Is your company a foreign-owned U.S. subsidiary or a foreign company doing business in the U.S.?
Are you a foreign individual living and working in the U.S.?
Is your U.S. company paying interest, dividends, or royalties to a foreign party?
If the answer is “yes” to any of these questions, making sure all the Internal Revenue Service (IRS) reporting requirements applicable to your circumstance are filed is critical to avoid penalties and to take full advantage of tax treaty benefits.
The IRS continues to increase scrutiny of the reporting requirements applicable to foreign persons and U.S. companies with foreign transactions. It is important to fully understand these U.S. obligations because failure to report income, activities, and investments can lead to extensive penalties. Here is an overview of these common U.S. reporting requirements including tax reform changes from the Tax Cuts and Jobs Act (TCJA) passed in December 2017.
U.S. Reporting Requirements
Form 5472: Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business
Form 5472 is a high exposure reporting requirement and can be considered the IRS’s road map to understanding global transactions between domestic and foreign-related parties. Many of the transactions reported on Form 5472 require other reporting or U.S. tax withholding with applicable penalties for noncompliance. TCJA increased the penalty for failure to file a Form 5472 when due and in the manner prescribed to $25,000, a significant increase over the pre-tax reform penalty of $10,000.
Form 5472 is required to be filed by a reporting corporation if it had a reportable transaction with a foreign or domestic related party. A reporting corporation can be either a U.S. corporation with 25 percent direct or indirect foreign ownership or a foreign corporation engaged in a trade or business within the U.S. A foreign-owned U.S. disregarded entity such as domestic single-member limited liability company (SMLLC) is also considered a reporting corporation.
Reportable transactions include loans, sales of goods and services, commissions, rent, royalties, interest and other amounts paid or received between foreign and domestic related parties. Form 5472 is included in the taxpayer’s U.S. corporate income tax return with separate 5472’s required for each related party with which the taxpayer had reportable transactions. Additional disclosures are now required for the foreign-owned U.S. disregarded entities.
Form 5472 requirements are impacted from the addition of Internal Revenue Code (IRC) Section 59A, the Tax on Base Erosion Payments of Taxpayers with Substantial Gross Receipts. This new tax law imposes a base erosion minimum tax on certain taxpayers, primarily affecting large corporations that make deductible payments, such as interest, royalties and service payments to foreign related parties. Form 5472 includes a new section to report amounts computed under Section 59A.
Form 5472 requirements have also been expanded by tax reform to include the reporting of the following:
- Deductions for the eligible percentage of foreign-derived intangible income (FDII) and global intangible low-tax income (GITI) (IRC Section 250)
- Disallowed interest or royalties paid to a related party (IRC Section 267A)
W-8BEN and W-8BEN-E: Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals and Entities)
U.S. tax withholding is required on fixed or determinable, annual or periodical (FDAP) payments, such as interest, dividends, rents, royalties, and other similar payments to foreign parties, individuals or entities. The U.S. tax withholding rate is 30 percent; however, U.S. income tax treaties with certain countries can reduce or eliminate the withholding requirement.
In advance of making FDAP payments to a foreign party, a U.S. entity is required to obtain documentation, generally, a Form W-8BEN or W-8BEN-E, to support a payee’s tax status and treaty benefit claims in order to determine the U.S. tax withholding requirement. It is a best practice for U.S. companies to request a W-8 from every foreign party to which it makes any type of payment, not just FDAP payments.
With the increased enforcement of the Foreign Account Tax Compliance Act (FATCA) rules, a non-resident alien individual or foreign entity should anticipate the request to provide a Form W-8BEN or W-8BEN-E when conducting any type of business with a U.S. entity. A U.S. Taxpayer Identification Number (TIN) or foreign TIN may be required.
