Few Americans consider the United States to be a money laundering haven, but it is. Earlier this year, the European Parliament wrote:
“The USA is seen as an emerging leading tax and secrecy haven for rich foreigners, when in parallel it has reprimanded other countries for helping rich Americans hide their money offshore. It is difficult to estimate how much revenue the United States loses from tax avoidance and evasion, but some have suggested that the annual cost of offshore tax abuses may be around US $100 billion per year.”1
To combat U.S. money laundering by foreign citizens, the Internal Revenue Service (“IRS”) and the U.S. Department of Treasury Financial Crimes Enforcement Network (“FinCEN”) implemented new and strengthened existing reporting requirements for foreign individuals who have financial interests in the United States. Although these regulations are applied broadly, there has been very little discussion about their implementation in the United States. Presumably, there has been even less discussion abroad.
This article focuses on two new, wide-ranging regulatory requirements: 1) the requirement that foreign-owned entities, treated as “disregarded entities” for U.S. federal income tax purposes, file an IRS Form 5472, Information Return of a 25 Percent Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business; and 2) the requirement that all entities report beneficial ownership when opening a bank account. Failure to comply with these requirements may subject foreign nationals and U.S. individuals who do business with them to civil and criminal sanctions.
IRS Form 5472 Filing Requirements: Old and New
As has always been the case, an IRS Form 5472 is required to be filed:
“If, at any time during a taxable year, a corporation …
- is a domestic corporation…, and
- is 25-percent foreign-owned.”2
The IRS Form 5472 has always been intended to be a mechanism for the IRS to obtain information on transactions between a domestic corporation and their foreign owners. The requirements for transactions that trigger an IRS Form 5472 filing are described on the form and are broad. They include most monetary transactions (rent, royalties, payments for services, sale of property, etc.), and also include transactions in which less than full consideration is paid.
The IRS Form 5472 collects the following information: 1) name; 2) principal place of business; 3) nature of the business; and 4) country or countries in which each related party—with any transaction with the reporting corporation—is organized or resides.3 The form requires that the taxpayer report gratuitous transfers (i.e., gifts).4 The IRS also has attribution rules, so if a company’s shares are owned by close family members, their ownership may be attributed to one person.5 For example, a domestic corporation, whose members include a father and son who are both foreign persons and both have a 15 percent ownership interest, must file an IRS Form 5472.
While the IRS Form 5472 filing requirements described above are not new, recently enacted Treasury regulations expanded the application of the IRS Form 5472 from domestic corporations to both domestic corporations and entities that are disregarded for U.S. federal income tax purposes (“DE”).6 This is a dramatic change. The transactions that must be reported by a DE are arguably broader than that of a domestic corporation and include:
“any sale, assignment, lease, license, loan, advance, contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented. A transaction also includes the performance of any services for the benefit of, or on behalf of, another taxpayer.”7
A limited liability company formed in the United States and wholly owned by a foreign person will be subject to the reporting requirements of Section 6038A.8
How does a DE file an IRS Form 5472 (which is required to be attached to a U.S. tax return) when a DE does not have a U.S. tax return filing obligation to begin with? The Treasury Regulations cross-reference the instructions to IRS Form 5472, which require that all DEs file a pro forma tax return on IRS Form 1120 and attach the IRS Form 5472 to the IRS Form 1120.9 The only information required on an IRS Form 1120 filed by a DE is its name and address, its employer identification number, and Box E of the IRS Form 1120. “Foreign-owned U.S. DE” should be written across the top of the Form 1120 with Form 5472 attached, and it may be faxed or mailed to the IRS.
For example, suppose a Canadian citizen purchases a winter home in South Florida. As is the case with many individuals who may want to make a real estate purchase with some level of anonymity, he/she can title the property in the name of a LLC. This LLC, historically, would never have had any U.S. tax filings obligations. Under the new Treasury regulations described above, the LLC must now must file a Form 5472 every year (along with a pro forma IRS Form 1120) because a reportable transaction includes a right to use property granted by a DE (i.e., the LLC) to a foreign-related party.10
These rules discussed above are in addition to the longstanding reporting requirements imposed on foreign corporations that are engaged in a U.S. trade or business in the United States during a taxable year.11 The IRS requires that any foreign corporation engaged in a U.S. trade or business file an IRS Form 5472. Foreign corporations are corporations that incorporated offshore.12 Thus, a corporation can be foreign even if its shareholders are U.S. persons.
An IRS Form 5472 is generally due on the successive March 15 for that calendar year (e.g., the 2017 form was due on March 15, 2018). It must be filed with an IRS Form 1120—corporate tax return—even if the entity does not pay U.S. taxes, and in the case of a DE, it must be filed with a pro forma IRS Form 1120.
