Should You File Form 5471 or Disregard a Foreign Corporation?

Should You File Form 5471 or Disregard a Foreign Corporation?

Should You File Form 5471 or Disregard the Entity 

When a US person has ownership over a foreign corporation, they may have to file the annual form 5471 which is an IRS international information return used to report foreign corporations on a Tax Return. Unlike other international information reporting forms, such as the FBAR or Form 8938 (FATCA), Form 5471 requires the extensive disclosure of business items, Annual Income, Profit and Loss (P&L), and Balance Sheets.  In addition, there are many other requirements that a US person may have to consider depending on the type of income and the amount of ownership by US shareholders, such as Controlled Foreign Corporation tax issues involving Subpart F and GILTI.  Sometimes, it may benefit the taxpayer to simply disregard the foreign entity, but other times it may not be the best option (from an income tax perspective). Let’s go through five important facts about whether a taxpayer should file Form 5471 or disregard the entity.

What is a Per Se Corporation?

The first thing to note is that some foreign corporations cannot be disregarded — because they are considered to be a per se corporation. If the foreign corporation is considered a per se corporation, that means the taxpayer does not have the opportunity to disregard the entity. Some common examples of per se entities are a Canadian Corporation or Company, or a Sociedad Anonima. In these types of situations, the US government has determined that they will not allow the Taxpayer to disregard the entity and therefore the Taxpayer will have a Form 541 filing requirement – even if they do not want to.

Current Income Taxable for Disregarded Entity

One benefit of having a foreign corporation is that excluding items such as Subpart F and GILTI – ownership of a foreign corporation does not mean a taxpayer has current income. If the Taxpayer is a shareholder of a foreign corporation, but no income was distributed to the Taxpayer, they may not have any tax liability and the filings with the IRS is merely a reporting exercise –– but if the person disregards the entity, then the income attributed to their ownership percentage could become current income.

No (or Limited) Foreign Tax Credits with Disregarding the Entity

In addition to having current income in a year that the taxpayer disregards the entity, another issue is that typically the individual taxpayer did not pay taxes abroad. Instead, the foreign corporation paid the tax.  Therefore, if the taxpayer disregards the entity they may have an immediate tax liability for income associated with their ownership of the company that would not be able to be offset by foreign tax credits (excluding GILTI).

No GILTI or Subpart F with Disregarding the Entity

One benefit of disregarding the entity is that since it is not a controlled foreign corporation, the individual would not be subject to the GILTI and Subpart F Income.  The reason why taxpayers wanted to avoid these two issues is that in a situation in which there is either GILTI or Subpart F Income, a Taxpayer may still be liable for tax on income that has not been distributed to them – and may never be distributed to them.

Less Reporting with Disregarding the Entity

When a person disregards a foreign entity, they still have an annual reporting requirement, but the forms are much less complicated than they are when a person is reporting a foreign corporation — especially a CFC. This is largely due to the fact, that especially in situations in which there would with ownership in a controlled foreign corporation, the more complex tax issues such as GILTI and Subpart F income would not be applicable.

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