It is early December and after all your research you decide to incorporate your business in the United States. You live and work in France and think a great way to enhance your business will be having a presence in the US. You have done your homework and decided on the state in which you want to form your LLC. You engage an incorporation service and incorporate your business. The service gives you a nice new set of documents and collects its fees. You diligently apply for a Federal Identification Number and in January you open a bank account for your new business. You have had no income yet but anticipate this changing soon.
You wake up on April 16th unaware that the filing date for something called Form 5472 had been the day before and you are now subject to a $25,000 penalty. Your business started to generate income in March and think it is wise to get some advice on your tax situation. You do a little research and go through the confusing terminology and tax structures. Weeks go by and you select an advisor who simplifies things for you and touts something called a Single Member LLC. Your new advisor asks about your business activities, and you tell him that you did not start earning income until just recently and really did not have anything to report in the previous year other than a few startup costs. He suggests that because you have no income you should be able to file a1040NR the following year. He also advises you that because you have no physical business location or payroll in the US your earnings will be exempt from taxation in the US.
You think to yourself what is all the fuss about, the US tax system is wonderful! Going forward you have a great year in the US and elsewhere and close out the year having made some respectable profits. Taking the advice of your new tax advisor you applied for and received an ITIN to be used on your 1040NR. It’s now late April of the following year and are meeting for a coffee with your fellow entrepreneurs. Enjoying your croissant and café you casually ask if they were going to be filing their 1040NR’s soon. A discussion ensued with one member of your group stating she likes to file early and make sure the 5472 for her C-Corp. was filed on time. The other members nodded their approval. Trying not to look stupid you agree and return to your office and begin to do a Google search on Form 5472.
After a few minutes you now realize you missed two years of filing and currently owe the tidy sum of $50,000 in penalties plus interest. Your US tax advisor is not taking your calls or e-mails and you begin to search for a second advisor. It is now May you cannot believe this is possible. Your research reveals that there are not a lot of ways to avoid these penalties, but you are confident a good advisor will calm your fears.
Here are some of the facts outlined by your new advisor:
1. The 5472 Information Return of a 25% Foreign- Owned U.S Corporation is strictly an information return. It is used to report certain reportable transactions. It is not income based but rather informational and must be filed by the due date of a corporate Form 1120. If you are not a corporation you report as a single member LLC, the Form 5472 must be filed as an attachment to a dummy 1120 filed at a unique address at the IRS.
2. Multi member LLC’s have a similar form which is numbered 8805 and follows the due date of the Form 1065 for the partnership.
3. The penalty for non-filing or incomplete filing is $25,000.
4. The penalty can only be waived showing good cause which is very narrowly defined.
5. Ignorance of the law and reliance on an advisor may help showing good cause but on their own will seldom eliminate the penalty.
6. A Single Member LLC uses a calendar year for filing. So even though you may have incorporated on the last week of the year you are responsible for reporting the transactions for that year. Filing the SS-4 for an employer ID also helps fix the date the business began doing business as this is a question on the Form.SS-4.
7. Reportable transactions are very broadly defined. An example of such a transaction would be a foreign person paying for the incorporation costs, filing fees and the like for the new entity. These transactions would qualify even though the entity had no income or even no bank account.
8. The First Time Removal of the penalty which is a program for Failure to File penalties available to most taxpayers may not be available to foreign taxpayers for a few different reasons. What makes matters worse is that the 5472 is a specific example in the IRS’s Manual dealing with penalties of an item not eligible for Removal.
9. A pathway to remove a first-year penalty may be available but it must follow very specific steps. These involve complete compliance, a reasonable cause, no willful intent and an absence of previous history of non-compliance.
What to do now. There is no easy answer as this foreign taxpayer now finds himself in a very difficult situation. Unfortunately, the damage has been done by the lapse of time and lack of advice from the very beginning. It does not seem fair that the not reporting $500 dollars of organization costs could yield a penalty of $25,000.
There is a somewhat favorable IRS provision which calls for the following guidance to its examiners:
A. Treas. Reg. 1.6038A-4(b)(2)(ii) states that reasonable cause will be applied liberally when the small corporation had no knowledge of the IRC 6038A requirements, has limited presence in (and contact with) the U.S., promptly and fully complies with all requests to file Form 5472, and promptly and fully complies with all requests to furnish books and records relevant to the reportable transaction.
With that said this taxpayer should have his advisor file the past due forms as quickly as possible and include the best possible reasonable cause statement. Keep in mind that these appeals are done on a case-by-case basis. Therefore, there is no guaranteed outcome.
Written by John M Matras CPA
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