Tax-exempt and/or nonprofit organizations may be required to file form 5471. There are several instances where form 5471 would be required. Often, detailed analysis and thorough understanding of the tax rules are required to determine if there is a filing obligation. Failing to file (including late filing) for form is subject to a $10,000 penalty on a per form per year basis. The penalty may be abated if the taxpayer has reasonable cause for the failure to file the form 5471.
Please consult with a qualified professional when making determinations of form 5471 filing obligations. As you might expect, I am such a qualified professional. Please reach out with any form 5471 questions. Please see my contact information below.
When is a tax-exempt and/or nonprofit entity or organization required to file form 5471?
On its face, it seems unlikely that tax-exempt (TE) and/or a nonprofit (NP) entity or organization would ever be required to file form 5471, but there are a number of occasions where the form 5471 is required to be filed by a TE and/or NP entity .
To understand the form 5471 filing requirement, it helps to know who is required to file form 5471? In a very condensed summary, US persons (individuals, corporations, partnerships, trusts) are required to file form 5471 if they own or control certain percentage amounts of a foreign corporation. Specifically, if a US person owns, controls, purchases or disposes of 10% or more of a foreign corporation, there is a strong likelihood of a form 5471 filing obligation at some point in the lifecycle of the investment. US entities or people who own 10% or more of a foreign corporation are considered US Shareholders for definitional purposes of form 5471 filing obligations. For a more thorough discussion on when a form 5471 is required to be filed, please read this discussion.
US TE and NP organizations are generally organized in one of two ways: either as a state corporation or a trust. Both corporations and trusts are subject to the rules for filing form 5471 as they are specifically considered US persons as defined by the Internal Revenue Code (IRC). As such, TE and NP organizations would be considered US persons for purposes of applying the form 5471 filing rules.
There are a couple reasons why a TE and/or NP organization would own shares in a foreign corporation. First, and the most obvious, is the organization has established an entity in foreign country to carry out its mission. For the vast majority of TE and/or NP organizations, this scenario won’t arise, but could be a possibility. Second, the TE and/or NP has invested in a foreign corporation either directly or indirectly through its fund investments. The most likely instance a TE and/or NP organization would have a form 5471 filing obligation arises when that organization has made investments in non-open market vehicles such as hedge fun or private equity fund investments. Hedge fund, private equity fund and special purpose investments can give rise to form 5471 filing obligations depending on how the investment is structured.
Why should a TE and/or NP organization care if had or has a form 5471 filing obligation?
In short, penalties. Failure to file form 5471 may result in a $10,000 penalty per form per year. Additional penalties may apply depending on category filer the shareholder falls into for form 5471. Filing the form 5471 late is considered a failure to file the form and subject to penalty.
For a large organization, the failure to file penalties can add up to a large amount if it is determined the organization has failed to file multiple forms 5471 over several years.
What can be done to prevent the form 5471 penalty?
Timely filing the from 5471 will prevent a penalty. If the 5471 is already delinquent, the organization may be able to avoid the penalty if it has reasonable cause for its failure to file. Note, reasonable cause is ill defined and a fairly subjective standard in the hands of an IRS examiner.
Where does form 5471 get filed?
Generally, the form 5471 is attached to an income tax return. For a TE and/or NP entity, the form 5471 is generally attached to form 990-T, whether or not the organization has any unrelated business taxable income.
How can a TE and/or NP organization tell if they have a form 5471 filing obligation?
The only sure way to tell if the organization has a form 5471 filing obligation is through a thorough analysis of its investments. Often, it is not obvious that an investment has been made in a foreign corporation, but taking the following steps could help make the determination:
- Step 1
- Analyze each of the investments the TE and/or NP has made to determine if it is a foreign or US formed entity.
- Step 2
- If the entity is foreign, determine what type of entity it is and if there have been any US choice of entity elections made.
- Step 3
- If the foreign entity is a corporation for US tax purposes, determine how much of the entity is owned by the organization. This ownership analysis includes determining the percentage owned of value of the foreign corporation and the percentage owned of voting rights of the foreign corporation.
