The last thing any business wants to receive is an audit notice from the Internal Revenue Service (IRS). Your first reaction will naturally be panic or fear. So, what protective measures can a business or business owner put in place? An easy, but often overlooked tactic is to simply review your tax compliance activity on a regular basis. This simple step can help alleviate many of these concerns and result in a more favorable outcome should you have an IRS audit.
Don’t Overlook Form 5472
Here, we’ll discuss one of the most commonly filed forms by our inbound clients: Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business Tax. As laws continually change, it’s critical for business owners to keep up with the updates to legislation. This is a high-exposure reporting requirement and is usually used by the IRS to understand global transactions and identify transfer pricing and withholding tax issues between domestic and foreign-related parties. In 2017, tax legislation from the Tax Cuts and Jobs Act (TCJA) increased the noncompliance penalty from $10,000 per form to $25,000 per form, plus an additional $25,000 for each month the failure continues, beginning 90 days after the day which the IRS notice about the failure is mailed to the taxpayer. There is no upper limit on the penalty; it may continue to accrue until the failure is cured. A simple oversight can be costly.
Form 5472 is generally included in the taxpayer’s U.S. corporate income tax return. If a taxpayer fails to file Form 5472 or the filed form is substantially incomplete, the statute of limitations on the taxpayer’s corporate income tax return will be extended until three years after the date the completed Form 5472s are submitted to the IRS.
Who Does Form 5472 Apply to?
Form 5472 applies to any U.S. corporation with 25% or more direct or indirect foreign ownership AND with reportable transactions with a foreign or domestic related party during the tax year. The form also applies to a foreign corporation engaged in a U.S. trade or business, or to businesses including the foreign-owned U.S. disregarded entities, such as domestic single-member limited liability companies. If you are a foreign-owned US corporation and have transactions with foreign or domestic related parties, this form most likely will be applicable to you.
Form 5472 Reporting Requirement
Reportable transactions include loans, sales of goods and services, commissions, rent, royalties, interest, and other amounts paid or received between the related parties. The reporting requirement of Form 5472 has also been expanded by TCJA to include information reporting related to some newly enacted international tax rules (e.g. disallowed deductions paid in hybrid transactions or with hybrid entities under IRC 267A, foreign-derived intangible income deduction under IRC 250 and information related to Base Erosion and Anti-Abuse Tax under IRC 59A). Separate 5472 forms are required for each related party with reportable transactions.
Potential Penalty Relief
For taxpayers that might have overlooked this filing requirement previously, the IRS offers Delinquent International Information Return Submission Procedures that can provide relief to taxpayers with reasonable cause for the failure to file. To qualify for the Delinquent International Information Return Submission Procedures, a taxpayer must not be under a civil examination or a criminal investigation by the IRS and have not already been contacted by the IRS about the delinquent information returns. The delinquent information return must be attached to an amended income tax return (Form 1120X, Amended US Corporate Income Tax Return), and a reasonable-cause statement is required to be attached.
In a recent court case, Farhy v. Commissioner, 160 T.C. No. 6 (April 3, 2023), the US Tax Court held that the IRS may not automatically assess penalties for failure to file Form 5471 (Information Return of U.S. Persons with respect to Certain Foreign Corporations). However, the IRS can still assess penalties through civil action. It is also expected that the IRS will appeal this decision. While not certain, the Farhy ruling could have significant implications by extension to other information reporting penalties, such as the automatic penalty of Form 5472.
Continue the Conversation
While we’re discussing Form 5472 for inbound clients, there are many other forms that could also apply. If you are making a decision about your next CPA, or your business has expanded to require a CPA with international experience, Clayton & McKervey can help. Contact us today for additional information on international information return compliance and penalty relief.