Form 8865 and IRS Foreign Partnership Filing: The IRS Form 8865 is used to report foreign partnerships to the IRS. It is the counterpart to Form 5471, which is used to report foreign corporations. While the Form 5471 is very common, the 8865 form is also an important form for U.S. Persons who have certain interest in, or ownership of a foreign partnership. The Form 8865 can be complicated, and it is required even if the person does not necessarily receive any income. The failure to report the Form 8865 may result in significant fines and offshore penalties, but these penalties may be abatement or avoided with Reasonable Cause or Voluntary Disclosure/Tax Amnesty.
What is the Purpose Form 8865?
The purpose of Form 8865 is to ensure that U.S. Persons report their ownership interest in a Foreign Partnership to the IRS.
As provided by the IRS:
“Use Form 8865 to report the information required under section 6038 (reporting with respect to controlled foreign partnerships), section 6038B (reporting of transfers to foreign partnerships), or section 6046A (reporting of acquisitions, dispositions, and changes in foreign partnership interests).”
4 Categories of 8865 Filers
Not every Taxpayer who owns a foreign partnership is required to file Form 8865. Rather, the IRS requires four categories of filers to file Form 8865 when applicable.
Let’s go through the different categories. For each category of filer, we will reproduce the IRS instruction, followed by our own example.
Category 1 Filer
“Category 1 filer.
A Category 1 filer is a U.S. person who controlled the foreign partnership at any time during the partnership’s tax year.
Control of a partnership is ownership of more than a 50% interest in the partnership. See the definition of 50% interest, later.
There may be more than one Category 1 filer for a partnership for a particular partnership tax year.
See U.S. person and Foreign partnership, later.
A Category 1 filer also includes a U.S. transferor who must report certain information with respect to a section 721(c) partnership for the year of contribution and subsequent years, pursuant to Temporary Regulations section 1.721(c)-6T. A Category 1 filer fulfills this reporting requirement by filing Schedule G and, in certain circumstances, Schedule H. See Section 721(c) partnership and U.S. transferor, later.”
Example of Category 1:
David is a U.S. Person. He is originally from Taiwan, and still owns foreign rental properties with his brother back in Taiwan. David owns 65% of the foreign partnership. David would most likely qualify as a Category 1 Filer.
Category 2 Filer
“Category 2 filer.
A Category 2 filer is a U.S. person who at any time during the tax year of the foreign partnership owned a 10% or greater interest in the partnership while the partnership was controlled by U.S. persons each owning at least a 10% interest.
However, if the foreign partnership had a Category 1 filer at any time during that tax year, no person will be considered a Category 2 filer. See the definition of a 10% interest, later.”
Example of Category 2:
Michelle is a U.S. Person who purchased a 15% ownership stake in a foreign partnership in the U.K. The Partnership is owned 60% by U.S. persons, who each own 12% of the foreign partnership. Michelle would most likely qualify as a Category 2 Filer.
Category 3 Filer
The Category 3 Filer is more complicated.
“Category 3 filer.
“A Category 3 filer is a U.S. person who contributed property during that person’s tax year to a foreign partnership in exchange for an interest in the partnership (a section 721 transfer), if that person either:
1. Owned directly or constructively at least a 10% interest in the foreign partnership immediately after the contribution, or
2. The value of the property contributed (when added to the value of any other property contributed to the partnership by such person, or any related person, during the 12-month period ending on the date of transfer) exceeds $100,000. If a domestic partnership contributes property to a foreign partnership, the domestic partnership’s partners are considered to have transferred a proportionate share of the contributed property to the foreign partnership.
However, if the domestic partnership files Form 8865 and properly reports all the required information with respect to the contribution, its partners will not be required to report the transfer. A Category 3 filer includes a U.S. transferor who (i) contributes section 721(c) property to a section 721(c) partnership, and (ii) has reporting requirements pursuant to Temporary Regulations section 1.721(c)-6T(b) (2). The Category 3 filer fulfills this reporting requirement by filing Schedule G, in addition to Schedule O, and, in certain circumstances, Schedule H. See Section 721(c) property, later.
