You are a U.S. taxpayer and you had at least 10% ownership in a foreign corporation for several years. You never heard of Form 5471 until now and consequently never filed Form 5471 with the IRS. Does this sound familiar? If so, this article is for you.
Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, is an information return that reports a U.S. taxpayer’s ownership interest in a foreign corporation. Prior to 2017, Form 5471 was used almost exclusively for information reporting purposes only. In other words, the form often had little to no impact on the U.S. taxpayer’s taxable income with the notable exception of actual distributions paid by the foreign corporation to the U.S. shareholder. To learn more about the basics of Form 5471 reporting, visit my previous article, IRS Form 5471: What U.S. Taxpayers Should Know About Foreign Corporation Reporting.
Consider the following scenario: a taxpayer diligently engages a U.S. tax professional to report their U.S. income on Form 1040 with the IRS, and a foreign tax professional to report income from the foreign corporation with the foreign tax authority, in accordance with the laws of each country. The taxpayer is confident that they have satisfied their reporting requirements in both countries. Here is the difficulty with this situation. In addition to reporting income earned within the U.S., the IRS also requires the reporting of certain foreign income items and the disclosure of foreign information.
What are the consequences of not filing Form 5471?
The Tax Cuts and Jobs Act of 2017 (TCJA) implemented two new taxes for U.S. owners of controlled foreign corporations: 1) IRC Section 965, also known as the Transition Tax, which taxes income earned by the foreign corporation in previous years as if those earnings had been repatriated to the U. S.; and 2) IRC Section 951A or the Global Intangible Low-Taxed Income (GILTI), which functions as a current-year tax. As a result, the previously informational Form 5471 has become an integral part of reporting these two newly introduced taxes. TCJA also changed the relationship of the form to taxable income. For example, the previously untaxed accumulated earnings and profits from Form 5471 became the starting point for the computation of the transition tax. Similarly, the portion of the annual income subject to the GILTI rules now flows through both Form 5471 and the calculation of the GILTI tax on Form 1040.
In the case of a calendar-year-end foreign corporation that is considered to be a corporation controlled by U.S. shareholders, failure to file Form 5471 for the 2017 tax year likely means failure to file 2017 Form 965 and pay the resulting transition tax on time. Subsequently, 2018 and 2019 Form 8992 calculating the U.S. shareholder portion of GILTI tax are possibly also missed, resulting in unpaid taxes during these years. Other forms that are potentially missing or misstated include Form 1116 reporting foreign tax credit, Form 114 or Foreign Bank Account Report, and Form 8938 for reporting specified foreign financial assets.
Another issue to consider is the latest effort by the IRS to step up its enforcement campaign related to Section 965. In October of 2020, taxpayers suspected of failing to report their transition tax began receiving so called “soft letters” from the agency. Letter 6311 warns U.S. taxpayers who previously filed Form 5471, but neglected to file their 2017 Form 965, of the potential obligation to file Form 965 and pay any resulting taxes.
How can I rectify my oversight?
One of the available solutions is to participate in a voluntary IRS program such as the Streamlined Filing Compliance Procedures. The main requirements of the streamlined program include the filing of amended income tax returns complete with all necessary forms and schedules, such as the forms described above, for the 3 most recent tax years, along with the Foreign Bank Account Reports for the 6 most recent tax years. The involvement of a tax accountant and a tax attorney both experienced in the field of U.S. tax and foreign compliance is highly recommended.
In light of all this information, why do taxpayers choose to participate in the streamlined program? The penalty of $10,000 for failure to file Form 5471 alone is staggering. Taking advantage of the program not only reduces the potential penalties but brings the taxpayer into compliance with the IRS, thus providing peace of mind. Here at the KB International Tax Team, we have the expertise and the experience to help taxpayers with their U.S. tax returns and foreign informational filings. We have a dedicated team of professionals specializing in the reporting requirements of both the Streamlined Filing Compliance program and Form 5471.