Information Reporting Obligations for U.S. Individuals Owning Interests in Foreign Entities
It is no longer uncommon for tax practitioners to see their individual clients living outside the U.S. for extended periods or holding foreign investments. U.S. citizens and residents are not only subject to tax in the U.S. on their worldwide income but also to extensive information reporting requirements in relation to their foreign assets. With the introduction of the Foreign Account Tax Compliance Act (FATCA), the IRS is gaining more transparency on U.S. persons’ foreign financial assets and may assess penalties on U.S. individuals (i.e., U.S. citizens and residents) who fail to comply with their international information reporting obligations. This Practice Alert, excerpted from Journal of Taxation07201702, briefly summarizes various international information reporting obligations for U.S. individuals and discusses options for individuals with delinquent international information returns to become compliant.
Information reporting obligations for U.S. individuals owning interests in foreign entities. Information reporting is often required when U.S. individuals make direct or indirect investments in foreign entities.
Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, is required to be filed by U.S. individuals to report certain direct and indirect transfers of cash or property to a foreign corporation.
Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is required for the year in which a U.S. individual acquires a 10% or more ownership interest (in value or voting power) in a foreign corporation; acquires stock that brings the individual’s ownership interest to at least 10% in a foreign corporation; or begins the year with a 10% or larger ownership interest, disposes of stock during the year, and after the disposition he or she owns less than 10% of the corporation. Form 5471 is required for certain U.S. shareholders of controlled foreign corporations (CFCs), as well as certain other interests in foreign corporations that are not CFCs.
Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships, is required for the year in which a U.S. individual acquires a 10% or more direct interest (valued by capital, profits or deductions or losses) in a foreign partnership; acquires a direct interest and, as a result, owns a 10% or greater direct interest in the partnership; or begins the year with a 10% or larger ownership interest, disposes of stock during the year, then owns less than a 10% interest. A U.S. individual is also required to file Form 8865 when he or she and any “related persons” under Reg. § 1.6038B-2(i)(4) contribute over $100,000 of property to a foreign partnership during any 12-month period ending on the date of transfer. Any 10% owners of a controlled foreign partnership (CFP) (i.e., more than 50% controlled by U.S. persons) are also required to file an annual Form 8865.
Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company [PFIC] or Qualified Electing Fund [QEF], generally must be filed by a U.S. individual that is a direct or indirect shareholder of a PFIC for each tax year that he or she receives certain direct or indirect distributions from a PFIC, recognizes gain on a direct or indirect disposition of PFIC stock, or is making a QEF or Mark to Market (MTM) election with respect to the PFIC. U.S. individuals are also required to file Forms 8621 annually to report ownership of PFICs under Code Sec. 1298(f).
Form 8858, Information Return of U.S. Persons with Respect to Foreign Disregarded Entities [FDEs], is required to be filed by a U.S. individual that is the tax owner of an FDE (i.e., an entity that is not created or organized in the U.S. and that is disregarded as an entity separate from its owner for U.S. income tax purposes) or owns a specified interest in an FDE indirectly or constructively through a CFC or CFP.
Information reporting obligations related to foreign trusts. A trust is a domestic trust if a court within the U.S. is able to exercise primary supervision over the administration of the trust (court test) and one or more U.S. persons have the authority to control all substantial decisions of the trust (control test). A foreign trust is a trust that fails either the court test or the control test. (Reg. § 301.7701-7(a))
Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, must be filed by a U.S. owner of a foreign trust. In general, a U.S. individual who directly or indirectly transfers property to a foreign trust is treated as the owner of the portion of the trust attributable to such property if the trust has a U.S. beneficiary in the year of the transfer. (Code Sec. 679(a)) A U.S. individual may also be treated as the owner of a foreign trust if he or she is the grantor of the trust under Code Sec. 671 – Code Sec. 678.
Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, must be filed by a U.S. individual who is treated as the owner of a foreign trust, if he makes a contribution to or receives a distribution from a foreign trust, engages in loan transactions with a foreign trust, or receives certain gifts from a foreign individual, estate, corporation, or partnership. (Code Sec. 6048; Code Sec. 6039F)
Reporting of Specified Foreign Financial Assets. U.S. individuals with an interest in “specified foreign financial assets” (SFFAs) during the tax year must attach Form 8938, Statement of Specified Foreign Financial Assets, to their U.S. income tax return if the total value of their SFFAs exceeds the reporting threshold on either the last day of the tax year or at any time during the tax year. (Reg. § 1.6038D-2) SFFAs include financial accounts maintained by a foreign financial institution as well as foreign financial assets not held in an account, such as an interest in a foreign entity.
For tax years beginning after 12/31/15, certain domestic corporations, partnerships, and trusts that are considered to have been “formed or availed of” for the purpose of holding, directly or indirectly, specified foreign financial assets must file Form 8938 if the total value of those assets exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year. (Reg. § 1.6038D-6)
Report of Foreign Bank and Financial Accounts. A U.S. person with a financial interest in or signature authority over certain foreign financial accounts must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year. A U.S. individual is considered to have a financial interest in a foreign financial account for which he or she is the owner of record or holder of legal title, regardless of whether the account is maintained for his or her benefit. A U.S. individual is also considered to have a financial interest in an account owned by a corporation in which he or she has more than a 50% direct or indirect ownership interest (by value or voting power), a partnership in which he or she owns directly or indirectly an interest in more than 50% of the partnership’s profits or capital, or a trust of which he or she is the grantor or owner or has a greater than 50% present beneficial interest in the assets or income of the trust for the calendar year. (31 CFR §1010.350).
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