Category 3 also includes a U.S. person that previously transferred appreciated property to the partnership and was required to report that transfer under section 6038B, if the foreign partnership disposed of such property while the U.S. person remained a direct or indirect partner in the partnership.”
Example of Category 3:
Nigel is a Legal Permanent Resident. He decided he wanted an interest in his friend’s foreign partnership in the U.K. Therefore, Nigel contributed assets to the foreign partnership in exchange for a 15% ownership interest in the partnership. After contributing the assets, he was granted 15% direct ownership.
Nigel would most likely qualify as a Category 3 Filer.
Category 4 Filer
The Category 4 Filer is also a bit more complicated.
“Category 4 filer.
A Category 4 filer is a U.S. person that had a reportable event under section 6046A during that person’s tax year.
There are three categories of reportable events under section 6046A: acquisitions, dispositions, and changes in proportional interests.
A U.S. person that acquires a foreign partnership interest has a reportable event if:
• The person didn’t own a 10% or greater direct interest in the partnership and as a result of the acquisition, the person owns a 10% or greater direct interest in the partnership (for example, from 9% to 10%). For purposes of this rule, an acquisition includes an increase in a person’s direct proportional interest (see Changes in proportional interests, later); or
• Compared to the person’s direct interest when the person last had a reportable event, after the acquisition the person’s direct interest has increased by at least a 10% interest (for example, from 11% to 21%). An acquisition of a section 721(c) partnership interest may be an acceleration event exception under the gain deferral method. See Temporary Regulations section 1.721(c)-5T. In this case, the acquirer may become a successor U.S. transferor and may have a reporting requirement under Temporary Regulations section 1.721(c)-6T. See the specific instructions for Schedule H, later.
A U.S. person that disposes of a foreign partnership interest has a reportable event if:
• The person owned a 10% or greater direct interest in the partnership before the disposition and as a result of the disposition the person owns less than a 10% direct interest (for example, from 10% to 8%). For purposes of this rule, a disposition includes a decrease in a person’s direct proportional interest; or
• Compared to the person’s direct interest when the person last had a reportable event, after the disposition the person’s direct interest has decreased by at least a 10% interest (for example, from 21% to 11%). A disposition of a section 721(c) partnership interest may be an acceleration event for purposes of applying the gain deferral method.
The U.S. transferor may be required to recognize gain in an amount equal to the remaining built-in gain on the section 721(c) property previously contributed to the section 721(c) partnership. See Temporary Regulations section 1.721(c)-4T. For acceleration events exceptions, see Temporary Regulations section 1.721(c)-5T. See the specific instructions for Schedule H, later.
Changes in Proportional Interests
A U.S. person has a reportable event if compared to the person’s direct proportional interest the last time the person had a reportable event, the person’s direct proportional interest has increased or decreased by at least the equivalent of a 10% interest in the partnership. Special rule for a partnership interest owned on December 31, 1999.
If the U.S. person owned at least a 10% direct interest in the foreign partnership on December 31,1999, then comparisons should be made to the person’s direct interest on December 31,1999. Once the person has a reportable event after December 31,1999, future comparisons should be made by reference to the last reportable event.
Example of Category 4:
Petra is from Australia, and is now a U.S. Citizen. She owned 4% of a foreign partnership when she was deemed a U.S. person. She purchase a larger stake in the foreign partnership and now owns 22%.
Petra would most likely qualify as a Category 4 Filer.
Exceptions to Filing Form 8865
As with any IRS International Information Reporting Form, the Internal Revenue Service also provides for certain exceptions.
Here are some of the more common exceptions:
Multiple Category 1 Filers
“If during the tax year of the partnership more than one U.S. person qualifies as a Category 1 filer, only one of these Category 1 partners is required to file Form 8865. A U.S. person with a controlling interest in the losses or deductions of the partnership isn’t permitted to be the filer of Form 8865 if another U.S. person has a controlling interest in capital or profits; only the latter may file the return. The U.S. person that files the Form 8865 must complete item F on page 1.”
” A Category 1 or 2 filer that doesn’t own a direct interest in the partnership and that is required to file this form solely because of constructive ownership from a U.S. person(s).”