- Step 4
- If the organization owns between 10% and 50%, determine how much of the entity is owned by other US Shareholders (those owning vote or value of 10% or more). This analysis helps determine if the entity was a controlled foreign corporation while the organization owned its interest.
- Step 5
- Determine if the entity owns an interest in other foreign entities.
- Step 6
- If you have owned this investment longer than the current tax year, analyze when the investment was made and make determinations as to whether there was a filing obligation in the past as well.
What is the point of all these steps?
The point of these steps is to gather enough information to determine if there is, or should have been, a form 5471 filing obligation.
Step 1 details:
In step 1, the entire list of the alternative investments made by the organization should be reviewed to determine if the entity is US or foreign. The best way to make that determination is to work through your investment consultant or inquire directly with the investment company.
Step 2 details:
In step 2, determining what type of entity will help direct what US tax forms may be required. With respect to form 5471, the entity in question would be a corporation for US tax purposes. There are a few ways to get an indication of the type of entity, but the best way is to inquire of the fund. Sometimes reliance on common sense will result in the wrong answer. For example, the fund may be organized as a limited partnership in the Cayman Islands. It seems clear the entity is a partnership in the Cayman Islands. For Cayman Islands legal (and tax) purposes, that entity is in fact, a partnership. What can’t be determined just by the name of the entity is if the US owner (current or past) has made a check-the-box election to treat that Cayman Islands partnership as a corporation for US tax purposes. Certain entities are eligible to choose how they will be treated in the US for US income tax purposes, either as an association taxable as a corporation, a partnership, or a disregarded entity. If the owner made the check-the-box election to treat that Cayman Islands partnership as a corporation for US tax purposes, it should be considered a corporation for determining form 5471 filing obligations.
Inquiry to the fund asking specifically about any check-the-box elections is preferred.
Step 3 details:
At this point the form 5471 determinations can start to be made. Understanding the ownership percentages will allow the owner to determine if they are considered a US Shareholder or not. If the TE and/or NP organization is a US Shareholder then at some point a form 5471 should have been filed with respect to that ownership of the foreign corporation. If the TE and/or NP owns more than 50% of the foreign corporation, there is a clear form 5471 filing obligation for the TE or NPF organization.
Step 4 details:
If the TE and/or NP owns between 10% and 50% of the foreign corporation, certain annual form 5471 filing obligations will be required if the foreign corporation is considered a Controlled Foreign Corporation (CFC). A foreign corporation is a CFC when US Shareholders (US people that own 10% or more) own more than 50% of the foreign corporation. Thus, in the instance a TE and/or NP organization is consider a sub-50% US Shareholder of a foreign corporation, it will need to understand if there are other US Shareholder such that the foreign corporation is considered a CFC in order to determine how to file form 5471.
Step 5 details:
In step five, a determination or inquiry should be made to understand if the foreign corporation owned by the TE and/or NP organization owns an interest in other foreign corporations as subsidiary companies. If so, the TE and/or NP organization may be required to file form 5471 for those lower tier entities as the TE and/or NP organization is deemed to own what its investment owns in proportionate share.
Step 6 details:
Step 6 ensures that the TE and/or NP organization either has or doesn’t have delinquent form 5471 filing obligations.
What happens if a TE and/or NP is required to file form 5471?
If the discovery is made for the current tax year filing and the tax return is still timely and not late, then prepare and file the form 5471. That’s an easy thing to say, but the form 5471 is a relatively complicated form and understanding what needs to be completed on the form should be addressed. Generally, it is best to seek professional advice.
If it is determined that the form 5471 filing should have occurred in a prior year, the prior year return should be amended to attach the form 5471. As discussed earlier, late filed form 5471 is subject to penalty. The penalty may be abated if the failure to file was due to reasonable cause. Work with a qualified professional to determine how best to proceed.
Christopher Stroh, J.D. & LL.M (Taxation)
Christopher has spent the majority of his career focused on the international tax implications for businesses, tax-exempt organizations and individuals who engage in some form of cross-border activity, either knowingly or not! Christopher advises entities and individuals who need help or advice with the US international tax implications of structuring businesses (US or foreign) or has any sort of non-US activity that may require US tax reporting. In addition to planning and consulting on US international tax items, Christopher helps prepare and advise on all manner of US international tax forms.