US citizens with foreign business and Green Card holders are required to report and pay taxes on their worldwide income each year. This is the case even if you have established an entity in a foreign country. Different entities, whether foreign or domestic, have their own US tax reporting requirements. This article, although not all-inclusive, will discuss the requirements for some of the more common types of foreign entities.
The IRS is very specific regarding the treatment of the more common types of domestic businesses: corporations, limited liability companies, partnerships, trusts, etc. While some foreign countries will use the same nomenclature for its entities, there are numerous types of foreign companies that cannot be easily classified into one of these categories. It is important to evaluate the structure and characteristics of the entity and classify it according to IRS Code.
For example, one of the more popular types of structures in Hungary is the Korlátolt felelősségű társaság (KFT). The KFT is popular for its low tax and ease of setup and maintenance. Because of the features of the KFT, namely limited liability for its owners, the KFT is treated similarly to a US LLC by the IRS.
You may want to work with a tax professional to determine the proper classification of your entity in a foreign country. The following discussion will briefly summarize the tax reporting requirements of various types of foreign businesses.
If you have ownership in a foreign corporation, you may be required to file Form 5471 annually with your individual tax return. Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, should be completed for any US person who:
- owns 10% or more (directly or indirectly) in a foreign corporation,
- is an officer or director of a foreign corporation and acquired stock in the company during the year, or
- has any amount of ownership in a controlled foreign corporation (CFC) – generally, this is a foreign corporation that is 50% or more owned by US persons.
Also, US taxpayers who made a transfer to a foreign corporation during the year may be required to complete and attach Form 926 to their individual return. This form is required if the US person owns more than 10% of the foreign corporation’s stock at the end of the year, or if they transferred more than $100,000 USD to the company in the foreign country during the year.
If a US taxpayer holds a controlling interest (greater than 50%) in a foreign partnership, he/she should include a Form 8865 with his/her annual individual tax return. This form is also required if a US person acquires, changes, or disposes of his/her interest in the foreign partnership. If no one partner holds a controlling interest in the foreign partnership, then any US person owning more than 10% of the company’s stock should attach a completed Form 8865 to their US tax returns.
This form generally requires the same information as would be reported on a domestic partnership US income tax return (a Form 1065). This includes a profit and loss statement, a balance sheet, and a schedule of owners, among other things. The partnership income reported on the 8865 K-1 should reflect the same income reported on the Form 1040.
Foreign LLC Taxes
One of the most popular types of entities, foreign or domestic, is the Foreign Limited Liability Company. Ownership in this type of entity will still prompt additional filing requirements. A domestic LLC can be considered “disregarded” for tax purposes, meaning no separate filing is required and all of the profits flow through to the individual’s US income tax return.
While a US taxpayer with ownership in a foreign LLC can also elect this “disregarded” treatment by a one-time filing of Form 8832, Form 8858 may still have an annual submission requirement thereafter. This form is required by any US person owning 100% of a foreign LLC that has elected to be treated as disregarded for tax purposes. The profits associated with the foreign LLC will still flow through to the personal return, but Form 8858 will be attached to the individual return reporting the additional foreign LLC information.
If the US owner of a foreign LLC does not elect disregarded entity status by filing Form 8832, then the foreign LLC may be treated as a corporation for tax purposes. In this instance, the taxpayer in a foreign country would be required to file Form 5471 annually with his/her individual tax return. The instructions for Form 8832 for foreign LLC taxes list numerous companies that are treated as foreign corporations by the IRS by default.
For reasons of asset protection and tax planning, investment in foreign trusts by US taxpayers has become increasingly popular. Unfortunately, the tax reporting requirements for this entity can be quite onerous. The IRS code may classify a wide variety of foreign entities as foreign trusts depending upon the characteristics. Some foreign pensions or other investment mediums are considered foreign trusts by the IRS. If unsure, consult with a tax professional to determine the proper status.
Generally, if a US person has any involvement with a foreign trust (creation, transfer, distribution, ownership, etc), the IRS will require Form 3520 and possibly Form 3520-A to report the relationship activity during the year. Unlike many of the other forms discussed above, Form 3520-A should be filed separately from the US taxpayer’s individual return, and is due by March 15th each year. Form 3520, on the other hand, will be filed with the taxpayer’s individual return.
If the foreign company has an interest in a foreign bank or financial account, the taxpayer should be aware of the FinCen Form 114 (also known as FBAR) reporting requirement for foreign earned income exclusions. This is required for US taxpayers having ownership or signature authority over foreign bank accounts whose cumulative balances exceeded $10,000 USD at any one time during the year. Please note that as an individual, if you have signature authority over your business’s foreign bank account you must report the business’s account on your personal FBAR.
Final Thoughts on US Income Tax Reporting Requirements for Foreign Businesses
Be aware that this article does not list all forms required for US income tax reporting requirements for foreign businesses. The penalties associated with the failure to file many of these forms can be quite high. It’s important to consult with an international tax expert to be sure of your filing requirements.
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