Reporting of an ownership interest in a foreign corporation can prove to be a difficult hurdle for U.S. taxpayers to tackle. Various factors need to be considered when determining which IRS forms and schedules are appropriate for a given U.S. shareholder's unique circumstances.
Some of these factors include:
Each scenario has to be carefully examined. For example, in the case of a U.S. taxpayer husband and a U.S. taxpayer wife, both having a 50% ownership, the foreign corporation is considered to be wholly controlled by U.S. shareholders and is subject to the most rigorous reporting requirements. Other factors that affect the extent of reporting include the acquisition or disposition of the ownership in the foreign corporation by all U.S. or non-U.S. shareholders and the date the U.S. shareholder became subject to U.S. tax reporting.
Due to the myriad of possible ownership structures and applicable rules, failure to correctly identify Form 5471 filing requirements is not unheard of. If you suspect that you may have missed out on your foreign corporation reporting, visit my article on this topic, Form 5471 Filing - Failure to Report Foreign Investments Can Have Costly Consequences.
Form 5471 Becomes More Complex Under the TCJA
Since its introduction in 1962, Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, has had a reputation as one of the most notoriously difficult U.S. tax forms to prepare. Recent efforts by Congress to require U.S. taxpayers to repatriate their foreign earnings under the Tax Cuts and Jobs Acts of 2017 (TCJA) has further complicated Form 5471. Prior to the passing of TCJA, Form 5471 was comprised of eleven schedules and three worksheets. While some of these schedules and worksheets were quite long and time consuming, others remained short and involved only relatively basic information.
For tax year 2018, most of the existing schedules were significantly expanded and three additional schedules were created to accommodate the TCJA's newly passed sections: IRC Section 965 on Transition Tax and IRC Section 951A on Global Intangible Low-Taxed Income. Furthermore, the reporting requirement was expanded to include U.S. taxpayers previously excluded from Form 5471 reporting. This was due to updates to the definition of a U.S. shareholder and the determination of control. The definition of a U.S. shareholder was amended from U.S. persons who own 10% or more of the total voting power to include U.S. persons who own 10% or more of value of all classes of shares. Finally, the period required for the determination of control held during the tax year was changed from a minimum of 30 days to any period of time, even for a single day.
The 2019 tax year presents new challenges. In addition to further expanding the previous Form 5471 schedules, new and complex distribution ordering rules are now also included.
Increased Recordkeeping with Form 5471
What does this mean for the U.S. shareholder of a foreign corporation reportable on Form 5471? The new rules translate to increased recordkeeping and even more reporting to the IRS. In order to accurately complete the taxpayer’s 2019 Form 5471 and tax return, tax accountants will have to separate previously taxed earnings and profits (PTEP) into several categories, called buckets. As the shareholders of the company receive distributions from PTEP, these buckets have to be depleted in very specific order. Earnings from U.S. property take priority. This is the first bucket to be depleted starting with the earliest year and going back in time. This treatment is called last in first out, or LIFO.
Once the first bucket becomes empty, any additional distributions are associated with the second bucket. The second bucket contains various items, such as income that was subject to the transition tax, GILTI income, passive earnings and foreign branch income of the company. This bucket is also depleted in the LIFO order. After emptying the first two buckets, additional distributions received are deemed to be coming from a third bucket that contains earnings and profits that have not been taxed yet.
Related Foreign Disclosure Forms to Consider
Related foreign disclosure forms, such as Form 8992, From 114 or FBAR, and Form 8938, present yet another layer of complexity. Form 8992 reports the U.S. taxpayer's share of GILTI income, while Forms 114 and 8938 report foreign financial accounts and assets. As the information reported on these forms is interrelated, special attention is needed to ensure that all forms are prepared in accordance with the applicable rules and one another.
Keeping detailed records of these complex rules will require specific knowledge and understanding. Here at the KB International Tax Team, we have the expertise and the experience to help taxpayers with both their U.S. tax returns and foreign informational filings. We have a dedicated team of professionals specializing in the reporting requirements of Form 5471, its schedules, and related forms. We are continuously researching and testing these changes in an effort to provide taxpayers with the most up-to-date advice.