalties.
The United States continues to see more investment from foreign companies and individuals who want a business presence here. When a foreign company decides to conduct business in the U.S., not only must it decide what legal entity structure to use, but after the entity is established, it must comply with all applicable U.S. tax laws. Filing the right tax returns and informational forms is critical to avoiding penalties.
For the purposes of this post, a foreigner is a corporation from outside the U.S. or an individual who is not a U.S. citizen or a resident. Generally, foreigners can use two types of legal entities in the US market to conduct business here: a limited liability company (LLC), or a C-corporation.
Tax filing requirements for foreign-owned corporations
Generally, a corporation doing business in the United States is required to file applicable federal and state income tax returns following each annual tax period. A U.S. corporation with non-U.S. shareholders who own 25% or more of the corporation’s stock are generally required to file Form 5472, which has the long-winded title, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.”
Form 5472 is a separate filing requirement from the U.S. entity’s obligation to file income tax returns under the U.S. Internal Revenue Code (Code). This form must be attached to the reporting corporation’s federal income tax return. It requires certain information disclosures about the corporation’s foreign shareholders and any transactions between it and such shareholders during the tax year.
For example, two shareholders, one from the U.S. and one from Germany, form Reliant Panel, Inc., to manufacture industrial control panels in the U.S. They each own 50% of the company’s shares. Under the Code, Reliant Panel must file Form 5472.
Requirements for LLCs taxed as partnerships
In addition to filing Form 1065 (U.S. Return of Partnership Income), a partnership with foreign partners could be responsible for complying with other filing requirements such as Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), Partnership Withholding, and Nonresident Alien Withholding.
A partnership that has income effectively connected with a U.S. trade or business is required to pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners. A foreign partner is anyone who is not considered a U.S. person, which includes nonresident aliens, foreign partnerships, foreign corporations, and foreign trusts or estates.
The partnership must pay the withholding tax regardless of the foreign partner’s U.S. income tax liability for the year and even if there were no partnership distributions made during the year. Withholding tax must be paid on a quarterly basis.
Form 5472 for LLCs with a single foreign owner
When a U.S. LLC has a single owner (defined in U.S. law as a “member”), it is disregarded as an entity separate from its owner (“disregarded entity”). Newly issued regulations treat such disregarded entities as domestic corporations rather than as disregarded entities for the purpose of the foreign reporting requirements. Under these new rules, such disregarded entities are required to file Form 5472.
For example, Forco, Inc., a Polish corporation, forms Domeco LLC in New York, a wholly-owned LLC that is treated as a disregarded entity for income tax purposes. Under prior IRS rules, Domeco had no foreign reporting obligations. However, under the new regulations Domeco is required to file Form 5472.
Form 5472 requirements
Form 5472 requires the disclosure of the foreign shareholders’ names, address and country of citizenship, organization or incorporation, principal business activity, and the nature and amount of the reportable transaction(s) with each foreign shareholder.
Whether a reportable transaction has occurred is a complex determination. For example, a loan to a U.S. LLC by the foreign shareholder is considered a “reportable transaction” and requires the disclosure on Form 5472. In general, a reportable transaction is any exchange of money or property with the foreign shareholder, except for the payment of dividends.
Filing deadlines for Form 5472
Form 5472 is filed with the U.S. Corporation’s federal income tax return, including any extensions of time to file same.
Why is filing Form 5472 is so important?
Penalties for failure to file information returns are separate from payments relating to underpayment of income taxes. Under certain circumstances, the penalties for failure to file information returns can be significantly greater than the U.S. income tax liabilities. Failure to maintain the proper records, failure to file the correct Form 5472, or failure to file a required Form 5472 may result in a $10,000 penalty for each failure per tax year.
Additionally, if a failure to file continues for more than 90 days after notification of a failure to file by the IRS, an additional $10,000 may apply for each 30-day period, or fraction thereof, that the failure continues.
These fines can’t be appealed to the IRS! That is why foreigners doing business in the U.S. are strongly encouraged to consult with their tax advisors and ensure compliance with all U.S. tax and reporting obligations.
We’ve got your back
Whether you’re new to investing in U.S. companies or quite experienced, it is always important to have knowledgeable CPAs behind you to ensure that you are making the right moves when it comes to complying with the often confusing U.S. tax code. The experts at KRS CPAs are here to guide you through tax season and beyond. For more information or to speak to one of our partners, give us a call at 201.655.7411 or email me at [email protected].
Special thanks to attorney Jacek Cieszynski for his assistance in developing this post.