Tag Archives: form 5471

Caution: Corporations with NOLs and a Foreign Subsidiary Must File Federal Tax Returns with Form 5471 on Time to Avoid Penalties

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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.

For more information, please contact Aronson international tax advisor Alison Dougherty at 301.231.6290 or ADougherty@aronsonllc.com.

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Options for Delinquent Prior Year FBARs and U.S. Foreign Reporting Forms 8938, 5471, 8865, 3520, etc.

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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:

  • First, ask whether all of the taxable income from the offshore assets or foreign accounts was reported on the U.S. taxpayer’s federal tax return. Unfortunately, it is likely that all of the taxable income was not properly reported if the offshore assets and foreign accounts were not being reported on the required information returns.
  • Second, ask whether the failure to report the offshore assets and foreign accounts, including the related taxable income, was due to non-willful conduct or conduct that was intentional or willful.

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.

Please contact Aronson LLC tax advisor Alison Dougherty at 301.231.6290 for more information.

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Hedge Fund Schedule K-1s and U.S. Foreign Reporting

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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.

  1. Form 926 reporting for transfers to foreign corporations. A hedge fund’s Schedule K-1 footnote disclosure will provide the partner with information regarding the partner’s share of the hedge fund’s capital contributions to a foreign corporation. If the partner’s share of the capital contribution is $100,000 USD or greater taking into account all transfers during the 12 months preceding the date of transfer then the partner is within the Form 926 filing threshold. Depending on the partner’s ownership percentage in the hedge fund, if the partner is considered to own indirectly 10% or more of the foreign corporation after the hedge fund’s capital contribution, then the partner is within the Form 926 filing threshold.
  2. Form 5471 reporting for ownership interests in foreign corporations. Typically hedge funds acquire smaller percentages of ownership in foreign corporations. A partner in a hedge fund that invests in a foreign corporation may not be considered to acquire a 10% indirect interest so they may not be within the Form 5471 filing threshold. However, if the fund invests in a foreign insurance company then any percentage ownership in the foreign corporation would trigger a Form 5471 filing requirement for the partner.
  3. Form 8621 Passive Foreign Investment Company and Qualified Electing Fund reporting. Hedge funds actively invest in PFICs. Some U.S. hedge funds file the QEF election with respect to the PFIC investment at the fund level with the hedge fund’s U.S. Federal partnership tax return. If the fund files the QEF election, then the partner in the fund is not required to file the Form 8621 to make the QEF election separately with the partner’s respective U.S. Federal tax return. If the fund makes the QEF election at the fund level, the QEF’s income is included annually in the partner’s Schedule K-1 income that it receives from the fund. If the fund does not make the QEF election, then the U.S. partners in the fund must file the Form 8621 to make the QEF election with respect to each separate PFIC investment by the fund. The fund’s Schedule K-1 to the partner will provide sufficient information for the partner to report the QEF’s income on the partner’s Form 8621 filed with the U.S. Federal tax return.
  4. U.S. Treas. Reg. Section 1.1411-10(g) Election with respect to CFC and PFIC/QEF income. The Schedule K-1 footnote disclosure will advise individual partner’s in the fund to make this election if the fund has included PFIC/QEF income in the partner’s Schedule K-1 taxable income. The election trues up the timing of the partner’s recognition of CFC and PFIC/QEF income. A shareholder in a foreign corporation may be required to pay U.S. Federal tax on undistributed income from a CFC or PFIC/QEF. This election allows the U.S. shareholder to recognize the undistributed CFC or PFIC/QEF income for Net Investment Income Tax purposes in the same year that it recognizes the income for regular tax purposes. Without the election, the Net Investment Income Tax on the income is deferred until the year when an actual distribution is received.
  5. Foreign 8865 reporting for transfers to and ownership interests in foreign partnerships. The fund’s Schedule K-1 will provide sufficient information to the partners to file the Form 8865 to report their share of the fund’s contributions to foreign partnerships. If the partner is considered to have transferred $100,000 USD to a foreign partnership or if it owns 10% of the foreign partnership after the transfer by the fund, then the partner is within the Form 8865 filing threshold.
  6. Form 8938 reporting for specified foreign financial assets. The hedge fund’s Schedule K-1 will often include a footnote disclosure regarding the Form 8938 filing requirements for individual partners. While an individual partner in a hedge fund generally may not be required to report the value of the fund’s investment in foreign corporations, PFICs and foreign partnerships on the partner’s Form 8938, it is advisable to consult a tax advisor.

Please consult Aronson LLC tax advisor, Alison N. Dougherty at 301.231.6290 for more information.

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IRS Issues New Transfer Pricing Audit Roadmap

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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.

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