Avoid this common misunderstanding. U.S. corporate leaders may assume that their U.S. federal Form 1120 corporate income tax return does not need to be filed on time if the company has a loss for the year. If the U.S. corporation owns an interest in a foreign subsidiary corporation, this misunderstanding can cost a U.S. corporation with a net operating loss substantially in penalties.
The applicable penalties are assessed based on failure to file U.S. federal Form 5471 with the tax return on time. There is a $10,000 USD penalty per year, per foreign subsidiary corporation for failing to file the Form, which reports ownership of a foreign subsidiary corporation, on time.
U.S. federal corporate income tax penalties, such as late filing and late payment penalties are typically assessed on the unpaid tax due with the tax return. If the corporation has a net operating loss for the year and zero taxable income, then no tax is due with the tax return so certain penalties would not be assessed.
Late filing penalties are automatically assessed on any U.S. federal corporate income tax return that is filed after the due date with a Form 5471 attached. In some cases, a corporation may incur net operating losses for several years and stop filing U.S. federal corporate tax returns during that time. Resulting in a problem: how to resolve the prior year Form 5471 filing delinquencies when the corporation starts to earn a profit in subsequent years and starts filing tax returns again.
In addition to the prior year Form 5471 filing delinquencies, the U.S. corporation may have been required to file a prior year Foreign Bank Account Report (FBAR) to report foreign accounts owned by the foreign subsidiary corporation. Late FBAR filings can also lead to a minimum penalty of $10,000 USD per year.
It’s vital to speak to a qualified U.S. international tax reporting professional to resolve the prior year filing delinquencies. Form 5471 reporting and FBAR preparation often involve specialized skills in the area of U.S. international tax that many general tax practitioners may not have. A qualified U.S. international tax-reporting specialist can provide guidance on how to navigate certain IRS amnesty filing procedures including Form 5471 and FBAR penalty abatement.
With proper guidance, a corporation may qualify for certain IRS amnesty procedures that will allow late filing of Forms 5471 and FBARs, without any late filing charges. It is advisable for a corporation to catch-up with its prior year filings before filing its current year tax return, Form 5471, and FBAR. This approach will improve the corporation’s chances of qualifying for relief from the penalties.
Are you a U.S. taxpayer with foreign accounts or offshore assets? Have you reported all of the income from the foreign accounts or offshore assets on your U.S. federal tax return? Have you filed all required Foreign Bank Account Reports (FBARs) and other foreign reporting information returns, such as the Form 5471 to report ownership of a foreign corporation or the Form 8865 to report ownership of a foreign partnership? Are you in compliance with the FBAR filings and foreign reporting for prior years? Are you aware of the substantial penalty risk and exposure that could apply if you are not in compliance with FBAR filings and foreign reporting for prior years? The late filing penalty is $10,000 USD per form per year for the FBAR and certain foreign reporting information returns such as the Forms 5471 and 8865. The penalty for the willful failure to file the FBAR is the greater of $100,000 USD or 50% of the highest account balance or value per year.
The IRS currently has several amnesty programs available for U.S. taxpayers with unreported foreign accounts and offshore assets. The best available option typically depends on whether the U.S. taxpayer has unreported income from the foreign accounts or offshore assets in addition to delinquent FBARs or other foreign reporting information returns.
Delinquent FBAR Submission Procedures
The IRS will allow U.S. taxpayers to file delinquent FinCEN Forms 114 Report of Foreign Bank and Financial Accounts (FBARs) for prior years without imposing any penalties if all taxable income from the reportable foreign accounts was properly reported on the U.S. federal tax return. To qualify, the U.S. taxpayer cannot be under a current civil or criminal examination by the IRS. This option is not available if the IRS has contacted the U.S. taxpayer regarding the delinquent FBARs prior to being submitted. The reason for filing the FBAR late should be included when the delinquent FBARs are filed. FBARs are not automatically subject to audit under these procedures but they may be subject to audit under the existing audit selection processes that are in place for tax and information returns.
