Who files Form 5471?
Any U.S. citizen, U.S. resident alien, corporation, partnership, trust, or estate who has at least 10% ownership in a foreign corporation, will likely be required to file Form 5471. The tax code explains that any “U.S. person” who meets certain requirements relating to ownership or control of the foreign corporation would need to file. Actual rules for who is a U.S. person and how to calculate the 10% ownership gets very complex and this article is an oversimplified summary. Get the right tax advice before taking action and note our disclaimer at the bottom.
What is the Purpose of Form 5471?
Form 5471 “Information Return of U.S. Persons With Respect to Certain Foreign Corporations” is relevant to a US person who has an ownership stake in a foreign corporation. This ownership stake is either in the form of ownership of the number of shares of the entity, or ownership with respect to the overall value of the entity if no shares are issued. The form is an information return which reports the tax and financial profile of the entity, and it is attached to the US individual’s Form 1040 or a US entity’s business, trust or estate return. It is also relevant to the extent that the US person may be an officer or director of the foreign corporation.
Filing Categories of Form 5471
In order to complete the form correctly, the US person needs to determine what is his proper category filer. There are five possible categories to the Form 5471, in which the US person may satisfy at least one. The following conditions will determine if there is a need to file the form and the proper category the filer must check upon filing the form:
- Category 1: The US person has paid or is liable to pay the Section 965 tax.
- Category 2: A U.S. person becomes a director or officer of a foreign corporation in which he acquires minimum 10% ownership.
- Category 3: A U.S. person acquires an interest in a foreign corporation that exceeds the minimum 10% threshold, or he sells shares in a foreign corporation that reduces his interest in the foreign corporation to less than the 10% thresholds.
- Category 4: A U.S. person who has over 50% ownership over a foreign corporation for an uninterrupted period of at least 30 days per year.
- Category 5: A U.S. person is a shareholder of a minimum 10% in a foreign corporation that is a CFC (controlled foreign corporation) for an uninterrupted period of at least 30 days in a year and that person is the owner of those shares on the last day of the year. A CFC is a foreign corporation in which it is over 50% owned by US persons, with each person owning at least 10%.
Types of Taxable Income from a Foreign Corporation
The US owner of a foreign corporation must include the taxable income of the entity in their own income tax returns. Generally, a US shareholder will only include dividend, or deemed dividend, income from the CFC. However, the amount and type of income from the entity is not all the same and not taxed at the same rate. The below are the types of income that needs to be recognized by the US person:
- Dividend Income – to the extent the foreign corporation makes an actual distribution of cash to the US person, the US person needs to include this as a dividend in his 1040 or business entity return. This dividend will be taxed at ordinary rates and reported on the Form 1040 Schedule B, similar to all other dividend income.
- Subpart F Income – there are different subcategories of Subpart F, but the most prevalent type is passive income, e.g. Interest, dividends, rents, annuities, etc. To the extent the foreign corporation receives Subpart F income, this income will be recognized by the US person owner, regardless of whether or not there is an actual distribution. Usually, income from a CFC is deferred unless there is a distribution. Subpart eliminates deferral and renders all passive income from a CFC taxable to the US shareholder in the year it is earned.
- Loans to shareholders – to the extent that the foreign corporation provides a loan to the US shareholder, the shareholder will have to report the amount of the loan in his return as a deemed distribution. As such, this entire loan will be reported and taxed to the US shareholder as though it is a dividend. This is regardless of whether or not the loan is paid back or any interest is charged.
- GILTI inclusion – this is a new tax which is part of the Tax Cuts and Jobs Act passed at the end of 2017. It is a tax which must be paid each year by the US shareholder of a CFC. Generally, the way the tax works is that to the extent that the earnings of the CFC are more than 10% of the CFC’s tangible business assets, such earnings will be recognized by the US shareholder. Should the individual taxpayer make a Section 962 election, the GILTI inclusion can be taxed at a reduced rate, however, there may be double tax in future year. This GILTI tax basically is another layer of tax imposed on owners of the CFC in that it further prevents deferral of some of the earnings of the CFC. To the extent the CFC carries a lot of intangible assets i.e. intellectual property on its balance sheet, the GILTI inclusion will generally be higher.
Form 5471 – The Most Notable Schedules
The 5471 has numerous schedules, from Schedule A to Schedule P. Which schedule the taxpayer needs to complete depends on the category of filer. Category 4 and Category 5 filers need to complete the most number of schedules. Each schedule has a different purpose. Some schedules require more data input than others. Schedule C is just an inclusion of the income statement, so it is relatively simple. Other schedules, such as schedule J, require more input and specialization. Generally, the most notable schedules are the following:
- Schedule H – this separate schedule reports the current year earnings and profits. This schedule summarizes the current year income for the entity, which is not necessarily the same as current year income as reported on the income statement. Current year earnings and profits are determined based on tax law, regardless of the accounting treatment on the financial statements.
- Schedule I – this is the summary of the taxable income to be included on the US shareholder’s own return. Basically, any income reported in this schedule will be recognized by the US shareholder.
- Schedule J – this is a summary of all current and prior year earnings and profits, divided into different categories of income, as well as any distributions of dividends made. For example, any Subpart F income or loans to shareholders, is separately stated into their own category columns on this schedule.
Significant Additions and Changes to the Form 5471
- Schedule E: All foreign taxes paid or accrued are now separated into their respective category of income to which the taxes apply. For example, GILTI income (951A) will have its own category, separate from General Category income. The prior version Schedule E lumps all income together for the purpose of reporting foreign taxes paid.
- Schedule I-1: Information for Global Intangible Low Taxed Income (GILTI) – this is used specifically to report the new GILTI inclusion tax. This inclusion does not include such income as Subpart F, income from US sources, and high taxed income.
- Schedule P : Previously Taxed Earnings and Profits of a US Shareholder of Certain Foreign Corporations – this is an expanded continuation of Schedule J to include only the income from the entity that was already reported and taxed in the past.
The IRS explains the penalty for failing to file the Form 5471 is $10,000 USD for each foreign corporation the information return is filed late. This penalty may be increased by $10,000 USD if the return is still not filed after the IRS has mailed a notice to the taxpayer.
The above is for general and informational purposes only and should not be used as legal or other tax advice. Please consult your own professional CPA or lawyer for clarification.