U.S. tax compliance obligations for U.S. nonprofit (NP) organizations are generally fairly straightforward. If the entity is organized as a trust and operates as a pension fund, there may be no formal U.S. tax filing obligation (outside of Form 5500 with the DOL), assuming there is no unrelated business income (UBI). NP organizations may need to file Form 990 (or equivalent) and Form 990-T (to report UBI). Often overlooked or misunderstood are the information reporting requirements for U.S. organizations that have investments in entities outside the U.S.
The U.S. government is very interested in knowing what its taxpayers are up to, and that counts double for investments made outside of the U.S. As such, the U.S. Congress enacted laws that compel certain information form reporting when taxpayers have certain outside U.S. interests. These forms generally have no direct tax impact on the taxpayer, but they are required to be reported with failure to do so being subject to stiff monetary penalties. That begs the question, how on earth would a NP organization have investments made outside the U.S.?
Why would a nonprofit have to file an international informational tax form?
The primary way a NP organization makes investments in entities outside the U.S. is through its investment portfolio, most often with hedge funds, private equity funds and investment partnerships. Either the hedge fund or private equity fund is structured as a foreign corporation/partnership or the domestic partnership the NP has invested in, or owns an interest in, has invested in foreign entities. Thus, the NP investment in a foreign entity could be either a direct or an indirect investment, and depending on the circumstances, could require filing international informational forms.
It is also possible the NP organization has set up an entity outside the U.S. itself to help further its mission. In that instance there is a far greater chance the informational forms will be required.
How would a nonprofit know if they must file an international form?
A NP should conduct a thorough review of their investments and work with the companies they invest in to determine if the investments will give rise to any of the later discussed international informational reporting forms. Understanding the type of entity the NP has invested in and how the U.S. treats that entity is critical to getting the filings correct. Beyond just knowing the type of entity, the NP should clearly understand how much of the entity (by voting rights and value) is owned at the beginning of the tax year and the end of the tax year. The NP should keep good records of the contributions made to the foreign entities per year as well.
On occasion, the NP will receive documents from its investment company or foreign entity that will help determine if any filing obligations are necessary. Items to pay attention to include:
- A Passive Foreign Investment Company (PFIC) statement. That should key the NP that there is an investment in a foreign corporation and some attention should be given to its reporting obligations.
- Form 926 statements. These statements also indicate an investment in a foreign corporation, and something may need to be reported with respect to the investment.
- If the NP has invested in a domestic or foreign partnership, they should be receiving a Schedule K-1 and/or Schedule K-3. Each of these Schedules could provide information needed by the NP to make international informational form filing assessments. As a note of caution, just because a NP does not receive a K-1 or K-3 from one of its investments, doesn’t mean it does not have any international informational filing obligations. Additional due diligence should be conducted to ensure the NP is compliant with all of its U.S. filing obligations.
- A 5471 statement and attachment. Occasionally a NP will receive a copy of the actual form it needs to file. Don’t discard this form as it likely indicates it needs to be filed with the tax return.
What kind for international informational forms might a nonprofit have to file?
Foreign Bank Account Reporting (FBAR)
The FBAR is a form that needs to be reported through the Financial Crimes and Enforcement Network (FinCEN). Per the IRS, and through the Bank Secrecy Act, every year, a U.S. person must report certain foreign financial accounts, such as bank accounts, brokerage accounts and mutual funds, to the Treasury Department and keep certain records of those accounts. The filer reports the accounts by filing a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form 114.
The NP could have an FBAR reporting obligation if it directly controlled a foreign bank account or if it controls (more than 50% ownership) an entity (foreign or domestic) that has a foreign bank account. Further, U.S. individuals that have signature authority over the foreign bank account may have a separate filing obligation.
There is a threshold for filing the FBAR when the collective balance of the foreign accounts is USD 10,000 or more at any point during the calendar year.
The penalty for failure to file the FBAR is $10,000 per year. Failure to file is deemed to occur when the forms have not been filed or when they are filed late. As of the writing of this article, there is split legal authority as to whether the penalty applies on a per form or per account basis.
Form 5471 Information Return of U.S. Persons With Respect to Certain Foreign Corporations:
The Form 5471 may be required to be filed by the NP if the NP meets certain ownership thresholds of a foreign corporation. Generally, when a NP owns 10% or more of a foreign corporation, consideration should be made to filing the Form 5471.
