Do you own a foreign company or trust Have you given or received money or property to or from a foreign company, trust or person? The IRS wants to know about it!
Requirements for filing an informational return on foreign entities in which you have a stake
The IRS requires every “US person” (I.e., US citizens, permanent residents - “green card” holders and “tax residents” (those spending substantial time in the US) to file an informational return for foreign entities in which they have a stake. US persons must file informational returns even if they do not owe taxes on the foreign entity’s income.
The IRS also requires US persons to report certain transactions with foreign individuals, trusts and entities (such as transfers to those foreign persons and receipts from those foreign persons).
The reporting obligations for different types of foreign entities are as follows:
Controlled Foreign Corporations (CFC)
Generally, if a majority of shares (by vote or value) of a foreign corporation are owned by certain US persons (only count those that own more than 10%), the IRS considers it a CFC. At least one of the US persons must file Form 5471 or 5472 (depending on the circumstances), which reports the income and assets for the CFC. Taxation of CFCs can be complex but the bottom line is that you must pay taxes on certain type of the CFC’s income in the year it is earned.
Passive Foreign Investment Company (PFIC) or Qualified Electing Fund
If a US person owns an interest in a foreign corporation that is NOT a CFC, it can still be a PFIC. (Deciding if a foreign corporation is a PFIC is based on meeting either an income or asset test, which are beyond the scope of this article).
A US person owning an interest in a PFIC generally must file Form 8621 to report ANY of the following:
- Receipt of a distribution (direct or indirect) from a PFIC.
- Recognition of gain on a disposition (direct or indirect) of PFIC shares.
- Information on a QEF or section 1296 mark-to-market election.
- The making of an election reportable in Part II of Form 8621.
The good news is that generally the US person is only taxed when she receives a distribution from the PFIC (in contrast to a CFC, where you are taxed on certain income even if you do not receive a distribution).
If a US person is a partner in a foreign partnership, she must file Form 8865. Form 8865 reports the income and financial position of the partnership and certain transactions between the partner and the partnership. The form is required to be filed with the US person’s tax return.
A US person (or executor of a US decedent) must file Form 3520 to report ANY of the following:
- Certain transactions with foreign trusts (such as transfers to a foreign trust or receipts from a foreign trust).
- Ownership of foreign trusts.
- Receipt of large gifts from certain foreign trusts and other foreign persons ($100,000 from a foreign individual, trust or estate and $14,723 from a foreign corporation or partnership).
What if I Forgot to Report?
Failure to file FinCEN Form 114 and Form 8938 (as well as other reporting obligations) can lead to stiff penalties, including punitive financial fees and criminal prosecution. Currently, the IRS has made available several tax amnesty programs that can help those that are delinquent in filing. However, one of the key amnesty programs expired in late 2018. The legal costs, interest and penalties are likely to continue to be more severe in the future. Self-reporting is likely to be treated less severely than detection and enforcement.
What if I Have Failed to File?
Failure to timely file these international information returns can lead to stiff consequences, including significant fines (see below) and criminal prosecution. Significant fines include:
- US$10,000 penalty per each unfiled form per month, even when no income tax was owed with the taxpayer's return.
Currently, the IRS has made available several tax amnesty programs that can help those that are delinquent in filing. However, these may not be available for long; one of the key amnesty programs expired in late 2018. The legal costs, interest and penalties are likely to continue to be more severe in the future. Self-reporting is likely to be treated less severely than detection and enforcement.
Consult a tax advisor immediately!
I hope you’ve found this article on the Foreign Earned Income Exclusion for 2018 to be helpful. For more information on any expat tax concerns please log into our webpage: www.lagattatax.com