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Indirect Ownership of Foreign Entities for Form 5471 Purposes

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Every now and then, I encounter foreign business structures built on the incorrect belief that only direct ownership matters for U.S. tax reporting purposes in general and Form 5471 purposes in particular. In this essay, I broadly address the question of Form 5471 reporting with respect to indirect ownership of a foreign company (I am not discussing the major issue of “constructive ownership” in this essay).

Form 5471 Reporting Requirements

In an earlier article I already discussed the purpose of Form 5471 and the general reporting requirements this form entails, but I will briefly address these issues here.

Form 5471 is used by certain categories of U.S. taxpayers to report their ownership of foreign corporations. Generally, the form is designed to address the reporting requirements of IRC (Internal Revenue Code) Sections 6038 and 6046.

Under these IRC provisions, four general categories of U.S. taxpayers must file Form 5471 together with their U.S. tax returns: (1) U.S. taxpayers considered as U.S. shareholders (generally, U.S. taxpayers who own 10% or more of a foreign corporation) (these are category 3 filers), (2) U.S. persons who are directors and/or officers of a foreign corporation in which there are U.S. shareholders which meet the requirements of Form 5471 (these are category 2 filers), (3) U.S. persons who had control of a foreign corporation for an uninterrupted period of 30 days (these are category 4 filers); and (4) U.S. shareholders who owned a stock in a foreign corporation that is considered to be a Controlled Foreign Corporation for an uninterrupted period of 30 days and who owned that stock on the last day of the year (these are category 5 filers). Note, that Category 1 was repealed by Congress in section 413(c)(26) of the American Jobs Creation Act of 2004.

What truly adds to the complexity of the application of these four categories are the specific definitions of virtually every word in the description of these four categories which may differ from category to category. For example, “US taxpayer”, “US person”, “control”, “owned” – these are some of the words that are separately defined in the IRS regulations with respect to each category above.

Therefore, for a non-attorney, it is extremely dangerous to rely on these general definitions. Rather, the determination of whether Form 5471 requirement applies to you should be made by an international tax attorney.

Ownership Has Broad Definition for Form 5471 Purposes

As mentioned above, word “owned” has a number of diverse and special meanings for Form 5471 purposes. Generally, it includes not only the direct ownership of a stock, but also indirect ownership and constructive ownership. The concepts of “indirect ownership” and “constructive ownership” are described in separate complex IRS regulations.

The upshot of this discussion is that “ownership” is defined very broadly under the IRS regulations related to Form 5471, and one should not rely on direct ownership in determining whether Form 5471 needs to be filed.

Indirect Ownership for Form 5471 Purposes: IRC Section 958

We now came to the main purpose of this article – discussion of “indirect ownership” for Form 5471 purposes. Form 5471 Instructions as well as IRS regulations generally refer to IRC Section 958 for the definition of indirect ownership.

This provision sets forth the rules for determining stock ownership, including direct, indirect and constructive ownership of a stock. For the purposes of our discussion, we concentrate on Section 958(a)(2) which describes the rules for stock ownership through foreign entities. It states as follows:

“(2) Stock ownership through foreign entities: For purposes of subparagraph (B) of paragraph (1), stock owned, directly or indirectly, by or for a foreign corporation, foreign partnership, or foreign trust or foreign estate (within the meaning of section 7701(a)(31)) shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries. Stock considered to be owned by a person by reason of the application of the preceding sentence shall, for purposes of applying such sentence, be treated as actually owned by such person.”

Thus, it becomes clear that, generally, a U.S. shareholder of a foreign company is likely to be considered a shareholder of other foreign companies owned by this foreign company. For example, where foreign corporation A owns 25% of foreign corporation B, a 45% shareholder of Company A is likely to be deemed as a 11.25% owner of company B. Obviously, this is a very general example and there are various facts and circumstances that may change this simplified calculation. Again, you should retain an international tax attorney to determine your ownership of foreign companies under IRC Section 958.

