Classification and Commonly Missed Foreign Entity Filings

February 18, 2025

If you’re a US person with ownership in a foreign entity, it’s crucial to understand your IRS reporting obligations. Failing to file the correct forms can result in steep penalties—even if you don’t owe additional taxes.

Who Is Considered a "US Person"? 

A "US person" includes:

• US citizens and legal permanent residents (or “green-card holders”)
• Non-US citizens who meet the "substantial presence test" (aka the “183 day” test)
• US flow-through entities like partnerships and S-Corporations
• US taxable entities like complex trusts and corporations

If you fall into one of these categories and have investments in foreign corporations, partnerships, or branches, you may need to file additional tax forms.

Why Reporting Matters

The IRS requires detailed disclosures about foreign business interests. Missing these filings—even unintentionally—can lead to severe penalties. For example, a late filed Form 5471 for a newly formed foreign corporation may be subject to penalties of $20,000 even if no related tax is due.

For this reason, it is also important for US persons to ensure they have a valid extension on file with the IRS if they plan to file their return after the original due date.

Understanding Foreign Entity Classifications

The forms required by the IRS depend on the type of foreign entity owned as well as the ownership percentage. Foreign businesses are classified based on ownership structure and liability. The default IRS classifications include:

• Corporations: Entities where all owners have limited liability (e.g., foreign LLCs).

  • Absent filing an entity classification election on Form 8832, the default classification rules apply to treat a foreign entity as a corporation when all owners have limited liability.
  • For example, ownership in a foreign Limited Liability Company is treated as ownership in a foreign corporation (reported on Form 5471) absent an election. This treatment is very different from the default treatment of a US Limited Liability Company which is a flow-through entity (similar to a branch or partnership).

• Flow-Through Entities: Businesses where at least one owner has unlimited liability. These include foreign branches (single-owner businesses) and general partnerships (multiple owners).

  • A flow-through entity with one owner is generally considered branch or disregarded from its sole owner (reported on Form 8858).
  • A flow-through entity with more than one owner is treated as a partnership (reported on Form 8865).
  • For example, a Canadian unlimited liability company is treated as a flow-through entity for US tax purposes because no owners have limited liability.

Different entity types have very different US tax implications so it is important for US owners of foreign entities to do a structure review and analysis in the first year of the entity’s formation.

If you want to change an entity’s tax classification, you must file Form 8832. This allows eligible foreign entities to be taxed differently from their default classification. 

For example, an eligible entity may decide to elect treatment as a branch/disregarded entity or partnership for US tax purposes for individual owners to take advantage of foreign tax credits. This is commonly known as making the “check-the-box” election. Without a check-the-box election, the entity will be taxed based on their default classification discussed above.

Failing to file this form correctly can lead to unintended tax consequences. Here are some items to consider:

1. Form 8832 is often incorrectly filed to change the entity classification for a per se corporation. IRS classifies certain corporations as "per se" corporations, which are not allowed to elect a change to be a branch or partnership. The list of these entity types by country can be found in Treas. Reg. 301.7701-2(b)(8).
2. A foreign entity is required to have a US taxpayer identification number in order to make an election on Form 8832 even if it does not need to file a US tax return and its owner has a US tax ID number.
3. Entity classification elections have US tax implications and may create deemed taxable transactions especially if made for foreign entities that are in existence prior to the effective date of the election. It is important to understand these implications including impact on foreign filings as well as pros/cons of the election before it is made.
4. Form 8832 is due 75 days following the desired effective date of the classification election. Depending on your facts, late filing relief under Revenue Procedure 2009-41 may be available.

Commonly Missed IRS Forms for Foreign Entities

1. Form 5471: Reporting Ownership in a Foreign Corporation
   • US persons who own at least 10% of a foreign corporation may be required to report their stake using Form 5471. The IRS considers direct, indirect and constructive ownership, meaning shares held by family members (spouses, parents or children) may count toward your total.
     • Without considering the attribution rules from relatives, US persons often miss the reporting of Form 5471. When US individuals own foreign corporations with family members, ownership by spouse, parents or children will be attributed to the US individual.
     • For example, if a US individual owns 8% of a foreign corporation and the remaining 92% are owned by his or her foreign parents, then they are considered as owning 100% of the foreign corporation through constructive ownership rules and will be required to report Form 5471 with their US individual tax return.

   • Schedule O (Category 3) is required to be completed and attached to Form 5471:

     • For the first year ownership the foreign corporation exceeds 10% in a foreign entity,

     • In years where ownership increases by 10%,

     • Years where ownership falls below 10%, or

     • In years where a nonresident becomes a US Person.

   • Form 5471 is due with the Taxpayer’s return (including extension).

   • Penalty for non-filing: $10,000+ per year
     • A $10,000 penalty per Form 5471 may be imposed for every year the Taxpayer fails to furnish the required information by the due date of the tax return.
     • Schedule O has its own $10,000 penalty so in years it is required, the total applicable penalty can be $20,000 for a single foreign corporation.
2. Form 8621: Passive Foreign Investment Companies ("PFICs")

   • If you invest in foreign mutual funds, hedge funds, or foreign companies earning mostly passive income (like interest or dividends), you may need to file Form 8621. The taxation on these investments can be complex, often leading to higher tax rates without proper planning.

