Late last year, the U.S. Treasury imposed new information reporting obligations on certain foreign-owned U.S. “disregarded” entities — that is, certain U.S. entities that are wholly owned by one non-U.S. person so they are essentially ignored for U.S. federal income tax reporting and payment purposes (“reportable disregarded entities”). A U.S. limited liability company organized in Delaware or elsewhere and directly or indirectly owned by one non-U.S. person is the prototypical example of a reportable disregarded entity captured by these new information reporting requirements.
The new rules apply for tax years beginning on or after Jan. 1, 2017, and ending on or after Dec. 13, 2017. This means the new reporting requirements will begin in early 2018.
Notably, only reportable disregarded entities that have engaged in a “reportable transaction” with a “related party” during the tax year are subject to the new reporting requirements. That said, the concept of “reportable transactions” for reportable disregarded entities is extremely broad and includes exchanges of money or property between the entity and its foreign member, and includes any amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the entity.
It is imperative that non-U.S. families and trustees with responsibility over U.S. structures work now to identify any reportable disregarded entities (e.g., Delaware LLCs) that may be captured by the new information reporting rules. Although reporting will not be required until early 2018, preparation for these new rules is important, as the noncompliance penalties can be substantial.
Under the new rules, these entities will be reported on Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business) filed with the Internal Revenue Service. Draft instructions to Form 5472 released in September 2017 indicate that a reportable disregarded entity must file Form 5472 along with a U.S. Corporation Income Tax Return (Form 1120). The sole purpose of the Form 1120 is to provide a mechanism to file Form 5472 with the IRS. In general, the only information required on Form 1120 for the reportable disregarded entity is its name, address and U.S. tax ID number. Additionally, the draft instructions provide that the phrase “Foreign-owned U.S. DE” must be written across the top of the Form 1120.
Penalties for failure to timely file a required Form 5472 are substantial. The initial penalty is $10,000, with an additional $10,000 penalty imposed if the IRS notifies the taxpayer of such failure and the taxpayer does not comply with the Form 5472 filing requirements within 90 days of notification. Additional $10,000 penalties are imposed for each 30-day period of noncompliance beyond that initial 90-day grace period. Note that an incomplete or inaccurate Form 5472 will be considered an untimely filing and, as such, subject to these penalties.
Importantly, each reportable disregarded entity will need to obtain a U.S. Employer Identification Number (EIN) as a prerequisite to reporting. In most cases, a reportable disregarded entity will not have had a need for an EIN prior to these new rules and therefore will have to obtain an EIN quickly to comply with the new information reporting requirements. To obtain an EIN, reportable disregarded entities must file Form SS-4, which requires the entity to list a “responsible party” and that responsible party’s social security number (SSN), individual taxpayer identification number (ITIN) or EIN. A “responsible party” for a reportable disregarded entity is an individual or entity that controls, manages, or directs the entity and the disposition of its funds and assets (generally, the entity’s principal officer, general partner, grantor, owner or trustor).
In many cases, a reportable disregarded entity will encounter problems obtaining an EIN because the chosen responsible party does not have an SSN, ITIN or EIN. That is because many such responsible parties constitute non-U.S. individuals or non-U.S. entities, which themselves lack U.S. taxpayer identification numbers. Reportable disregarded entities should identify whether this is an issue and immediately take steps to either obtain a U.S. taxpayer identification number for the responsible party or explore other alternatives. Any failure to address these issues now could prevent a reportable disregarded entity from timely complying with the new information reporting requirements — exposing the entity to potential penalties of $10,000 or more.
Please contact Matthew Sperry, Nicholas Heuer or any other member of the McGuireWoods global private client team to learn more about the new reporting requirements or for assistance complying with them.