Until recently, disregarded entities (DREs) were typically not required to obtain an employer identification number (EIN) and generally did not have federal tax filing requirements. As long as the DRE or its foreign owner did not receive U.S.-source income, federal income tax returns were not necessary, unlike the situation for corporations, partnerships and foreign corporations engaged in U.S. trade or business, which must file annual tax returns and, in certain cases, Form 5472.
Final Regulations (TD 9796), applicable to tax years beginning on or after January 1, 2017, changes all that and imposes new filing requirements on DREs. Under TD 9796, domestic disregarded entities wholly owned, directly or indirectly, by foreign persons are now treated as domestic corporations solely for purposes of making them subject to the reporting requirements that apply to 25% foreign-owned domestic corporations 1. Essentially, DREs are now treated as separate from their owners for purposes of reporting, record maintenance and associated compliance. A foreign person is deemed to wholly own a domestic disregarded entity if that person has direct or indirect sole ownership of the entity.
For taxable years beginning in 2017, then, foreign-owned domestic disregarded entities must maintain a set of adequate financial records, obtain from the Internal Revenue Service (IRS) an EIN, and file both a U.S. corporate income tax return and Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation). Further, the new regulations expand the scope of reportable transactions that give rise to a Form 5472 filing requirement which include sale, assignment, lease, license, loan, advance, contribution or other transfer of any interest.
Final Regulations are designed to improve financial transparency and enhance sharing of information with partner authorities. The new rules could potentially lead to a time consuming and burdensome tax preparation process for foreign-owned DREs, and result in penalties for failure to file 5472 and/or maintain adequate records.
On the other hand, there are some planning opportunities. A single member LLC (which is, by default, treated as a DRE), may consider an election to be treated as a corporation for U.S. income tax purposes to take advantage of the newly established corporate income tax rate (21%). Note that this would not eliminate the tax return filing requirement or, in some instances, the requirement to file Form 5472.
Alternatively, the LLC may be liquidated and avoid a U.S. corporate tax return filing requirement going forward until the property is sold. But this option may have broader tax implications, including foreign tax consequences, depending on the entity’s ownership of other assets and entity’s U.S. activities in general.
Contact your SD service team for assistance with your filing requirements.
1 Internal Revenue Code Section 6038A