“Members of an affiliated group of corporations filing a consolidated return. If one or more members of an affiliated group of corporations filing a consolidated return qualify as Category 1 or 2 filers for a particular foreign partnership, the common parent corporation may file one Form 8865 on behalf of all of the members of the group required to report.
Except for group members who also qualify under the constructive owners exception, the Form 8865 must contain all the information that would have been required to be submitted if each group member filed its own Form 8865.”
Foreign Trust (Limited)
“Trusts relating to state and local government employee retirement plans aren’t required to file Form 8865.”
Form 8865 Penalties
If the Form 8865 is not filed timely, the IRS may issue penalties:
Category 1 and 2 Filers
“A $10,000 penalty is imposed for each tax year of each foreign partnership for failure to furnish the required information within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign partnership) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired.
The additional penalty is limited to a maximum of $50,000 for each failure.
• Any person who fails to furnish all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901, 902 (for dividends paid in pre-2018 tax years of foreign corporations), and 960.
If the failure continues 90 days or more after the date the IRS mails notice of the failure, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired.
See section 6038 (and the underlying regulations) for the maximum reduction, the exception due to reasonable cause, and for limits on the amount of these penalties.
Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file or for filing false or fraudulent information. Additionally, any person that files under the constructive owners exception may be subject to these penalties if all the requirements of the exception aren’t met. Any person required to file Form 8865 who doesn’t file under the multiple Category 1 filers exception may be subject to the above penalties if the other person doesn’t file a correctly completed form and schedules.”
Category 3 Filers
“Any person that fails to properly report a contribution to a foreign partnership that is required to be reported under section 6038B and the regulations under that section is subject to a penalty equal to 10% of the fair market value (FMV) of the property at the time of the contribution.
This penalty is subject to a $100,000 limit, unless the failure is due to intentional disregard. In addition, the transferor must recognize gain on the contribution as if the contributed property had been sold for its FMV.
See section 6038B for the exception due to reasonable cause.”
Category 4 Filers
“Any person who fails to properly report all the information requested by section 6046A is subject to a $10,000 penalty, in addition to the section 7203 criminal penalty, unless it is shown that such failure is due to reasonable cause.
If the failure continues for more than 90 days after the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period (or fraction thereof) during which the failure continues after the 90-day period has expired.
The additional penalty shall not exceed $50,000.”
Out of Form 8865 Compliance?
If you have not properly reported your Form 8865, we can assist you with getting into offshore compliance through reasonable cause or one of the specific IRS voluntary disclosure/offshore tax amnesty programs available.
We Specialize in Streamlined & Offshore Voluntary Disclosure
Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe. Our attorneys have worked with thousands of clients on offshore disclosure matters, including FATCA & FBAR.
Each case is led by a Board-Certified Tax Law Specialist with 20-years experience, and the entire matter (tax and legal) is handled by our team, in-house.
*Please beware of copycat tax and law firms misleading the public about their credentials and experience.
Less than 1% of Tax Attorneys Nationwide Are Certified Specialists
Our lead attorney is one of less than 350 Attorneys (out of more than 200,000 practicing California Attorneys) to earn the Certified Tax Law Specialist credential. The credential is awarded to less than 1% of Attorneys.
Recent Case Highlights
- We represented a client in an 8-figure disclosure that spanned 7 countries.
- We represented a high-net-worth client to facilitate a complex expatriation with offshore disclosure.
- We represented an overseas family with bringing multiple businesses & personal investments into U.S. tax and offshore compliance.
- We took over a case from a small firm that unsuccessfully submitted multiple clients to IRS Offshore Disclosure.
- We successfully completed several recent disclosures for clients with assets ranging from $50,000 – $7,000,000+.
How to Hire Experienced Offshore Counsel?
Generally, experienced attorneys in this field will have the following credentials/experience:
- 20-years experience as a practicing attorney
- Extensive litigation, high-stakes audit and trial experience
- Board Certified Tax Law Specialist credential
- Master’s of Tax Law (LL.M.)
- Dually Licensed as an EA (Enrolled Agent) or CPA
Interested in Learning More about our Firm?
No matter where in the world you reside, our international tax team can get you IRS offshore compliant.
We specialize in FBAR and FATCA. Contact our firm today for assistance with getting compliant.