IRS Form 8858: Filing Requirements and Instructions
US taxpayers who own foreign disregarded entities or operate foreign branches have additional tax reporting requirements, including filing IRS Form 8858. Failing to comply with these requirements can lead to substantial penalties. This guide will explain everything you need to know about Form 8858, including when you should file and what information you’ll need.
Key Takeaways
- Form 8858 is a tax form that certain US taxpayers with foreign disregarded entities or foreign branches must file.
- A foreign disregarded entity is a business entity created outside the US that is not recognized as separate from its owner for tax purposes. All income is reported on the owner’s personal tax return.
- Because Form 8858 is purely an informational return, it does not create any new tax liabilities on its own.
- Penalties for failing to file Form 8858 can range from $10,000 to over $60,000, with additional penalties if the IRS sends a notice and the taxpayer fails to comply.
What Is Form 8858?
Form 8858, titled Information Return of U.S. Persons with Respect to Foreign Disregarded Entities and Foreign Branches, is an informational form that certain US taxpayers must file. Form 8858 reports financial information about foreign disregarded entities (FDEs) or foreign branches controlled by US persons, either directly or indirectly.
The IRS uses this form to monitor the activities of foreign businesses owned by US taxpayers. While filing Form 8858 will not result in additional taxes, it provides the IRS with transparency on how much income your foreign disregarded entity or foreign branch generates.
This form is particularly important for entrepreneurs and expats who set up businesses abroad. Even if your business is not taxed separately from your personal income, you will likely need to report it on Form 8858.
What Is a Foreign Disregarded Entity?
A foreign disregarded entity (FDE) is any non-US business entity that is disregarded for US tax purposes, meaning that the entity itself does not pay taxes. Instead, its income and expenses flow through to the owner’s tax return. The owner reports that income on their personal income tax return (Form 1040), and it is taxed at their tax rates.
Many entrepreneurs prefer this structure because it offers limited liability while avoiding the complexities and double taxation nature of a corporation.
Disregarded Entity vs. Sole Proprietorship
A disregarded entity is similar to a sole proprietorship, and both are taxed the same way — on the owner’s personal tax return. However, unlike a sole proprietorship, a disregarded entity is still recognized as a separate entity on paper, distinct from the owner. In the United States, LLCs and partnerships are examples of disregarded entities.
Who Needs to File Form 8858?
You must file Form 8858 if you are a US person who is the tax owner of an FDE or operates a foreign branch. Specific examples of individuals and entities required to file include:
- US persons who are direct or indirect owners of an FDE
- US persons operating a foreign branch, either directly or indirectly through tiers of FDEs or partnerships
- US persons are required to file Form 5471 for controlled foreign corporations that hold FDEs or foreign branches
Some taxpayers may also need to file Form 8865 for foreign partnerships or Form 5471 for foreign corporations.
Tax Owner vs. Direct Owner of a Foreign Disregarded Entity
For filing purposes, there are two types of FDE owners: tax owners and direct owners.
- A tax owner is someone who is considered the owner of the FDE’s assets and liabilities for tax purposes.
- A direct owner is the true legal owner of the FDE.
The IRS created these two categories of ownership as a way to prevent any loopholes that might allow owners to escape having to file Form 8858.
Key Information Required
When preparing Form 8858, you will need to provide:
- Basic identifying information about the FDE or foreign branch, such as its Employer Identification Number (EIN), functional currency, and the country where it was established
- A summary of the entity’s profits and losses
- A balance sheet detailing assets, liabilities, and equity
- Transactions between the entity and its owner
- Other details as applicable (more info below!)
The IRS requires all financial information to be reported in US dollars. When converting foreign currency to dollars, use the appropriate exchange rate for that tax year.
Step-By-Step Guide to Completing Form 8858
To complete Form 8858, you must fill out the required information on the form itself as well as Schedule M. Then, attach Schedule M and an organization chart to your Form 8858 and file these three items with your federal income tax return.
To help simplify this process, let’s look at an example.
Example: John Expat
John, a lawyer from Vermont, moved to Mexico on January 1, 2021. That same day he created an LLC for his legal consulting services in the city of Oaxaca, Mexico. Here are some important numbers he’ll need to know:
- In 2021, the Mexican Peso exchange rate to the US Dollar was 20.0000.
- For his services, he earned the US equivalent of $100,000 and received $1,000 in interest from his local Mexican bank account.
- Expenses totaled $51,000, giving him a profit of $50,000 before tax.
- He paid a Mexican income tax of $16,500 on these profits, which resulted in a net income of $33,500.
- On the last day of the year, he owed a publisher $500 for legal books. He also bought furniture costing $10,000 for an office he was going to open sometime near the end of February 2022.
Now, it’s time for John to fill out Form 8858 for his LLC.
Form 8858 Section I
John will fill out the first section of Form 8858 with his identifying information, including his:
- Name
- Address
- Company EIN
- Country in which his company was created and the date it was created
Schedule C
Next, he’ll use Schedule C of Form 8858 for his income statement, which is also commonly called a profit and loss statement. He will summarize all his income and expenses in his “functional currency,” the Mexican peso. Then, he’ll convert all amounts to US dollars at the 20.0000 exchange rate for 2021.
