What U.S. Taxpayers Should Know About Form 5471

What Is Form 5471? 

The title of Form 5471 lays it out succinctly, “Information Return of U.S. Persons Concerning Certain Foreign Corporations.” 

It is the form used to report information about a foreign corporation where a US person owns an interest in the said foreign corporation. It sounds simple enough….

A taxpayer or tax practitioner should begin thinking about whether or not a form 5471 is required when a US person (generally an individual, partnership, corporation, or trust) owns an interest in a foreign entity. That is a fair place to get form 5471 on your radar. It won’t always mean the form is required, but it should warrant some investigation.

One of the first determinations is what exactly the taxpayer owns. For Form 5471, you should be looking for the taxpayer to own an interest in a foreign corporation.

What Is A Foreign Corporation?

Foreign Corporations: The Regulations provide that “per se” corporations, as listed in 301-7701-2(b)(8), are corporations as are associations as defined in Tres. Reg. 301-7701-3.

Foreign entities where all members have limited liability are considered, by default, to be associations treated as corporations for US tax law. A member has limited liability when, under the laws of which it is organized, the member has no personal liability for the debts of or claims against the entity because of being a member.

This is an exciting point because a foreign limited liability company, where all members have limited liability, is treated as a corporation for US tax purposes under the default rules. 

This is contrary to how a US-based limited liability company (LLC) is treated for US tax purposes. Often, taxpayers and practitioners assume that foreign limited liability companies are treated as flow-through entities for US tax purposes (as a US LLC is treated). Still, they are not treated that way unless an entity classification election has been made.

Suppose a US person owns an interest in a foreign entity treated as an association for US tax purposes. In that case, that entity defaults to a corporation for US tax purposes.

Once the determination is made on the type of entity owned, the US person needs to determine how much of the entity that person owns.

How Much Of The Foreign Corporation Do You Own?

Ownership of a foreign corporation is determined in three ways:

1. Direct Ownership

2. Indirect Ownership

3. Constructive Ownership

Direct Ownership

As the name implies, the shareholder can own an interest directly. When determining how much of an entity a person owns, the voting interest in the corporation and the value of the corporation’s shares are considered. Generally, the higher percentage of interest is the deemed ownership for determining filing obligations.

Indirect Ownership

Indirect ownership arises when the US person owns an interest in a foreign corporation through the US person’s ownership in another entity. If the US person owns an interest in a partnership or other foreign corporation, that US person may be deemed to own a proportionate share of what that entity owns (see also Constructive ownership).

Again, consideration should be given to voting rights and values of ownership.

Constructive Ownership

There are several instances whereby the US person is deemed to own interests in a foreign corporation because of a related person (or entity) owning an interest in a foreign corporation. These rules can be complicated as they apply the constructive ownership rules under Section 318, with some tweaks. 

The constructive ownership rules broadly say a US person is deemed to own what certain family members own and what certain corporations, partnerships, trusts, and estates own. A formal discussion of 318 is more than this article hopes to present, but at least knowing to look for related party interests can help frame the need to either look more deeply into what the US person owns or to find some help.

A Quick Example Of How The 318 Rules Can Play Out

A US person (individual) owns 2% of a foreign corporation’s voting rights and value. You will see later that a 2% interest does not, on its own, create a filing obligation for form 5471. 

Since you’ve read this article, you know enough to ask who the other owners are. The US person’s non-resident alien (not a US person) father owns 90% of the foreign corporation. After applying the 318 rules, it is deemed that the US person owns 92% of the foreign corporation for specific form 5471 reporting purposes. Several layers of tax law must be applied and considered to get the correct answer.

A point to remember is that sometimes the face of the facts is not enough to make a proper filing determination for form 5471. Be sure to inquire deeper than the surface.

Now that you know a US person owning an interest in a foreign corporation and know how much of that foreign corporation the US person owns, you can apply that information to determine if the 5471 needs to be filed.

 

Categories of US Persons Who File Form 5471

The form instructions provide that the return must be filed by US persons (US individuals or US entities)

who meet specific ownership amounts or are a director or officer of the foreign corporations. The form instructions outline the ownership requirements provided across several internal revenue code sections, primarily sections 951, 953, 957, 958, 6038, 6046, and 965. The instructions break down the different filing obligations into certain Category filers to determine who has to file form 5471.

Category 1 Filers (Sec. 965)

A Category 1 filer is a US person considered a US Shareholder of a foreign corporation that is a section 965 specified foreign corporations. Effectively that means the taxpayer is a US person who owns 10% or more (vote or value) of a foreign corporation (making the taxpayer a US Shareholder), which is a controlled foreign corporation (discussed later) or the taxpayer is a US person who owns 10% or more of a foreign corporation where a domestic corporation owns 10% or more of the foreign corporation.

Note, that a domestic corporation could mean either a C-Corporation or an S-Corporation. Still, the rules and regulations on this are very unclear for applying the specified foreign corporation rules.

