Tax Reporting For Cross-Border Transactions - Froms, Penalties, Statute of Limitations, Possible Defenses

TAX REPORTING FOR CROSS-BORDER TRANSACTIONS – FORMS, PENALTIES,
STATUTE OF LIMITATIONS, POSSIBLE DEFENSES
Mark C. Peltz
and
Jennifer Sklar-Romano
I. INTRODUCTION
International tax reporting requires the consideration of various issues and concepts that do
not apply to domestic corporations, including currency conversions, foreign tax credits,
Subpart F income, and transfer pricing. The Internal Revenue Service (IRS) applies
heightened scrutiny to U.S. persons with foreign activities and continues to prioritize these
taxpayers for examination. Failure to timely and accurately file foreign information reporting
forms can result in significant penalties assessed against the taxpayer. The foreign
information reporting returns have grown in complexity over time and require extensive
financial information.
II. U.S. TAXATION OF FOREIGN EARNINGS AND PROFITS (E&P)
A. Basic Principles of U.S. International Taxation
1. Foreign Corporation
a. Generally, a foreign corporation is taxable in the U.S. only on the following types
of income:
1) U.S. source fixed, determinable, annual or periodical income (FDAP) income,
e.g., dividends, interest, rents and royalties1
2) Income effectively connected with the conduct of a U.S. trade or business
(ECI)2
b. U.S. Shareholder of a Foreign Corporation. Generally, a U.S. shareholder of a
foreign corporation is not taxable until income is repatriated or shares are sold.3
However, under the anti-deferral regimes, a U.S. shareholder may be subject to
U.S. taxation on certain income earned by the foreign corporation.
c. U.S. Anti-Deferral Regimes
A U.S. shareholder of a controlled foreign corporation (CFC) may be required to
include in income amounts attributable to foreign operations before profits are
repatriated to the U.S. A CFC is a foreign corporation of which more than 50
1
I.R.C. 881(a).
2
I.R.C. § 882(a).
3
I.R.C. §§ 301, 302(a), 61(a)(3).
1

percent in vote or value is owned directly, indirectly or constructively by U.S.
shareholders.4
In general, a U.S. shareholder is a U.S. person who is a direct,
indirect or constructive owner of at least 10 percent of the voting stock of the
CFC.5
1) U.S. Person. For purposes of determining who is a U.S. Shareholder, a U.S.
person includes:
a) U.S. citizen or resident;
b) Domestic partnership;
c) Domestic corporation; or
d) Domestic estate or trust.6
2) Ownership. For purposes of determining if a U.S. person owns a foreign
corporation, ownership includes:
a) Direct ownership;7
b) Indirect ownership – A U.S. person is treated as owning the stock owned
through foreign entities – shareholders, partners and beneficiaries are
treated as owning stock held by the foreign corporation, partnership, trust
or estate;8
and
c) Constructive ownership – An individual is treated as owning the stock
owned by members of his/her family.9
A person may also be treated as
owning the stock owned by entities of which the person is an owner and
the stock owned by an owner of an entity may be treated as owned by that
entity.10
3) Subpart F Income
a) A U.S. shareholder of a CFC is currently taxed in the U.S. on certain types
of income earned by the CFC to the extent of the CFC’s current E&P.11
b) The U.S. shareholder must own the stock of the CFC, directly or indirectly
through a foreign entity.12
A U.S. shareholder that constructively owns the
stock of the CFC is not subject to the Subpart F regime.13
c) Subpart F income includes the following categories of foreign base
company income (FBCI):
4
I.R.C. § 957(a).
5
I.R.C. §§ 951(b), 957(c).
6
I.R.C. § 7701(a)(30).
7
I.R.C. § 958(a)(1)(A).
8
I.R.C. § 958(a)(2).
9
I.R.C. §§ 958(b), 318(a)(1).
10
I.R.C. §§ 958(b), 318(a)(2).
11
I.R.C. §§ 951(a)(1)(A), 952(a), (c)(1)(A).
12
I.R.C. § 951(a)(1).
13
Id.
2

i. Foreign Personal Holding Company Income. Foreign personal
holding company income (FPHCI) includes interest, dividends,
royalties, rents, annuities and net gains from the sale or exchange of
property that yield these categories of passive income.14
FPHCI,
however, does not include (1) rents and royalties from an unrelated
person if derived from the active conduct of a trade or business; (2)
interest derived in the conduct of a banking business that constitutes
export financing interest; (3) dividends and interest from a related
person that is a corporation organized in the same foreign country as
the CFC and uses a substantial part of its business assets in that
country; or (4) rents, royalties and similar amounts received from a
related person for the use of, or privilege of using, property within the
CFC’s country of incorporation.15
ii. Foreign Base Company Sales Income. Foreign base company sales
income is primarily concerned with the separation of sales income
from the manufacturing activities of a related party so that the sales
income is generated in a low tax or no tax foreign jurisdiction.
Foreign base company sales income is income earned by a CFC with
respect to (1) the purchase of personal property from a related person
and its sale to any person; (2) the sale of personal property to any
person on behalf of a related person; (3) the purchase of personal
property from any person and its sale to a related person; or (4) the
purchase of personal property from any person on behalf of a related
person.16
The income, however, is treated as foreign base company
sales income only if the property is manufactured or produced outside
the CFC’s country of incorporation and sold or purchased for use
outside that country.17
A foreign branch of a CFC may be treated as a
separate corporation under certain conditions for purposes of
determining foreign base company sales income.18
iii. Foreign Base Company Services Income. Foreign base company
services income is primarily concerned with the separation of services
income from the manufacturing activities of a related party so that the
services income is generated in a low tax or no tax foreign jurisdiction.
Foreign base company services income is income from the
performance of technical, managerial, engineering, architectural,
scientific, skilled, industrial, commercial, or similar services, provided
such services are performed for a related person outside the CFC’s
country of incorporation.19
14
I.R.C. § 954(c).
15
I.R.C. §§ 954(c)(2)(A), (B), 954(c)(3)(A).
16
I.R.C. § 954(d)(1); Treas. Reg. § 1.954-3(a)(1)(i).
17
I.R.C. § 954(d)(1); Treas. Reg. §§ 1.954-3(a)(3), -3(a)(4).
18
I.R.C. § 954(d)(2).
19
I.R.C. § 954(e)(1); Treas. Reg. § 1.954-4.
3

d) For Subpart F income purposes, a related person is an individual,
corporation, partnership, trust, or estate that controls, or is controlled by,
the CFC or a corporation, partnership, trust, or estate that is controlled by
the same person (or persons) that controls the CFC.20
Control is defined as
direct, indirect, or constructive ownership of more than 50 percent of the
vote or value of a corporation or more than 50 percent of the value of the
beneficial interests in a partnership, estate, or trust.21
e) Subpart F income may be subject to an “all or none” rule of taxation.
Under the full inclusion rule, the entire gross income of the CFC will be
treated as FBCI if the CFC’s FBCI exceeds 70 percent of its gross
income.22
f) Exceptions. Certain exceptions to Subpart F income may apply:
i. De Minimis Rule. Under the de minimis rule, no portion of the CFC’s
gross income will be treated as FBCI if the CFC’s FBCI is less than
the lesser of 5 percent of its gross income or $1,000,000.23
ii. High Foreign Tax Exception. Under the high foreign tax exception,
FBCI will not be subject to current U.S. taxation if the effective rate of
tax imposed by a foreign country is greater than 90 percent of the
maximum U.S. corporate tax rate.24
iii. CFC Look-through Rule. FPHCI does not include dividends,
interest, rents, and royalties received or accrued from a related CFC
and attributable to income of the related CFC that is not Subpart F
income.25
For this purpose, a related CFC is a CFC that controls or is
controlled by the other CFC, or a CFC that is controlled by the same
person(s) that control the other CFC. Control is defined as ownership
of more than 50 percent by vote or value of the CFC’s stock. The
look-through rule does not apply to the extent the interest, rent, or
royalties create or increase a deficit that may reduce Subpart F income
of the payor CFC or another CFC.26
g) Subpart F income inclusions are not eligible for qualified dividend
treatment and are, therefore, subject to tax at ordinary income tax rates.27
20
I.R.C. § 954(d)(3).
21
Id.
22
I.R.C. § 954(b)(3)(B).
23
I.R.C. § 954(b)(3)(A).
24
I.R.C. § 954(b)(3)(C).
25
I.R.C. § 954(c)(6)(A).
26
I.R.C. § 954(c)(6)(B).
27
Rodriguez v. Comm’r., No. 12-60533 (3d Cir. July 5, 2013).
4

h) An indirect foreign tax credit is available for U.S. corporate shareholders
who have a Subpart F income inclusion during the taxable year.28
i) Determining Subpart F Income. For purposes of determining Subpart F
income:
i. Subpart F income is equal to net FBCI. The CFC calculates its
separate items of Subpart F income by allocating and apportioning
expenses to each item of gross income.29
ii. Subpart F income is limited to the foreign corporation’s current E&P.
There is no Subpart F inclusion if the CFC has an overall loss for the
taxable year.30
iii. Recapture of Subpart F income. When the CFC has net FBCI, but an
overall loss, the FBCI reduced by the loss must be recaptured in a
subsequent year when the CFC has non-Subpart F income.31
4) Section 956 – Investment of Earnings in U.S. Property
a) A U.S. shareholder32
of a CFC is subject to immediate U.S. taxation for
any taxable year on the lesser of (1) the U.S. shareholder’s pro rata share
of the average amount of U.S. property held (directly or indirectly) by the
CFC as of the close of each quarter of the taxable year, less that portion of
the CFC’s E&P attributable to amounts previously included in the
shareholder’s gross income on account of investment in U.S. property (or
which would have been so included except that it had already been
included under another provision of the CFC rules), or (2) the U.S.
shareholder’s pro rata share of the CFC’s applicable earnings.33
A CFC’s
applicable earnings are generally defined as current and accumulated
E&P, reduced by distributions during the taxable year and by E&P already
taxed under the investment in U.S. property rules.34
b) Section 956 is primarily concerned with U.S. shareholders attempting to
repatriate earnings of a CFC through nontaxable transactions.
c) Examples of Investment of Earnings in U.S. Property:
28
I.R.C. § 960(a)(1).
29
I.R.C. § 954(b)(5)
30
I.R.C. § 952(c)(1)(A).
31
I.R.C. § 952(c)(2).
32
See supra note 5 and accompanying text.
33
I.R.C. § 956(a).
34
I.R.C. § 956(b)(1).
5

i. Loan from CFC to U.S. Parent including CFC’s guarantee of a loan of
U.S. Parent.35
However, intercompany balances due from U.S. parent
resulting from intercompany sales made in the ordinary course of
business are not treated as investments in U.S. property.36
For an
intercompany balance to be excluded from current taxation as an
investment in U.S. property, such balance should not exceed the
amount that would be ordinary and necessary to carry on the CFC’s
and the U.S. parent’s trade or business.37
ii. Investment by CFC in stock of U.S. Parent.38
d) Section 956 income inclusions are not eligible for qualified dividend
treatment and are, therefore, subject to tax at ordinary income tax rates.39
e) An indirect foreign tax credit is available for U.S. corporate shareholders
who have a Section 956 income inclusion during the taxable year.40
2. Foreign Partnership – A partnership is not subject to income tax.41
The partners in
the partnership report their distributive share of the partnership’s income, gain, loss,
deduction, or credit.42
Therefore, if a foreign partnership has a foreign partner whose
distributive share includes U.S. source income or ECI, the foreign partner is subject to
U.S. taxation with respect to this income.
3. Foreign Disregarded Entity (FDE) – A FDE is a foreign corporation under the laws
of its country of incorporation but disregarded as separate from its owner for U.S.
income tax purposes.43
The activities of a disregarded entity, whether domestic or
foreign, are treated in the same manner as a sole proprietorship, branch, or division of
the owner.44
If the owner of the FDE is a U.S. person, the activities of the FDE must
be reported on the tax return of the U.S. person and the income is subject to U.S.
taxation. Alternatively, if the FDE is owned by a foreign person, the foreign person
will be subject to U.S. taxation only on income generated by the FDE that is
characterized as U.S. source income or ECI.
III.COMPLIANCE AND REPORTING FOR FOREIGN ENTITIES
A. Foreign Corporations
35
I.R.C. §§ 956(c)(1)(C), (d).
36
I.R.C. § 956(c)(2)(C); Temp. Reg. §1.956-2T(d)(2)(i)(B).
37
I.R.C. § 956(c)(2)(C).
38
I.R.C. § 956(c)(1)(B).
39
Rodriguez v. Comm’r., No. 12-60533 (3d Cir. July 5, 2013).
40
I.R.C. § 960(a)(1).
41
I.R.C. § 701.
42
I.R.C. § 702.
43
Treas. Reg. § 301.7701-3.
44
Treas. Reg. § 301.7701-2(a).
6

1. Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. A
U.S. person that transfers property described in Section 6038B, Section 367(d) or
Section 367(e) to a foreign corporation must file Form 926 to report such transfer.45
Form 926 is filed with the transferor’s income tax return for the year that includes the
date of the transfer.46
a. The purpose for filing Form 926 is to identify the requirements for gain
recognition agreements47
and dual consolidated loss recapture.48
b. Form 926 is required to be filed for the following transactions involving an actual
or deemed transfer to a foreign corporation:
1) Organization (section 351) of a foreign corporation by a U.S. person. The
organization of a second tier CFC by a first tier CFC does not trigger a filing
requirement because the transferor is a foreign person.
2) B reorganization (section 368(a)(1)(B)) of a foreign corporation.
3) Conversion of a FDE to a foreign corporation pursuant to a check-the-box
election.49
4) Conversion of a foreign partnership to a foreign corporation pursuant to a
check-the-box election.50
c. In general, the transfer of cash to a foreign corporation in a nonrecognition
transaction must be reported if the amount of cash contributed exceeds $100,000
or the transferor owns directly or indirectly at least 10 percent of the vote or value
of the foreign corporation immediately after the transfer.51
d. If the transferor is a domestic or foreign partnership, the U.S. partners of the
partnership, rather than the partnership itself, are required to file Form 926.52
2. Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign
Corporations
a. Category of Filers. Certain “categories” of U.S. persons are required to file Form
5471. In general, for purposes of all categories of filers, U.S. persons include
citizens or residents of the U.S., domestic partnerships, domestic corporations,
45
I.R.C. § 6038B(a); Treas. Reg. § 1.6038B-1(b).
46
Treas. Reg. § 1.6038B-1(b).
47
Under I.R.C. § 367(a)(1), appreciated stock or securities may be subject to full gain recognition unless a gain recognition
agreement is established; see Treas. Reg. § 1.367(a)-3(b)(1); see also Treas. Reg. § 1.367(a)-3(c).
48
See Treas. Reg. § 1.1503-2.
49
See Treas. Reg. §§ 301.7701-3(c), (g)(1)(iv).
50
See Treas. Reg. §§ 301.7701-3(c), (g)(1)(i).
51
Treas. Reg. § 1.6038B-1(b)(3).
52
Instructions for Form 926 at 1 (Jan. 2015).
7

and domestic trusts and estates.53
The information that must be disclosed on Form
5471 is set forth in Sections 6038 and 6046. The rules are complex and often lead
to taxpayers neglecting to file or filing incomplete or inaccurate information.54
1) Category 2 Filer. A U.S. citizen or resident who is an officer or director of a
foreign corporation in which a U.S. person has acquired at least 10 percent in
vote or value.55
2) Category 3 Filer. A U.S. person who acquires at least 10 percent in vote or
value of a foreign corporation, a person who becomes a U.S. person while
meeting the ownership requirement of at least 10 percent in vote or value of a
foreign corporation, or a U.S. person who disposes of sufficient stock to own
less than 10 percent in vote or value of a foreign corporation.56
3) Category 4 Filer. A U.S. person who owned, directly, indirectly or
constructively, more than 50 percent in vote or value of a foreign corporation
for an uninterrupted period of at least 30 days during the accounting period of
the foreign corporation.57
4) Category 5 Filer. A U.S. shareholder58
who owns stock in a foreign
corporation that is a CFC for 30 days or more during the tax year of the
foreign corporation and who owned such stock on the last day of that year.59
5) Some categories may overlap with respect to a particular U.S. person and,
therefore, the filer may be subject to multiple classifications.
b. Indirect and Constructive Ownership Rules. For purposes of the above filing
categories, there are three separate sets of constructive and indirect ownership
rules that apply for purposes of Form 5471. Further, even within Form 5471,
different constructive ownership rules apply to different filing categories.
1) Category 2 and Category 3. For purposes of determining who is required to
file as a Category 2 or Category 3 filer, the following attribution rules apply:60
a) Family attribution. An individual is deemed to own stock owned directly
or indirectly by or for his/her spouse, children, grandchildren, parents,
grandparents and siblings.61
Stock that a family member owns by
53
Treas. Reg. §§ 1.6038-2(d), 1.6046-1(f)(3); see I.R.C. § 7701(a)(30).
54
See G. Paul Glunt, Form 5471: Dispelling Seven Common Myths, J. OF CORP. TAX’N (Mar/Apr 2013).
55
Treas. Reg. § 1.6046-1(a)(2).
56
Treas. Reg. § 1.6046-1(c).
57
Treas. Reg. §§ 1.6038-2(a), -2(b), -2(c).
58
59
Id.
60
I.R.C. § 6046(c); Treas. Reg. §1.6046-1(i).
61
Treas. Reg. § 1.6046-1(i)(2).
8

attribution will not be reattributed to another member of the family for
purposes of again applying the family attribution rules.62
b) “Upwards or “From Entity” Attribution. A person is deemed to
proportionately own stock owned directly or indirectly by or for a foreign
corporation or a foreign partnership in which he/she is a shareholder or
partner.63
There is no attribution from nongrantor trusts or estates.
Attribution applies only to foreign entities, and stock owned by a U.S.
entity is not treated as owned by its owners. Stock owned constructively
through a foreign corporation or partnership will be treated as actually
owned for purposes of applying family attribution.
c) “Downward” or “To Entity” Attribution. Section 6046 does not
provide for attribution to corporations, partnerships, trusts, or estates from
their owners or beneficiaries.
2) Category 4 and Category 5. For purposes of determining who is required to
file as a Category 4 or Category 5 filer, there is a hierarchy of attribution rules
under Section 318 as modified by Sections 6038 and 958.64
a) Family Attribution
i. Category 4 and Category 5: An individual is deemed to own stock
owned directly or indirectly by or for his/her spouse, children,
grandchildren and parents.65
In contrast to a Category 2 or Category 3
filer, there is no attribution from siblings or grandparents for a
Category 4 or Category 5 filer. Stock that a family member owns by
attribution will not be reattributed to another family member for
purposes of again applying the family attribution rules.66
ii. Category 5: Stock owned by a nonresident alien individual cannot be
attributed to U.S. family members.67
b) “Upwards or “From Entity” Attribution.
i. Category 4 and Category 5
62
Id.
63
Treas. Reg. § 1.6046-1(i)(1).
64
Treas. Reg. § 1.6038-2(c).
65
I.R.C. §§ 958(b), 318(a)(1).
66
I.R.C. § 318(a)(5)(B).
67
I.R.C. § 958(b)(1); Treas. Reg. § 1.958-2(b)(3).
9

i) Partnerships and Estates: Stock owned by or for a partnership or
an estate is deemed owned proportionately by its partners or
beneficiaries.68
ii) Trusts: Stock owned by a trust is deemed owned by the
beneficiaries in proportion to their actuarial interest in the trust.69
Stock owned by a grantor trust is deemed owned by the owner of
the grantor trust.70
iii) Corporations: If at least 10 percent in value of the stock in a
corporation is owned, directly or indirectly, by a shareholder, such
shareholder is deemed to own his/her proportionate share of the
stock owned by the corporation.71
Moreover, if a person is in
control of a corporation which, in turn, controls another
corporation, such person will be deemed to control the controlled
subsidiary corporation.72
ii. Category 5
i) Stock owned, directly or indirectly, by or for a foreign corporation,
foreign partnership, foreign estate, or foreign trust is deemed as
owned proportionately by its shareholders, partners, beneficiaries,
or owners.73
ii) If a corporation, partnership, estate, or trust owns, directly or
indirectly, more than 50 percent of the total combined voting
power in a corporation, it is deemed to own all of the voting
stock.74
This rule only applies if the U.S. person owns at least 10
percent of the stock of the corporation.
c) “Downward” or “To Entity” Attribution.
i. Partnerships and Estates: Stock owned by a partner or a beneficiary
is deemed owned by the partnership or the estate.75
ii. Trusts: Stock owned by a beneficiary of a trust is deemed owned by
the trust unless the beneficiary’s interest is a remote contingent
68
Id.
69
I.R.C. § 318(a)(2)(A).
70
I.R.C. § 318(a)(2)(B)(i).
71
I.R.C. §§ 318(a)(2)(C), 6038(e)(2)(B); Treas. Reg. § 1.6038-2(c)(3).
72
I.R.C. § 318(a)(2)(C).
73
I.R.C. § 958(a).
74
I.R.C. § 958(b)(2); Treas. Reg. § 1.958-2(c)(2).
75
I.R.C. § 318(a)(3)(A).
10

interest.76
Stocked owned by an owner of a grantor trust is deemed
owned by the trust.77
iii. Corporations: If at least 50 percent in value of the stock in a
corporation is owned, directly or indirectly, by or for any person, the
corporation is deemed to own the stock owned, directly, or indirectly,
by such person.78
iv. Stock that is attributed to a corporation, partnership, estate, or trust is
not reattributed to other shareholders, partners, or beneficiaries.79
v. Attribution to a corporation, partnership, estate, or trust cannot be used
to make a U.S. person a constructive owner of stock owned by a non-
U.S. person.80
c. The IRS generally uses Form 5471 to determine the following:
1) Transactions between related parties and whether there has been compliance
with transfer pricing rules.
2) Current U.S. taxation of a CFC’s E&P as Subpart F or Section 956 income.
3) Accurate computation of foreign E&P and foreign income taxes.
4) Consistent reporting of a foreign corporation’s information.
5) Adequacy of stated interest paid or accrued with respect to amounts loaned or
borrowed between related parties.
d. A separate Form 5471 must be filed for each foreign corporation for each tax year
of the foreign corporation ending during the U.S. person’s tax year.81
Therefore,
even if a foreign corporation is included in a foreign consolidated group (e.g.,
German Organs haft), the foreign corporation has a separate filing requirement.
There is no concept of a “consolidated” Form 5471 for multiple tiers of foreign
corporations.
e. Form 5471 must be filed even if the foreign corporation had no activities during
its tax year. The IRS permits a summary filing of Form 5471 for a foreign
corporation that satisfies the criteria of a dormant foreign corporation.82
76
I.R.C. § 318(a)(3)(B)(i).
77
I.R.C. § 318(a)(3)(B)(ii).
78
I.R.C. § 318(a)(3)(C).
79
I.R.C. § 318(a)(5)(C).
80
I.R.C. § 6038(e)(2)(A); Treas. Reg. §§ 1.6038-2(c)(1) & (2) .
81
Treas. Reg. § 1.6038-2(a).
82
Rev. Proc. 92-70, 1992-2 C.B. 435.
11

