New Proposed Reporting Requirements for Foreign-Owned Domestic Disregarded Entities

The Internal Revenue Service has recently issued Proposed Regulations REG-127199-15 that would amend Reg. 301.7701-s(c) to treat a domestic disregarded entity that is wholly owned by one by one foreign person as  a domestic corportation separate from its owner for the limited purposes of the reporting and record maintenance requirements under Section 6038A.1.  The proposed regulations would not alter the framework of the existing entity classification regulations, including the treatment of certain entities as disregarded.

 Foreign-Owned Disregarded Domestic LLC’s

The IRS states that when an entity, such as an LLC, is classified as a corporation or a partnership for tax purposes, general ownership and accounting information is available to the IRS through the return filing and an employer identification number (EIN) application requirements. However, a disregarded entity is not subject to a separate income or information return filing requirement. Its owner is treated as owning the entity’s assets and liabilities directly and the information available with respect to the disregarded entity depends on the owner’s own return filings, if any are required.

For a disregarded entity that is formed in the United States and is wholly owned by a foreign corporation, foreign partnership, or nonresident alien individual, in most cases no U.S. income or information return has to be filed if neither the disregarded entity nor its owner received any U.S.-source income or was engaged in a U.S. trade or business during the tax year.

Also, if a disregarded entity receives only certain types of U.S.-source income, such as portfolio interest or U.S.-source income that is fully withheld on at source, its owner may not have a U.S. return filing requirement. Even when the disregarded entity has an EIN, as well as when income earned through a disregarded entity must be reported on its owner’s return, it may be difficult to associate the income with the disregarded entity based solely on the owner’s return. Treasury also points out that although ownership and accounting information is generally available under the reporting requirements established by the U.S. federal tax system with respect to many types of domestic entities, the absence of specific return filing and associated recordkeeping requirements for foreign-owned, single-member domestic entities hinders law enforcement efforts and compliance with international standards of transparency and cooperation in the area of tax information exchange. The lack of ready access to information on ownership of, and transactions involving, these entities also makes it difficult for the IRS to ascertain whether the entity or its owner is liable for any federal tax.

The Proposed Regulations would treat the affected domestic entities as foreign-owned domestic corporations for the specific purposes of Section 6038A and, because such entities are foreign owned, they would be reporting corporations within the meaning of Section 6038A . Consequently, they would be required to (1) file Form 5472, 4 an information return with respect to reportable transactions between the entity and its foreign owner or other foreign related parties – transactions that would have been regarded under general U.S. tax principles if the entity had been, in fact, a corporation for U.S. tax purposes; and (2) maintain records sufficient to establish the accuracy of the information return and the correct U.S. tax treatment of such transactions. In addition, because these entities would have a filing obligation, they would be required under the Proposed Regulations to obtain an EIN by filing a Form SS-4 that includes responsible-party information