In short: There are several IRS forms that must be completed for those with foreign income or large penalties can be assessed.
Taxpayers with foreign income have additional Internal Revenue Service (IRS) forms they must complete each tax season. These forms lead to more pitfalls for taxpayers and can lead to hefty additional penalties. Our professionals see recurring issues for taxpayers with business in foreign countries with three types of international forms in particular: (1) Form 3520 and Form 3520-A, (2) Form 5471 and Form 5472, and (3) Form 8804. Below, is an outline of common mistakes for tax return forms and how to get related penalties abated.
What Forms are Required?
IRS Forms 3520 and 3520-A are required for U.S. taxpayers that own any stake in a foreign trust including most foreign retirement accounts. A taxpayer has to file IRS Form 3520 for each foreign trust owned or performed certain transactions with. Additionally, a foreign trust with a U.S. owner must file an IRS Form 3520-A so the U.S. owner can meet his information reporting requirements.
A U.S. person is required to file an IRS Form 5471 if he owns, controls or has certain business relationships with a foreign corporation. Foreign corporations conducting business in the U.S. or a U.S. business that is at least 25% foreign-owned are generally required to file an IRS Form 5472.
Partnerships with effectively connected taxable income (ECTI) allocable to a foreign partner are required to file a Form 8804. Unlike most partnerships, a partnership with ECTI allocable to a foreign partner is required to withhold on that amount under IRC 1446. A Form 8804 is used to report the total amount that withholding must be conducted on under IRC 1446 and a Form 8805 is used for the amount allocable to each foreign partner individually.
What Are Some Common Mistakes and Associated Penalties?
As with any forms, common mistakes for both Forms 3520 and 3520-A usually involve late or incomplete filing failures. Due to the complexity of these forms, we often see taxpayers who filed only one form when they needed both or simply were unaware of their filing obligation until the IRS notified them of the missed filing requirements. Such mistakes result in large penalties with a minimum penalty of $10,000 or a higher amount depending on the gross value of certain transactions or the trust. Additionally, if the taxpayer fails to address the issue within 90 days of IRS sending a notice of the error, the IRS will assess a $10,000 penalty for every 30 days the issue remains unresolved.
For Form 5471, a late or incomplete filing results in a minimum penalty of $10,000. As with the Form 3520, if a taxpayer does not respond within 90 days of the IRS notice of the issue, an additional $10,000 will be assessed every 30 days. However, unlike the Form 3520, the additional penalties beyond 90 days are capped at a maximum penalty of $50,000 for Form 5471. Failure to file a Form 5472 results in a $25,000 penalty and an additional $25,000 penalty for every 30 days the error is not corrected after the IRS notifies the taxpayer.
The Form 8804 penalties are based on a percentage of the unpaid tax balance. Failure to file a Form 8804 results in a penalty of 5% of the unpaid tax for each month the return is late, up to a maximum penalty of 25% of the unpaid tax.
How to Get These Penalties Abated
Fortunately, lawmakers understood that taxpayers make mistakes and many of these mistakes can result from good faith oversights or factors beyond the taxpayer’s control. Thus, these penalties are eligible for a reasonable cause abatement. The grounds for reasonable cause vary from case to case. Generally, the rule is that a taxpayer must exercise ordinary care and act as a reasonably prudent person would in the situation.
We’re Here to Help
Bennett Thrasher’s Tax Controversy practice can help you comply with international tax reporting requirements and minimize any penalties for late or incomplete filings. To learn more about our services and for additional information, contact James Pickett, Director of our Tax Controversy practice, by emailing Bennett-Thrasher@btcpa.net.