f. Dormant Foreign Corporation
1) To be treated as dormant, the foreign corporation must satisfy all of the
following requirements:
a) The foreign corporation conducted no business and owned no stock in any
other corporation other than another dormant foreign corporation;
b) No shares of the foreign corporation (other than directors’ qualifying
shares) were sold, exchanged, redeemed, or otherwise transferred, nor was
the foreign corporation a party to a reorganization;
c) No assets of the foreign corporation were sold, exchanged, or otherwise
transferred, except for de minimis transfers described in (4) and (5) below;
d) The foreign corporation received or accrued no more than $5,000 of gross
income or gross receipts;
e) The foreign corporation paid or accrued no more than $5,000 of expenses;
f) The value of the foreign corporation's assets as determined pursuant to
U.S. GAAP (but not reduced by any mortgages or other liabilities) did not
exceed $100,000;
g) No distributions were made by the foreign corporation; and
h) The foreign corporation either had no current or accumulated E&P or had
only de minimis changes in its beginning and ending accumulated E&P
balances by reason of income or expenses specified in (d) or (e) above.83
2) If the foreign corporation satisfies all of the above requirements, the filer must
attach and file page 1 of Form 5471 with the top margin labeled “Filed
Pursuant to Rev. Proc. 92-70 for Dormant Foreign Corporations.”84
Moreover,
the following information must be reported:
a) The filer's name and address, identifying number, filing Category (Item
B), stock ownership percentage (Item C), and tax year; and
b) The foreign corporation's annual accounting period, name and address
(Item 1a), employer identification number, if any, (Item 1b(1)) or
reference ID number (Item 1b(2)), country of incorporation (Item 1c), and
date of incorporation (Item 1d).85
g. Exceptions from Filing Requirements
1) Multiple Filer Exception: If two or more U.S. persons are required to file
Form 5471, one U.S. person may file on behalf of the others.
83
Rev. Proc. 92-70, 1992-2 C.B. 435, §3.
84
Instructions for Form 5471 at 4 (Dec. 2014).
85
Id.
12

a) The U.S. person that files Form 5471 must report the other U.S. persons
on whose behalf the Form 5471 is being filed on Item D of Form 5471.86
b) Only the members of a consolidated group that are direct owners of the
foreign corporation must be included on Item D.87
c) The U.S. persons on whose behalf the Form 5471 is filed must attach a
statement to their income tax returns stating the following:
i. Their filing requirements have been or will be satisfied;
ii. The name, address, and identifying number of the return with which
the information was or will be filed; and
iii. The IRS Service Center where the return was or will be filed. If the
return was or will be filed electronically, “e-file” should be entered.88
2) Member of Consolidated Group Exception
a) A Category 4 filer is not required to file Form 5471 for a corporation
described in section 1504(d) that files a consolidated return for the tax
year.89
b) A corporation described in section 1504(d) is a wholly-owned subsidiary
of a domestic corporation that is formed in a contiguous foreign country
(e.g., Canada, Mexico) for purposes of complying with foreign law.90
3) Constructive Ownership Exception
a) A Category 3, Category 4 or Category 5 filer is not required to file Form
5471 if the following conditions are met:
i. The U.S. person has no direct interest in the foreign corporation and is
required to file solely because of constructive ownership from another
U.S. person, and
ii. The other U.S. person files a Form 5471.91
b) If a U.S. officer or director is a Category 2 filer, the U.S. officer or
director is not required to file Form 5471 if either of the following
conditions is satisfied:
86
87
88
Id.
89
90
I.R.C. § 1504(d).
91
Id.; Treas. Reg. §§ 1.958-2, 1.6038-2(c), 1.6038-2(j)(2)(i), 1.6046-1(e)(4)(iii), 1.6046-1(i).
13

i. Immediately after a reportable stock acquisition, not more than three
U.S. persons own 95% or more in value of the stock of the foreign
corporation and the U.S. person making the acquisition files Form
5471 for the acquisition as a Category 3 filer; or
ii. The U.S. person(s) for which the Category 2 filer is required to file
Form 5471 does not directly own an interest in the foreign corporation
but is required to furnish the information solely because of
constructive stock ownership from a U.S. person and the person from
whom the stock ownership is attributed furnishes all of the required
information.92
c) If a U.S. person is a Category 4 or Category 5 filer and owns an interest in
the foreign corporation solely through constructive ownership from a
nonresident alien, the U.S. person is not required to file Form 5471.93
h. Filing Requirements for Categories of Filers. All required information and
schedules for each filing Category must be completed as follows:94
i. Reportable Information
1) Annual accounting period and taxable year-end of the foreign corporation.
92
Treas. Reg. § 1.6046-1(e)(4)(i).
93
Treas. Reg. § 1.6038-2(l).
94
See Instructions for Form 5471 at 2 (Dec. 2014).
14

a) In general, the annual accounting period of the foreign corporation is the
annual period on the basis of which it regularly computes its income in
maintaining its books.95
b) The taxable year of a CFC, however, must conform to the tax year of the
majority U.S. shareholder(s) unless there is no Subpart F income inclusion
for the year.96
c) In general, Form 5471 must include information for the tax year of the
foreign corporation that ends with or within the U.S. filer’s tax year.97
For
purposes of Schedule O reporting, however, a Category 2 or Category 3
filer must report transactions that occurred during its tax year.98
i. If the taxpayer sells all of its stock in the foreign corporation, the
activities of the foreign corporation for the entire tax year should be
reported.
ii. If the taxpayer liquidates the foreign corporation, the activities of the
corporation up through the date of liquidation should be reported.
2) Each foreign corporation must have an identifying number.99
If the foreign
corporation does not have a U.S. EIN, the foreign corporation must be
assigned a unique reference ID number that must be used consistently from
year to year.100
3) Shares of the foreign corporation’s stock issued and outstanding (Schedule
A).101
4) Stock ownership, including direct, indirect and constructive ownership
(Schedule B).102
5) Company operations (Schedule C) – The income statement must be reported
in functional currency and converted to U.S. dollars (USD) in accordance with
U.S. GAAP using the average exchange rate for the foreign corporation’s tax
year.103
6) U.S. and foreign income taxes paid or accrued (Schedule E).
95
Treas. Reg. § 1.6038-2(e).
96
I.R.C. § 898; Prop. Treas. Reg. § 1.898-1(c).
97
I.R.C. § 6038(a)(2); Treas. Reg. § 1.6038-2(a).
98
99
Treas. Reg. § 1.6038-2(f)(1).
100
Instructions for Form 5471 at 5-6 (Dec. 2014).
101
Treas. Reg. § 1.6038-2(f)(8).
102
Treas. Reg. § 1.6038-2(f)(8).
103
Treas. Reg. § 1.6038-2(h).
15

a) For accrual method taxpayers, foreign income taxes generally must be
converted to USD using the average exchange rate for the foreign
corporation’s tax year to which the tax relates.104
Accrual method
taxpayers must, however, translate foreign income taxes paid before the
beginning of the accrual year or more than two years after the year ends at
the average exchange rate at the time the taxes are paid.105
Moreover, use
of the average exchange rate at the time the taxes are paid is mandatory for
all foreign income taxes denominated in inflationary currencies,106
and
optional for foreign income taxes denominated in currencies other than the
foreign corporation’s functional currency if an election is made.107
b) For cash basis taxpayers, all foreign income taxes must be converted to
USD using the exchange rate at the time the taxes are paid, even if the
taxes are prepaid (e.g., withholding taxes, estimated taxes).108
c) The USD amount of foreign income taxes will be included in the foreign
corporation’s foreign tax pool used to calculate the section 902 deemed
paid foreign tax credit.
7) Balance sheet (Schedule F) – All amounts are reported in USD in accordance
with U.S. GAAP using the spot rate as of the end of the foreign corporation’s
tax year.109
8) E&P (Schedule H) – The current E&P should be reported in functional
currency and translated to USD using the average exchange rate for the
foreign corporation’s tax year.110
Moreover, the E&P should be adjusted to
conform the functional currency book income or loss to U.S. GAAP and to
U.S. tax accounting principles.111
These adjustments may include:
a) Deferred income taxes
b) Bad debt reserves
c) Inventory reserves (excess stock reserves)
d) UNICAP
e) LIFO recapture
f) Contingency reserves (e.g., litigation, environmental)
g) Employee benefit reserves (e.g., pension benefits, severance)
h) Corporate restructuring reserves
104
I.R.C. § 986(a)(1)(A).
105
I.R.C. §§ 986(a)(1)(B), (2)(A).
106
I.R.C. § 986(a)(1)(C).
107
I.R.C. § 986(a)(1)(D).
108
I.R.C. § 986(a)(2)(A).
109
Treas. Reg. § 1.6038-2(h).
110
111
Id.
16

i) Depreciation and amortization – Generally, depreciation must be
computed in accordance with section 167 (e.g., straight-line, sum-of-the-
year digits, declining balance).112
If at least 20 percent of the foreign
corporation’s income is from U.S. sources, depreciation must be computed
using the straight line method.113
Moreover, allowance for depreciation and
amortization must be based upon the historical cost of the asset.114
j) Unrealized foreign exchange gain or loss
k) Unrealized gain or loss on investments
l) Advances – For accrual method taxpayers, an advance receipt must be
included in E&P unless it is properly deferred under Rev. Proc. 2004-34,
2004-22 IRB 991.115
9) Shareholder’s income from the company that is currently includable by the
shareholder, including Subpart F income and earnings invested in U.S.
property, as well as actual dividends received from the foreign corporation
(Schedule I).
a) Subpart F income must be converted from functional currency to USD
using the average exchange rate for the CFC’s tax year.116
b) Earnings invested in U.S. property must be converted from functional
currency to USD using the spot rate on the last day of the CFC’s tax
year.117
c) Actual dividends received from the CFC (and not previously taxed as
Subpart F income or earnings invested in U.S. property) must be
converted from functional currency to USD using the spot rate on the date
the dividend was included in income.118
10) E&P (current and accumulated), dividends (actual and deemed), and
previously taxed income (PTI) (Schedule J).
a) Current and accumulated E&P before actual and deemed dividends during
the year (Line 3) is the denominator in the fraction used to compute the
Section 902 deemed paid foreign tax credit – (functional currency
dividend/post-1986 E&P in functional currency) x post-1986 foreign tax
pool, converted to USD using the average exchange rate, or the spot rate if
elected.
112
Treas. Reg. §§ 1.964-1(c)(1)(iii).
113
Id; Treas. Reg. § 1.312-15(a)(1).
114
Treas. Reg. § 1.964-1(b)(1)(ii).
115
See Rev. Rul. 79-68, 1979-1 C.B. 133 (citing Rev. Proc. 71-21, 1971-2 C.B. 549, which was superseded by Rev. Proc. 2004-
34); see also I.R.S. P.L.R. 200817029 (Jan. 29, 2008).
116
I.R.C. §§ 986(b)(2), 989(b)(3).
117
I.R.C. §§ 986(b)(2), 989(b), last sentence.
118
I.R.C. §§ 986(b)(2), 989(b)(1).
17

