On May 10, 2016, the Treasury Department issued proposed regulations (the Proposed Regulations) which enable the Internal Revenue Service (IRS) to collect certain information about domestic disregarded entities with a single foreign owner. The purpose of the Proposed Regulations is to collect information to be used in the exchange of information with foreign countries under tax treaties, taxpayer information exchange agreements, and other inter-governmental agreements in order to better enforce the tax laws of the United States. The information collected under this new initiative will be used to help prevent money laundering, tax evasion, and other illicit financial activities.

Background

Under the current law a domestic disregarded entity with a single foreign owner often has no obligation to report any information to the United States government about itself or its foreign owner. The Treasury Department was concerned that these types of disregarded entities could be used surreptitiously by foreign persons in connection with illegal activities or for purposes of tax evasion. Treasury Secretary Jacob J. Lew views this issue as an example of a gap in the tax law that allows "bad actors to deliberately use U.S. companies to hide money laundering, tax evasion, and other illicit financial activities."

A disregarded entity is a term used to describe a company with a single owner that is not regarded as a separate entity from its owner for United States federal tax purposes. In other words, a disregarded entity is generally nonexistent from a substantive U.S. federal tax perspective. For example, a single-member limited liability company formed under the law of Florida is classified by default as a disregarded entity.

Partly in response to international pressure, one of the Treasury Department's recent priorities has shifted to the creation of a more transparent tax and financial system in the United States. It views greater transparency in tax administration as necessary to strengthen its ability to counter money laundering, tax evasion, and other illicit activities. With this objective, the Treasury Department issued the Proposed Regulations which enable the IRS to collect certain information about domestic disregarded entities with a single foreign owner. The United States intends to exchange this information with foreign countries under tax treaties, taxpayer information exchange agreements and other inter-governmental agreements, and also use it to better enforce the tax laws of the United States.

At present, § 6038A of the Internal Revenue Code (the Code) requires a domestic corporation which is at least twenty-five percent (25%) foreign-owned to furnish certain information to the IRS with regard to reportable transactions. The regulations extend this obligation to a foreign corporation that is twenty-five percent (25%) foreign-owned and engaged in trade or business within the United States. The reportable information includes the name, principal place of business, nature of business, and country of organization or residency of each foreign person which is a related party with respect to the corporation and had a reportable transaction with the corporation during its taxable year. Information about reportable transactions must also be included in the report to the IRS. A related party includes a shareholder who owns twenty-five percent (25%) or more of the voting power or value of the corporation. Reportable transactions include transactions between the corporation and its twenty-five percent (25%) foreign shareholder such as sales of certain types of property, payments of commissions and loans.

The information required to be reported under § 6038A of the Code must be furnished to the IRS annually on Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business (Under Sections 6038A and 6038C of the Internal Revenue Code). The corporation is also required to maintain books and records that are sufficient to establish the accuracy of the information. A monetary penalty of $10,000 may be assessed on any corporation that fails to file Form 5472 when due or that fails to maintain the required books and records. Criminal penalties may also apply for failure to submit the required information or for filing false or fraudulent information.

Proposed Regulations

The Proposed Regulations extend the information reporting obligations under § 6038A of the Code to domestic disregarded entities with a single foreign owner by treating such entities as domestic corporations for this limited purpose. The Proposed Regulations also expand the category of reportable transactions that apply to these domestic disregarded entities to include "any sale, assignment, lease, license, loan, advance, contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented." Thus, a foreign person's contributions to, and distributions from, a domestic disregarded entity are reportable transactions. Under the Proposed Regulations, a domestic disregarded entity with a single foreign owner that has a reportable transaction would be required to apply for and obtain an Employer Identification Number (EIN) for purposes of satisfying its reporting obligations on Form 5472.

By requiring domestic disregarded entities to obtain an EIN and file Form 5472, the Treasury Department wants to deter abuses from the use of these types of entities and collect more information about the owners and related transactions which it can use for law enforcement purposes.

The Proposed Regulations would provide that the exceptions from the record maintenance requirements for small corporations and de minimis transactions will not apply to affected entities.

The Proposed Regulations would also amend Treas. Regs. Sec. 301.7701-2(c) (part of the check-the-box regulations) to treat a domestic disregarded entity that is wholly owned by one foreign person as a domestic corporation that is separate from its owner for purposes of the Sec. 6038A reporting and records requirements. The Proposed Regulations are not intended to otherwise alter the existing framework of the entity classification regulations.

The Proposed Regulations apply to taxable years of domestic disregarded entities ending on or after the date that is 12 months after the date of publication of the Treasury Department's decision adopting the rules as final regulations in the Federal Register.

Conclusion

The Proposed Regulations extend the information reporting obligations under § 6038A of the Code to a domestic disregarded entity with a solitary foreign owner by treating such an entity as domestic corporation for this limited purpose and expand the category of reportable transactions to include "any sale, assignment, lease, license, loan, advance, contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented." The purpose of the Proposed Regulations is to collect information to be used to help prevent money laundering, tax evasion, and other illicit financial activities.