Determining if the entity is a foreign corporation may not be a simple or straightforward process. Local country and U.S. tax options may come into play for the analysis. Determining how much is owned may not be very straight forward. Ownership considerations for direct, indirect or constructive ownership scenarios apply when determining how much of the entity the NP is considered to own for U.S. tax reporting purposes. An annual analysis should be conducted to determine the Form 5471 filing obligations.
The penalty for failure to file the Form 5471 is $10,000 per form per year. In certain circumstances there could be an additional $10,000 penalty if certain category filers should have filed and did not. Failure to file is deemed to occur when the forms have not been filed, when they are filed late, or when they are filed with insufficient information.
Form 8858 Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)
Form 8858 is used to report the activity of a foreign branch or disregarded entity. Most often, a NP will have a form 8858 filing if it owns a foreign corporation which then owns a foreign branch or disregarded entity.
The Form 8858 also has a $10,000 penalty when it should be attached to a Form 5471, but was not.
Form 8865 Return of U.S. Persons With Respect to Certain Foreign Partnerships
Similar to a foreign corporation, a NP may have a Form 8865 filing obligation if it meets certain ownership thresholds of a foreign partnership or if it makes certain contributions to a foreign partnership. In general, if a NP owns more than 10% of a foreign partnership, it should make further inquiry to its filing obligations. In addition, if a NP contributes $100,000 or more in cash or other property to a foreign partnership during its tax year, it will have a Form 8865 filing obligation.
The penalty for failure to file the 8865 is $10,000 per form per year. If you are a category 3 filer, the penalty is 10% of the amount contributed to the foreign partnership up to $100,000. Failure to file is deemed to occur when the forms have not been filed or when they are filed late.
Form 926 Return by a U.S. Transferor of Property to a Foreign Corporation
Form 926 is required when a U.S. taxpayer transfers certain property to a foreign corporation. Similar to Form 5471, there are certain qualifications and requirements to be met when determining if a Form 926 needs to be filed. Generally, when a U.S. taxpayer transfers property (including cash) to a foreign corporation in a non-recognition exchange for shares, the Form 926 may be required. The most common requirement occurs when a U.S. person contributes $100,000 cash. The threshold is removed for non-cash contributions of property, but there are exceptions for NP organizations.
The penalty for failure to file is 10% of the amount contributed up to $100,000. Failure to file is deemed to occur when the forms have not been filed or when they are filed late.
Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
The Form 8621 is required when U.S. persons own an interest in a Passive Foreign Investment Company (PFIC). A PFIC is a foreign corporation (again that determination may need to be made) whose activity is considered primarily passive (income of interest, dividends, rents, royalties or when the assets give rise to passive income). Often, the NP will be notified if it has invested in a PFIC either directly or through Schedule K-1 or K-3, but not always. Work should be done to determine if the NP has invested in PFICs.
Generally, a NP does not have to file Form 8621 for an investment in a PFIC, unless the PFIC generates UBI. It is sometimes very difficult to determine if a PFIC generates UBI, often to the point that you can’t make the determination. A risk-based approach may be warranted for filing.
Most often, the PFIC notice comes from either Sch. K-1 or Sch. K-3, but it could arise otherwise if owned directly.
How does a nonprofit file the required international information forms?
The FBAR is filed on its own with FinCEN. The other forms are attached to a tax return. If the NP does not otherwise have a filing obligation, they will need to file a Form 990-T and attach the required forms.
What should the nonprofit do if it discovers it didn’t file these forms, but should have?
If the NP finds they are late in filing the any of the above listed forms, the organization should amend its prior year returns and file the forms. There is a good chance the NP will receive a penalty notice for late filing those forms. The penalties may be abated by the IRS if the NP has reasonable cause for failure to file those forms timely. The amended returns should be filed with a reasonable cause statement, but there is no certainly the IRS will review the reasonable cause statement at that time.
If the NP has failed to file or failed to timely file its international information reporting forms, it should seek the help of a qualified advisor to assist with penalty abatement avenues.
The international informational tax forms required by the IRS can be challenging. Even knowing if you must file the forms can be challenging. Our firm has extensive expertise in this area and helps nonprofits make the required determinations with respect to international informational tax forms and helps organizations get, and stay, compliant with their current and past international informational tax filing obligations. Please reach out to John McGuire or Christopher Stroh with any questions or needed assistance.