b) The cumulative balance of PTI resulting from Subpart F and section 956
income inclusions (column (c)) can be used to track the amount of an
actual distribution that will be taxable as a dividend to the US
shareholder(s).
11) Related party transactions (Schedule M) – Certain transactions between the
foreign corporation and a related party must be reported. The reportable
amounts must be converted from functional currency to USD using the
average exchange rate for the foreign corporation’s tax year.119
a) For purposes of Schedule M, a related person includes the following:
i. The U.S. filer;
ii. Any U.S. or foreign corporation or partnership controlled by the U.S.
filer;
iii. Any U.S. person owning at the time of the transaction at least 10
percent in value of any class of stock outstanding of the foreign
corporation other than the U.S. filer; and
iv. Any U.S. person owning at the time of the transaction at least 10
percent in value of any class of stock outstanding of any corporation
controlling the foreign corporation.120
b) The reportable transactions on Schedule M include the following:
i. Sales and purchases of stock in trade;121
ii. Sales and purchases of tangible property other than stock in trade;122
iii. Sales and purchases of patents, inventions, models, or designs
(whether or not patented), copyrights, trademarks, secret formulas or
processes, or any other similar property rights;123
iv. Compensation paid and compensation received for the rendition of
technical, managerial, engineering, construction, scientific, or like
services;124
v. Commissions paid and commissions received;125
vi. Rents and royalties paid and rents and royalties received;126
119
120
See Schedule M (Form 5471) (Dec. 2012).
121
Treas. Reg. §1.6038-2(f)(11)(i)(A).
122
Treas. Reg. §1.6038-2(f)(11)(i)(B).
123
Treas. Reg. §1.6038-2(f)(11)(i)(C).
124
Treas. Reg. §1.6038-2(f)(11)(i)(D).
125
Treas. Reg. §1.6038-2(f)(11)(i)(E).
126
Treas. Reg. §1.6038-2(f)(11)(i)(F).
18

vii. Amounts loaned and amounts borrowed.127
viii. Dividends paid and dividends received;128
ix. Interest paid and interest received;129
and
x. Premiums paid and premiums received for insurance or reinsurance.130
c) Lines 1-11 include amounts received by the foreign corporation.
d) Lines 13-23 include amounts paid by the foreign corporation.
e) If the foreign corporation is an accrual method taxpayer, accrued receipts
and accrued payments must be reflected in the reported amounts.
f) Lines 1-11 – If the amount is treated as Subpart F income, Worksheet A
should be completed and the Subpart F income should be reported on
Schedule I, line 1 and Schedule J, lines 4(a) and 4(c)(iii).
g) Line 25 (Amounts borrowed) – Accounts payable resulting from sales and
purchases attributable to transactions conducted in the ordinary course of
business should not be included on Lines 25. Rather, these amounts
should be reflected on other Schedule M line items (e.g., purchases on
Line 13).
h) Line 26 (Amounts loaned).
i. Accounts receivable resulting from sales and purchases attributable to
transactions conducted in the ordinary course of business should not be
included on Line 26. Rather, these amounts should be reflected on
other Schedule M line items (e.g., sales on Line 1).
ii. If the borrower is either the U.S. filer or a domestic corporation that is
owned at least 25% by the CFC’s U.S. shareholders, the loan will be
treated as a Section 956 Investment in U.S. Property.131
As such,
Worksheet B should be completed and the amount should be reported
on Schedule I, line 2 and Schedule J, lines 4(a) and 4(c)(i).
12) Organization or reorganization of foreign corporation, and acquisitions and
dispositions of its stock (Schedule O) – All Category 2 and Category 3 filers
must complete Schedule O.132
a) Part I must be completed by Category 2 filers.
127
Treas. Reg. §1.6038-2(f)(11)(i)(G).
128
Treas. Reg. §1.6038-2(f)(11)(i)(H).
129
Treas. Reg. §1.6038-2(f)(11)(i)(I).
130
Treas. Reg. §1.6038-2(f)(11)(i)(J).
131
I.R.C. § 956(c)(2)(F).
132
See Treas. Reg. § 1.6046-1.
19

b) Part II must be completed by Category 3 filers.
c) An acquisition of the stock of the foreign corporation by the U.S. person
must be reported in Section C. An acquisition includes a purchase, gift, or
bequest of the stock.
d) A disposition of the stock of the foreign corporation by the U.S. person
must be reported in Section D. A disposition includes a sale of the stock
(including a constructive disposition resulting from the sale of the stock of
an intermediary subsidiary) and a liquidation of the foreign corporation.
e) An organization or reorganization (e.g., section 351 and section 368
transaction) of the foreign corporation by the U.S. person must be reported
in Section E. This includes the organization or reorganization of a second
tier CFC by a first tier CFC.
f) Deemed transactions pursuant to a check-the-box election must be
reported on Schedule O as follows:
i. Conversion of a CFC to a foreign partnership or FDE must be reported
as a disposition of the stock of the foreign corporation in Section D.133
ii. Conversion of a foreign partnership or FDE to a foreign corporation
must be reported as a an organization of a foreign corporation (section
351 transaction) in Section E.134
g) In addition to completing Schedule O, all Category 3 filers must attach a
statement that includes (1) the amount and type of any indebtedness the
foreign corporation has to any U.S. person owning at least 5 percent in
value of its stock or any other foreign corporation owning at least 5
percent in value of its stock provided the U.S. filer owns at least 5 percent
in value of the stock of such other foreign corporation,135
and (2) the name,
address, identifying number, and number of shares subscribed to by each
subscriber to the foreign corporation’s stock.136
13) Functional Currency and Translation
a) If the foreign corporation uses a functional currency other than the USD,
the functional currency must be converted using the method specified for
each reportable item.137
133
Treas. Reg. §§ 301.7701-3(c), (g)(1)(ii) & (iii).
134
Treas. Reg. §§ 301.7701-3(c), (g)(1)(i) & (iv).
135
Treas. Reg. § 1.6046-1(b)(11).
136
Treas. Reg. § 1.6046-1(b)(12).
137
See supra notes 103-119 and accompanying text.
20

b) Divide-by-convention. Amounts should be reported as units of foreign
currency that equal one USD, rounded to at least four decimal places.138
c) United States Dollar Approximate Separate Transactions Method
(DASTM). In certain cases, the special rules for hyperinflationary
currency may apply.139
3. Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a
Foreign Corporation Engaged in a U.S. Trade or Business
a. A domestic corporation that is at least 25% foreign-owned at any time during a
taxable year or a foreign corporation engaged in a U.S. trade or business must file
Form 5472 to report all monetary and nonmonetary transactions with related
parties.140
b. Related Party. For purposes of Form 5472, a related party includes the
following:
1) Any direct or indirect 25% foreign shareholder of the reporting domestic
corporation.141
2) Any person related to the reporting domestic corporation within the meaning
of IRC §267(b) or §707(b)(1).142
3) Any person related to a 25% foreign shareholder of the reporting domestic
corporation within the meaning of IRC §267(b) or §707(b)(1).143
4) Any other person related to the reporting domestic corporation within the
meaning of IRC §482 and the regulations thereunder.144
c. Form 5472 is not required if the reporting domestic corporation has no reportable
transactions (contrary to the requirement that Forms 5471, 8865, and 8858 be
filed even if there is no activity to report).145
d. Form 5472 is not required to report transactions between two parties where
neither is a U.S. person and the transaction does not generate U.S.-source gross
income or ECI or any expense, loss, or deduction allocable to such income.146
B. Foreign Partnerships
138
139
Treas. Reg. §1.985-3.
140
I.R.C. § 6038A(a).
141
I.R.C. § 6038A(c)(2)(A).
142
I.R.C. § 6038A(c)(2)(B).
143
I.R.C. § 6038A(c)(2)(B).
144
I.R.C. § 6038A(c)(2)(C).
145
Instructions for Form 5472 (rev. Dec. 2014).
146
Instructions for Form 5472 (rev. Dec. 2014).
21

1. Category of Filers. Similar to the filing requirements for Form 5471, certain
categories of U.S. persons that have an interest in a foreign partnership are required to
file Form 8865, Return of U.S. Persons with Respect to Certain Foreign
Partnerships.147
a. Category 1 Filer. A U.S. person who owned directly, indirectly, or
constructively, at least 50 percent of the capital, profits, or deductions/losses of
the foreign partnership at any time during the partnership's tax year.148
A Category
1 filer is treated as controlling the foreign partnership.
b. Category 2 Filer. A U.S. person who at any time during the tax year of the
foreign partnership owned at least 10 percent of the capital, profits, or
deductions/losses of the foreign partnership while the partnership was controlled
by U.S. persons, each owning at least a 10 percent interest.149
c. Category 3 Filer.
1) A U.S. person who contributed property during that person's tax year to a
foreign partnership in exchange for a partnership interest (section 721
transfer), if that person either:
a) Owned directly or constructively at least a 10 percent interest in the
foreign partnership immediately after the contribution, or
b) 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 the transfer)
exceeds $100,000.150
2) Transfers by a domestic partnership are not required to be reported by the
partnership’s U.S. partners if the partnership files Form 8865.151
3) Transfers by a foreign partnership with U.S. partners are not required to be
reported, however, the IRS may require such reporting in the future.152
d. Category 4 Filer. A U.S. person who had a reportable event under section
6046A during that person's tax year.153
A reportable event includes the following:
147
I.R.C. §§ 6038, 6038B, 6046A.
148
I.R.C. § 6038(e)(3); Treas. Reg. §1.6038-3(a)(1).
149
Treas. Reg. § 1.6038-3(b)(3).
150
Treas. Reg. § 1.6038B-1(a)(1).
151
Treas. Reg. § 1.6038B-2(a)(2).
152
Treas. Reg. § 1.6038B-2(a)(3).
153
Treas. Reg. § 1.6046A-1.
22

1) A U.S. person either acquires an additional 10 percent direct interest in the
foreign partnership, or has less than a 10 percent interest before the
acquisition and at least a 10 percent interest after the acquisition;
2) A U.S. person either disposes of at least a 10 percent direct interest in the
foreign partnership, or after the disposition the U.S. person has less than a 10
percent interest in the foreign partnership; and
3) The U.S. person’s direct proportionate interest in the foreign partnership is
increased or decreased by at least 10 percent.154
2. Some categories may overlap with respect to a particular U.S. person and, therefore,
the filer may be subject to multiple classifications.
3. Indirect and Constructive Ownership Rules. All categories under Form 8865
apply the same constructive ownership rules of section 267(c), with certain
modifications.
a. Family Attribution. An individual is deemed to own stock owned directly or
indirectly by or for his/her spouse, children, grandchildren, parents, grandparents
and siblings.155
An interest in the partnership may be attributed from a nonresident
alien to a US person only if the US person owns a direct or an indirect (through
application of the constructive ownership rules for entity attribution) interest.156
b. “Upwards or “From Entity” Attribution. A person is deemed to
proportionately own a partnership interest owned directly or indirectly by or for a
corporation, partnership, estate, or trust in which he/she is a shareholder, partner,
or beneficiary.157
c. “Downward” or “To Entity” Attribution. Section 267(c) does not provide for
attribution to corporations, partnerships, trusts, or estates from their owners or
beneficiaries. In addition, for purposes of Form 8865, the section 267(c)(3)
partner-to-partner attribution rule does not apply.158
4. Exceptions from Filing Requirements
a. Multiple Category 1 Filer Exception: A Category 1 filer may file Form 8865
on behalf of other Category 1 filers.159
The Category 1 filers on whose behalf
Form 8865 is filed must attach a statement entitled “Controlled Foreign
Partnership Reporting” to their income tax returns stating the following:
154
Treas. Reg. § 1.6046A-1(b)(1).
155
I.R.C. §§ 267(c)(2), (4); Treas. Reg. § 1.267(c)-1(a)(4).
156
Treas. Reg. § 1.6038-3(b)(4).
157
I.R.C. § 267(c)(1).
158
Treas. Reg. § 1.6038-3(b)(4).
159
Treas. Reg. § 1.6038-3(c)(1).
23