Implications for Form 5471 Reporting and Tax Planning Strategies

The most obvious result of IRC Section 958 are additional Forms 5471 that need to be timely filed with the U.S. shareholder’s US tax return. It is now easy to see why I would encounter in my practice a situation where a client would comply with Form 5471 requirements for the purposes of some of his companies and fail to do so with respect to the others because either he or his accountant simply did not understand the implications of Section 958 indirect ownership rules.

Section 958 also has a major influence on a U.S. person’s tax plan. Where such person and his tax advisor ignore the relevant implications of IRC Section 958, they are engaging in a potentially disastrous course of action. Beyond the penalties associated with the failure to file Form 5471 timely (as well as other potential penalties stemming from other U.S. international tax forms that may need to be filed), the effect of the entire tax structure could be nullified and potentially expose U.S. taxpayer to additional US taxes.

Contact Sherayzen Law Office for Help With Form 5471 and Tax Planning

If you or your business own companies overseas, contact Sherayzen Law Office for help with U.S. tax compliance, including Form 5471, as well as creating a comprehensible tax plan that would allow you to avoid over-payment of U.S. taxes while remaining in compliance with the Internal Revenue Code.

Automatic 5471 Penalties Submitted With Form 1120

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In an earlier article, I discussed various penalties generally associated with late or inaccurate filing of Form 5471 (this form is required under IRC Section 6038(a) to provide information with respect to certain US shareholders of foreign corporations). These penalties are generally subject to “reasonable cause” exception and are not imposed in every case.

Since 2009, however, this is not the case. Starting January 1, 2009, the IRS automatically assesses a $10,000 penalty (under IRC Section 6038(b)(1)) for each late filed Form 5471 if the related Form 1120 is not filed timely. Note, the automatic assessment of penalty results in this case even if there is no tax due.

Furthermore, IRC Section 6038(c) provides for a 10% reduction of the foreign taxes available for credit under IRC Sections 901, 902 and 960. Per IRC Section 6038(c)(3), this reduction to the foreign taxes can be applied in addition to the monetary penalty. It is important to realize that the automatic assessment of the $10,000 penalty does not preclude a later assessment under IRC Section 6038(c).

In addition, the IRS will also assess the penalty for the failure to file income tax returns (i.e. Form 1120) under IRC Section 6651(a)(1). The penalty is 5% of the tax required to be shown on the income tax return for each month (or fraction thereof) during which such failure continues. The amount of the penalty shall not exceed 25%. No penalty is applicable under IRC Section 6651(a)(1) if no underpayment of tax is shown on the return.

There is an interesting procedural twist with respect to automatic assessment of penalties – the IRS does not want you to include the reasonable cause statement together with Form 5471 filed late together with Form 1120. Rather, the IRS Service Centers will first send the taxpayer a Notice to Respond and the taxpayer can respond with a reasonable cause statement.

Whether or not to follow this procedural suggestion will depend on the individual case and such decision should be made by your tax attorney.

Of course, the situation is radically different if Form 1120 has already been timely filed. In this case, the taxpayer must file Form 1120X with the late Form 5471 and he should include his reasonable cause statement.

Contact Sherayzen Law Office For Help with Form 5471 Penalties

If you have not filed your Form 5471 yet or if you are facing a penalty for the already filed Form 5471, contact Sherayzen Law Office for legal help. Our experienced international tax firm will thoroughly analyze your case, present options for proceeding forward, prepare all of the required documentation and tax forms, and rigorously represent your interests during your negotiations with the IRS.

Dormant Foreign Corporation

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Certain categories of US shareholders of a foreign corporation are required to file Form 5471 with the IRS. Form 5471, however, is one of the most complex forms in the Internal Revenue Code and the compliance costs for such a corporation can be very high. Such costs can be especially disproportionate for an inactive corporation that does not do any business but merely exists.

In order to alleviate the compliance costs in these cases, the IRS allows certain foreign corporations, that satisfy the required criteria for being considered as “dormant foreign corporations”, to make a limited filing that does not include a detailed financial statements and supporting schedules. IRS Revenue Procedure (Rev. Proc.) 92-70 (1992-2 C.B. 435) details the requirements for the classification of dormant foreign corporation.

