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No Form 5471 and Form 3520 Penalties – Q&A 18 of the OVDP

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In my practice I have encountered situations where a taxpayer has delinquent Form 5471 or Form 3520, but there is no additional tax liability associated with the delinquent forms. In these situations, a natural questions arises on how to best deal with this situation.

One of the options is to follow Q&A 18 of the Offshore Voluntary Disclosure Program (OVDP) Rules. (This program is now discontinued). In very limited circumstances, Q&A 18 allows a small number of eligible taxpayers escape Form 5471 and Form 3520 penalties.

Background Information

Form 5471 is used by the IRS to satisfy the informational reporting requirements of 26 U.S.C. § 6038 (“Information reporting with respect to certain foreign corporations and partnerships”) and 26 U.S.C. § 6046 (“Returns as to organization or reorganization of foreign corporations and as to acquisitions of their stock”). It must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in specified foreign corporations, if various requirements are met. Failure to file Form 5471 may result in the imposition of steep penalties (see this article for more details).

Form 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts) is used by U.S. persons (and executors of estates of U.S. decedents) to report certain transactions with foreign trusts, ownership of foreign trusts under the rules of IRC §§ 671 through 679, and receipt of certain large gifts or bequests from certain foreign persons. Failure to file Form 3520 may result in very heavy penalties.

Q&A 18

Q&A 18 of the OVDP Rules provides a potentially zero-penalty option for non-compliant taxpayers who failed to file tax information returns, such as Form 5471 and Form 3520.

From the outset, it is important to understand that Q&A 18 has a very limited application. It is only relevant in the situation where the taxpayer failed to file Forms 5471 or Forms 3520, but he reported and paid tax on all their taxable income with respect to all transactions related to the foreign corporations or foreign trusts. The IRS is not likely to impose a penalty for the failure to file the delinquent Forms 5471 and 3520 if there are no underreported tax liabilities and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns.

Whether Q&A 18 applies to your particular situation is a question that should be determined by an international tax attorney experienced in the area of voluntary disclosures. NOTE: IRS OVDI & OVDP Programs are closed. If your attorney determines that this OVDP provision is applicable in your situation, the attorney should file delinquent information returns with the appropriate service center according to the instructions for the form and attach a statement explaining why the information returns are filed late. Note that the Form 5471 should be submitted with an amended return showing no change to income or tax liability. The attorney should further include at the top of the first page of each information return “OVDI – FAQ #18” to indicate that the returns are being submitted under this procedure.

Amended Return Shows Additional Income Unrelated to Form 5471

An interesting question arises in situations where amended tax returns do show additional income, but the income is not in any way related to Form 5471. While your attorney should carefully review the nature and source of the income, it is possible that Q&A 18 will still apply assuming all other requirement of Q&A 18 are met.

Contact Sherayzen Law Office for Voluntary Disclosure Help with Tax Information Returns

It must be remembered that this article is produced for educational purposes only and does not constitute legal advice; only your tax attorney can determine whether Q&A 18 applies to your situation and how to best comply with its requirements.

Note: The OVDP has been discontinued. If you have undisclosed foreign business entities or foreign trusts, contact Sherayzen Law Office for help. Our experienced international tax team will thoroughly review your case, assess your information tax return (Form 5471, 8865, 3520, et cetera) liability, identify the available voluntary disclosure options and implement the agreed-upon strategy (including preparation of all legal and tax documents).

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.