1) They are required to file Form 8865, but are not doing so under the multiple
Category 1 filers exception;
2) The name, address, and identifying number (if any) of the foreign partnership;
3) The filing requirement has been or will be satisfied;
4) The name and address of the U.S. person filing Form 8865 for the foreign
partnership; and
5) The IRS Service Center where the return was or will be filed. If the return
was or will be filed electronically, “e-file” should be entered.160
b. Category 4 Filer Exception: A person who contributes property in exchange for
at least a 10 percent interest in the foreign partnership, may file only as a
Category 3 filer rather than as both a Category 3 and Category 4 filer161
c. Member of Consolidated Group Exception: A Category 1 or Category 2 filer
that is a member of an affiliated group of corporations filing a consolidated tax
return is not required to file Form 8865 if the common parent corporation files
Form 8865 on behalf of all the members of the group required to report.162
d. Constructive Ownership Exception: A Category 1 or Category 2 filer is not
required to file Form 8865 if the following conditions are met:
1) The U.S. person has no direct interest in the foreign partnership and is
required to file solely because of constructive ownership from another U.S.
person, and
2) The other U.S. person files Form 8865, the other U.S. person qualifies for this
filing exception, or Form 8865 is filed by another Category 1 filer.163
3) The U.S. persons on whose behalf Form 8865 is filed must attach a statement
to their income tax returns stating the following:
a) They are required to file Form 8865, but are not doing so under the
constructive ownership exception;
b) The names and addresses of the U.S. persons whose interests they
constructively own; and
c) The name and address of the foreign partnership for which they would
have had to have filed Form 8865, but for the constructive ownership
exception.164
5. A separate Form 8865 must be filed for each foreign partnership for each tax year of
the foreign partnership ending during the U.S. person’s tax year.
160
Id.
161
Treas. Reg. § 1.6046A-1(f).
162
Treas. Reg. § 1.6038-3(c)(3).
163
Treas. Reg. § 1.6038-3(c)(2).
164
Id.
24

6. Filing Requirements for Categories of Filers.165
Below is a table that provides the
filing requirements for each filing category:
7. Reportable Information166
a. For Category 1 and Category 2 filers, Form 8865 must include information for the
tax year of the foreign partnership that ends with or within the tax year of the U.S.
filer.167
For Category 3 and Category 4 filers, Form 8865 must include
transactions that occurred during the U.S. filer’s tax year (rather than during the
partnership’s tax year).168
b. Each foreign partnership must have an identifying number. If the foreign
partnership does not have a U.S. EIN, the foreign partnership must be assigned a
unique reference ID number that must be used consistently from year to year.
c. Ownership of interests in the foreign partnership, including direct, indirect and
constructive ownership (Schedules A and A-1).
d. Ownership of interests of the foreign partnership in lower-tier domestic or foreign
partnership interests (Schedule A-2).
e. Partnership operations (Schedule B).
f. Partners’ allocable share of partnership items (Schedules K and K-1).
g. Balance sheets (Schedules L and M).
165
Instructions for Form 8865 at 2 ( 2014).
166
See Treas. Reg. § 1.6038-3(g).
167
Treas. Reg. § 1.6038-3(f).
168
Instructions to Form 8865 at 6 ( 2014).
25

h. Book to tax reconciliation (Schedule M-1).
i. Related party transactions (Schedule N). For purposes of Schedule N, a related
party includes the U.S. filer, any U.S. or foreign corporation or partnership
controlling or controlled by the U.S. filer, and any U.S. person owning at the time
of the transaction at least a 10 percent direct interest in the foreign partnership
other than the U.S. filer. The transactions required to be reported on Schedule N
are similar to the transactions required to be reported on Schedule M of Form
5471.169
j. Acquisitions and dispositions of partnership interests, and changes in proportional
interests in the partnership (Schedules O and P). Deemed transactions pursuant
to a check-the-box election must be reported as follows:
i. Conversion of a foreign corporation to a foreign partnership must be reported
as a transfer of property to a foreign partnership on Schedule O.170
ii. Conversion of a foreign partnership to a foreign corporation must be reported
as a disposition of a partnership interest on Schedule P.171
8. Functional Currency and Translation. All amounts on Form 8865 must be
reported in USD.172
Similar to the exchange rate requirements for Form 5471, Form
8865 requires that the methods specified in sections 985 through 989 be used to
convert functional currency to USD and that the exchange rates be reported using the
divide-by-convention rounded to at least four decimal places.173
C. Foreign Disregarded Entities
1. Form 8832, Entity Classification Election. A sole owner of an entity incorporated
under the laws of a foreign country (other than a “per se corporation”) may elect to
treat the entity as a flow-through entity for U.S. income tax purposes by making a
check the box election.174
2. Form 8858, Information Return of U.S. Persons With Respect to Foreign
Disregarded Entities
a. A direct or indirect U.S. owner of a FDE is required to file Form 8858.175
1) Direct owner of FDE. A U.S. person that is the tax owner of a FDE at any
time during its tax year is required to file Form 8858.176
169
170
Treas. Reg. §§ 301.7701-3(c), (g)(1)(ii).
171
Treas. Reg. §§ 301.7701-3(c), (g)(1)(i).
172
Treas. Reg. § 1.6046A-1(g).
173
Instructions for Form 8865 at 7 (2014).
174
Treas. Reg. §§ 301.7701-3(c), 301.7701-2(b)(8).
175
Ann. 2004-4, 2004-4 I.R.B. 357.
176
26

2) U.S. partner of a controlled foreign partnership (CFP). A U.S. person that
is a Category 1 or Category 2 filer with respect to a CFP is required to file
Form 8858 if at any time during the CFP’s annual accounting period the CFP
was a tax owner of a FDE.177
3) U.S. shareholder of a CFC. A U.S. person that is a Category 4 or Category 5
filer with respect to a CFC is required to file Form 8858 if at any time during
the CFC’s annual accounting period the CFC was a tax owner of a FDE.178
b. The multiple filer exceptions that apply to Category 1 filers of Form 8865 and
Category 4 or Category 5 filers of Form 5471 may also be used by these filers
with respect to the filing of Form 8858.179
c. Reportable Information
1) The annual accounting period of a FDE is the annual accounting period of its
tax owner.180
Therefore, the annual accounting period of a FDE will be the
taxable year of its U.S. tax owner or the annual accounting period of the CFC
or CFP.
2) Each FDE must have an identifying number. If the FDE does not have a U.S.
EIN, the FDE must include a reference ID number that is used consistently
from year to year.181
If the tax owner of the FDE is a CFC, the reference ID
number reported on the CFC’s Form 5471 should be used. If the tax owner of
the FDE is a CFP, the reference ID number reported on the CFP’s Form 8865
should be used.182
3) Ownership of FDE, including tax owner and legal (direct) owner, if
different.183
4) An organizational chart that includes the chain of ownership (including
disregarded entities) between the tax owner and the FDE and the chain of
ownership (including disregarded entities) between the FDE and all entities in
which the FDE owns at least a 10 percent direct or indirect interest.184
5) Company operations (Schedule C). Only a summary income statement is
required. The income statement must be reported in functional currency and
converted to USD in accordance with U.S. GAAP.185
If the FDE does not
177
Id.
178
Id.
179
Id.
180
181
182
Id.
183
Id.
184
Id.
185
Id.
27

maintain U.S. GAAP income statements in USD, the average exchange rate
may be used.186
Tax owners of a FDE that are Category 5 filers of Form 5471
or Category 2 filers of Form 8865 are not required to complete Schedule C.187
6) Remittances received from the FDE (including exchange gain/loss on any
remittances) (Schedule C-1).188
Tax owners of a FDE that are Category 5
filers of Form 5471 or Category 2 filers of Form 8865 are not required to
complete Schedule C-1.189
7) Balance sheet (Schedule F). Only a summary balance sheet is required. The
balance sheet must be converted to USD in accordance with U.S. GAAP.190
Tax owners of a FDE that are Category 5 filers of Form 5471 or Category 2
filers of Form 8865 are not required to complete Schedule F.191
8) E&P (Schedule H)
a) If the tax owner of the FDE is a U.S. person or a CFP, the FDE’s taxable
income must be reported on Schedule H.192
If the tax owner of the FDE is
a CFC, the FDE’s current E&P must be reported on Schedule H.193
b) E&P should be converted to USD using the average exchange rate for the
FDE’s tax year.194
c) The E&P must be adjusted to conform the functional currency book
income or loss to U.S. GAAP and to U.S. tax accounting principles.195
The
adjustments are the same as those used to conform E&P for purposes of
Form 5471 reporting.196
d) Any difference between the functional currency amount of the income
taxes reported on Schedule C, Line 7 and the amount of income taxes that
reduce E&P of a FDE owned by a CFC or that are deductible in
computing the U.S. taxable income of a FDE owned by a U.S. person or
CFP, should be reported as a net addition or subtraction on Line 2 or 3,
respectively.197
186
Id.
187
188
189
190
191
192
Id.
193
Id.
194
Id.
195
Id.
196
197
28

9) Related party transactions (Schedule M).
a) Only tax owners of a FDE that are U.S. persons, Category 4 filers of Form
5471, or Category 1 filers of Form 8865 are required to complete Schedule
M.198
b) The reportable amounts must be converted from functional currency to
USD using the average exchange rate for the foreign corporation’s tax
year.199
c) For purposes of Schedule M, a related party includes the following:200
i. CFP as tax owner of FDE - U.S. filer, any U.S corporation or
partnership controlling or controlled by the U.S. filer, any foreign
corporation or partnership controlling or controlled by the U.S. filer
(other than the tax owner), and any U.S. person owning at the time of
the transaction at least a 10 percent direct interest in the foreign
partnership other than the U.S. filer.
ii. CFC as tax owner of FDE - U.S. filer, any U.S corporation or
partnership controlled by the U.S. filer, any foreign corporation or
partnership controlled by the U.S. filer (other than the tax owner), any
U.S. person owning at the time of the transaction at least a 10 percent
interest in any corporation controlling the tax owner, and any U.S.
person owning at the time of the transaction at least a 10 percent
interest in any entity controlling the tax owner.
d) The transactions required to be reported on Schedule M are similar to the
transactions required to be reported on Schedule M of Form 5471.201
d. Similar to Form 5471, there is a summary filing procedure for filing Form 8858
for a dormant FDE.
e. Functional Currency and Translation. Similar to the exchange rate
requirements applicable to Forms 5471 and 8865, the divide-by-convention must
be used, rounded to at least four decimal places, and the DASTM may be required
under certain circumstances.202
f. There are questions regarding whether a 165(g)(3) loss was recognized as a result
of a CTB, whether the FDE is a ‘‘separate unit’’ (within the meaning of the 1503
regulations, and whether the sales branch or manufacturing branch rules of 954(d)
198
199
200
See Schedule M (Form 8858) (Dec. 2012).
201
202
Instructions for Form 8858 at 2, 4 & 5 (Dec. 2013).
29