Under the Rev. Proc. 92-70, eight conditions must be met in order for a foreign corporation to be considered dormant:

(1) the foreign corporation conducted no business and owned no stock in any other corporation other than another dormant foreign corporation;

(2) no shares of the foreign corporation (other than directors’ qualifying shares) were sold, exchanged, redeemed, or otherwise transferred, nor was the foreign corporation a party to a reorganization;

(3) no assets of the foreign corporation were sold, exchanged, or otherwise transferred, except for de minimis transfers described in (4) and (5) below;

( 4) the foreign corporation received or accrued no more than $5,000 of gross income or gross receipts;

(5) the foreign corporation paid or accrued no more than $5,000 of expenses;

(6) the value of the foreign corporation’s assets as determined pursuant to U.S. generally accepted accounting principles (but not reduced by any mortgages or other liabilities) did not exceed $100,000;
(7) no distributions were made by the foreign corporation; and

(8) the foreign corporation either had no current or accumulated earnings and profits or had only de minimis changes in its beginning and ending accumulated earnings and profits balances by reason of income or expenses specified in (4) or (5) above.

If all eight conditions are met, the filer only needs to fill-out and complete the first page of Form 5471 (which includes: filer information, such as name and address, Items A through C, and tax year; corporate information, such as the dormant corporation’s annual accounting period (below the title of the form) and Items 1a, 1b, 1c, and 1d), and label the top margin of the first page of Form 5471 with this exact phrase “Filed Pursuant to Rev. Proc. 92-70 for Dormant Foreign Corporations.”

The form should be filed in the manner described in “When and Where To File on page 1 of the Instructions for Form 5471“. For the tax year 2011, this means that it should be attached to and filed together with your income tax return by the relevant due date.

Contact Sherayzen Law Office for Help With U.S. Tax Compliance Regarding U.S. Ownership of a Foreign Corporation

If you own shares in a foreign corporation, contact Sherayzen Law Office for help with U.S. tax compliance. Our experienced international tax firm will thoroughly review the facts of your case, identify your U.S. tax compliance requirements, and complete the required forms and filings (including Form 5471).

If you only now became aware of your potential Form 5471 filing requirements and you have not filed the form with the IRS previously, our tax firm will assist you with finding the right type of voluntary disclosure and vigorously represent your interests during IRS negotiations.

IRS Increases Criminal Prosecutions for Willful Failure to File FBARs: U.S. v. Jacques Wajsfelner

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In U.S. v. Jacques Wajsfelner, the IRS’s criminal prosecution of the defendant for willful failure to file FBARs was completed when the defendant, Mr. Jacques Wajsfelner, decided to plead guilty. Mr. Wajsfelner pled guilty to willful failure to file the FBAR in Manhattan federal court and he now faces civil penalties of $2.84 million and restitution of $419,940. Under advisory guidelines, he faces 30 months to 37 months in prison at sentencing scheduled for December 20, 2012.

Basic Facts

Mr. Wajsfelner, an 83-year old Holocaust survivor, fled the Nazis as a teenager and became a U.S. citizen, working in real estate and advertisement in New York and Boston. He admitted that he held an account in his own name at Credit Suisse in 1995. In 2006, his advisor helped him open an account in the name of Ample Lion Ltd. At the end of 2007, the account held almost $5.7 million. In 2008, as Credit Suisse started to wind down its U.S. cross-border banking business, Mr. Wajsfelner opened an account with Wegelin and transferred the money from Credit Suisse to the new account. In the later years, the value on this account went down to only $4 million.

In addition to moving money among two accounts, Mr. Wajsfelner also made a huge error of not telling the truth to the IRS about the account, Ample Lion Ltd. (A Hong Kong corporation), and his advisor (Beda Singenberger’s corporation Sinco Treuhand AG) during an interview conducted by the IRS after the investigation commenced. As part of his plea agreement, the IRS agreed not to prosecute him for these statements.

In the end, Mr. Wajsfelner plead guilty to knowing and willful failure to file the FBARs from 2006 through 2011 with the IRS.

