Maintain International Tax Compliance With Our Four Tips
A U.S. taxpayer with foreign involvement is likely subject to additional reporting requirements, particularly in the realm of international tax compliance. While many of these additional requirements have historically been informational, the passing of the Tax Cuts and Jobs Act (TCJA) in 2017 introduced new tax requirements. Like all tax standards, non-compliance can lead to sizable penalties.
While there were a variety of changes to foreign taxation in the TCJA, there were four substantial changes this article will focus on. At a very high level, these four changes helped shift the U.S. from a world-wide tax regime to a more hybrid and territorial approach.
1. The Participation Exemption
Applies to U.S. corporations owning 10% or more of a controlled foreign corporation (CFC) for longer than one year. This exemption eliminates additional U.S. tax on repatriated foreign profits via a 100% deductible dividend, but only if the CFC does not receive a similar deduction in the foreign country for paying the dividend to the U.S. parent.
2. Global Intangible Low Tax Income (GILTI)
Applies to U.S. corporations owning CFCs. This is a tax on tested income, defined as foreign income of the CFC that has not yet been taxed by the U.S. Tested income is reduced by 10% of the qualified business asset investment (QBAI), which is essentially the adjusted basis of all depreciable assets owned by the CFC.
3. Foreign Derived Intangible Income (FDII)
FDII is a sister tax to GILTI, which applies to U.S. corporations with foreign exports. The foreign derived income from these exports is taxed at the U.S. corporate rate of 21%, however a 37.5% FDII deduction is allowed.
4. Base Erosion and Anti-Abuse Tax (BEAT)
Applies to large multi-nationals with gross receipts of $500 million or more. BEAT is similar to alternative minimum tax (AMT) in that a 10% minimum tax is applied to modified taxable income. Modified taxable income is defined as taxable income plus any base erosion payments, which are payments made to related foreign entities more than 3% of total deductions.
In addition to the critical and informational forms required pre-TCJA, the Act expanded on many existing forms and requires supplemental filings, as well. While the list below is not exhaustive and does not deeply examine any one form, we have identified some of the most common and most missed foreign tax filings by taxpayers:
Form 5471
U.S. citizens or corporations that meet one of these filing requirements must file form 5471: owning 10% or more of the total voting power, owning 50% or more of the total value of a foreign corporation, or if they are an officer/director of a foreign corporation with U.S. stockholders meeting the 10% or 50% limits.
Some common pitfalls and issues with Form 5471 include:
Missing a schedule, with more than a dozen complex schedules: Taxpayers often leave out schedules they are required to file.
Using the incorrect currency or translation rate: Some forms require reporting in U.S. dollars, and some require functional currency reporting.
Knowing when to use and average exchange rate versus a spot rate.
Filing Form 5471 with an individual or entity return.
Failure to file penalty: $10,000 for each annual account period of each CFC or controlled foreign partnership (CFP) for failure to provide information.
If the information is not filed within 90 days of the IRS mailing the notice of failure to the U.S. person, an additional $10,000 penalty (per CFC/CFP) is charged for each 30-day period, or fraction thereof, after the 90-day period has expired. This additional penalty has a $50,000 cap.
Any person who fails to file or report all information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901 and 960. If the failure continues 90 days or more after the IRS notice, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired.
Form 8865
Required information reporting with respect to CFPs, including transfers, dispositions, and acquisitions. Filing kicks in with transfers over $100k or U.S. partners owning 10%+ of the CFP.
Filed with the individual or entity return.
Similarly, the greatest issue with Form 8865 is failure to file or missing related schedules.
The same penalty structure for Form 5471 applies to Form 8865.
Form 8858
U.S. persons who are tax owners of foreign disregarded entities (FDEs), owners or operators of foreign branches (FBs), or persons who own certain tax interests in FDEs and FBs are required to file.
Category 4 and Category 5 Form 5471 filers may also be required to complete all or part of this form.
Category 1 and Category 2 Form 8865 filers may also be required to complete all or part of this form.
U.S. partnerships that own FDEs or operate FBs (directly or indirectly through a tiered structure) are required to file Form 8858.
Corporations are required to file form 8858 if they are a partner in a U.S. partnership that is required to file the form and the partnership must provide all necessary information to do so.
The same penalty structure for Form 5471 and 8865 applies to Form 8858.
Form 3520
U.S. persons (and executors of estates of U.S. decedents) file Form 3520 to report:
Certain reportable transactions with foreign trusts, including:
The creation of a foreign trust by a U.S. person
Transfer of money or property directly or indirectly to a foreign trust by a U.S. person (including transfer by reason of death)
The death of a citizen of the U.S. if the decedent was treated as the owner of any portion of a foreign trust or any portion of a foreign trust was included in the gross estate of the decedent.