(2) were implicated in any transactions between the FDE and its CFC parent.203
Therefore, the taxpayer must understand such concepts as the foreign exchange
gain/loss rules of 987 and the sales/manufacturing branch rules of 954(d)(2).
D. Other Foreign Information Reporting Requirements204
1. FinCEN Form 114, Report of Foreign Bank and Financial Accounts (formerly
TD F 90-22.1) (FBAR)205
a. A U.S. person with a financial interest in or signatory authority over one or more
financial accounts located in a foreign country must file an FBAR if the aggregate
value of such accounts exceeded $10,000 at any time during the calendar year.206
b. A U.S. person includes the following:
a. U.S. citizen;
b. U.S. residents;
c. Corporation, partnership or LLC created or organized under the laws of the
U.S.; and
d. Trust or estate established under the laws of the U.S.207
c. A U.S. person has a financial interest in a foreign account for which the U.S.
person is the owner of record or holder of legal title whether the account is
maintained for the benefit of the U.S. person or for the benefit of another person.
A U.S. person also has a financial interest in each account for which the owner of
record or holder of legal title is an entity in which the U.S. person owns, directly
or indirectly, more than 50 percent of the voting power, total value of equity
interest or assets, or interest in profits.208
Moreover, the owner of a grantor trust is
treated as the owner of the financial accounts for which the trust is the owner of
record or holder of legal title.209
d. A U.S. person has signature authority over a foreign account if the person can
control the disposition of the assets held in the account by directly communicating
with the financial institution that maintains the account.210
2. Form 8938, Statement of Specified Financial Accounts
203
See Form 8858, Schedule G (Dec. 2013).
204
A detailed discussion of the other foreign information returns is beyond the scope of this discussion.
205
Many taxpayers required to file an FBAR often satisfy the filing requirements for Form 8938, Statement of Specified Foreign
Financial Assets, which is currently only filed by individual taxpayers.
206
Report of Foreign Bank and Financial Accounts (FBAR), http://www.irs.gov/Businesses/Small-Businesses-&-Self-
Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR.
207
Id.
208
Financial Crimes Enforcement Network, BSA Electronic Filing Requirements For Report of Foreign Bank and Financial
Accounts (FinCEN Form 114), http://www.fincen.gov/forms/files/FBAR%20Line%20Item%20Filing%20Instructions.pdf.
[hereinafter FinCEN].
209
Id.
210
Id.
30

a. Specified individuals are required to file Form 8938 if they have an interest in
specified foreign financial assets and meet the reporting threshold.211
b. Specified individuals include U.S. citizens, resident aliens, and certain non-
resident aliens.212
c. The reporting threshold is $50,000 on the last day of the tax year or $75,000 at
any time during the tax year for single (and married filing separately taxpayers)
and $100,000 on the last day of the tax year or $150,000 at any time during the
tax year for married filing jointly taxpayers.213
d. Specified foreign financial assets include financial accounts maintained by a
foreign financial institution, foreign stock or securities held for investment, any
interest in a foreign entity held for investment, and any financial instrument or
contract held for investment that has a foreign issuer or counterparty.214
3. Form 8621, Information Return by a Shareholder of a Passive Foreign
Investment Company or Qualified Electing Fund
a. Certain U.S. shareholders of passive foreign investment companies (PFICs) are
required to file Form 8621 to disclose their PFIC investments.215
b. A foreign corporation qualifies as a PFIC if at least 75 percent of its gross income
is passive or at least 50 percent of its assets produce passive income (e.g., interest,
dividends, rents and gain from the sale of investment assets).216
4. Form 3520, Annual Return to Report Transactions with Foreign Trusts and
Receipt of Certain Foreign Gifts. U.S. persons (and executors of estates of U.S.
decedents) must file Form 3520 to report any of the following:217
a. Certain transactions with foreign trusts, such as the transfer of money or other
property to the trust or a direct or indirect distribution from the trust.
b. Ownership of foreign trusts under IRC §§671-679.218
c. Receipt of certain large gifts or bequests from certain foreign persons.
1) A gift or bequest from a foreign person or estate of at least $100,000
211
I.R.C. § 6038D(a).
212
Treas. Reg. § 1.6038D-1(a)(2).
213
Treas. Reg. § 1.6038D-2(a)(1), (2).
214
I.R.C. § 6038D(b); Treas. Reg. § 1.6038D-3.
215
I.R.C. § 1298(f); Treas. Reg. § 1.1298-1T(b).
216
I.R.C. § 1297(a), (b).
217
I.R.C. § 6048(a).
218
Pursuant to I.R.C. § 6048(b), the foreign trust must file Form 3520-A, Annual Information Return of Foreign Trust with a U.S.
Owner.
31

2) A gift or bequest from a foreign corporation or partnership of at least $15,358.
IV. PENALTIES FOR NONCOMPLIANCE WITH FOREIGN INFORMATION
REPORTING REQUIREMENTS
A. Monetary Penalties
1. NonCompliance with Section 6038B - Form 926; Category 3 Filers of Form 8865.
The monetary penalty that may be imposed for failure to file is equal to 10 percent of
the fair market value of the property at the time of the transfer, with a $100,000 cap
unless the failure to file with respect to the transfer was due to intentional disregard.219
2. NonCompliance with Sections 6038, 6038A, 6038D - Form 5471; Form 5472;
Category 1, Category 2 and Category 4 Filers of Form 8865; Form 8938
a. The monetary penalty for failure to file Form 5471 as any Category filer, Form
5472, Form 8865 as a Category 1, Category 2 or Category 4 filer, or Form 8938 is
$10,000 for each Form 5471, Form 5472, or Form 8865 that is filed after the due
date of the income tax return (including extensions) or that does not include
complete and accurate information described in Section 6038(a) (with respect to
Category 4 and Category 5 filers of Form 5471 and Category 1 and Category 2
filers of Form 8865), Section 6038A(b) (with respect to Form 5472), Section 6046
(with respect to Category 2 and Category 3 filers of Form 5471), Section
6038D(c) (with respect to Form 8938) or Section 6046A (with respect to Category
4 filers of Form 8865).220
b. If the IRS mails a notice to the taxpayer for failure to file and the failure continues
for more than 90 days after the notice is mailed, the taxpayer shall pay an
additional penalty of $10,000 for each 30-day period after the 90-day period has
expired, not to exceed $50,000 for each failure.221
c. Effective January 1, 2009, the IRS Center began to automatically apply the
monetary penalty to late-filed or incomplete Forms 5471 with respect to which the
taxpayer is a Category 4 or Category 5 filer.222
d. Section 6662(j) provides for a 40 percent accuracy related penalty for
underpayments of tax as a result of transactions involving an undisclosed
specified foreign financial asset, defined as any asset with respect to which a
taxpayer was required to provide information under Section 6038, Section 6038B,
219
I.R.C. § 6038B(c).
220
I.R.C. §§ 6038(b)(1), 6038A(d)(1), 6038D(d)(1), 6679(a)(1); Treas. Reg. §§1.6038-2(k)(1), 1.6038A-4(a)(1), 1.6038D-8(a).
221
I.R.C. §§ 6038(b)(2), 6038A(d)(2), 6038D(d)(2), 6679(a)(2); Treas. Reg. §§ 1.6038-2(k)(1)(ii), -3(k)(3)(i)(B), (C), 1.6038A-
4(d)(1), 1.6038D-8(c).
222
Forms 5471 – Automatic Assessment of Penalties under IRC Section 6038(b)(1), http://www.irs.gov/Businesses/Corporations/
Forms-5471---Automatic-Assessment-of-Penalties-under-IRC-Section-6038(b)(1).
32

Section 6038D, Section 6046A, or Section 6048, but failed to do so.223
Therefore,
a taxpayer’s failure to file Form 5471 or Form 8865 may trigger a 40 percent
penalty with respect to an underpayment of tax that is attributable to such failure
(e.g., failure to report and pay tax on Subpart F income).
B. Reduction of Foreign Tax Credits
1. Applies to foreign tax credits under Section 901, Section 902, and Section 960 for
Category 4 and Category 5 filers of Form 5471 and foreign tax credits under Section
901 for Category 1 and Category 2 filers of Form 8865.
2. Section 6038(c) provides for a 10% reduction of the foreign taxes available for credit
under Section 901, Section 902 and Section 960 for each late-filed or incomplete
Form 5471 or Form 8865.224
This reduction in the foreign tax credit may be applied in
addition to the monetary penalty; however, the amount of the reduction penalty must
be reduced by the amount of the monetary penalty imposed for the same period.225
The
reduction is limited to the greater of $10,000 or the income of the foreign corporation
or foreign partnership for the applicable accounting period.226
If the IRS mails a
notice to the taxpayer for the failure to file Form 5471 or Form 8865 and the failure
continues for more than 90 days after the notice is mailed, there is an additional 5%
reduction for each 3-month period after the 90-day period has expired.227
C. Extension of Statute of Limitations
1. Generally, taxes are required to be assessed within three years after the return is
filed.228
However, for certain foreign filings, the limitations period does not expire for
the assessment of income tax with respect to the return upon which the information
should have been reported until three years after the required information is provided
to the IRS.229
2. For returns filed after March 18, 2010, and returns filed on or before March 18, 2010
as to which the limitations period had not yet expired as of March 18, 2010, the
extension of the imitations period applies to any tax return, event or period to which
the unreported information relates, unless the failure to report the information is due
to reasonable cause and not willful neglect230
If the taxpayer, however, can show the
failure to provide the required information was due to reasonable cause and not
willful neglect, the extended time for assessment will be limited to the unreported
information.231
223
I.R.C. § 6662(j).
224
I.R.C. § 6038(c); Treas. Reg. § 1.6038-2(k)(2), (3)(ii).
225
I.R.C. § 6038(c)(3);Treas. Reg. § 1.6038-2(k)(2)(vi).
226
Treas. Reg. § 1.6038-2(k)(2)(v).
227
Treas. Reg. § 1.6038-2(k)(2)(iv), (3)(ii).
228
I.R.C. § 6501(a).
229
I.R.C. § 6501(c)(8).
230
Id.
231
I.R.C. § 6501(c)(8)(B); See also C.C.A. 2014-32-020 (July 22, 2014), C.C.A. 2012-06-014 (Oct. 17, 2011).
33

