IRS Proposes Reporting of U.S. Disregarded Entities Owned by Foreign Persons

Posted by John Cohn       The IRS announced this morning that it is proposing regulations to treat a foreign-owned domestic disregarded entity as a corporation for reporting its existence, its ownership and the transactions in which it enters with related parties.A wholly-owned domestic limited liability company generally is disregarded for U.S. tax purposes unless it makes a “check-the-box” election to be classified as a corporation.  Thus, it was possible for a foreign person to own a U.S. limited liability company and have no U.S. reporting obligations – or even obtain a U.S. taxpayer identification number – if:It did not have any U.S. source income, andIt did not conduct a U.S. trade or business.The IRS acknowledged that this made it difficult for the U.S. to satisfy its obligations under tax treaties, tax information exchange agreements, and similar international agreements.The proposed regulations would treat such a domestic disregarded entity as a domestic corporation for the limited purposes of the reporting and record maintenance under Section 6038A of the Internal Revenue Code.  As a consequence:Taxpayer ID number. The entity would need to obtain an employer identification number (“EIN”) on IRS Form SS-4, Application for Employer Identification Number.Responsible party disclosure. On the IRS Form SS-4, the entity would need to name and provide a U.S. Social Security Number (“SSN”) or Individual Taxpayer Identification Number (“ITIN”) of a “responsible party” – generally, the individual who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the  individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets.  It would also be required to report any subsequent change in the responsible party.Related disclosure. The entity would be required to file IRS Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.  The return reports “reportable transactions” with “related parties”  including any direct or indirect 25% foreign owner or person under common control with the reporting entity. The IRS anticipates that the scope of reportable transactions with related parties would be very broad, including sales, assignments, leases, licenses, loans, advances, contributions, or other transfers of any interest in or a right to use any property or money, as well as the performance of any services for the benefit of, or on behalf of, a related party.  Specifically, contributions to and distributions from the entity would be considered reportable transactions, even though the transactions involve a disregarded entity.The penalty for failing to file Form 5472 when due and in the manner prescribed is $10,000.  If the failure continues for more than 90 days after notification by the IRS, an additional penalty of $10,000 applies.  Criminal penalties may also apply for failure to submit information or for filing false or fraudulent information.The regulations are scheduled to be published in the Federal Register next Tuesday, May 10, 2016.  They are proposed to be applicable for taxable years ending on or after the date that is 12 months after the date these regulations are published as final regulations in the Federal Register.