Ownership of foreign trusts under the rules of sections Internal Revenue Code 671 through 679.
Receipt of certain large gifts or bequests from certain foreign personssuch as $100,000 or more from non-resident alien individual or foreign estate (or foreign persons related to that nonresident alien or foreign estate)that you treated as gifts or bequests; OR more than $16,649 from foreign corporations or partnerships that you treated as gifts.
Exceptions to filing apply for certain transfers.
Filing a protective Form 3520 has two benefits: Starting the 3-year statute of limitations and avoiding penalties.
Initial penalty is the greater of $10,000 or:
35% of the gross value of the property transferred to a foreign trust for failure by U.S. transferor to report creation or transfer to foreign trust.
35% of the gross value of property distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution.
5% of the gross value of the portion of the foreign trusts assets treated as owned by a U.S. person under grantor trust rules if the trust fails to file Form 3520-A and furnish required information to U.S. owners and beneficiaries. Owners can avoid being subject to this penalty by completing and attaching a substitute Form 3520-A to their timely filed Form 3520.
Additional penalties will be imposed if noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting.
Penalties can be reduced to assure the aggregate of the penalties does not exceed the gross reportable amount.
FBAR Report
A U.S. person must file an FBAR to report financial interest in or signature authority over a financial account located outside the U.S. if the aggregate value of the account(s) exceeded $10,000 at an time during the reporting year. For these purposes a U.S. Person includes a citizen, resident, corporation, partnership, limited liability company, or trust and estate.
Maximum Penalties:
Non-willful violation: $12,921
Willful violation: greater of $129,210 or 50% of the amount or the balance of the account at the time of the violation
Negligent violation by financial institution or non-financial trade or business: $1,118
Pattern of negligent activity by financial institution or non-financial trade or business: $86,976
If FBARs should have been filed and have not been and the taxpayer is not under IRS investigation, they should be filed ASAP to mitigate or prevent penalties.
Form 8938
Filed by a specified person (can be a domestic entity) who has an interest in specified foreign assets with a value above the reporting threshold.
Types of specified foreign financial assets:
Financial accounts maintained by foreign financial institutions.
The following foreign financial assets if they are held for investment and not held in an account maintained by a financial institution:
Stock or securities held for investment that were issued by someone that is not a U.S. person
Any interest in a foreign entity
Any financial instrument or contract that has an in issuer or counter party that is not a U.S. person
Reporting Thresholds:
Unmarried taxpayers or married filing separately: more than $50,000 on the last day of the year or more than $75,000 at any point during the year ($200,000/$300,000 if living outside the U.S.)
Married filing jointly: more than $100,000 on the last day of the year or more than $15,000 at any point during the year ($400,000/$600,000 if living outside the U.S.)
Domestic entities: more than $50,000 on the last day of the year or more than $75,000 at any point during the year
If the IRS requests information about the valuation of an asset they determined you have an interest in and the documentation is not sufficient, it is presumed you meet the reporting requirements and you will be subject to failure to file penalties if you do not file Form 8938.
Failure to File: $10,000
If a correct and complete Form 8938 is not filed within 90 days of the IRS notice, an additional $10,000 penalty is charged for each 30-day period, or fraction thereof, after the 90-day period has expired. This additional penalty has a $50,000 cap.
Failure to file penalty applies to MFJ couples as if they were a single person.
Accuracy-related penalty: If you underpay tax because of transactions involving an undisclosed specified foreign financial asset, you may have to pay a penalty equal to 40% of that underpayment. If you underpay your tax due to fraud, you must pay a penalty equal to 75% of the underpayment due to fraud.
Schedules K-2/K-3
Filed by partnerships, S corporations, and foreign disregarded entities.
Extension of Schedule K and reports items of international tax relevance.
Default is for all pass-through entities to file Schedules K-2 and K-3, regardless of foreign activity, unless they qualify for the Domestic Filing Exception or Form 1116 Exception.
Penalties (same as filing Schedule K-1 without all required information):
$310 per each incomplete K-1, maximum amount of $3,783,000
If intentionally failing to produce complete K-1s, the penalty is $630 per K-1 or 10% of aggregate amounts of items that should have been reported (whichever is greater). No maximum penalty if the omission was intentional.
Partner with CSH
If you have foreign interests and are potentially impacted by any of these updates, make sure you are leveraging the expertise of a tax professional to stay compliant. The international tax team at CSH stays abreast of the latest requirements and can help you, or your business, navigate these waters. Tax regulations can be a moving target, and leaning on a partner who is specialized in this complex area will save you time and money. Reach out to CSH for information on how we can partner with your business.
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