Shareholders in Closely-Held Foreign Corporations: Beware Form 5471

A U.S. taxpayer whose interest in a closely-held foreign corporation meets a specified threshold must file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, with his U.S. income tax return.  Significant penalties may be assessed for failure to file Form 5471.  More importantly, the assessment statute of limitations as to a tax return—the entire tax return, not limited to the penalty for failure to file an information return–does not expire until three years after all Forms 5471 and like information returns due with the tax return have been filed.

What Is Form 5471?

Form 5471 is the primary means by which the Internal Revenue Service identifies (1) controlled foreign corporations that are subject to the anti-deferral regime of Internal Revenue Code Subpart F; and (2) foreign corporations availed of to disguise U.S. persons’ beneficial ownership of foreign investments.  Form 5471 requires reporting of information about the filer and the foreign corporation.

Form 5471 also requires 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 5471.

Form 5471 is filed with the filer’s U.S. income tax return.

Who Must File Form 5471?

Form 5471 filers include Category 2 filers, Category 3 filers, Category 4 filers, and Category 5 filers (Category 1 has been repealed).  A Category 2 filer is a U.S. citizen or resident who is an officer or director of a foreign corporation in which a U.S. person (not necessarily the taxpayer in question) meets the “10% ownership requirement.”   A person meets the 10% ownership requirement with respect to a foreign corporation if he has acquired, in one or more transactions, (1) 10% or more of the foreign corporation’s outstanding stock, or (2) an additional 10% or more of the foreign corporation’s outstanding stock.  A citizen or resident of the U.S. remains a Category 2 filer for as long as two tests are satisfied: (1) a U.S. person an officer or director of the foreign corporation, and (2) said U.S. person meets the 10% ownership requirement with respect to the foreign corporation.

“U.S. person” means a citizen or resident of the U.S., or a U.S.-based corporation, partnership, estate, or trust.  Another article examines “U.S. person.”

A Category 3 filer includes (1) a U.S. person who acquires stock in a foreign corporation which, when added to stock already owned on the acquisition date, meets the 10% stock ownership requirement; (2) a U.S. person who acquires stock in a foreign corporation which, without regard to stock owned on the acquisition date, meets the 10% stock ownership requirement; (3) a person who becomes a U.S. person while meeting the 10% stock ownership requirement with respect to the foreign corporation; and (4) a U.S. person who disposes of stock in the foreign corporation reducing his interest to less than the 10% of the corporation’s stock, by vote or value.  A person is a Category 3 filer only for the year in which he (1) acquires stock in a foreign corporation which, when added to stock already owned on the acquisition date, meets the 10% stock ownership requirement; (2) acquires stock in a foreign corporation which, without regard to stock owned on the acquisition date, meets the 10% stock ownership requirement with respect to the foreign corporation; (3) becomes a U.S. person while meeting the 10% stock ownership requirement with respect to the foreign corporation; or (4) disposes of in the foreign corporation reducing his interest to less than 10% of the corporation’s stock, by vote or value.

A Category 4 filer is a U.S. person who owned, at any time during the tax year, (1) more than 50% of the foreign corporation’s outstanding stock (by vote or value).

A Category 5 filer is a person who is a U.S. shareholder of a controlled foreign corporation at any time during the tax year.  A “U.S. shareholder” is a U.S. person (defined above) who owned at least 10% of the voting power of the foreign corporation’s stock.  A “controlled foreign corporation” is a foreign corporation more than 50% of the stock of which, by vote or value, is owned by U.S. shareholders.

What Is A “Foreign Corporation”?

Form 5471 applies only to foreign “corporations.”  For U.S. tax purposes, a business entity is classified as either a corporation or a partnership. The analog to Form 5471 for partnerships is Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.   The Form 5471 filing requirement has been in effect since 1963, but the Form 8865 requirement has been in effect only since 2000.  I will examine Form 8865 in a separate post.

A taxpayer can file Form 8832, Entity Classification Election, electing to classify an entity, even a foreign entity, as either a partnership or a corporation for U.S. tax purposes.  But Form 8832 generally cannot be effective more than 75 days before it is filed.

If Form 8832 is not in effect with respect to an entity, the default rule determines the classification of the entity for Federal tax purposes.  Under that rule, an entity is classified as a corporation if no member (owner) may have personal liability for debts of the business, and as a partnership if at least one member may have personal liability for the debts of the business.  The law of the jurisdiction in which an entity is organized determines whether members may have personal liability for the entity’s debts.

Consequences of Failure to File Form 5471

The penalty for failure to file Form 5471 is $10,000.  A taxpayer must file a Form 5471 with respect to a foreign corporation for each year the taxpayer meets a Form 5471 filing threshold as to that corporation.  As noted above, the Form 5471 filing requirement was first effective for 1963.

The assessment statute of limitations with respect to Form 5471 is three years.   But it does not start running until the Form 5471 in question is filed.  In other words, there is no assessment statute of limitations on the penalty for failure to file Form 5471.

Significantly, Internal Revenue Code (“IRC”) § 6501(c)(8)(A) provides that the failure to file Form 5471 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.

I have a case in which the IRS has proposed assessing against a taxpayer penalties for failure to file Forms 5471 for several foreign corporations going back nearly 30 years.

Reasonable Cause for Penalty Relief

If the IRS proposes or assesses a penalty for failure to file Form 5471, 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 make any filing with the IRS concerning his interest in a foreign corporation, when the taxpayer was actually required to file Form 5471, has reasonable cause for not filing Form 5471.  A taxpayer could also have reasonable cause for failing to file Form 5471 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 5471, where the taxpayer did not otherwise know that he was required to file Form 5471.

Conclusion

A taxpayer with one or more delinquent Forms 5471 should file them as soon as possible.

Other posts of interest :

The FBAR Filing Requirement

Americans’ Interests in Foreign Partnerships Reportable on Form 8865

Forms 3502 and 3520-A and the Grantor Trust Rules

Americans’ Interests in Foreign Accounts Reportable on Form 8938

Mysterious Form 926