Schedule F
Next comes Schedule F, the abbreviated balance sheet. John will list his company’s assets, debts, and the equity of all owners. (In this case, that’s just him.)
- Since John started this business on January 1, 2021, all beginning balances in Column A are listed as $0.
- The ending balances in Column B show that there was $23,500 in cash in the bank account, which is the profit he earned after $33,500 in tax minus the $10,000 he paid for the furniture, which is listed as “Other Assets.”
- His liabilities are $500 for the amount he owes a publisher.
- The difference between his total assets of $33,500 and his debt of $500 equals his total equity in his firm of $33,000.
Schedule J
Schedule J shows the income tax that John paid in Mexico. This is important because John can claim that amount as a Foreign Tax Credit to reduce his US tax bill.
- In total, John spent $16,500 in Mexican income tax.
- His income before tax totaled $50,000.
- His interest income of $1,000 is 2% of his entire income.
- Therefore, 2% of the tax of $16,500, or $330, was the tax paid for interest. This amount is reported under Column G as interest income.
- His income from legal fees totaled $49,000, or 98% of his entire income. Therefore, 98% of the tax of $16,500, ($16,170) is the tax paid for his legal services. This amount is reported under Column H as business income.
The remaining schedules of Form 8858 include schedules C-1, G, H, I, and M. For tax reporting purposes, the following schedules provide specific information:
- Schedule C-1: Details gains or losses from foreign currency exchange
- Schedule G: Covers ownership of trusts, interests in foreign partnerships, and whether the company is part of a consolidated group
- Schedule H: Displays current earnings and profits and any necessary adjustments to comply with US tax accounting requirements
- Schedule I: Requires information about asset transfers
- Schedule M: Lists transactions between the company and its owner and is usually the first schedule reviewed during an audit.
For more information, see the instructions for Form 8858 provided by the IRS.
Form 8858 Filing Deadline
For most taxpayers, Form 8858 is due on April 15 — the same day as your annual tax return. However, expats receive an automatic two-month extension, pushing the deadline to June 15, 2024. If you need even more time, you can file for a further extension to October 15 or, in some cases, even December 15.
(These extensions must be requested for your Form 1040 tax return, which will then apply automatically to Form 8858 as well.)
Potential Penalties
Failing to file Form 8858 when required can lead to severe penalties:
- If the form is not filed on time, there will be a base penalty of $10,000 per year, per company.
- If the IRS sends a failure-to-file notice, you have 90 days to comply. After that, penalties increase by $10,000 per month, up to a maximum of $60,000Additionally, failing to file Form 8858 can reduce your Foreign Tax Credit (FTC) by 10%, with further reductions for continued delays.
- In rare cases of intentional tax fraud, criminal penalties may also apply.
Common Mistakes (And How to Avoid Them)
Not Reporting Transactions
Failing to report loans, payments, or capital contributions on Schedule M is a common error. Keep detailed records of all transactions between you and the entity.
Missing the Filing Deadline
Penalties for missing the deadline can be severe. Always make sure to file Form 8858 on time and as required.
Incorrect Financial Reporting
Errors in income, expenses, or exchange rates can trigger penalties. Use the correct exchange rate to convert currency and verify all financial entries.
Forgetting Required Schedules
Missing schedules like Schedule M or Schedule F can lead to incomplete filing. Ensure you complete all required schedules based on your entity’s financial activity
This comprehensive guide is filled with valuable insights and tools to help you confidently explore the realm of global property investment.
FAQs
When is Form 8858 due?
Form 8858 is due at the same time as your federal tax return. For most individuals, this means April 15, 2024, but US taxpayers living abroad get an automatic two-month extension to June 15, 2024. If necessary, you can also file for an extension to October 15 or December 15.
Do I need to file a separate Form 8858 for each foreign entity?
If you own multiple foreign disregarded entities (FDEs) or foreign branches (FBs), you must file a separate Form 8858 for each entity. Each form must include the required schedules, such as Schedule C (Profit and Loss) and Schedule F (Balance Sheet).
Does Form 8858 affect self-employment tax?
It may. If your foreign disregarded entity generates self-employment income, it will flow through to Schedule C of your Form 1040, and you may be required to pay self-employment tax. However, if you live in a country with a Totalization Agreement with the US, you might not be subject to self-employment tax.
Greenback Can Make Filing Form 8858 a Breeze!
If you’re an American living overseas, Greenback Expat Tax Services is here to make your tax season smooth and stress-free. We’ve already filed taxes for more than 18,000 expats in 193 countries — and we’re ready to do the same for you!
Most of our expert CPAs and Enrolled Agents are expats themselves. That means they understand the complexities of US and international tax laws. We will match you with the perfect representative for your unique situation, providing you with peace of mind and unmatched service.
If you’re ready to be matched with a Greenback accountant, click the get started button below. For general questions on expat taxes or working with Greenback, contact our Customer Champions.
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