Reminder, if the US person owns less than 50% of the foreign corporation (directly, indirectly, or constructively), you should always check to see if the Category 1 filer rules apply.

Category 2 Filers (Sec. 6046)

A Category 2 filer is a US citizen or resident who is an officer or director of a foreign corporation in which a US person has acquired enough stock to exceed 10% overall ownership or an additional 10% purchase.

When a US citizen or resident is an officer or director of a foreign corporation, and another US person buys enough stock, that US citizen or resident has to file form 5471 to report that other person’s purchase.

Category 3 Filers (Sec. 6046)

A Category 3 filer is a US person who acquires stock in a foreign corporation which either increases the US person’s ownership over 10% of the vote or value of the foreign corporation or adds 10% ownership of the vote or value of the foreign corporation. Additionally, a person who becomes a US person while owning 10% or more of a foreign corporation is a Category 3 filer. 

US persons who dispose of enough stock to drop that person under the 10% ownership threshold are also a Category 3 filer.

Finally, a person treated as a US shareholder of a foreign insurance company is a Category 3 filer.

Here are a few examples of this rule (assuming direct ownership):

US person owns 3% of a foreign corporation. That person purchases an additional 9% of the foreign corporation. In that year, the total ownership went over 10%, thus, that US person is a Category 3 filer that year. 

US person owns 15% of a foreign corporation. Unless that person bought that 15% in the current year, there is no Category 3 filing obligation for that year. BUT, if the US person buys an additional 10% or more during the year, that person would be a Category 3 filer.

In year 1, US persons own 40% of a foreign corporation. That US person disposes of 20% of their interest in year 2, leaving them with a 20% interest. That disposition does not give rise to Category 3 filing obligation. 

In year 3, that US person disposes of an additional 15% of their holdings, bringing their total holdings under 10%. That person is a Category 3 filer in year 3.

Category 4 Filers (6038)

In short, a category 4 filer is a US person who “controls” a foreign corporation. Control means the US person owns (directly, indirectly, or constructively) more than 50% of the vote or value of the foreign corporation at any time during the foreign corporation year.

Referring back to the example in the constructive ownership section, since the US person’s son would be deemed to own 92%, even though he only directly owns 2%, he would be deemed to control the foreign corporation for purposes of  Category 4 and who is required to file form 5471.

Category 5 Filers – Controlled Foreign Corporations (Sections 951, 957, 958, 6038)

If a foreign corporation is considered a controlled foreign corporation (CFC), US persons who are US shareholders are Category 5 filers. A US person is a US shareholder if that person owns 10% or more of the vote or value of the foreign corporation. A foreign corporation is a CFC if US shareholders own more than 50% of the vote or value of the foreign corporation.

Concerning each Category filer, there may be exceptions to the required filing. Careful examination should be made to determine if an exception applies.

A person can fall into multiple categories in any given year.

What Happens If I Don’t File Form 5471 or It Is Late?

The taxpayer that fails to file form 5471 or is late and was required to file the form may be subject to a $10,000 penalty per form per year.

What Other Forms Should I Consider Filing?

Often the requirement to file the form 5471 means there may also be other international forms or elections that should be filed. 

If the taxpayer is filing form 5471, that taxpayer should also look into filing the following forms or elections as well (note, this is not an exhaustive list, just a sample):

Form 8938 – Statement of Specified Foreign Financial Assets Foreign Bank Account Reporting (FBAR)

Form 926 – Return by US Transferor of Property to a Foreign Corporation

Form 8992 – US Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI)

Form 8993 – Section 250 Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI)

Section 962 Election – Election by Individuals to be subject to tax at corporate rates.

Form 8858 – Information Return of U.S. Persons concerning Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs).

Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund

Summary of Form 5471:

The 5471 is a challenging form to file. It can be challenging to determine if you have a filing obligation for form 5471. As a brief summary and something that should get you thinking about form 5471, broadly consider the following:

A taxpayer may have to file form 5471 if the taxpayer is a US person and owns (by voting rights or value).

An interest in a foreign corporation, and that interest exceeds 10% of the voting rights or value of the foreign corporation, or that foreign corporation is an insurance company, and the taxpayer owns any amount, or the taxpayer is a director or an officer of a foreign corporation. A US person has acquired 10% of the stock of a foreign corporation.

This can be an area that can be quite detailed and, at times, difficult just to determine if there is a filing obligation, to say nothing of the actual preparation and filing of the forms. 

Unless you practice in this area, it is likely worthwhile to seek professional advice.

*This article is meant to present a very high-level discussion of filling obligations for Form 5471 and does not present a thorough or complete discussion on the subject. There is a lot of information and rules in this area, which can get quite deep.

Should you have any questions about form 5471 or would like some help with issues around this form, please contact Christopher Stroh, JD, LL.M (Taxation) at The McGuire Law Firm. To speak with our professional Tax Attorneys, call us at 720-833-7705.