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Jan 04 2017

IRS Imposes Regulations on Foreign-Owned Single-Member LLCs

by John Gordon | 20:01 GMT

Important Change in How US Treats Foreign-Owned US LLCs

Effective January 1, 2017, Limited Liability Companies (LLCs) formed in any state of the United States or the District of Columbia, which are wholly owned by foreign persons and do not elect to be treated as corporations for tax purposes, will become subject to new IRS reporting requirements.  New and existing LLCs will need to obtain an EIN after formation, and to do so will need to designate a Responsible Person. The LLC will need to maintain adequate books and records of transactions to track any payments or transfers of money, property or other reportable transactions between the disregarded entity and its sole member, whether such transactions are direct or indirect. These records must be available for inspection by the IRS upon demand.

Summary of Foreign-Owned Disregarded Entities

  • Required to obtain an Employer Identification Number (EIN, or federal tax number).
  • In order to obtain an EIN, the disregarded entity must designate a “responsible person.”
  • Required to file Form 5472, if there have been any “reportable transactions” during the previous tax year. Formation and dissolution filings are considered to be reportable transactions.
  • Required to maintain adequate books and records to support the filing of Form 5472, for as many years as necessary, and make them available to the IRS upon demand
  • The new regulations treat each foreign-owned disregarded LLC as a separate corporation for reporting purposes. Therefore, if one foreign person owns more than one disregarded LLC, each LLC will report individually its reportable transactions. If a disregarded LLC owns another disregarded LLC, by itself, with another disregarded LLC or with the foreign person, each of these LLCs are considered separate and must report separately.

The new regulations do NOT create a new tax obligation. Single member LLCs remain disregarded for income tax purposes. Form 5472 is an Information return for tax purposes, and as such is not publicly available.

Some Definitions

As defined by the IRS, “A foreign person includes a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, a foreign estate, and any other person that is not a U.S. person.”

In general, “Reportable Transactions” are any exchange of money or property between the LLC and its foreign member, such as sale, assignment, lease, license, loan, advance, contribution, or other transfer of any interest in or a right to use any property or money, as well as the performance of any services for the benefit of, or on behalf of, another taxpayer, and includes any amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the entity.

A Disregarded Entity is an entity that exists for legal purposes but not for income tax purposes. An LLC, formed under these laws of one of the states or the District of Columbia, which has not elected to be treated as a corporation, is automatically treated as a disregarded entity. For income tax purposes, such an LLC is considered to be a sole proprietorship if owned by an individual or a branch if owned by a corporation or other entity. The only entity that fits the description of a disregarded entity is a single-member LLC that has not elected to be treated as a corporation.

The IRS, as part of the new regulations, is emphasizing that in order to obtain an Employer Identification number, the LLC must identify a responsible party, if the applicant is a non-publicly-listed entity. The definition of this “responsible party” is “the individual who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets.” The entity must also report any subsequent change in the responsible party.

The penalty for failure to file form 5472 on a timely basis is $10,000. If the form is submitted on time but is incomplete or inaccurate, it is considered to be late and subject to the $10,000 penalty.

What Does it Mean for Foreign-Owned Single-Member LLCs

In the words of the Internal Revenue Service, the new regulations “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 under section 6038A of the Internal Revenue Code. The changes are intended to provide the IRS with improved access to information that it needs to satisfy its obligations under US tax treaties, tax information exchange agreements and similar international agreements, as well as to strengthen the enforcement of US tax laws.”

Disregarded Entities owned by a non-US resident that are in existence before January 1, 2017, will need to have an EIN. The disregarded entity will need to designate a responsible party to sign the application. If the responsible person is no longer associated with the LLC, then a new responsible party must be designated, and the IRS informed on the change. Only a duly empowered person should be designated as the Responsible Person, and if this person changes the IRS must be notified by following the “IRS How to update Information” link.

An LLC that existed before the new requirement may not have to file Form 5472 if it does not have any reportable transactions, but once such a transaction takes place, Form 5472 will need to be filed. The creation of a single-member LLC whose sole member is not a US person is itself a reportable transaction, and creates the requirement to file Form 5472 in the first year of existence.

After an LLC is dissolved/canceled/liquidated, it must file a final Form 5472, including any distribution of assets to its sole member. If the LLC changes status by electing to be treated as a corporation, or adding members and thereby becoming a partnership, it still must file a final Form 5472.

 

We have helped thousands of non-US residents to set up their companies in the US with 34 years of expertise. For more information, check out our blog and follow us on Facebook and Twitter to make sure you do it right. 

John Gordon John Gordon

Founder, President & CEO of USA Corporate Services Inc., a New York City-based incorporation and company management firm. He is a graduate of the Global Executive MBA program from Columbia Business School and London Business School.

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