The Treasury Department has clamped down on a key reporting exemption that was previously enjoyed by foreign-owned, single-member limited liability companies (SMLLCs). This change has significant impacts on any foreign person or entity with holdings in U.S. SMLLCs that are disregarded for federal income tax purposes. Previously, these entities were exempt from the comprehensive record maintenance and associated compliance requirements that applied to 25% foreign-owned domestic corporations. Now, substantially any transaction between U.S. domestic disregarded entities and their foreign owners, including any of the owner’s related entities, may be reportable.
These regulations are part of a larger effort by the Treasury Department to increase financial transparency. Entities subject to these regulations will continue to be treated as disregarded for other federal tax purposes. The Treasury Department explained that there is a class of foreign-owned U.S. entity (typically SMLLCs) that has no obligation to report information to the IRS or even obtain a tax identification number. According to the government, these “disregarded entities” could be used to shield the foreign owners of non-U.S. assets or bank accounts. By treating domestic disregarded entities that are wholly owned by a foreign person as a domestic corporation separate from its owner (for these limited reporting and compliance requirements), the regulations enable the IRS to determine the existence and magnitude of any tax liability and share information with tax authorities in other countries.
Previously, certain disregarded entities and their foreign owners may not have had an obligation to file a tax return or obtain an Employer Identification Number (EIN). The final regulations require foreign owned domestic disregarded entities to:
- Obtain EINs from the IRS
- Annually file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business
- Identify “reportable transactions” between the LLC and any related parties, including the LLC’s foreign owner
- Maintain supporting books and records
These rules treat U.S. disregarded entities as stand-alone foreign-owned domestic corporations. Therefore, they are now required to file Form 5472 with respect to reportable transactions between the entity and its foreign owner or other foreign related parties. Transactions are reportable as if the entity were a corporation for U.S. tax purposes. These entities also are required to maintain records sufficient to establish the accuracy of the information return and the proper U.S. tax treatment of such transactions.
Please see the regulations for examples of reportable transactions that require reporting, elimination of certain reporting exemptions, and overlap rules affecting controlled foreign corporations and foreign sales corporations.
The final regulations require the domestic reporting corporations to have the same tax year as their foreign owner if that foreign owner has an existing U.S. reporting obligation. If the foreign owner has no U.S. return filing obligation, then the domestic reporting corporation must report on a calendar year basis.
The final regulations are effective December 13, 2016, and apply to tax years beginning on or after January 1, 2017, and ending on or after December 13, 2017.
Lisa S. Goldman, CPA is Partner-in-Charge of Wealth Management at Raich Ende Malter & Co. LLP, with more than 20 years’ experience serving Fortune 500 corporations and privately-owned companies in the real estate, manufacturing, and consumer products industries. She specializes in international taxation and in providing services for high-net-worth individuals and their businesses. Ms. Goldman is a trust and estate practitioner (TEP) under the auspices of STEP and is a member of the NYSSCPA’s International Taxation Committee and the AICPA Tax Division. She frequently writes and lectures on international tax topics. Reach Lisa at 212-944-4433 or firstname.lastname@example.org.