IRS Penalties

Automatic Assessment of Penalties under IRC Section 6038(b)(1)

Have you established a local limited liability company (LLC) or partnership to hold your interest in property or to manage a business? Are you simply a secretary or director of that interest?  Is this company controlled or owned more than 50% by Americans? Many otherwise well-informed US executives are surprised to discover that their small foreign corporation or partnership is subject to several US reporting requirements. Most persons will use form 5471 Information Return of U.S. Persons with Respect to Certain Foreign Corporations.

In August, 2008, the Internal Revenue Service began issuing letters to some taxpayers to alert them to an upcoming procedural change relative to the automatic assessment of penalties. These letters were issued to taxpayers who may not have timely filed their corporate return and/or not timely filed their Forms 5471.

IRC Section 6038(a) requires information reporting with respect to certain foreign corporations (Form 5471) and describes the information required to be reported on this form.   IRC Section 6038(b)(1) provides for a monetary penalty of $10,000 for each Form 5471 that is filed after the due date of the income tax return (including extensions) or does not include the complete and accurate information described in Section 6038(a).

IRC Section 6038(c) provides for a 10% reduction of the foreign taxes available for credit under IRC Sections 901, 902 and 960.  Per IRC Section 6038(c)(3), this reduction to the foreign taxes can be applied in addition to the monetary penalty.

Taxpayers are encouraged to submit delinquent Forms 5471 for past income tax periods prior to January 1, 2009 to the address indicated in the instructions.

If you are subject to these regulations, you should seek to comply before year-end 2008, or failing that as soon as possible thereafter. If you are contemplating an investment that would subject you to these regulations, please make the time to familiarize yourself with your obligations under the law. Should the underlying business objective support the formation of a foreign entity, these regulations are unlikely to stop the project. On the other hand, perhaps the pleasures of additional regulation can be avoided.