The IRS has issued proposed regs that would impose new reporting requirements on U.S. disregarded entities (DEs) solely owned by a foreign party. The IRS stated that, under current law, these DEs and their foreign owners are unknown because they do not have to obtain a tax identification number or file any tax returns with the agency.
Take away. The IRS issued the regs as part of a campaign by Treasury “to strengthen financial transparency and combat the misuse of companies to engage in illicit activities.” In a letter to House Speaker Paul Ryan, R-Wis., Treasury Secretary Jack Lew said that “gaps in our laws … allow bad actors to deliberately use U.S. companies to hide money laundering, tax evasion, and other illicit financial activities.”
Take away. The regs are proposed to apply to tax years ending on or after 12 months after final regs are published.
Lew emphasized U.S. efforts to counter money laundering, crack down on tax evasion, and fight financing of terrorist activities and weapons of mass destruction. Lew highlighted the Foreign Account Tax Compliance Act (FATCA) as a critical tool to fight tax evasion. To reciprocate with foreign governments, Treasury is sending legislation to Congress to require U.S. financial institutions to provide information about foreign ownership of their accounts, Lew said.
Lew urged the Senate to approve pending tax treaties, many of which have awaited floor consideration for five years or more. “Failure to consent to those treaties limits our ability to enforce U.S. tax laws,” Lew said.
The IRS “issued proposed rules to close a current loophole in our system that allows foreign persons to hide assets in U.S. accounts will be treated as a single,” Treasury stated. “There is a narrow class of foreign-owned U.S. entities that have no obligation to obtain a tax identification number or to report to the IRS. This loophole can be used to shield the foreign owners of non-U.S. assets or non-U.S. bank accounts.” The regs “will strengthen the IRS’s ability to prevent the use of these entities for foreign tax avoidance purposes,” Treasury stated.
In the preamble, the IRS stated that “the absence of specific return filing and associated record keeping requirements for foreign-owned, single member domestic entities hinders law enforcement efforts and … cooperation in the area of tax information exchange” under U.S. tax treaties, tax information exchange agreements and similar international agreements. It also makes it difficult for the IRS to ascertain whether the entity or its owner is liable for any federal tax, the IRS indicated.
Some business entities, such as single-member (owner) limited liability companies, may be classified as an entity “disregarded as separate from its owner.” The owner is treated as directly owning the DE’s assets and income and must report the DE’s income on the owner’s return. Some DEs are not obligated to file a return or obtain an employer identification number (EIN).
The law currently requires domestic corporations that are 25 percent foreign-owned to file an information report, Form 5472, on their ownership. The proposed regulations “would treat a domestic disregarded entity wholly owned by a foreign person as a domestic corporation separate from its owner for the limited purposes of the reporting, record maintenance and associated compliance requirements that apply to 25 percent foreign-owned domestic corporations” . The proposed regs would not alter existing rules on entity classification, including the treatment of entities as DEs.
Form 5472 requires information on “reportable transactions” between the entity and its foreign owner. Under the new regs, contributions and distributions involving the DE would be reportable, for example. The IRS may modify other information returns to require corporations, partnerships and others to identify all of their foreign and domestic DEs.
If you have any questions regarding these proposed regulations or the impact to your specific situation, please do not hesitate to contact us.