Editor: Valrie Chambers, CPA, Ph.D.
The Internal Revenue Code imposes penalties for the failure to timely file international information returns on Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations; Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business; and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.
The purpose of this item is to highlight penalty abatement options, or avenues to mitigate penalty exposure, for untimely filed Forms 5471, 5472, and 8865. As recent years have seen changes to these penalties, including an increase in the penalty amount for Form 5472 and updated Internal Revenue Manual (IRM) language on penalty abatement, taxpayers and practitioners alike must be diligent in their knowledge of procedures for the assessment and abatement of these penalties.
International information return reporting requirements and penalties
Sec. 6038 requires every U.S. person to furnish, for any foreign business entity that person controls, the information listed in Sec. 6038(a)(1). The information is reported on Form 5471 or Form 8865, as applicable. 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. Sec. 6038C provides for additional information about foreign corporations engaged in U.S. business to be reported on Form 5472, and Sec. 6038B provides for additional information regarding certain transfers to foreign persons to be reported on Form 8865.
Note that other forms relating to international reporting, such as Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, and FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), are beyond the scope of this discussion.
Failure to timely file a Form 5471 or Form 8865 is generally subject to a $10,000 penalty per information return, plus an additional $10,000 for each month the failure continues, beginning 90 days after the IRS notifies the taxpayer of the failure, up to a maximum of $60,000 per return. Where a Form 8865 fails to properly report a transfer or contribution of property, the applicable penalty is 10% of the value of the transferred or contributed property not reported, up to a maximum of $100,000 (unless the failure is due to intentional disregard). A failure to timely file a Form 5472 is subject to a $25,000 penalty per information return, plus an additional $25,000 for each month the failure continues, beginning 90 days after the IRS notifies the taxpayer of the failure, with no maximum penalty.
As an important aside, failure to timely file a Form 5471, 5472, or 8865 also generally implicates Sec. 6501(c)(8). This section provides that the period of limitation on assessment does not begin to run until the information required to be reported under Secs. 6038, 6038A, and 6038B (among others) is furnished to the IRS, after which date a three-year assessment period begins; accordingly, where an international information return is not timely filed, Sec. 6501(c)(8) will keep open the assessment statute for any tax return, event, or period to which the information return relates. However, if the failure to timely file is due to reasonable cause and not willful neglect, the period of limitation on assessment is extended only for the item or items related to the failure.
Where a penalty for failure to timely file an international information return either has been assessed by the IRS, or may be assessed, several potential avenues for penalty relief should be considered.
Timely filing: As an initial matter, proof of timely filing renders any of the failure-to-file penalties discussed herein inapplicable. Where a penalty has been assessed by the IRS, it is often worthwhile to verify whether the relevant information return was in fact timely and correctly filed, and whether there is simply a mismatch between taxpayer and IRS records — for example, where a Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns, was timely filed by the taxpayer but is not reflected on the IRS Master File. In this case, the IRS should be notified that IRS records need to be updated to reflect timely filing, such as by correctly recording a Form 7004 to the account.
First-time penalty abatement: The IRS's First Time Abate (FTA) policy provides an additional avenue for penalty relief. Under the FTA policy, the IRS will generally abate certain penalties for a limited universe of forms if the following FTA criteria are met:
- The taxpayer has not been required to file the same return, or no tax modules for the same return are delinquent, for the three years preceding the penalized tax period;
- If required to file the same return during the preceding three years, there are no unreversed penalties (except an estimated tax penalty) or penalties manually suppressed or reversed using FTA or tolerance criteria;
- The taxpayer has filed, or filed a valid extension for, all required returns currently due; and
- The taxpayer has paid, or arranged to pay, any tax currently due (see IRM §126.96.36.199.3.2.1 (10/19/20), First Time Abate (FTA)).
As a general matter, FTA does not apply to event-based filing requirements, such as Form 5471 or Form 5472. However, the IRM provides that FTA applies to Forms 5471 and 5472 for which late-filing penalties have been systematically assessed, provided the additional following criteria are met:
- The failure-to-file penalty on the related Form 1120, U.S. Corporation Income Tax Return, or Form 1065, U.S. Return of Partnership Income, filing is abated under the FTA provisions (or would have been eligible for FTA, but a failure-to-file penalty was not assessed because there was $0 tax due or it was a fully paid return);
- The taxpayer had no similar penalties in the three prior periods; and
- The related Form 1120 or Form 1065 was not filed late in the three prior periods (see IRM §188.8.131.52.5 (1/29/21), Reasonable Cause, ¶3, and IRM §184.108.40.206.5 (1/29/21), Reasonable Cause, ¶3).
