The Internal Revenue Service (IRS) is thoroughly strict on foreign businesses’ taxation reports. As a foreign business owner, you are required to file your tax report depending on which entity your business belongs to. It is important to know which entity your foreign business belongs to because each one has its own specific tax report requirements. It is important to determine the entity’s structure and properties and categorize it appropriately according to the IRS Code. These foreign business entities include:
- Foreign corporations.
- Foreign limited liability companies (LLC).
- Foreign partnerships.
- Foreign trusts.
If you own a foreign corporation in the United States, you will be taxed based on the business activities that your corporation engages in or if your corporation receives income from United States resources.
All foreign corporations operating in the United States must file a U.S. corporate income tax return. This requirement also applies to foreign corporations with no permanent address in the United States.
A foreign corporation that is engaged in a US trade or business at any time during the year must file a return on Form 1120-F. The return is required even if the foreign company had no effectively connected income or the income was free from US tax under a tax treaty. Furthermore, quarterly estimated tax payments are required to cover the anticipated tax liability.
If the withholding tax on US source income is insufficient to cover the tax liability, a foreign corporation that was not engaged in a US trade or business must file Form 1120-F. When the withholding tax on US source income is excessive under the provisions of a tax treaty, a tax return may be filed solely as a claim for refund.
If a foreign corporation is classified as a Controlled Foreign Corporation (CFC) or a Passive Foreign Investment Company (PFIC), the rules change. A foreign corporation or equivalent entity is a CFC if US shareholders own more than 50% of its outstanding voting power stock or more than 50% of the corporation’s total value at any time during the year. A foreign corporation or mutual fund is a PFIC if passive activities generate more than 75 percent of the company’s income or more than 50 percent of the fair market value of all corporate assets.
If a foreign corporation has a branch, employees, or other dependent agents in the United States, it is considered to be engaged in a US trade or business. A branch is any unincorporated entity in the United States, such as a Limited Liability Company, Partnership, or Joint Venture. Aside from applicable federal and state income taxes, a foreign corporation with a branch in the United States can be is also subject to the Branch Profits Tax on earnings repatriated from the branch.
If the country where your foreign corporation is a tax resident of and the United States have a tax treaty that is packaged with benefits, then your taxes may be a little different from other foreign corporations. For instance, whenever a foreign company is subject to income tax in the United States under the Internal Revenue Code, the terms of the applicable taxation agreement must be observed.
In addition to filing Form 1120-F, your foreign corporation may be required to also file an information return. This return depends on the business activities your foreign corporation partakes in. For example, Form 1042 will be required by the IRS if payments were made to a foreign person.
What is A tax identification number?
The tax identification number is also called an Employer Identification Number (EIN). In case your foreign corporation does not have an EIN, then you will be required to file Form-SS4 to the IRS. This EIN is for use on tax-related documents.
Income Tax Compliance for Controlled Foreign Corporations
Each Controlled Foreign Corporation (CFC) that does not file a consolidated return with a US parent must file an annual information return on Form 5471. Furthermore, Form 926 is required if a US person transfers tangible or intangible property, including cash, to a foreign corporation and the US person immediately after the transfer owns 10% or more of the transferee’s voting power or value; or if the transfer is over $100,000 on annual basis.
The anti-deferral regime that applies to certain items of income is another important aspect of the CFC provisions. The US tax on a foreign corporation or subsidiary is generally deferred until earnings and profits are repatriated to the US as dividends to US shareholders. This provision, however, does not apply to Subpart F income earned by a CFC. Dividends, interest, rents, royalties, certain income from the purchase or sale of goods to a related party, and income from services provided outside the country of incorporation are all examples of Subpart F income. As a result, the anti-deferral regime requires that more than 10% of US shareholders recognize deemed dividends and include a pro-rata share of CFCs Subpart F income in income.
Taxation of Passive Foreign Investment Companies & Qualified Electing Funds
The PFIC regime seeks to tax passive income earned by US investors in foreign mutual funds and US shareholders of passive foreign investment companies. As a result, US investors must file Form 8621 with respect to the PFIC on an annual basis.
The PFIC rules differ greatly depending on the information available to the US investor and the choices made on Form 8621. Investors who have enough information may choose to treat the PFIC as a Qualified Electing Fund (QEF) and pay taxes on a pro-rata share of the PFIC earnings.
Another option is to choose mark-to-market if the PFIC stock is regularly traded on a well-known stock exchange. Finally, US investors who do not choose the QEF or mark-to-market elections must postpone paying taxes until the PFIC stock is sold or an excess distribution of PFIC earnings is made. If the PFIC is also a CFC, the reporting requirements become even more stringent.
Foreign limited liability company (LLC)
Do you own a foreign limited company in the US? If yes, then the United States will require you to file Form 8832 to classify the entity in the US. If you fail to file this form, then your foreign LLC will be taxed as a corporation.
If you are a U.S. resident who owns more than 50% in a foreign partnership, then you must fill out Form 8865 together with your annual personal tax return. If no partner has a controlling interest in the foreign partnership, then any U.S. resident with more than 10% shares should file Form 8865. This form majorly comprises of:
- A profit statement.
- A loss statement.
- A balance sheet.
- A schedule of owners, among other things.
If the foreign LLC has only one 100% owner, the company will be considered disregarded for US tax purposes, and the owner will have to file form 8858 with his personal US tax return.
Over the recent years, United States residents have increasingly setup foreign trusts for asset protection and tax planning. Unfortunately, this entity’s tax regulatory requirements can be somewhat stringent. The IRS code has a wide variation of foreign entities in the classification of foreign trusts. It means that not all trusts that have foreign origins are considered by the IRS as foreign trusts. In case you are unsure what type of trust you are currently using, seek advice from a tax professional.
If you own a foreign trust, then you are required to file one or two forms:
- Form 3520
- Form 3520-A
These forms are filed annually by the 15th day of the third month after the year end of the trust. Form 3520 is required to be filed alongside your taxpayer returns, whereas, Form 3520-A is filed separately.
The infractions for failing to file most of these forms can be quite harsh. It’s indeed critical to consult with a tax expert to help make sure that your tax return filing requirements have been met.