Delinquent Information Return Submission Procedures
The IRS will allow U.S. taxpayers to file delinquent information returns without imposing the $10,000 late filing penalty for Forms 5471 and 8865, etc. if reasonable cause is demonstrated. To qualify, the U.S. taxpayer cannot be under a current civil or criminal examination by the IRS. This option is not available if the IRS has contacted the U.S. taxpayer regarding the delinquent information returns prior to being submitted. The delinquent information returns should be filed with an amended U.S. federal tax return including a reasonable cause statement.
Streamlined Domestic/Foreign Offshore Filing Compliance Procedures
The IRS will allow U.S. individual taxpayers to file six years of delinquent FBARs and three years of amended U.S. federal tax returns with delinquent foreign reporting information returns attached. All of the applicable FBAR and information return late filing penalties and accuracy-related penalties will not be imposed unless the amended returns are selected for audit through the regular audit selection process and the IRS is able to detect fraud on the original U.S. federal tax return and/or the FBAR delinquency was willful. There is a 5% Streamlined Domestic Offshore filing penalty that is based on the highest year’s aggregate balance or value of unreported foreign financial assets as determined at the year end for each year. To qualify, the U.S. individual taxpayer must be able to certify under penalties of perjury that the delinquencies resulted from non-willful conduct. The U.S. individual taxpayer cannot be under a current IRS civil or criminal examination. This option is not available if the IRS has contacted the U.S. taxpayer regarding the delinquencies prior to filing the Streamlined disclosure.
Offshore Voluntary Disclosure Program (OVDP)
The IRS OVDP is designed for U.S. individual taxpayers with foreign reporting delinquencies that involve willful or intentional conduct. The OVDP penalty is 27.5% of the highest year’s aggregate balance or value of unreported foreign financial assets. If the U.S. government has identified the foreign financial institution where the unreported foreign accounts are maintained on a publicized list then the OVDP penalty is increased substantially. A significant advantage of the OVDP is that it protects U.S. individual taxpayers from criminal prosecution for willful FBAR delinquencies which otherwise could result in imprisonment.
What do I do if I had unreported offshore assets or foreign accounts for prior years?
What is the risk of not filing U.S. foreign reporting forms for prior years?
These are questions that U.S. international tax reporting and compliance specialists hear often these days. Surprisingly, the average tax return preparer does not have specialized capability to address the issues that arise when a U.S. taxpayer has offshore assets or foreign accounts. As a result, reliance on someone without this capability can lead to U.S. foreign reporting delinquencies.
Resolution of prior year delinquencies can be a very expensive and time consuming process for U.S. taxpayers, and the failure to address these delinquencies can result in substantial penalty exposure, including criminal prosecution for the intentional or willful failure to file. So, what options are available to a U.S. taxpayer who discovers that offshore assets or foreign accounts should have been reported but were not?
The answer depends on two critical factors:
If all of the taxable income was reported and the failure to file the U.S. foreign reporting forms was due to non-willful conduct, it is possible for the U.S. taxpayer to file the delinquent forms for the prior years and attach a reasonable cause statement. In this case, the IRS will not impose the civil penalties for late filing the FinCEN Form 114 (f/k/a Form TD F 90-22.1) Foreign Bank Account Report (FBAR) and Forms 8938, 5471, 8865, 3520, etc. This procedure actually replaces FAQs #17 and 18, which are no longer in effect.
If some or all of the taxable income was not reported and the failure to file the U.S. foreign reporting forms was due to non-willful conduct, there are two main options. First, the IRS has new Streamlined Offshore filing compliance procedures that allow the U.S. taxpayer to file three years of amended U.S. federal tax returns and six years of FBARs. The cost of the filing is a 5% Streamlined Offshore penalty plus additional tax and interest on the tax due with the amended tax returns. There is some risk of audit with a Streamlined Offshore filing but the IRS will not impose the civil failure to file penalties which are generally $10,000 USD per form per year unless there is evidence of fraud on the original federal tax returns. Second, there is the quiet disclosure option to which the IRS is seriously opposed and which invites audit risk for all open years including the risk of all applicable penalties being imposed. If the U.S. foreign reporting forms were required but they were not filed, the statute of limitations will still be open on the prior year’s federal tax return.
