Foreign-owned domestic disregarded entities: why new reporting requirements?

• Author: Freeman, Jason B.

Domestic disregarded entities wholly owned by foreign persons are now subject to new reporting obligations. The Treasury Department and the 1RS recently issued final regulations (T.D. 9796) that treat such entities as domestic corporations rather than as disregarded entities for purposes of the reporting requirements under Sec. 6038A.The regulations are effective for tax years beginning on or after Jan. 1,2017, and ending on or after Dec. 13,2017. Under the new rules, many domestic disregarded entities with foreign owners that previously had no filing obligations will now be required to obtain an employer identification number (EIN) and to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.

Background

The check-the-box entity classification regulations under Regs. Sees. 301.7701-1 through 301.7701-3 treat a domestic business entity with a single owner either as a corporation or as an entity disregarded as separate from its owner (i.e., a "disregarded entity"). The default rules classify a single-owner entity as a disregarded entity for federal tax purposes unless the entity makes a formal election to be treated as a corporation.

Disregarded entities are typically not required to obtain an EIN and generally do not have federal tax filing obligations separate from those of their owner. Therefore, no federal income or information return filing is generally required for disregarded entities owned by foreign persons if neither the disregarded entity nor its owner received U.S.-source income or engaged in a U.S. trade or business during the tax year.

Unlike disregarded entities, however, domestic corporations are generally required to file annual income tax returns. Sec. 6038A also imposes additional information-reporting obligations and record-maintenance requirements on domestic corporations that have a foreign owner with a 25%-or-greater interest. Such 25% foreign-owned corporations are required to file Form 5472 to report "reportable transactions" with related parties. These corporations are also subject to the record-maintenance requirements imposed by Sec. 6001.

Why the changes?

Under the newly finalized regulations, disregarded entities wholly owned by a foreign person will now be treated as domestic corporations for the limited purpose of the reporting, record-maintenance, and other compliance requirements under Sec. 6038A.The changes are part of a...