Avoid Penalties Related to International Tax Filings

The IRS Large Business and International Process Unit (LB&I) issues internal practice guidance from time to time regarding U.S. international tax requirements. On May 11, 2017, the IRS provided guidance on the Form 5471 penalties in an International Practice Unit (IPU) release.

The U.S. federal Form 5471 is a U.S. international information return that discloses a U.S. person’s ownership of a foreign corporation. The Form 5471 is required to be attached to the U.S. filer’s U.S. federal income tax return. There is an initial $10,000 penalty for the failure to file the Form 5471, the late filing of the Form 5471, or if the Form 5471 is not complete when filed. The IRS may assess additional penalties up to $50,000 if the delinquency continues after the IRS sends a notice. The maximum Form 5471 penalty that can apply is up to $60,000 which is the $10,000 initial penalty plus an additional $50,000 maximum continuation penalty.

Filer Categories

The Form 5471 is required to be filed when the U.S. person is within the scope of certain filer categories:

• Category 2 filer is a U.S. person that is a U.S. officer or director of a foreign corporation in a year when any U.S. person acquires 10% of the foreign corporation
• Category 3 filer is a U.S. person who acquires or disposes of a 10% interest in a foreign corporation
• Category 4 filer is a U.S. person who controls a foreign corporation for an uninterrupted period of 30 days during the year
• Category 5 filer is a U.S. person that owns at least 10% of the voting stock of a foreign corporation of which the vote or value is controlled by U.S. persons who each own at least 10%

Penalties

The IRS IPU on the Form 5471 Penalties for Category 2 and 3 filers outlines the procedures for IRS agents to determine the Form 5471 filing requirements and to assess the penalties. The IRS IPU also outlines the criteria for IRS agents to determine if the Form 5471 penalties should not be assessed due to reasonable cause. The IRS states in the IPU that only the initial penalty can be considered for the reasonable cause exception. The reasonable cause exception does not apply to the continuation penalty.

The U.S. taxpayer must state the reasonable cause exception in writing, provide all of the facts alleged to establish reasonable cause, and provide a written declaration that the statement is made under penalties of perjury. In determining whether to allow the reasonable cause exception, the IRS will consider whether the U.S. taxpayer has complied with certain reporting and recordkeeping requirements for all years open under the statute of limitations. Reasonable cause is established where the U.S. taxpayer can demonstrate that they exercised ordinary business care and prudence but nevertheless they were unable to provide the information required on the Form 5471.

Reasonable Cause

The IRS has identified certain factors in the Internal Revenue Manual that are considered in determining whether the U.S. taxpayer exercised ordinary business care and prudence. Reasonable cause would include the U.S. taxpayer’s reliance on erroneous advice, the inability to obtain records, and death, serious illness, or unavoidable absence. The U.S. taxpayer’s ignorance of the law, by itself, is not reasonable cause. However, the IRS does recognize that ignorance of the law in conjunction with other factors could be sufficient to establish reasonable cause. Other relevant factors include the U.S. taxpayer’s education, whether the U.S. taxpayer was penalized before, and whether the U.S. taxpayer could not reasonably be expected to know of recent changes in the tax law or forms and the level of complexity of a tax or compliance issue. It is the IRS’s position that reasonable cause cannot be established based on the fact that a foreign jurisdiction would impose a civil or criminal penalty on the U.S. taxpayer or other person for disclosing the required information about the foreign corporation on the Form 5471.

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