U.S. taxpayers with interests in foreign corporations may be required to file Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations. Form 5471 is an informational return detailing the ownership and transactional data for U.S. officers, directors, and shareholders of foreign corporations. Form 5471 is an informational return that is filed with an individual’s 1040. Failing to file Form 5471, or filing it with incorrect information can result in severe penalties.
Initial $10,000 Penalty
The IRS assesses an initial $10,000 penalty for each Form 5471 that is not filed in a timely manner or when it is filed but the information is incorrect or incomplete. The penalty applies to each required Form 5471 for each year. So, taxpayers with interests in multiple foreign corporations for multiple years can face substantial cumulative penalties. For example, if a taxpayer was required to file Form 5471 for three different corporations for two consecutive years, the taxpayer would face $60,000 in initial penalties.
Continuation Penalties
The penalties can increase substantially from the $10,000 initial penalty if the taxpayer does not take corrective action after receiving a notice from the IRS. The taxpayer has 90 days after receiving an IRS notice of a failure-to-file to come into compliance or else face an additional penalty of $10,000 for each 30-day period of noncompliance. The continuation penalty is capped at $50,000 per Form 5471 per year. So, the maximum penalties for failing to file a particular Form 5471 is $60,000 ($10,000 initial penalty plus $50,000 continuation penalty). For example, an individual who was required to file Form 5471 for three corporations for two consecutive years, would face $60,000 in combined penalties for each of the six different Form 5471s, for a grand total in $360,000 of penalties.
Reduction of Foreign Tax Credits
Form 5471 noncompliance can also affect a taxpayer’s foreign tax credits. In addition to the significant monetary penalties, the amount of an individual’s foreign tax credits can be reduced by an initial 10%. If the noncompliance continues for 90 days after receiving an IRS notice, the reduction in FTC can be increased by an additional 5% for each 3-month period the noncompliance continues. For example, if an individual would otherwise be entitled to a foreign tax credit of $10,000 but the individual did not file form 5471 until 6 months after receiving an IRS notice, the individual would get their foreign tax credit reduced by 20% (10% initial reduction plus two 5% additional reductions for each 3-month period). So, the taxpayer would only be entitled to a foreign tax credit of $8,000 instead of $10,000.
40% Accuracy-Related Penalty
Form 5471 reporting failures can also lead to increased accuracy-related penalties. The IRS may apply a 20% accuracy-related penalty for underpayment of tax if the underpayment is substantial or due to negligence. But the penalty is doubled to 40% if the underpayment is due to a foreign financial asset that was undisclosed by failing to file Form 5471.
Form 5471 is due with the taxpayer’s 1040. If a taxpayer fails to file Form 5471 in a timely manner, the penalties can be severe. The IRS can assess penalties totaling up to $60,000 for each Form 5471 that was not filed. In addition, accuracy-related penalties can be doubled for any underpayment of tax. Given the complexities surrounding foreign corporations, it is imperative to review your reporting obligations with a tax professional annually.
At Safeguard Law, PLLC, our team of experienced tax attorneys specializes in helping our clients navigate issues such as this. Contact us today to schedule a consultation! Our main business line is (202) 505-1741.