Form 1042: Annual Withholding Tax Return for U.S. Source Income of Foreign Person
Form 1042 is used to report payments of FDAP income such as interest, dividend, rent, and royalty to foreign individuals or entities. This form is required even if the rate of U.S. tax withholding is reduced to zero under the terms of the applicable U.S. income tax treaty. Form 1042 is required to be filed by March 15 following the calendar year in which the payment is made, and Form 1042-S must be provided to the recipient of the income.
For partnership tax years beginning on or after January 1, 2018, under the new centralized partnership audit regime a partnership may be required to withhold U.S. tax on adjustments allocable to a foreign person. A partnership would report U.S. tax withholding on Form 1042.
Form 8990: Limitation on Business Interest Expense Under IRC Section 163(j)
The TCJA amended Section 163(j) to include a limitation on the deduction for business interest expense for certain taxpayers. Accordingly, the previous disqualified corporate interest expense rules of Section 163(j) were repealed for tax years beginning after 2017, making Form 8926 obsolete. Form 8990, Limitations on Business Interest Expense under IRC Section 163(j) is now used to calculate the amount of business interest expense a taxpayer can deduct and carry forward to next year. The new rules limit the business interest expense allowed in a tax year to the sum of business interest income, 30% of the taxpayer’s adjusted taxable income and floor plan financing interest expense. There are exceptions to the limitation for small businesses with average annual gross receipts below $25 million; however, when computing the gross receipts, all members of controlled groups are considered in aggregate. Form 1120-F is due by the 15th day of the third month or sixth month after the end of the foreign corporation’s tax year, depending on whether the foreign corporation has an office or place of business in the U.S.
1120-F: U.S. Income Tax Return of a Foreign Corporation
Form 1120-F is used to report income, gains, losses, deductions, credits, and to calculate the U.S. income tax liability of a foreign corporation. It is also used to claim any refund that is due, to file a treaty-based position on Form 8833 or to calculate and pay branch profits tax liability. Form 1120-F is due by the 15th day of the third month or sixth month after the end of the foreign corporation’s tax year, depending on whether the foreign corporation has an office or place of business in the U.S.
As with domestic corporations, tax reform impacts foreign corporation filing a U.S. income tax return. The significant changes include a reduction in the corporate tax rate to a flat 21%, repeal of the alternative minimum tax and domestic production activities deduction, application of the base erosion minimum tax, expanded eligibility of use of cash basis method for small taxpayers, the business interest expense limitations and changes to application of net operating losses.
1040NR: U.S. Non-resident Alien Income Tax Return
All non-resident alien individuals are required to file Form 1040NR if they are engaged in trade or business within the U.S., if they have U.S. source income or if they are claiming a treaty-based position. Form 1040NR is due on April 15 for the previous calendar year-end. If the nonresident alien did not receive wages as an employee subject to U.S. income tax withholding, Form 1040NR is due on June 15 for the previous calendar year.
Tax reform changes impact individuals filing a Form 1040NR. The significant changes include a tax rate reduction, suspension of the personal exemption, limitations on state tax deductions, and a new credit for other dependents.
Form 8938: Statement of Specified Foreign Financial Assets
Specified individuals, including U.S. resident aliens, are required to file Form 8938 if they have an interest in specified foreign financial assets and the value of those assets is more than the applicable reporting threshold. Financial accounts maintained by a foreign financial institution, stock and securities not issued by a U.S. person and interests in a foreign entity are examples of specified foreign financial assets. Form 8938 is included with the taxpayer’s individual income tax return.
The filing requirements of Form 8938 also applies to specified domestic entities including closely-held domestic corporations and partnerships with at least 50 percent of gross income from passive income or of assets held to produce passive income as well as domestic trusts with one or more specified person as a beneficiary.
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This overview includes the most common forms encountered by foreign and U.S. parties with global transactions. There are many other forms that could also apply. When coming to the U.S., we recommend speaking to a U.S. tax advisor to assist with meeting reporting obligations in order to avoid penalties and to take advantage of treaty benefits. To learn more, contact Clayton & McKervey.