It takes a brave, adventurous soul to leave his or her comfort zone and move to a different country. These same words can also be used to describe many entrepreneurs who moved to start their own businesses in foreign countries. Most US citizens are surprised to find that their businesses might still have a US tax filing requirement even if they have no economic ties to the US! If you own at least 10% of a foreign corporation, you are required to file Form 5471 with your individual expat income tax return each year.
Who Must File Form 5471?
Many US expats are under the misconception that this form is only required for directors or officers of foreign corporations. Unfortunately, the scope of the filing requirement is much more extensive and is broad enough to include any US person who owns at least 10% of a foreign corporation.
The IRS has identified four different categories of US persons who are required to file Form 5471 with their US expat taxes each year. By their definition, a “US person” includes US citizens, partnerships, trusts, estates and corporations. The four categories of filers are as follows:
- A US person who is an officer or director of a foreign corporation in which any US person owns or acquires 10% or more of the stock of the foreign corporation,
- A person who becomes a US person while owning 10% or more of the stock of the foreign corporation,
- A US person who had control of a foreign corporation for at least 30 days, or
- A US shareholder who owns stock in a foreign corporation that is a controlled foreign corporation for an uninterrupted period of at least 30 days and who owned that stock on the last day of the that year.
More information about the categories of filers can be found on the IRS website. Properly choosing the category is important because Form 5471 schedules and reporting requirements vary by category.
Those familiar with US business terminology should not automatically assume that their foreign business is not a corporation if it is not labeled as such in their resident countries. The IRS has expanded the term “corporation” for Form 5471 reporting purposes to include international business companies and foreign limited liability companies.
It is important to consider the liability of the foreign company when determining whether the foreign company will be considered a corporation. If the structure provides the owner(s) with limited or no liability, it will very likely be considered a corporation by IRS standards. However, some foreign companies have the option to elect “disregarded entity” status by filing Form 8832 within 75 days of the company’s formation to avoid the Form 5471 annual filing requirement.
When Is Form 5471 Due?
Form 5471 is due with the filer’s annual US tax return. For most people who live abroad, this would be June 15—the automatic extension for Americans living abroad when taxes are due on April 15. If they have requested the automatic extension of time to file, this would be October 15.
Will Form 5471 Impact My US Tax Liability?
Possibly. The most common situation involves US owners of foreign corporations being taxed on their dividends in the year of receipt and deferring any unpaid earnings and profits until they are distributed or until the company is liquidated.
However, the IRS has many complex tax laws in place to prevent a US citizen from setting up an offshore company simply to avoid US tax. Therefore, it’s very important to consider the type of income that the foreign company receives as well as the source. The IRS has labeled several types of income as subpart F. Subpart F income will likely end up as taxable income to the US owner regardless of whether it was distributed as dividends. Furthermore, foreign corporations with US-sourced income will be subject to US taxes just as a US domestic company.
What Happens If I Don’t File Form 5471?
In recent years, the IRS has been cracking down on US persons who fail to file US tax returns. In addition to failing to file an individual return, the IRS reserves the right to assess an additional penalty for failing to file Form 5471. For each year that this form is not filed, the IRS can assess a penalty of $10,000. If the IRS has specifically requested the US person to file this form and the US person has not complied, the IRS can assess an additional $10,000 per month (after the first 90 days), up to a total of $50,000. The IRS describes the potential penalties and their assessments in more detail on their website.
The IRS has put a lot of focus on US citizens living abroad who are not in compliance with their US expat tax filing obligations. They have recently entered into agreements with numerous foreign countries to exchange information regarding foreign activities, and noncompliance is more likely to be discovered. If you believe you might be subject to Form 5471 filing requirements, it is recommended to become compliant sooner than later to avoid the potential $10,000 penalty on the failure to file this form.
Have Questions About Expat Income Tax for Entrepreneurs?
We have a section of this blog devoted exclusively to answering questions entrepreneurs and small-business owners tend to have. If you have questions about Form 5471’s filing requirements, or if you would like help with your US expat tax return, please contact us.