Form 5471 substantial compliance: what does it mean and why is it critical?

• Author: Pasmanik, Philip T.

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PREVIEW

* Form 5471 must be filed by certain U.S. persons who are officers, directors, or shareholders in certain foreign corporations.

* Not filing the form, filing it late, or making an incomplete filing subjects taxpayers to penalties and an indefinitely extended statute of limitation.

* Find out the IRS's stringent standards for determining substantial compliance with the filing requirements.

Last year, the IRS released a new International Practice Unit (IPU) (1) providing guidance (2) to its examiners on the penalties that apply if certain categories of U.S. shareholders fail to comply with the reporting requirements on Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. The IRS has stringent standards to determine when a Form 5471 is substantially complete and thus not subject to the $10,000 penalty (discussed below) under Sec. 6038(b). (3)

It is important to note that the statute of limitation remains open on the taxpayer's entire tax return if Form 5471 is not filed, and does not expire until three years after the date on which the information required to be reported is filed and properly reported. (4)

To adhere to the reporting requirements of Secs. 6038 and 6046, Form 5471 is required to be filed by certain U.S. persons who are officers, directors, or shareholders in certain foreign corporations. (5)

Generally, certain U.S. persons must complete the schedules, statements, and/or other information requested. Four categories (6) of U.S. persons (7) are required to file Form 5471. (8) Form 5471 is required to be attached to and filed with the income tax return that the particular person must file (Form 1040, U.S. Individual Income Tax Return-, Form 1120, U.S. Corporation Income Tax Return-, Form 1065, U.S. Return of Partnership Income-, or Form 990, Return of Organization Exempt From Income Tax). The reporting period during which the required information is provided is the annual accounting period of the foreign corporation ending with or within the U.S. person's tax year. (9)

Penalties

The IPU provides that penalties under Sec. 6038 may apply when a Form 5471 is filed late, is substantially incomplete, or is not filed at all. For any of these three types of failures, an initial penalty of $10,000 per Form 5471 per year may be assessed. Also, an additional penalty of $10,000 per Form 5471 per year may be assessed for every 30-day period (or fraction thereof) commencing 90 days after the U.S. person was notified that a failure exists. (10) The maximum amount of that penalty is $50,000 per Form 5471 per year. (11) These penalties may apply per Form 5471 required on an annual basis. (And the most significant penalty from a compliance standpoint is that the statute of limitation will not toll until the form is filed.)

Substantial Compliance

What is substantial compliance? Since a definition of "substantially complete" for Form 5471 reporting is not contained in the Code or the regulations, the IPU provides certain examples for IRS audit examiners where a Form 5471 may be considered not substantially complete. The IPU focuses on just two categories of Form 5471 filers: Category 4 and Category 5 filers.

A Category 4 filer includes a U.S. person who controlled a foreign corporation for at least 30 days during the tax year. (12) A...