Foreign Income & Taxpayers
Sec. 6038 requires every U.S. person to furnish, with respect to any foreign business entity that such person controls, the information listed in Sec. 6038(a)(1). That information is reported on Form 5471, Information Return With Respect to Certain Foreign Corporations, and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. Sec. 6038A requires any domestic corporation that is 25% foreign-owned to furnish the information listed in Sec. 6038A(b)(1). That information is 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.
Penalties apply for failure to report the information required under Secs. 6038 and 6038A by failing to timely file Form 5471, 5472, or 8865.
If a taxpayer fails to timely file Form 5471 or 8865, the IRS may assert a $10,000 penalty for each failure for each applicable annual accounting period, plus an additional $10,000 for each month the failure continues, beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $60,000 per return (initial penalty of $10,000 plus the continuation penalty maximum of $50,000 per return) (Sec. 6038(b)). If a taxpayer fails to timely file Form 5472, the IRS may assert a $10,000 penalty for each failure for each applicable tax year, plus an additional $10,000 for each month the failure continues, beginning 90 days after the taxpayer is notified of the delinquency. The statute does not provide a maximum penalty with respect to Form 5472 (Sec. 6038A(d)).
Note: A single failure to timely report Sec. 6038 or Sec. 6038A information causes a taxpayer's entire related federal income tax return to remain open for assessment indefinitely until the required information is provided to the IRS (Sec. 6501(c)(8)). A taxpayer can limit the extended assessment period to items that relate to the unreported Secs. 6038 and 6038A information if the taxpayer demonstrates that the reporting failure was due to reasonable cause.
Penalty Abatement vs. "Delinquent" Procedures
There are two procedural paths for a taxpayer that files a late Form 5471, 5472, or 8865. Which path may be available depends on whether the taxpayer (1) files the delinquent forms with an original, but untimely, federal income tax return or (2) files the delinquent forms with an amended income tax return and the original income tax return was timely filed.
1. Filing international information returns with an original, but untimely, federal income tax return: Forms 5471, 5472, and 8865 are to be filed with the taxpayer's federal income tax return on or before the due date of the return, including extensions (Regs. Secs. 1.6038-2(i), 1.6038A-2(d), and 1.6038-3(i), respectively). The Internal Revenue Manual (IRM) provides that if the taxpayer files Form 5471 or 5472 with an original, but untimely, federal income tax return, the IRS will systematically assess a $10,000 penalty per form upon receipt of the late Form 1120, U.S. Corporation Income Tax Return, or Form 1065, U.S. Return of Partnership Income (IRM §§220.127.116.11.2 and 18.104.22.168.2). While the IRM currently does not contain a systematic assessment procedure for a late Form 8865, the IRS has statutory authority to assess a penalty. Once the IRS has assessed penalties, the taxpayer may ask it to abate the penalties under two possible options:
- First-time abatement (FTA): Generally, an FTA can provide penalty relief if the taxpayer has not previously been required to file a return or has no prior penalties (except the estimated tax penalty) for the preceding three years with respect to the same IRS Master File module (IRM §22.214.171.124.6.1). With respect to a Form 5471 late-filing penalty, the IRM provides for an FTA if an FTA was applied to the taxpayer's related Form 1120 or Form 1065 late-filing penalty (IRM §126.96.36.199.2(3)). With respect to a Form 5472 late-filing penalty, the IRM provides for an FTA if an FTA was applied to the taxpayer's related Form 1120 late-filing penalty or no penalty was assessed on the related Form 1120 (IRM §188.8.131.52.2). The IRM is silent on applying an FTA to a Form 8865 late-filing penalty.
- Reasonable cause: Secs. 6038 and 6038A each provide a reasonable-cause basis for penalty relief (Regs. Secs. 1.6038-2(k)(3), 1.6038-3(k)(4), and 1.6038A-4(b)). A taxpayer may qualify for penalty relief based on reasonable cause if the IRS determines that the taxpayer exercised ordinary business care and prudence in determining its tax obligations but was nevertheless unable to timely file the return to which the Form 5471, 5472, or 8865 was attached.
2. Filing international information returns with an amended federal income tax return (timely original return filed): As of July 1, 2014, taxpayers that have failed to file a Form 5471, 5472, or 8865 may file it under the IRS's Delinquent International Information Return Submission Procedures. The procedures allow taxpayers to avoid penalties under Secs. 6038 and 6038A if the taxpayer timely filed its original income tax return but omitted the required international information forms.
The procedures are available for taxpayers that (1) have not filed one or more required international information returns, (2) have reasonable cause for not timely filing the information returns, (3) are not under a civil examination or a criminal investigation by the IRS, and (4) have not already been contacted by the IRS about the delinquent information returns. Taxpayers who have unreported income or unpaid tax are not precluded from filing delinquent international information returns.
Taxpayers that meet the requirements should file the delinquent information returns with an amended income tax return and attach a statement of all facts establishing reasonable cause for the failure to timely file the international information returns. As part of that statement, taxpayers must certify that any entity for which the information returns are being filed was not engaged in tax evasion. The reasonable-cause statement must be signed under penalties of perjury.
If a taxpayer does not attach a reasonable-cause statement to each delinquent information return filed, penalties may be assessed in accordance with existing procedures. The IRS also may impose penalties if it does not accept the taxpayer's explanation of reasonable cause.
If a taxpayer meets the requirements for and follows these procedures, the IRS presumably will not automatically assess penalties under Secs. 6038 and 6038A for the late filing of Forms 5471, 5472, and 8865.
Taxpayers should be aware of the procedures that apply to late filing of Forms 5471, 5472, or 8865. Whether the taxpayer files the form with a late income tax return or with an amended income tax return (original return timely filed) will determine whether the taxpayer faces assessment of penalties under Sec. 6038 or Sec. 6038A and needs to seek penalty abatement relief, or whether the taxpayer may seek to avoid penalties through submission of the untimely forms under the Delinquent International Information Return Submission Procedures with an amended income tax return.
Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington.
For additional information about these items, contact Ms. Smith at 202-414-1048 202-414-1048 or email@example.com.
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.