The US Treasury Department has issued final regulations requiring foreign owners of single-member US limited liability corporations (LLCs) to report their interests to the Internal Revenue Service (IRS), starting on 1 January 2017.
Wholly-owned LLCs have until now been considered as ‘disregarded entities’ (DREs).
Transactions by DREs did not have to be reported and were treated as being undertaken by the DRE’s owner and ignored for US federal income tax purposes.
DREs as tax planning tools
DREs have become a ubiquitous tax-planning tool in the US, says Heath Martin of New York law firm Davies Ward Phillips & Vineberg. They open up various tax-planning opportunities for foreigners, for example US investment assets held through a domestic DRE are treated as owned by a US person for the purposes of the securities laws and other non-tax laws, but are treated as owned by a foreign person for US federal income tax purposes. Thus any gain realised by the foreign person on a sale of the investment assets is generally free of US federal income tax.
However, under the new regulations, LLP owners will soon be required to report transactions to the IRS on Form 5472. A foreign person who fails to file on time must pay an initial penalty of USD10,000, which is doubled after 90 days and then increases by USD10,000 for each subsequent 30-day period.
Moreover, the usual exemptions from Form 5472 reporting are not permitted for foreign-owned DREs required to file under the new regulations. There is no de minimis exemption for corporations with gross receipts or related-party transactions of less than USD10 million or USD5 million per year respectively.
‘These regulations may create major headaches for foreign investors using wholly owned US LLCs to hold investments or conduct business in the US or abroad’, says Martin. ‘At the very least, they may become a trap for the unwary for foreign persons who hold non-US investments in US DREs, and who may not have US tax compliance controls in place and may not be consulting with US tax advisers regularly.’
Drive to obtain beneficial ownership information
The new rules only create an information reporting obligation, not any new US federal income tax liabilities. They form part of the Obama administration’s drive to obtain beneficial ownership information on anonymously owned companies, so that it can be used in tax and criminal investigations either by the IRS or by foreign governments. In a related move earlier this year, new draft regulations were issued requiring foreign-owned, single-member limited liability companies to obtain an IRS employer identification number.
If you have any questions regarding the new obligations on foreign owners of single-member US LLCs to now report to the IRS, please call Paul Barbeau at (604) 688-4900 ext 11, email me, or connect with me on LinkedIn.