On December 13, 2016, the IRS issued T.D. 9796, new regulations that require U.S. disregarded entities owned by a foreign person to file U.S. Federal Form 5472. The new Form 5472 filing requirement applies for tax years beginning after December 31, 2016 and ending on or after December 13, 2017.
Form 5472 is required to be filed by a reporting corporation that engages in reportable transactions with a U.S. or foreign related party. For this filing requirement, a reporting corporation is defined as either a U.S. C Corporation owned directly or indirectly by a 25% foreign shareholder or a foreign corporation engaged in a U.S. trade or business. The new regulations now state that a reporting corporation for the Form 5472 will include a U.S. disregarded entity that is owned directly or indirectly by one foreign person. A U.S. disregarded entity is a company or a grantor trust which is owned 100% by one person that is treated as the owner of all assets, liabilities, and income of the entity. A U.S. disregarded entity is considered to be owned indirectly by a foreign person if it is owned through one or more other disregarded entities or grantor trusts. The new regulations also expand the scope of reportable transactions to include the foreign owner’s capital contributions to a U.S. disregarded entity and distributions from a U.S. disregarded entity to its foreign owner.
The IRS has not yet updated U.S. Federal Form 5472 to reflect the new changes beginning with the 2017 tax year. It is unclear whether a U.S. disregarded entity with reportable related party transactions will be required to file Form 5472 separately with the IRS apart from a U.S. tax return. Based on the new regulations, the U.S. disregarded entity is classified as a U.S. C Corporation solely for purposes of the Form 5472 filing requirement. The IRS has not yet announced whether the U.S. disregarded entity would be required to file a U.S. corporate income tax return with the Form 5472 attached to report transactions with related parties.
In order to file Form 5472 as a reporting corporation, the U.S. disregarded entity will be required to obtain a U.S. FEIN as a taxpayer identification number. When applying for a FEIN for the U.S. disregarded entity on the U.S. Federal Form SS-4, it is necessary to provide the name and U.S. FEIN, Social Security Number (SSN), or individual taxpayer identification number (ITIN) of the foreign owner as the responsible party. This will require a foreign nonresident individual owner of a U.S. disregarded entity to apply for an ITIN on U.S. Federal Form W-7. There are certain procedures that a nonresident individual must follow to file the Form W-7 ITIN application. The processing time for the Form W-7 ITIN application with the IRS can take several months.
The new regulations also exclude a U.S. disregarded entity with a foreign owner from certain regulatory exceptions to Form 5472 recordkeeping requirements. Those exceptions typically exempt small corporations from the recordkeeping requirements if the corporation has less than $10 million in gross receipts and $5 million or less of reportable related party transactions that are less than 10% of gross income. A U.S. disregarded entity with a foreign owner is not eligible for such exceptions.
Form 5472 is an important U.S. international tax reporting requirement that should not be overlooked. The failure to file or the late filing of the Form 5472 can result in a $10,000 USD penalty per related party, per year.
For more information, please contact Alison Dougherty at ADougherty@aronsonllc.com or 301.231.6290. Alison will be presenting a webinar on Form 5472 filing requirements and the new regulations on September 12, 2017. For more information and to register, please see visit the Strafford website.
With increasing globalization and the expansion of cross-border business activities, U.S. employees are often relocating to work in foreign countries. U.S. expatriate employees typically may work in a foreign country for a U.S. company or for a foreign subsidiary company or foreign affiliate of the U.S. employer. There are certain U.S. federal tax considerations that may impact both the U.S. employee and employer when employees work in a foreign country.
A significant consideration is whether the U.S. employee will remain on the payroll of the U.S. employer. Regular U.S. federal Form W-2 reporting will apply if the employee continues to receive compensation from the payroll of the employer while working in the foreign country. This means that generally the U.S. employee will be subject to U.S. federal income tax, Social Security and Medicare withholding on the compensation earned while working in the foreign country. The employee may qualify for an exemption from U.S. federal income tax withholding on the foreign earned wages if the employee will qualify for the foreign earned income exclusion. There is also an exemption from federal income tax withholding on foreign earned wages if the wages are subject to employment tax withholding in the foreign country. A U.S. employee’s foreign earned wages generally continue to be subject to U.S. Social Security withholding. Some foreign countries have treaties with the United States referred to as Social Security Totalization Agreements, which provide that the employee working in the other country continues to be subject to the Social Security system of the home country unless the presence in the other country is greater than five years.
Alternatively, the U.S. employee could be transferred to the payroll of a foreign subsidiary or affiliate of the U.S. employer. If the employee receives compensation from the payroll of the foreign company, the foreign earned wages generally are not subject to U.S. federal income tax, Social Security or Medicare withholding. However, U.S. federal Social Security withholding is required for U.S. employees who are on the payroll of a foreign company and who are working on a U.S. government contract. Otherwise, the U.S. employee may lose the FICA contributions on the foreign earned wages. The U.S. employee also would lose the ability to participate in the U.S. employer’s benefit plan, including a 401(k) plan with respect to the foreign earned wages. However, there is an irrevocable election on Form 2032 which allows the U.S. employer to pay the FICA contributions with respect to the U.S. employee’s foreign earned wages received from the payroll of a foreign affiliate. The Form 2032 election requires the U.S. employer to have at least 10% direct or indirect ownership of the foreign employer. Another option is for the U.S. employer to enter into a secondment agreement with a controlled foreign subsidiary company. The secondment arrangement allows the employer to continue to report and pay the U.S. federal employment tax withholding on the U.S. employee’s foreign earned wages while the U.S. employee is on loan to the foreign subsidiary company.
Please contact your Aronson LLC tax advisor, Alison N. Dougherty, International Tax Services at 301.231.6290 for more information.