U.S. tax law require U.S. persons to disclose their foreign financial information with the filing of their federal income taxes regardless of whether the qualifying U.S. taxpayer resides in the U.S. or abroad.
In our earlier article: Common Tax Issues Faced by U.S. People Living Abroad, we had discussed the basic tax filing requirements of a U.S. person to report their foreign investments. Among these forms lies the Form 5471, which U.S. taxpayers with ownership in Foreign Corporations need to file.
Filing Form 5471 for U.S. Person with Foreign Corporation Ownership
Form 5471 reports the ownership of foreign corporations to the IRS and calculates the income (if any) required to be reported on the shareholders tax return. To break it down, U.S. persons that fall into one of the categories below are required to make certain disclosures and provide information to the IRS with regard to the foreign corporations that they have an interest in or a relationship to:
Category 2 Form 5471 Filers
U.S. citizens or residents who are an officer or director of a foreign corporation in which a U.S. person:
- has acquired 10% or more of votes or value of the foreign corporation in one or more transactions during the year, or
- has acquired an additional 10% or more of the votes or value of the foreign corporation in one or more transactions during the year.
Category 3 Form 5471 Filers
U.S. persons who acquire stock in a foreign corporation which, when added to any previously owned stock, meets or exceeds 10% of the votes or value of the foreign corporation. A Category 3 Filer may also be a previously non-U.S. person with 10% or more of the votes or value who becomes a U.S. person during a particular year. Finally, a Category 3 Filer includes a U.S. person who disposes enough stock in a foreign corporation to bring their ownership interest to below 10%.
Category 4 Form 5471 Filers
U.S. persons that have control of a foreign corporation for at least 30 days during the taxation year. Control, for the purposes of Category 4 reporting means owning directly, indirectly or constructively more than 50% of the total combined voting power or total value of all classes of stock in a foreign corporation.
Category 5 Form 5471 Filers
U.S. persons who own (directly, indirectly, or constructively), 10% or more of the total combined voting power of all classes of voting stock of a Controlled Foreign Corporation (CFC). A CFC is a foreign corporation with U.S. Shareholders (U.S. persons owning 10% or more of the voting power of such foreign corporation) that own greater than 50% of the vote or value of the foreign corporation. Shareholders of a CFC may also be required to include certain types of passive income on their tax returns. This income is referred to as Subpart F income.
A United States person includes U.S. citizens, U.S. residents and U.S. entities including corporations, partnerships, limited liability corporations, trust and estates that are created, organized or formed under the laws of the United States. For purposes of Category 4 a U.S. person also includes a nonresident alien (or spouse of a U.S. citizen or resident) who elects to be treated as a U.S. resident.
A separate Form 5471 is required for EACH corporation in which the shareholder has an interest.
What is indirect or constructive ownership?
Meaning of Indirect Ownership
U.S. persons who are shareholders of foreign corporations, partners in foreign partnerships or beneficiaries of foreign trusts or estates. This rule creates a chain of ownership through attribution, which stops with the first U.S. person in the chain. For example, John is a 40% owner of a foreign corporation. The corporation owns 80% of another foreign corporation. John indirectly owns 32% of the second corporation; (40% of 80%).
Meaning of Constructive Ownership
Under the constructive ownership rules, U.S. persons are considered to constructively own stock of the following:
- Family members (spouse, children, grandchildren and parents, but not siblings). Stock owned by a family member who is a nonresident alien is excluded.
- Stock owned directly or indirectly by or for a partnership, estate or trust is considered to be owned proportionally by the partners or beneficiaries.
- A shareholder is deemed to own a pro-rata share of any stock owned by a corporation, if the shareholder owns directly or indirectly 10 percent or more of the total value of the corporation.
- A partnership or estate is deemed to own all of the stock owned directly or indirectly by its partners or beneficiaries.
- A trust is considered to own all of the stock owned by beneficiaries who have more than a 5 percent actuarial interest in the trust. A grantor trust is considered to own all of the stock owned by the grantor.
- A corporation is considered to own all of the stock owned directly or indirectly by any shareholder who owns, directly or indirectly, 50 percent or more in value of the corporation’s stock.
- If a partnership, estate, trust or corporation owns directly or indirectly, more than 50 percent of the total combined voting power of all of the classes of stock entitled to vote, such entity is considered to own 100 percent of the stock entitle to vote.
- Any person with an option to purchase stock is considered as owning such stock.
Not reporting one’s ownership in foreign corporations could result in severe penalties. If you fail to file the form and were required to file the form you could be subject to a substantial penalty of $10,000 or more for each year.
It is easy to trigger filing requirements in the U.S. by investing in a corporation in a foreign country. In determining the ownership interest, the complex rules of direct, indirect, and constructive ownership, the category of filers it may get confusing, The Form 5471 filing instructions are complex and difficult to understand.
Even if the foreign corporation is not profitable, the IRS will attempt to assess penalties for the failure to file a Form 5471 when appropriate. At present, the federal government has focused primarily on tracking down U.S. residents who have undeclared foreign bank accounts through legislation like the Foreign Account Tax Compliance Act (FATCA). It is only a matter of time until the IRS and Department of Justice move on to target another group of taxpayers. If you have an interest in a foreign corporation and are either unsure of the tax compliance requirements or aware that you have failed to comply with them, an experienced tax attorney may be able to assist in coming into compliance while minimizing penalties and other negative consequences of filing non-compliance.
AG TAX LLP CAN HELP
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- US Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a tax consultation to discuss your US Canada cross border tax queries, please contact us at:
- 604-538-8735 (Greater Vancouver Area, BC)
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