Reporting Requirements for US Taxpayers with Offshore Companies

If you are an American taxpayer, and you look for or already have an offshore bank account or a company or other legal entity existing under the laws beyond the United States, you might be unaware of reporting and tax obligations imposed on you by the IRS. It’s better to be safe than sorry. Here we are giving certain facts and figures for your information.

A U.S. taxpayer investing in a foreign corporation, trust or account is generally subject to the same rules as domestic investors, even if the foreign entity’s business activity is conducted only offshore.

Report of Foreign Bank and Financial Account (FBAR)

A US person who has a financial interest, or signature authority, or other authority over any financial account in a foreign country, must file an FBAR, if the aggregate value of such accounts exceeds $10,000 at any time during the calendar year.

An FBAR is a Report of Foreign Bank and Financial Account. The form number is TD F 90-22.1. It is due by June 30th of the year following the year that the account holder meets the $10,000 threshold.

For the purposes of FBAR, the term “US Person” includes a citizen or resident of the United States, or a person in and doing business in the United States. The term “person” includes individuals and all forms of business entities, trusts, and estates.

Reporting on offshore accounts is required even if there are no activities on such accounts and they do not bring any income.

A person holding the power of attorney granting him signature authority over an offshore account is to report it on FBAR, even if he didn’t execute his signature right.

Investing In a Foreign Corporation

Being a shareholder of an offshore company (directly or indirectly), you are not required to file special tax reports on it, unless the company qualifies for one of the following criteria:

  • It is a personal holding company, or
  • It is a controlled foreign corporation; or
  • It is a passive foreign investment company.

Foreign Personal Holding Company

A personal holding company is defined in chapter 26, section 542 of the US Code. A corporation is treated as a personal holding company if it derives more than 60 percent of its income, after allowed adjustments, from dividends, interest, rent, royalties, and certain personal service contracts, and herewith more than 50 percent of its stock belongs up to five individuals.

Controlled Foreign Corporation

If US taxpayers own (directly or indirectly) in total more than 50 percent of a foreign company, the company qualifies as a controlled foreign corporation (CFC).

Each shareholder with at least 10 percent interest in a CFC is to file the form 5471 (Information Return of US Persons With Respect to Certain Foreign Corporations) along with the personal annual tax return.

In the case the CFC has any Subpart F income, such shareholder is required to include the part of this income attributable to his share, even if the company has not yet distributed this income to the shareholders.

Subpart F Income

Subpart F income is a category of mainly passive income from foreign sources subject to taxation in the United States. In the case of a CFC, it includes, among other things:

  • certain insurance income;
  • foreign personal holding company income (FPHCI), including dividends, interest, royalties, rent, annuities, capital gains, and income from certain personal contracts;
  • foreign base company sales income, which, in general, means income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with purchase or sale of personal property to, from, or on behalf of a related person, whereby such property was produced or is being sold or purchased in order to be consumed outside of the home country of the CFC;
  • foreign base company services income, which, in general, means income (whether in the form of compensation, commissions, fees, or otherwise) derived in connection with the performance of technical, managerial, engineering, architectural, scientific, skilled, industrial, commercial, or like services, which are performed for or on behalf of any related person outside the home country of the CFC. This position includes substantial assistance contributing to the performance of services by a CFC that has been furnished by a related person or persons.

Substantial assistance includes, but is not limited to, direction, supervision, services, know-how, financial assistance (other than contributions to capital), and equipment, material, or supplies, if such assistance furnishes skills being a principal element in producing the income, or if the assistance constitutes 50% of the service cost.

Herewith a related person is a person (individual, corporation, partnership, trust, or estate), which controls or is controlled by the CFC, or a person, which is controlled by the same person, which controls the CFC. Control means direct or indirect ownership of stock possessing more than 50 percent of the total voting power in the legal entity.

The law also provides for a de minimis rule. If the sum of foreign base company income (determined without adjustments as to deductions allowed to be taken into account) and the gross insurance income for the taxable year is less than the lesser of 5 percent of gross income or $1,000,000, then no part of the gross income for the taxable year shall be treated as foreign base company income or insurance income.

In the case of a CFC, Subpart F income does not include any item of income from sources within the United States, which is effectively connected with the conduct by such corporation of a trade or business within the United States (unless such item is tax exempt or subject to a lower tax under a tax treaty).

Foreign Passive Investment Companies (PFIC)

Following § 1297 of the US Code, a foreign-based corporation qualifies for treatment as a foreign passive investment company, if it has one of the following attributes:

  • 75 percent or more of the gross income of such corporation for the taxable year is passive income, resulting from investments rather than from active operating business, or
  • 50 percent or more of its assets produce passive income or are held for the production of passive income (dividends, interest, royalties, rents, and annuities).

For tax purposes, the PFIC concept includes foreign mutual funds and other pooled investment vehicles with at least one US shareholder.

PFIC is subject to quite complicated tax guidelines. The shareholders are required to keep accurate records on dividends, including undistributed income of the company. Most investors must pay the income tax on all such undistributed income attributable to their share in PFICs.

Other Information Reporting Obligations

You may also need to file the following information with the IRS:

  • Form 926 – Return by a US Transferor of Property to a Foreign Corporation;
  • Form 3520 – Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts;
  • Form 3520-A – Annual Information Return of Foreign Trust With a US Owner;
  • Form 5472 – Information Return of a 25 percent Foreign Owned US Corporation or a Foreign Corporation Engaged in a US Trade or Business;
  • Form 8865- Return of US Persons with Respect to Certain Foreign Partnerships.

The law provides for severe penalties for non-reporting and/or non-payment of the due tax on your offshore income or offshore income attributable to you directly or indirectly. The IRS policy is definitely not encouraging offshore investments in general.

If you are a “genuine trader”, which fairly requires an offshore entity in the work process, you might find your way through such economic obstacles. In any way, you need thorough consulting by a local CPA experienced in US tax law.

Disclaimer: pursuant to Internal Revenue Service guidance, please be informed that any information given in this article has been provided for academic purposes only; it was not intended and is not to be used as an advice to any person or entity for the purpose of avoiding taxes and penalties imposed under the Internal Revenue Code.