A U.S. taxpayer whose interest in a foreign partnership meets a specified threshold must file with his U.S. income tax return Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. Significant penalties lie for failure to file Form 8865. More importantly, the assessment statute of limitations as to a tax return—the entire tax return, not just the penalty for failure to file an information return—is suspended until Forms 8865 and like information returns due from the taxpayer have been filed.
What Is Form 8865?
Form 8865 is the primary means by which the Internal Revenue Service identifies U.S. taxpayers’ foreign partnerships, the income, gains, deductions, losses, and credits of which must be reported pro rata on the partners’ U.S. income tax returns. Information reportable on Form 8865 includes a set of financial statements for the foreign corporation, prepared in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”), converted into U.S. Dollars. I engage a CPA to prepare Forms 8865.
Form 8865 is filed with the filer’s U.S. income tax return.
Who Must File Form 8865?
There are four categories of Form 8865 filers. A Category 1 filer is a U.S. person who controlled a foreign partnership at any time during the partnership’s tax year. “Control” of a partnership means ownership of more than a 50% interest in the partnership.
A Category 2 filer is a U.S. person who at any time during the tax year of the foreign partnership owned a 10% or greater interest in the partnership while the partnership was controlled by U.S. persons each owning at least a 10% interest in the partnership.
A Category 3 filer is a U.S. person who contributed during that person’s tax year to a foreign partnership in exchange for an interest in the partnership, if that person either—
- Owned directly or constructively at least a 10% interest in the foreign partnership immediately after the contribution, or
- The value of the property contribute (when added to the value of any other property contributed to the partnership by such person, or any related person, during the 12-month period ending on the date of the transfer) exceeds $100,000.
There are four kinds of Category 4 filers:
- A U.S. person who did not own a 10% or greater interest in a foreign partnership, and who, as a result of an acquisition, owns a 10% or greater interest in the partnership.
- A U.S. person who increased his interest in a foreign partnership by 10 or more percentage points, for example, from 9% to 19%.
- A U.S. person who owned a 10% or greater interest in a foreign partnership, and who, as a result of a disposition, owns less than a 10% interest in the partnership.
- A U.S. person who decreased his interest in a foreign partnership by 10 or more percentage points, for example, from 18% to 8%.
A “foreign partnership” is a partnership formed under the laws of a foreign jurisdiction.
An “interest” in a partnership means an interest in the (1) capital, (2) profits, or (3) deductions or losses of the partnership.
A “U.S. person” is a citizen or resident of the U.S., or a U.S.-based corporation, partnership, estate, or trust. Another article examines “U.S. person.”
Consequences for Failure to File Form 8865
The penalty for failure to file Form 8865 is $10,000. A taxpayer must file a Form 8865 with respect to a foreign corporation for each year the taxpayer meets a Form 8865 filing threshold as to that corporation. The Form 8865 filing requirement applies to tax years of foreign partnerships ending on or after December 31, 2000.
The assessment statute of limitations with respect to Form 8865 is three years. But it does not start running until the Form 8865 in question is filed. In other words, there is no assessment statute of limitations on the penalty for failure to file Form 8865.
Significantly, Internal Revenue Code (“IRC”) § 6501(c)(8)(A) provides that the failure to file Form 8865 or like information return suspends the assessment statute of limitations, not only as to the penalty for failure to file the information return, but as to the taxpayer’s entire income tax return for that year.
Reasonable Cause Penalty Relief
If the IRS proposes or assesses a penalty for failure to file Form 8865, the taxpayer should consider requesting reasonable cause penalty relief. The classic articulation of reasonable cause is that the taxpayer exercised reasonable care but due to factors beyond his control was unable to comply with the law. For example, a taxpayer who was advised by a tax professional that he need not file anything with the IRS concerning his interest in a foreign partnership, when the taxpayer was actually required to file Form 8865, has reasonable cause for not filing Form 8865. A taxpayer could also have reasonable cause for failing to file Form 8865 if the taxpayer’s tax advisor knew or should have known of the taxpayer’s interest in a foreign corporation, and failed to advise the taxpayer to file Form 8865, where the taxpayer did not otherwise know that he was required to file Form 8865.
A taxpayer with one or more delinquent Forms 8865 should file them as soon as possible.
Other posts of interest:
Americans’ Interests in Foreign Accounts Reportable on Form 8938
Americans Owning Interests in Closely-Held Foreign Corporations: Beware Form 5471
Forms 3520 and 3520-A and the Grantor Trust Rules