Additional Considerations

It is possible that the misleading and untruthful statements to the IRS alone may have been the cause for Mr. Wajsfelner to plead guilty. However, there was another highly unfavorable fact – moving the money between the accounts would have been considered as circumstantial evidence of conspiracy to conceal the money from U.S. government. Also, Mr. Wajsfelner maintained very close contact with the account and directed various transactions to and from the accounts.

Another important consideration is to understand that this is a case of pure willful failure to file the FBARs; there was no associated pleading with respect to tax evasion. This is a very important because it shows that the IRS is willing to prosecute FBAR cases criminally even without tax evasion charges.

US v. Jacques Wajsfelner is Part of a Wave of Prosecutions

U.S. v. Jacques Wajsfelner is not an isolated case or limited only to specific facts of Mr. Wajsfelner.

In addition to Mr. Wajsfelner, the IRS also indicted his former Swiss adviser, Beda Singenberger, on a charge of conspiring to help more than 60 U.S. taxpayers hide $184 million from the Internal Revenue Service in offshore accounts. Wegelin, the 270-year-old Swiss bank, was also indicted February 2, 2012, on charges of helping U.S. taxpayers hide money from the IRS. Also, Credit Suisse said in July of 2011 that it was a target of a U.S. criminal probe. On July 21, 2011, seven of Credit Suisse’s bankers were indicted on charges of helping U.S. clients evade taxes through secret accounts.

In fact, since 2009, U.S. prosecutors have criminally charged about fifty U.S. taxpayers and more than twenty offshore bankers, lawyers and advisers.

FBAR Criminal Prosecutions Will Increase Due to Voluntary Disclosure Programs

It is critically important for non-compliant U.S. taxpayers to understand that, instead of subsiding, this wave of IRS criminal prosecutions regarding the FBARs will only increase.

The primary reason for this growth of FBAR prosecutions are the voluntary disclosure programs, like 2009 OVDP, 2011 OVDI AND 2012 OVDP (now closed). For many years now, the IRS has been collecting detailed information from the participating taxpayers regarding their advisors, banks and other U.S. taxpayers. This mountain of information allows the IRS to identify high-risk banks, advisors as well as specific taxpayers who are likely to be non-compliant with U.S. tax rules. The end-product of this analysis are targeted investigation and, ultimately, criminal prosecutions of non-compliant U.S. taxpayers and their advisors.

Contact Sherayzen Law Office for Legal Help With FBARs

If you have undisclosed foreign financial accounts that should have been reported to the IRS, contact Sherayzen Law Office as soon as possible. Our experienced tax firm will analyze the facts of your case, identify you potential FBAR liability and propose a specific course of action to deal with your specific situation. Sherayzen Law Office will guide you though your entire voluntary disclosure, including the preparation of all of the necessary tax documents and rigorous IRS representation.

Foreign Earned Income Exclusion: 2013

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If a qualified individual meets certain requirements of I.R.C. §911, he may exclude part or all of his foreign earned income from taxable gross income for the U.S. income tax purposes. This income may still be subject to U.S. Social Security taxes.

The IRS recently announced that the maximum foreign income exclusion amount for 2013 will be increased to $97,600 (currently, in 2012, it is $95,100).

Remember, if your overseas earnings are above $97,600 for the tax year 2013, then you may be subject to U.S. income taxation on the excess amount. For example, if you earned $105,000 in 2011, then you will have to pay U.S. income taxes on $ 7,400.

It is also important to note, despite the income tax exclusion, your tax bracket will still be the same as if you were taxed on the whole amount (i.e. as if you had not claimed the foreign earned income exclusion). For most U.S. expatriates, this means that the tax bracket is likely to start at 25% or higher. If you are self-employed, however, your situation may differ from this description.

Furthermore, it is worth noting that additional amount of earnings may also be excluded under the foreign housing exclusion.

Contact Sherayzen Law Office For Foreign Earned Income Exclusion Legal Help

If you are a U.S. taxpayer living abroad or you are planning to accept a job overseas, contact us to discuss your tax situation. Our experienced tax firm will guide you through the complex maze of U.S. tax reporting requirements, help you make sure that you are in full compliance with U.S. tax laws, and help you take advantage of the relevant provisions of the Internal Revenue Code to make sure that you do not over-pay your taxes in the United States.