Failure to file the IRS Form 5472 subjects the entity to a $25,000 penalty.13 The penalty is continuing, meaning that additional $25,000 penalties accrue each month after the taxpayer is placed on notice that it is not in compliance.14 The penalty is not subject to regular audit deficiency procedures, and the taxpayer may waive his right to present evidence at any hearing if he does not respond to the IRS at the first opportunity, which differs from typical procedures where the IRS gives the taxpayers multiple opportunities to comply.15
Effective May 11, 2018, All Legal Entities Must Disclose Any Natural Person with Control of and a 25 Percent or Greater Interest in the Entity to Financial Institutions
Separate and apart from the new IRS filing requirement imposed on DEs, effective May 11, 2018, any legal entity (domestic or foreign) opening an account at specified financial institutions (i.e., bank accounts, securities accounts, and futures trading accounts) must verify the identity of:
- each individual, if any, who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25 percent or more of the equity interests of a legal entity customer; and
- a single individual with significant responsibility to control, manage, or direct a legal entity customer, including:
- an executive officer or senior manager (g., a chief executive officer, chief financial officer, chief operating officer, managing member, general partner, president, vice president, or treasurer); or
- any other individual who regularly performs similar functions.16
These FinCEN regulations apply to any entity opening an account, including limited liability companies, corporations, and trusts. FinCEN’s rule differs from the IRS Form 5472 rules, so one needs to carefully consider the separate requirements for both rules. In particular, the Form 5472 rules focus exclusively on ownership, not control, whereas FinCEN’s rules require that covered financial institutions identify a controlling person with less than a 25 percent ownership stake as well individuals with a 25 percent or greater interest. The IRS Form 5472 also requires an attribution analysis. Consequently, multiple family members are considered to be one person for IRS purposes, but not when disclosing their identity to a financial institution. Thus, a family-owned business might be required to file an IRS Form 5472 listing individual family members but not identify family members to U.S. financial institutions where the entity has a U.S. bank or trading account.17
The FinCEN rules are prospective and financial institution are not required to verify the ownership interest in current accounts:
“The obligation to obtain or update beneficial ownership information on legal entity customers with accounts established before May 11, 2018, is triggered when a financial institution becomes aware of information about the customer during the course of normal monitoring relevant to assessing or reassessing the risk posed by the customer, and such information indicates a possible change of beneficial ownership.”18
However, when an account holder opens a new account or takes other action such as renewing a loan or rolling over a certificate of deposit, FinCEN requires the entity to provide evidence of the identity of the natural person who has a beneficial interest via a driver’s license or passport. Financial institutions may use non-documentary methods of verification such as contacting the natural person or references with other financial institutions.
Individuals who submit false or misleading information to financial institutions are subject to criminal prosecution under the bank fraud and money laundering statutes. Banks that are skeptical of the information furnished by the customer may close the account, file a suspicious activity report, or both.
In light of the interest in financial transparency, expect vigorous enforcement of these new statutes and regulations. Foreign citizens and companies with U.S. financial interests should consult with U.S. counsel to determine if they are complying with these regulations.
- EU-US Trade and Investment Relations: Effects on Tax Evasion, Money Laundering and Tax Transparency, p. 6, (Mar. 2017), available at europarl.europa.eu/RegData/etudes/IDAN/2017/598602/EPRS_IDA(2017)598602_EN.pdf.
- Section 6038A of the Internal Revenue Code of 1986, as amended (the “Code”).
- A copy of the form can be found here: irs.gov/pub/irs-pdf/f5472.pdf.
- 26 C.F.R. § 1.6038A-2(b)(4).
- 26 C.F.R. § 1.6038A-1(e) (citing 26 U.S.C. § 318).
- 26 C.F.R. § 1.6038A-1(c)(1).
- See 26 C.F.R. § 1.482-1(i)(7) and IRS Form 5472, Filing Instructions, Part V (“You must check the box in Part V if you are a foreign-owned DE that had any other transaction as defined by Regulations section 1.482-1(i)(7) not already entered in Part IV. These transactions include amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the entity.”).
- Note that in order to file an IRS Form 5472, one must obtain a taxpayer identification number by filing a Form SS-4, which will identify a responsible party.
- See IRS Form 5472, Filing Instructions, When and Where to File.
- See IRS Form 5472 instructions, Part V. See also 26 C.F.R. § 1.482-1(i)(7).
- See U.S.C. § 6038C.
- See 26 U.S.C. § 7701(a)(5).
- Congress raised the penalty from $10,000 to $25,000 in 2017. However, the regulations have not been amended and still reflect the lower amount. 26 C.F.R. § 1.6038A-4. An argument can be made that the lower amount should apply. See United States v. Colliot, AU-16-CA-01281-SS, 2018 WL 2271381 (W.D. Tex. May 16, 2018).
- 26 C.F.R. § 1.6038A-4(a)(3). Separate penalties may be assessed for failing to comply with the requirement to produce records.
- 26 C.F.R. § 1.6038A-6.
- FinCEN FAQ 13; 31 C.F.R. § 1010.230.
- FinCEN does not require identification of the beneficiary of the trust even though the bank account is held for the benefit of the trust’s beneficiary/beneficiaries.
- Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions (Apr. 3, 2018), available at fincen.gov/sites/default/files/2018-04/FinCEN_Guidance_CDD_FAQ_FINAL_508_2.pdf.