Delinquent International Information Return Submission Procedures: The IRS's Delinquent International Information Return Submission Procedures offer taxpayers a path for mitigating exposure to international information return penalties, in cases where taxpayers (1) have identified the need to file delinquent international information returns; (2) are not under an IRS civil examination or criminal investigation; and (3) have not already been contacted by the IRS about the delinquent information returns. In these cases, a taxpayer may file the delinquent information return(s) through amended return filing procedures (for example, attached to Form 1120X, Amended U.S. Corporation Income Tax Return) and attach a reasonable-cause statement to each delinquent information return filed for which reasonable cause is being asserted. In those cases, the IRS states that during processing of the delinquent information return:
[P]enalties may be assessed in accordance with existing procedures.. . . penalties may be assessed without considering the attached reasonable cause statement. It may be necessary for taxpayers to respond to specific correspondence and submit or resubmit reasonable cause information.
Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns. Note that the use of "information returns filed with amended returns" indicates that these procedures are available to a taxpayer who filed a timely original income tax return but now needs to file an amended income tax return to include an original international information return.
Streamlined Filing Compliance Procedures: The IRS's Streamlined Filing Compliance Procedures are available to taxpayers who are able to certify that their failure to report foreign financial assets and pay all tax due on those assets did not result from willful conduct on their part. The procedures are designed to provide taxpayers in such situations with a "streamlined" process for filing amended or delinquent returns as well as terms for resolving their tax and penalty obligations; the procedures, therefore, encompass the ability for a taxpayer to late-file Form 5471, Form 5472, or Form 8865. The streamlined procedures are available only to individual taxpayers (including estates) and are not available if the taxpayer is under civil or criminal examination. There are two distinct sets of procedures, one for U.S. residents (Streamlined Domestic Offshore Procedures) and one for non-U.S. residents (Streamlined Foreign Offshore Procedures). The notable distinction between the domestic procedures and the foreign procedures is that taxpayers eligible under the domestic procedures are subject to a Title 26 miscellaneous offshore penalty, while those eligible under the foreign procedures are not subject to a penalty.
Note that the streamlined procedures are separate from the Offshore Voluntary Disclosure Program (OVDP), which closed on Sept. 28, 2018. Further, they are distinct from the IRS Criminal Investigation Voluntary Disclosure Practice (see IRM §220.127.116.11 (9/17/20), Voluntary Disclosure Practice).
Reasonable cause: The penalty provisions in Secs. 6038, 6038A, 6038B, and 6038C provide that if a failure is due to reasonable cause and not to willful neglect, the penalty will not be imposed. If none of the other abatement or mitigation avenues discussed above are available, a taxpayer may assert reasonable cause to counter penalties assessed on a late-filed Form 5471, 5472, or 8865. The reasonable-cause determination is made on a case-by-case basis, taking into account all pertinent facts and circumstances (see Regs. Sec. 1.6038A-4(b)(2)(iii); see also Regs. Secs. 1.6038-2(k)(3)(ii) and 1.6038-3(k)(4)). The IRM states that reasonable-cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but was nevertheless unable to comply with those obligations (IRM §18.104.22.168.2 (11/21/17), Reasonable Cause, ¶1).
In her 2020 Annual Report to Congress, the national taxpayer advocate identified systemic assessments of international penalties under Secs. 6038 and 6038A as eighth on a list of the 10 "Most Serious Problems" facing taxpayers. Additionally, the COVID-19 pandemic has resulted in longer-than-average processing and review times for penalty abatement requests, emphasizing the importance of taxpayers' determining the appropriate avenue to seek penalty relief. A considered approach to seeking penalty relief for the international information return penalties described in this item continues to be exceedingly important in representing taxpayers before the IRS.
Contributors Valrie Chambers, CPA, Ph.D., is an associate professor of accounting at Stetson University in Celebration, Fla. Mark A. Bond, J.D., LL.M., is a senior manager; Keith M. Jones is a managing director; and Mary I. Slonina, J.D., is a director, all with PwC in Washington, D.C. Mr. Jones is a member of the AICPA Tax Practice & Procedures Committee. For more information on this article, contact email@example.com.
Valrie Chambers, CPA, Ph.D., is an associate professor of accounting at Stetson University in Celebration, Fla. Mark A. Bond, J.D., LL.M., is a senior manager; Keith M. Jones is a managing director; and Mary I. Slonina, J.D., is a director, all with PwC in Washington, D.C. Mr. Jones is a member of the AICPA Tax Practice & Procedures Committee. For more information on this article, contact firstname.lastname@example.org.