PLEASE NOTE: For new rules concerning single member foreign owned LLC’s please also read our post  New IRS Reporting Requirements Foreign-owned US LLCs.

With the passage and implementation of the Foreign Account and Tax Compliance Act (FATCA), much has been made of the US government’s attempt to crack down on its citizens’ use of accounts in so called “Tax Haven” jurisdictions.  However, many foreign governments and tax commentators have noted that, in fact, the US is one of the largest Tax Haven jurisdictions in the world.

For example, a foreign person (individual or entity) can set up a single member Limited Liability Company (LLC) in one of the 50 states (or the District of Columbia).  For US tax purposes, this single member LLC is treated as a disregarded entity, which is not subject to a separate income or information return filing requirement.  Instead, its owner is treated as owning directly the entity’s assets and liabilities, and the information available with respect to the disregarded entity depends on the owner’s own tax return filings (if any).  For a disregarded entity that is formed in the US and is owned by a foreign person, no US income or informational return is required to be filed if neither the disregarded entity nor its owner received any US source income or was engaged in a US trade or business during the taxable year.  Thus, a US single member LLC can be used by a foreign person to hold non-US assets which could generate income that does not have to be reported on a US tax return (or in any accounts for that matter, as there is usually no requirement at the state level to file accounts for such an entity).

In an effort to combat such criticism, on May 6, 2016, the US Department of Treasury issued proposed regulations to amend Treas. Reg. section 301.7701-2(c) to treat a domestic disregarded entity that is wholly owned by one foreign person as a domestic corporation separate from its owner for the limited purposes of the reporting and record maintenance requirements under Internal Revenue Code section 6038A.  Therefore, any entity subject to these changes would be required to file an annual information return (Form 5472) that not only discloses the identity of its foreign owners, but would also identify any reportable transactions between the entity and its foreign owner or other foreign related parties.  A reportable transaction is defined broadly as income from  “any sale, assignment, lease license, loan, advance, contribution, or other transfer of any interest in or a right to use any property or money, as well as the performance of any services for the benefit of, or on behalf of, another taxpayer.”  The proposed regulations specifically provide that any contributions or distributions would be considered a reportable transaction with respect to any entity subject to these changes.

Given the fact that any entity subject to these changes would have a US filing obligation, the entity would be required to obtain an Employer Identification Number (EIN) that includes responsible party information.  The entity would also be required to maintain records sufficient to establish the accuracy of the information return and the correct US tax treatment of such transactions.

Failure to file a Form 5472 (or maintain the proper supporting records as required) could result in a $10,000 civil penalty for each failure, and it should be noted that the IRS has been assessing this penalty automatically in recent years.  This penalty can increase by an additional $10,000 if the failure to report continues 90 days after notification by the IRS.  Furthermore, criminal penalties could also apply for failure to submit information or filing false or fraudulent information.

The Department of Treasury has noted “that the proposed changes are intended to provide the IRS with improved access to information that it needs to satisfy its obligations under US tax treaties, tax information exchange agreements and similar international agreements, as well as to strengthen the enforcement of US tax laws.”  Therefore, it appears that international criticism of the US in its ability and willingness to crack down on its own “offshore” structures is working.

Contact us for advice on US Corporate Tax.