3. The tolling or suspension of the statute of limitations applies to the following statutes
and applicable forms:
a. Section 6038B - Form 926, Return by a U.S. Transferor of Property to a Foreign
Corporation.
b. Sections 6038 and 6046 - Form 5471, Information Return of U.S. Persons with
Respect to Certain Foreign Corporation.
c. Section 6038A - Form 5472, Information Return of a 25% Foreign-Owned U.S.
Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.
d. Sections 6038 and 6046A - Form 8865, Return of U.S. Persons with Respect to
Certain Foreign Partnerships.
e. Section 6038 - Form 8858, Information Return of U.S. Persons with Respect to
Foreign Disregarded Entities.
f. Section 1298(f) - Form 8621, Information Return by a Shareholder of a Passive
Foreign Investment Company or Qualified Electing Fund.
g. Section 6038D - Form 8938, Statement of Specified Foreign Financial Assets.
h. Section 6048(a) - Form 3520, Annual Return to Report Transactions with Foreign
Trusts and Receipt of Certain Foreign Gifts.
i. Section 6048(b) - Form 3520-A, Annual Information Return of a Foreign Trust
with a U.S. Owner.
4. The extension of the statute of limitations applies to the omission of gross income
from the taxpayer’s return. If more than 25% of a taxpayer’s gross income is omitted
from the tax return, the statute of limitations is extended to six years.232
The HIRE
Act233
expanded this provision to provide that an omission of gross income attributable
to specified foreign financial assets in excess of $5,000 extends the period of
assessment to six years from the date the return was due or filed, whichever is later.234
The extension of the period of assessment applies even if the specified foreign
financial asset was not required to be disclosed on Form 8938 (e.g., the reporting
threshold was not met).235
5. The statute of limitations is extended to six years when a taxpayer owns at least 10%
of the voting shares of a CFC and the taxpayer omits from gross income certain
deemed inclusions of Subpart F income or Section 956 investments in U.S.
property.236
There is no minimum amount of income that must be omitted to extend
the statute of limitations to six years.
D. “Substantially Incomplete” Reporting
232
I.R.C. § 6501(e)(1)(A)(i).
233
Pub. L. No. 111-147, 124 Stat. 71 (2010).
234
I.R.C. § 6501(e)(1)(A)(ii).
235
I.R.C. § 6501(e)(1)(A)(ii)(I).
236
I.R.C. § 6501(e)(1)(C).
34

1. The IRS has considered the following facts and circumstances in determining whether
Form 5472 should be considered substantially incomplete:
1) The magnitude of the underreporting, or of the over-reporting, of the erroneously
reported transaction in relation to the actual amount of the transaction;
2) Whether the reporting corporation has reportable transactions other than the
erroneously reported transaction with the same related party and correctly
reported such other transactions;
3) The magnitude of the erroneously reported transaction in relation to all of the
other reportable transactions as correctly reported;
4) The magnitude of the erroneously reported transaction in relation to the reporting
corporation's volume of business and overall financial situation;
5) The significance of the erroneously reported transaction to the reporting
corporation's business in a broad functional sense;
6) Whether the erroneously reported transaction occurs in the context of a significant
ongoing transactional relationship with the related party; and
7) Whether the erroneously reported transaction is reflected in the determination and
computation of the reporting corporation's taxable income.237
2. The IRS has treated the following information returns as substantially incomplete:
a) Overreporting of purchases of stock in trade by more than 50 percent of the
correct amount on Form 5472. 238
b) Reporting of only $250,000 of a total of $400,000 of reportable transactions on
Form 5472.239
c) Failure to attach a Cost Sharing Statement to Form 5471.240
d) Failure to report the Income Statement and Balance Sheet in USD on Form
5471.241
V. IRS MITIGATION OF PENALTIES
A. A taxpayer may be able to mitigate the potential penalties by making an affirmative
showing that there was “reasonable cause.”242
If a taxpayer exercises ordinary business
care and prudence and is nevertheless unable to provide the required information, the
failure to provide such information will be considered to be due to reasonable cause.243
B. On July 8, 2015, the IRS updated the Internal Revenue Manual (IRM) to provide both its
field agents and taxpayers the current application of certain penalties associated with
237
C.C.A. 2004-29-007 (May 28, 2004).
238
Id..
239
C.C.A. 2000-24-051 (Apr. 20, 2000).
240
F.S.A. 2000-11-021 (Dec. 15, 1999).
241
C.C.A. 2006-45-023 (Jun. 20, 2006).
242
I.R.C. § 6679(a)(1).
243
Treas. Reg. § 301.6679-1(a)(3).
35

international tax compliance obligations.244
The IRS affirmatively states that reasonable
cause applies to most, if not all, of the penalties and it will be considered per I.R.M.
20.1.1, which addresses the criteria for abatement of penalties245
C. “Reasonable Cause” Exceptions. The most commonly used “reasonable cause”
exceptions include the following:
1. Ordinary Business Care and Prudence.
a. The IRS typically looks at the following factors in determining whether a
taxpayer has exercised ordinary business care and prudence:
1) The taxpayer should have a compelling reason for seeking abatement. All
appropriate explanations should coincide with the dates and circumstances
upon which the penalties were based;
2) The taxpayer should have a history of tax compliant behavior;246
3) The length of time it took the taxpayer to become compliant must be
reasonable under the circumstances; and
4) The underlying reason for noncompliance must be beyond the taxpayer’s
control.247
b. Taxpayers who conduct business or transactions offshore or in foreign countries
have a responsibility to exercise ordinary business care and prudence in
determining their filing obligations and other requirements. It is not reasonable or
prudent for taxpayers to have no knowledge of, or to solely rely on others for, the
tax treatment of international transactions.248
2. Death, Serious Illness, or Unavoidable Absence
a. It is important that the taxpayer sufficiently document the condition that caused
noncompliance. The IRS will consider the following information in determining
whether the taxpayer has demonstrated reasonable cause due to death, serious
illness or unavoidable absence:
1) The relationship between the taxpayer and the other parties involved;
2) The date of death;
3) The dates, duration, and severity of illness;
4) The dates and reasons for absence;
5) How the event prevented compliance;
6) Whether other business obligations were impaired; and
244
I.R.M. 20.1.9 (Jul. 8, 2015).
245
I.R.M. 20.1.9.1.1(4) (Jul. 8, 2015); I.R.M. 20.1.1.3 (Nov. 25, 2011).
246
See I.R.M. 20.1.1.3.2.2(2)(B) (Feb. 22, 2008).
247
I.R.M. 20.1.1.3.2.2 (Nov. 25, 2011).
248
IRM 20.1.9.1(4) (Jul. 8, 2015).
36

7) Whether tax obligations were promptly attended to when the illness passed, or
within a reasonable period of time after a death or return from an unavoidable
absence.249
3. Fire, Casualty, Natural Disaster, or Other Disturbance. The IRS will consider the
following factors in determining whether the taxpayer has demonstrated reasonable
cause due to fire, casualty, natural disaster or other disturbance:
a. The time frame between the fire, casualty, natural disaster or other disturbance
and the due date of the tax reporting obligations;
b. The effect on the conduct of the taxpayer’s overall business;
c. The steps undertaken by the taxpayer to attempt to comply; and
d. The taxpayer’s degree of compliance when circumstances permitted.250
4. Unable to obtain records.
a. The IRS will consider the following information in determining whether the
taxpayer has demonstrated reasonable cause due to the inability to obtain records:
1) Why the records were needed to comply;
2) Why the records were unavailable and the steps undertaken to secure the
records;
3) Whether other measures were explored to secure the necessary information;
4) Whether the taxpayer could have reasonably estimated the necessary
information;
5) Whether the taxpayer contacted the IRS for guidance;
6) Whether the taxpayer promptly complied once the information was obtained;
7) Supporting documentation such as correspondence indicating the taxpayer’s
efforts to obtain the information.251
b. With respect to international reporting obligations, the IRS will generally not
grant reasonable cause relief solely because of any of the following:
1) A foreign country would impose penalties for disclosing the required
information;
2) A foreign trustee refuses to provide the information; or
3) The taxpayer relied upon another person to file the returns (it is the taxpayer's
responsibility to ensure that all returns are filed timely and accurately.252
5. Mistake was made. The IRS will consider the following information in determining
whether the taxpayer has demonstrated reasonable cause due to making a mistake:
249
IRM 20.1.1.3.2.2.1 (Nov. 25, 2011).
250
IRM 20.1.1.3.2.2.2 (Nov. 25, 2011).
251
IRM 20.1.1.3.2.2.3 (Nov. 25, 2011).
252
IRM 20.1.9.1(4) (Oct. 24, 2013)
37

a. How and when the taxpayer became aware of the mistake;
b. The extent to which the mistake was corrected;
c. The relationship between the taxpayer and the person, if any, to whom the
taxpayer delegated the responsibility to report the information;
d. If the taxpayer undertook timely steps to correct the mistake after its discovery;
and
e. The supporting documentation.253
6. Erroneous Advice or Reliance.254
a. In Neonatology Associates, PA v. Commissioner,255
the court applied a three-
prong test to establish reasonable cause to negate an accuracy related penalty:
1) The advisor must be a competent professional who had sufficient expertise to
justify reliance;
2) The taxpayer must have given the advisor all necessary and accurate
information; and
3) The taxpayer must have actually relied in good faith on the advisor’s
judgment.256
b. Inherent conflict of interest. The taxpayer’s knowledge of an advisor’s
conflicting interest should preclude a finding of good faith and reasonable
reliance.257
c. Inadequate disclosure of facts by the taxpayer to the advisor. The taxpayer’s
reasonable cause defense should not be accepted where the taxpayer did not
sufficiently explain certain facts to the qualified tax professional to allow him to
form a sound opinion.258
d. Inadequate qualification of advisor. It is not reasonable for the taxpayer to rely
upon advice from an advisor who the taxpayer knows does not possess expertise
in the specific area of tax law.259
e. Actual reliance on advisor. Good faith reliance on an advisor’s opinion should
not be found if such reliance is unreasonable in light of the taxpayer’s is
sophistication, education, and experience.260
253
IRM 20.1.1.3.2.2.4 (Dec. 11, 2009).
254
IRM 20.1.1.3.2.2.5 (Nov. 25, 2011).
255
Neonatology Assocs., P.A. v. CIR, 115 TC 43 (Jul. 31, 2000), aff’d, 299 F3d 221 (3rd
Cir. 2002).
256
Id.
257
See, e.g., Blum v. CIR, 737 F3d 1303 (10th
Cir. 2013); Canal Corp. v. CIR, 135 TC 199 (2010).
258
See, e.g., Wright v. CIR, TC memo 2014-175 (2014).
259
See, e.g., Hristov v. CIR, TC Memo. 2012-147 (2012).
260
See, e.g., Woodsum v. CIR, 136 TC 585 (2011).
38

f. In the seminal case of United States v. Boyle,261
the Supreme Court discussed
penalty abatement where a taxpayer relies upon a professional advisor:
The administrative regulations and practices exempt late filings from the
penalty when the tardiness results from postal delays, illness, and other factors
largely beyond the taxpayer’s control… The principle underlying the IRS
regulations and practices – that a taxpayer should not be penalized for
circumstances beyond his control – already recognizes a range of exceptions
which there is no reason for us to pass on today. This principle might well
cover a filing default by a taxpayer who relied on an attorney or accountant
because the taxpayer was, for some reason, incapable by objective standards
of meeting the criteria of “ordinary business care and prudence.”262
7. Ignorance of the law. The ordinary business care and prudence standard requires
that taxpayers make reasonable efforts to determine their tax obligations.
a. The IRS will consider the following factors in conjunction with the taxpayer’s
demonstration of ignorance of the law:
1) The taxpayer’s level of education;
2) The taxpayer’s history of tax liability;
3) The taxpayer’s history of tax penalties;
4) Whether there were recent changes to the tax law or tax forms that the
taxpayer could not reasonably be expected to be aware of; and
5) The level of complexity of the tax or compliance issue.263
b. The IRS may find reasonable cause due to ignorance of the law provided either
of the following circumstances are present:
1) The taxpayer made a reasonable and good faith effort to comply with the tax
law, or
2) The taxpayer was not, and could not reasonably have been expected to be,
aware of a compliance requirement.264
c. Forgetfulness. The IRS will generally not consider a taxpayer’s assertion of
forgetfulness to demonstrate reasonable cause if the taxpayer relied upon another
person to undertake a required act because it is the sole responsibility of the
taxpayer to comply with tax obligations.265
D. First time Abatement (FTA) Waiver. The IRS provides an administrative penalty
waiver for penalties imposed upon first-time noncompliant taxpayers pursuant to Sections
261
United States v. Boyle, 469 US 241 (1985).
262
Id. at 255 n.6.
263
IRM 20.1.1.3.2.2.6 (Nov. 25, 2011).
264
Id.
265
IRM 20.1.1.3.2.2.7 (Aug. 5, 2014).
39

