As originally distributed by the WG&J Real Estate Tax Journal.
The international tax enforcement community has focused for many years on creating transparency and tracking sources of income across political borders. One example is the U.S. Foreign Account Tax Compliance Act (FATCA), which has been implemented with intergovernmental agreements (IGAs) between the U.S. and nearly 100 other countries to share information concerning financial accounts. Another is the Base Erosion and Profit Shifting (BEPS) project, which has been undertaken by the Organisation for Economic Co-operation and Development (OECD) with the participation of over 100 member nations to require, among other things, county-by-country reporting of revenue, income, taxes, employment, and other activities.
On 12/13/16, the U.S. Treasury Department issued final regulations 1 with the goal of bringing increased transparency to any domestic U.S. limited liability company (LLC) that is wholly owned by a foreign person. 2 Because this is a common form of ownership of U.S. real estate by foreign persons, we can expect that the new regulations will have an outsized impact on foreign individuals and businesses owning real estate in the US.
In short, the new regulations treat an LLC wholly owned by a foreign person as a domestic corporation for purposes of reporting, recordkeeping, and similar compliance requirements under Section 6038A . This means that an affected LLC will be required to file IRS Form 5472 3 to report information about the LLCs operations and transactions with its foreign owner.
In general, the new regulations are effective for tax years beginning on or after 1/1/17. 4
Discussion
Section 6038A has been a longstanding feature of the Code. 5 Under Section 6038A , a domestic corporation that is 25% foreign-owned is required to maintain certain records and furnish information relating to (1) the identity of each 25% foreign owner, measured by vote or value, and its related parties; and (2) any transactions between the domestic corporation and such 25% foreign owner or its related parties. This information is reported on Form 5472. Failure to properly maintain records or file Form 5472 can lead to penalties, including a $10,000 penalty for each tax year with respect to which such failure occurs. 6
Because Section 6038A applies to domestic corporations, it historically did not apply to an LLC unless the LLC had elected to be taxed as a corporation under the check-the-box rules. 7 More commonly, an LLC would be classified under the default rules-as a partnership if it had more than one owner, and as an entity disregarded from its owner if it had only one owner.
If treated as a disregarded entity, the LLC would be ignored for most tax-reporting purposes. Rather, its owner would be taxed on the operations of the LLC as if the owner had carried out the LLCs activities itself. 8 As a result, neither the LLC nor its foreign owner would necessarily obtain a U.S. employer identification number (EIN) or file annual U.S. tax returns. In general, a filing requirement would attach only if the foreign owner was engaged in a U.S. business (directly or via the disregarded LLC) or received reportable U.S.-source income. This is in sharp contrast to a domestic partnership or corporation, which must file tax returns annually.
The new regulations seek to dull this contrast, and increase transparency, by requiring LLCs that are wholly owned by foreign persons to file Form 5472 on an annual basis, regardless of whether the LLCs (or foreign owner) otherwise have a U.S. tax filing obligation. The new regulations apply to LLCs that are wholly owned, directly or indirectly, by a foreign person. 9 Accordingly, rules apply to each LLC that is wholly owned by a single foreign person through one or more other disregarded entities or grantor trusts, regardless of whether the disregarded entities or grantor trusts are domestic or foreign. The new regulations also require the LLC to comply with the recordkeeping, and similar compliance requirements, under Section 6038A . Importantly, the new regulations do not affect the LLCs classification for other purposes.
Form 5472 requires reporting any reportable transaction 10 between the reporting corporation and the foreign related person, including:
- Amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the entity.
- Purchases and sales of inventory and other tangible property.
- Payments and receipts of rents and royalties.
- Consideration paid or received for the use of intangible property, such as trademarks, patents, and copyrights.
- Consideration paid or received for technical, managerial, engineering, construction, scientific, or other services.
- Amounts loaned or borrowed and interest paid or received.
- Property transferred or received.
Form 5472 is filed with the reporting corporations income tax return for the tax year by the due date (including extensions) of that return. If the foreign owner of an LLC has no other U.S. tax return filing obligation, it is expected that the person will be deemed a calendar year taxpayer for this purpose. The instructions for Form 5472 are being revised and will contain rules to clarify the filing dates in those instances. 11
Conclusion
To comply with the Form 5472 requirements, the LLC will need to obtain an EIN, which will further require the LLC to identify a responsible person with a U.S. taxpayer identification number of its own. It will be important to have the EIN prior to the tax return deadline so the Form 5472 may be properly filed.
In addition, persons affected by these regulations should work through Form 5472 and make any necessary changes to their internal processes and procedures to ensure the information is readily available, and to ensure that appropriate arrangements have been made to include Form 5472 in a tax return preparation project.
1 TD 9796 , 81 FR 89849 (2016), 2017-3 IRB 380.
2 In a related initiative launched approximately one year ago, the Financial Crimes Enforcement Network of the U.S. Treasury Department (FinCEN) announced that it would require title insurance companies to identify and report the true beneficial owner behind a legal entity involved in certain high-end residential real estate transactions. See e.g., “FinCEN Expands Scope of Geographic Targeting Orders,” ABA Banking Journal (7/27/16), available at http://bankingjournal.aba.com/2016/07/fincen-expands-scope-of-geographic-targeting-orders/.
3 “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.”
4 Sections 1.6038A-1(n)(1) and Section 1.6038A-1(n)(2); Section 301.7701-2(e)(9).
5 See Section 339(a) of P.L. 97-248, 9/3/82), adding Code Section 6038A , effective for tax years beginning on or after 1/1/83.
8 Some existing exceptions to this general rule, under which an LLC itself is regarded as a corporation and required to make appropriate filings, apply for employment tax purposes (effective for wages paid on or after 1/1/09) and excise taxes reported on Form 720, 730, 2290, 11-C, or 8849 (effective for excise taxes reported and paid after 12/31/07).
9 Reg. 301.7701-2(c)(2)(vi) ; Reg. 1.6038A-2(b)(9), Example 2 , (demonstrating application of new regulations to indirect wholly owned LLCs).
10 Sections 1.6038A-2(b)(3) and (4).
11 Section 1.6038A-2(d).
Recent Tax Regulations May Impact Foreign Buyers of U.S. Real Estate, Daniel L. Gottfried, Real Estate Tax Journal Volume 45, Number 01, Fourth Quarter 2017 Thomson Reuters/Tax & Accounting.