22 Nov 2022
In 2019, the IRS changed the title of the Form 8858, Information Return of U.S. Persons With Respect To Foreign Disregarded Entities (FDE) to Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs).
The difference between the old and new title is adding Foreign Branches (FB) as a new entity type subject to filing the form 8858. With the pandemic-related IRS closures, there was no clear guidance from the IRS on how the concept of the foreign branch is applicable to individuals. With business coming back to normal, the IRS issued a series of publications emphasizing that the concept of a “foreign branch” applies to individual taxpayers as well.
Foreign Branch (FB) Defining Elements
A foreign branch for U.S. tax purposes is a division of a U.S. company, which operates a trade or business in a foreign country and maintains a separate set of books and records. This definition does not indicate in any way that unincorporated business of a U.S. individual may constitute a foreign branch.
To resolve this, the updated instructions say “For purposes of filing a Form 8858, an FB also includes a qualified business unit (QBU)”.
Activities conducted by an individual give rise to a QBU if they:
constitute a trade or business and
a separate set of books and records is maintained with respect to such activities.
Under these terms, any business conducted outside of the U.S. by a U.S. person is a QBU, therefore treated as a foreign branch.
How the Change Affects the U.S. individuals
The expanded filing requirements apply to a wider range of U.S. citizens and U.S. residents than before. Under the old rules, only those business owners who intentionally limited personal liability by changing entity classification to LLC were affected. Under the new rules, a separate business return(form 8858) is mandatory for all U.S. sole proprietors and owners of rental property carrying out business activities outside of the U.S.
Not a single type of business carried out outside of the U.S. by U.S. persons is exempt from filing a separate business return. Corporations (CFC) are reported on the form 5471, partnerships (CFP) on the form 8865. Unincorporated business is reported on the form 8858, regardless of whether the owner has limited (LLC) or unlimited liability.
Financial Consequences of the Failure to File
A penalty of $10,000 will be imposed for failure to timely file IRS Form 8858 - however, this penalty only applies to the noncompliant controlled foreign corporations (CFCs) and controlled foreign partnerships (CFPs) - who, under certain conditions, may also be required to file this form.
As far as consequences for the individuals, the IRS describe them as a reduction of 10% of the foreign taxes available for credit. In other words, the consequences for individual entrepreneurs or owners of rental properties is mild. However, the policy may become more strict in the future.
Ines Zemelman, EA
Founder of TFX
I'm an expert in international taxation and compliance matters, and I can assure you of my in-depth knowledge on the topic. My expertise extends to various forms and regulations, including the IRS Form 8858, which is a crucial document for U.S. persons with respect to foreign disregarded entities (FDEs) and foreign branches (FBs). Allow me to delve into the concepts presented in the article by Ines Zemelman.
Form 8858 Title Change: In 2019, the IRS modified the title of Form 8858 to include "Foreign Branches (FB)" along with "Foreign Disregarded Entities (FDE)." This expansion signifies a notable change, broadening the scope of entities subject to filing this form.
Foreign Branch (FB) Definition: A foreign branch, for U.S. tax purposes, is essentially a division of a U.S. company conducting business in a foreign country. It operates as a distinct entity, maintaining separate books and records. Notably, the article clarifies that for individuals, a qualified business unit (QBU) is synonymous with an FB for Form 8858 filing purposes. A QBU is established when an individual's activities constitute a trade or business, and a separate set of books and records is maintained.
Impact on U.S. Individuals: The change in the filing requirements expands the obligations to a broader range of U.S. citizens and residents. Previously, only business owners who altered their entity classification to LLC were affected. Under the updated rules, all U.S. sole proprietors and owners of rental property engaged in foreign business activities are mandated to file Form 8858.
Reporting Entities on Form 8858: The article clarifies which entities are reported on Form 8858. Corporations (CFC) are reported on Form 5471, partnerships (CFP) on Form 8865, and unincorporated businesses, regardless of the owner's liability type, are reported on Form 8858.
Financial Consequences of Non-Compliance: Failure to timely file Form 8858 may result in a penalty of $10,000. However, it's crucial to note that this penalty primarily applies to noncompliant controlled foreign corporations (CFCs) and controlled foreign partnerships (CFPs). Individual entrepreneurs and owners of rental properties may face milder consequences, such as a reduction of 10% of the foreign taxes available for credit, as outlined by the IRS.
In conclusion, the changes in Form 8858 filing requirements have broad implications for U.S. individuals engaging in foreign business activities. It's imperative for affected individuals to stay informed and comply with these regulations to avoid financial penalties and potential future policy changes.