6651(a)(1)-(3) (failure to file tax return or to pay tax), 6656 (failure to deposit tax),
6698(a)(1) (failure to file timely partnership return), and 6699(a)(1) (failure to file timely
S corporation return).266
1. The intent of the IRS in establishing the FTA program was to help administer the
abatement of penalties and reward past compliance.
2. In general, to qualify for a FTA waiver, the taxpayer must:
a. Have not had a previous filing requirement or prior penalties for the preceding 3
years with respect to tax returns currently required to be filed, and
b. Have filed or validly extended all tax returns currently required to be filed and
paid, or arranged, to pay any tax due.267
3. The taxpayer will not be granted FTA penalty relief based upon a clean compliance
history if:
a. There was a penalty imposed for any tax period within the preceding 3 years with
respect to the same tax return;.
b. The taxpayer has incurred unreversed penalties of a “significant amount” assessed
for any tax period within the preceding 3 years with respect to the same tax return
and the taxpayer received a notice of assessment from the IRS;
c. The taxpayer has incurred certain enumerated reversed or suppressed penalties
within the preceding 3 years with respect to the same tax return (regarding those
penalties not explicitly stated, a fully reversed penalty will demonstrate
compliance for that tax period);
d. The penalty was imposed for EFTPS avoidance (although FTA relief may still be
granted for any failure to file and failure to pay penalties;
e. There were at least 4 failure to deposit tax penalty waivers for any tax period
within the preceding 3 years with respect to the same tax return;
f. There was an estimated tax penalty assessed for any tax period within the
preceding 3 years.268
4. If the IRS does not grant FTA penalty relief because the taxpayer did not have a clean
compliance history, the IRS will use the taxpayer’s reasonable cause explanation to
determine whether the penalty may be abated under a reasonable cause exception.269
5. Generally, a taxpayer may request FTA penalty relief by filing a formal claim on
Form 843, Claim for Refund and Request for Abatement with the IRS.270
An informal
claim may also be made by filing with the IRS a written request signed by the
266
IRM 20.1.1.3.6.1 (Aug. 5, 2014).
267
IRM 20.1.1.3.6.1(1) (Aug. 5, 2014).
268
IRM 20.1.1.3.6.1(3), (5), (8) (Aug. 5, 2014).
269
IRM 20.1.1.3.6.1(4) (Aug. 5, 2014).
270
IRM 20.1.1.3.3.4(5) (Aug. 5, 2014).
40

taxpayer. The request should identify the penalty or addition to tax for which
abatement is being requested.271
6. FTA penalty relief generally does not apply to the failure to timely international
information returns; however, if there was also a penalty assessed for failure to file
Form 1120 and it qualifies FTA penalty relief, the IRS may also grant FTA penalty
relief with respect to the penalty for failure to file the international information
return.272
E. Offshore Voluntary Disclosure Program (OVDP) - The IRS has initiated various
iterations of OVDPs to encourage U.S. taxpayers to report previously undisclosed foreign
accounts and assets. These programs allow taxpayers to avoid substantial civil penalties
and criminal prosecution.
1. The OVDP covers all undisclosed foreign accounts and assets required to be reported
on the FBAR and foreign information returns with respect to which there are
underreported tax liabilities. If a taxpayer reported, and paid tax on, all taxable
income derived from foreign accounts and assets, the taxpayer does not need to use
the OVDP to file delinquent or amended tax returns if certain conditions are
satisfied.273
2. 2012 OVDP274
a. Unlike previous OVDPs, there is no deadline for taxpayers to apply.
b. The penalty rate is equal to 27.5 percent (or in limited circumstances, a reduced
penalty rate of 12.5 or 5 percent) of the highest aggregate balance in foreign
financial accounts or value of foreign assets and entities during the 8-year
voluntary disclosure period.
c. Additional penalties that may apply include a 20 percent accuracy-related penalty
as well as failure to file and failure to pay penalties.
3. 2014 OVDP275
a. The effective date is July 1, 2014.
b. This is a continuation of the 2012 OVDP with some significant modifications.
271
IRM Exhibit 20.1.1-8 (Aug. 5, 2014).
272
IRM 20.1.9.3.5(3) (July 8, 2015).
273
See Delinquent FBAR Submission Procedures, http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-FBAR-
Submission-Procedures; Delinquent International Information Return Submission Procedures,
http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-International-Information-Return-Submission-Procedures.
274
See Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers, http://www.irs.gov/Individuals/
International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers.
275
See Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers, http://www.irs.gov/Individuals/
International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers-2012-Revised.
41

c. A 50 percent penalty applies if the taxpayer maintains an account with a foreign
financial institution or had dealings with a facilitator who aided the taxpayer in
establishing or maintaining an offshore arrangement, and the institution or
facilitator is under government investigation.
d. The reduced penalty rates of 12.5 and 5 percent are eliminated due to the
expansion of the Streamlined Filing Compliance Procedures.276
F. Delinquent International Information Return Submission Procedures. In addition to
modifying the OVDP Program in 2014, the IRS eliminated FAQ #18 of the 2012 OVDP
and replaced it with the new Delinquent International Information Return Submission
Procedures.277
1. Taxpayers who have unreported income or unpaid tax are not precluded from filing
delinquent international information returns.278
2. A reasonable cause statement is now required and penalties may be imposed if the
IRS does not accept the taxpayer’s reasonable cause explanation.279
3. “The longstanding authorities regarding what constitutes reasonable cause continue to
apply, and existing procedures establishing reasonable cause, including requirements
to provide a statement of facts under penalties of perjury, continue to apply.”280
The
additional requirements are as follows:
a. The taxpayer has not filed one or more required international information returns;
b. The taxpayer has reasonable cause for not timely filing the international
information returns;
c. The taxpayer is not under a civil or criminal investigation by the IRS; and
d. The taxpayer has not already been contacted by the IRS about the delinquent
international information returns.281
G. Streamlined Filing Compliance Procedures.282
Individuals, including estates of
individuals, who failed to report foreign financial assets and pay all tax due with respect
276
See discussion infra Part V.G.
277
See Delinquent International Information Return Submission Procedures, http://www.irs.gov/Individuals/International-
Taxpayers/Delinquent-International-Information-Return-Submission-Procedures.
278
Id.
279
Id.
280
See Delinquent Information Return Submission Procedures Frequently Asked Questions and Answers,
http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-International-Information-Return-Submission-Procedures-
Frequently-Asked-Questions-and-Answers.
281
See Treas. Reg. §§ 1.6038-2(k)(3); 1.6038A-4(b); 301.6679-1(a)(3).
282
See Streamlined Filing Compliance Procedures, http://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-
Compliance-Procedures.
42

to those assets, may avail themselves of the modified streamlined filing compliance
procedures.283
1. Eligibility Criteria. The individual must satisfy a general eligibility requirement as
well as specific eligibility requirements that apply to both U.S. residents and
nonresidents.284
a. General Eligibility Requirement. The failure to report all income, pay all tax
and submit all required information returns, including FBARs, may not be due to
non-willful conduct.
b. Specific Eligibility Requirements
1) Streamlined Foreign Offshore Procedures.285
If the individual is a U.S.
nonresident, the individual must satisfy both of the following conditions:
a) The individual must meet the applicable non-residency requirement as
follows:
i. U.S. citizens or lawful permanent residents (“green card holders”). If
the individual is a U.S. citizen or a green card holder, the individual
did not have a U.S. abode and was physically present outside the
United States for at least 330 full days, in any one or more of the most
recent 3 years for which the U.S. tax return due date (or properly
applied for extended due date) has passed; and
ii. Individuals who are not U.S. citizens or green card holders. If the
individual is not a U.S. citizen and or green card holder, the individual
did not meet the substantial presence test of IRC section 7701(b)(3) in
any one or more of the last 3 years for which the U.S. tax return due
date (or properly applied for extended due date) has passed.286
b) The individual failed to report the income from a foreign financial asset
and pay the tax as required by U.S. law, and may have failed to file an
FBAR with respect to a foreign financial account.287
2) Streamlined Domestic Offshore Procedures.288
If the individual is a U.S.
resident, the individual must satisfy all of the following conditions:
283
Id.
284
Id.
285
See Instructions for Streamlined Procedures, Streamlined Filing Compliance Procedures, U.S. Taxpayers Residing in the
United States, http://www.irs.gov/Individuals/International-Taxpayers/U-S-Taxpayers-Residing-Outside-the-United-States
286
Id.
287
Id.
288
See Instructions for Streamlined Procedures, U.S. Taxpayers Residing in the United States,
http://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures
43

a) The individual failed to meet the applicable non-residency requirement;
b) The individual has previously filed a U.S. tax return (if required) for each
of the most recent 3 years for which the U.S. tax return due date (or
properly applied for extended due date) has passed; and
c) The individual has failed to report gross income from a foreign financial
asset and pay tax as required by U.S. law, and may have failed to file an
FBAR and/or one or more international information returns (e.g., Form
5471) with respect to the foreign financial asset.289
2. If the IRS has initiated a civil examination or criminal investigation, the taxpayer will
not be eligible to use the streamlined procedures.290
3. Taxpayers eligible to use streamlined procedures who have previously filed
delinquent or amended returns must pay previous penalty assessments.291
4. General Treatment Under the Streamlined Procedures
a) Tax returns submitted under the streamlined filing compliance procedures will be
processed like any other return submitted to the IRS. Consequently, receipt of the
returns will not be acknowledged by the IRS and the streamlined filing process
will not culminate in the signing of a closing agreement with the IRS.292
b) Returns submitted under the streamlined filing compliance procedures will not be
subject to IRS audit automatically, however, they may be selected for audit and
they may be subject to verification procedures, additional civil penalties, and,
potentially, criminal penalties, if appropriate.293
5. Coordination Between Streamlined Procedures and OVDP. If a taxpayer makes a
submission under the streamlined filing compliance procedures, the taxpayer may not
participate in the OVDP. Similarly, a taxpayer who submits an OVDP voluntary
disclosure letter pursuant to OVDP FAQ #24 on or after July 1, 2014, is not eligible
to participate in the streamlined filing compliance procedures.294
289
Id.
290
See Streamlined Filing Compliance Procedures, http://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-
Compliance-Procedures.
291
Id.
292
Id.
293
Id.
294
Id.
44

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