If some or all of the taxable income was not reported and the failure to file the U.S. foreign reporting forms was due to intentional or willful conduct, then the main option is the IRS Offshore Voluntary Disclosure Program (OVDP). In 2014, the IRS has extended the amnesty available under the protection of the OVDP. The cost of the filing is a 27.5% offshore penalty which, in some circumstances, could be higher if the U.S. taxpayer has foreign accounts with a foreign financial institution that has been identified on a specific list by the U.S. government. The main incentive offered with the OVDP is protection from criminal prosecution and possible imprisonment as a penalty for intentional or willful delinquencies.
Hedge funds are investment partnerships that issue a Schedule K-1 to investors which are partners in the partnership. The Schedule K-1 reports the partner’s distributive share of the taxable income, gain, loss, deduction and credit from the partnership. The Schedule K-1 is filed with the hedge fund’s U.S. federal partnership tax return. Hedge funds issue Schedule K-1s with detailed footnotes which include disclosures regarding additional reporting that may be required by the partners on their respective U.S. federal tax returns. Hedge fund Schedule K-1s typically include certain foreign reporting disclosures regarding the fund’s investments in foreign corporations including Passive Foreign Investment Companies (PFIC) and foreign partnerships.
Some of the U.S. foreign reporting disclosures that typically appear in hedge fund Schedule K-1s including the following.
Please consult Aronson LLC tax advisor, Alison N. Dougherty at 301.231.6290 for more information.
The IRS released a Transfer Pricing Audit Roadmap on February 18, 2014. The Roadmap, which was issued through the IRS Transfer Pricing Operations of the Large Business and International (LB&I) division, was developed to provide audit techniques and tools for transfer pricing examinations. The Roadmap is designed as a comprehensive toolkit based on an audit timeline.
Transfer pricing involves an area of U.S. federal taxation which requires payments in certain intercompany transactions to be based on an arm’s length standard. The arm’s length standard is applied to determine whether intercompany pricing is consistent with pricing that would be prevalent in a transaction between unrelated parties. Section 482 of the U.S. Internal Revenue Code is the provision of U.S. federal taxation law that governs transfer pricing. Under I.R.C. Section 482, the IRS has the authority to reallocate income, expense, deductions, credits and allowances to clearly reflect income or to prevent the evasion of taxes. Section 482 applies to intercompany payments between commonly controlled entities. The regulations under Section 482 provide that the best method must be applied in determining the transfer price that is the most reliable measure of the arm’s length standard.
The IRS typically targets U.S. taxpayers for transfer pricing audits based on information disclosed on foreign reporting forms filed with the U.S. federal tax return. U.S. taxpayers who file the Form 5471, 8865 or 8858 to report ownership of a foreign company are subject to a high level of scrutiny concerning intercompany payments reported on such forms. The Transfer Pricing Audit Roadmap identifies these forms and other forms such as the Forms 5472 and 926 as the starting point when the IRS reviews a U.S. federal tax return for controlled transactions.
There are specific phases of a transfer pricing audit that are outlined in the Roadmap. The Planning Phase includes the pre-examination analysis, the opening conference, taxpayer orientations, and the preparation of the initial risk analysis and the examination plan. The Pre-Examination Analysis includes the review of the taxpayer’s contemporaneous transfer pricing documentation. The Planning Phase is a process that may continue for up to six months. The Execution Phase, which may continue for up to 14 months, includes fact finding and information gathering followed by issue development with economic analysis and a preliminary report with findings. The Resolution Phase includes issue presentation, issue resolution and case closing. The Resolution Phase is a process that may continue for up to six months.
Overall, the Audit Roadmap is a definitive indication that transfer pricing audits with the IRS are typically a lengthy process. Therefore, it is important to substantiate intercompany transfer pricing with the appropriate policy, methodology and documentation.
Please contact your Aronson LLC tax advisor, Alison N. Dougherty, International Tax Services, at 301.231.6290 for more information.