   • Form 8621 is required to report direct or indirect ownership in a PFIC. In general, a foreign corporation is classified as a PFIC if:

     • (1) at least 75% if its gross income for the year is passive; or

     • (2) at least 50% of the assets it held during the year produce passive income or are held for the production of passive income. 

       • Common types of passive income may include rents, royalties, dividends, interest, and certain capital gains.

   • Form 8621 (or PFIC reporting) is often missed by individuals who have investments in foreign mutual funds or own PFICs though foreign investment partnerships.

     • Many nonresident aliens who become US persons do not realize their investments in foreign mutual funds lead to onerous reporting and punitive tax rules. The taxation of income related to PFIC stock is complex and absent planning often results in dividend income and capital gain on sale being taxed at ordinary rates plus an interest surcharge.

   • Form 8621 is required for US investors who are minority partners (less than 10%) in a foreign partnership that invests in PFICs.

     • For example, if a foreign partnership has 20 un-related individual partners who each own 5% of the partnership and the partnership holds 51% of a foreign corporation that is a PFIC, then a US investor in the partnership may have a Form 8621 filing requirement.

   • Form 8621 is filed with the US individual income tax return (including the extended deadline).

   • Penalty: No direct fine, but failing to file keeps your entire tax return open for IRS audit indefinitely.

3. Form 926: Transferring Property to a Foreign Corporation

   • US persons who contribute cash or assets to a foreign corporation may need to file Form 926. This often applies when forming or funding a foreign business.

     • For cash contributions, the form is required for transfers exceeding $100,000 over a 12-month period or if the US person holds more than 10% of the total vote or value of the foreign corporation immediately after the transfer.
     • US persons often miss the reporting for Form 926 when cash contribution is made directly or indirectly to the foreign corporation. When US persons form a new foreign corporation where their ownership is 10% or more, Form 926 is required regardless of how much is transferred.
     • Non-cash contributions to foreign corporations are not subject to a dollar threshold so even small amounts may require reporting on Form 926. These contributions may also have tax implications so it is best to discuss with a tax advisor whether exclusions apply.
   • Partners of partnerships making contributions are required to file. If 10 US individuals form a partnership and the partnership forms a foreign corporation, then the partners may have a Form 926 filing requirement. Form 926 is not filed by the partnership, but it needs to provide its partners information required to file this form. Partners should check the footnotes of Schedule K-1 received from partnerships to determine if this filing is required. 
   • Form 926 is due with the Taxpayer’s return (including extension).

   • Penalty for late/non-filing: 10% of the fair market value of the property at the time of the exchange/transfer (up to $100,000, or more for intentional violations).

4. Form 8865: Reporting Foreign Partnerships

   • US persons who contribute more than $100,000 to a foreign partnership or own at least 10% of a foreign partnership may need to file Form 8865.

     • A 10% interest in the foreign partnership is considered an interest in 10% of the capital, profits, or deductions or losses of the partnership. To determine your ownership interest percentage in a foreign partnership, you need to consider your direct, indirect, and constructive ownership in the entity.
   • US persons who make contributions to foreign partnership often miss the required reporting for Form 8865. Form 8865 is also required when a US owner increases or decreases their ownership in a foreign partnership by 10% or more during the year or if the interest falls below 10% ownership during the year.
   • Form 8865 is due with the Taxpayer’s return (including extension).

   • Penalty for non-filing: $10,000+ per year

5. Form 8858: Reporting Foreign Branches and Disregarded Entities

   • If you own a foreign single-member LLC, other foreign disregarded entity, or operate a foreign branch (such as a foreign rental property with separate books), you may need to file Form 8858.

   • US persons are generally required to file Form 8858 related to their direct ownership in a wholly-owned foreign disregarded entity (“DRE”). A foreign disregarded entity exists when a Taxpayer makes a check-the-box election (discussed above) to treat a foreign entity with a single owner as a branch for U.S. tax purposes.
   • Form 8858 is commonly missed by US persons with foreign rental property. A foreign rental property that keeps separate books and records is generally considered a foreign branch for US tax purposes. A US person who holds foreign rental property is generally required to report the foreign rental income/loss on Form 8858.
   • Form 8858 is due with the Taxpayer’s return (including extension).
   • Penalty: The penalty related to this form depends on the ownership structure of the property.
     • No direct fine for direct individual owners, but missing this form can extend the IRS audit window indefinitely.
     • If a foreign DRE or branch is held by a foreign corporation or a foreign partnership where a US person is required to file Form 5471 or Form 8865, then the penalties for failure to file Forms 5471/8865 can be imposed for the failure to file the related Form 8858 resulting in a $10,000 penalty per form.

Avoiding Costly Mistakes

Many taxpayers unintentionally miss these forms because they are unaware of the reporting requirements related to foreign entities and assume the reporting requirement is satisfied by filing a regular tax return. Here’s how to stay compliant:

• Review your ownership structure before starting a foreign business.

• Make timely elections (Form 8832) if you want to change your entity’s tax treatment.

• Double-check attribution rules to determine if you need to file, even if your stake seems small.

• File for an extension if you need more time to gather necessary information.

Conclusion

US persons with ownership in a foreign entity should ensure they are in compliance with all applicable US tax reporting and record-keeping obligations to avoid significant penalties. If you have any questions please contact Jane Chang (jane.chang@hcvt.com or 714-361-7628) or Michele Carter (michele.carter@hcvt.com or 714-361-7627) for a consultation.