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Proposed Treasury Regulations Target Foreign-Owned, Single-Member LLCs

By: A. Lee Lundy, Jr. and Jacob T. Byrne

Introduction

Under the current Internal Revenue Code and its implementing regulations (the “Code”), domestic LLCs that are wholly owned by a single foreign member (“Foreign Single Owner LLCs”) generally have no filing requirements during tax season.  This is because such entities are automatically “disregarded” by the Code, i.e., the entity is not considered separate from its owner.  According to the Secretary of the Treasury, this is a “loophole in our system that allows foreign persons to hide assets in U.S. accounts.”  To close this loophole, and to increase the U.S. government’s ability to carry out its obligations under tax treaties and similar international agreements, the Department of the Treasury (the “Treasury”) recently announced proposed regulations that will require these entities to file annual returns and comply with other record maintenance requirements.  In sum, foreign owners will no longer be able to operate in the U.S. through single owner LLCs without being required by regulation to disclose their identity, assets, or certain of their transactions.

Discussion

The tax consequences for any U.S. entity begin with its initial classification under the Code.  Currently, the Code classifies, by default, Foreign Single Owner LLCs as an entity “disregarded as separate from its owner” meaning, the member – not the LLC – is treated as owning the LLC’s assets and liabilities.  This is a critical distinction, because unlike corporations or LLCs with two or more members, “disregarded entities” are generally not required to file income tax or informational returns, nor need they apply for an Employment Identification Number (“EIN”).  Therefore, the information available to the Treasury and other U.S. agencies depends on the returns filed by the member.  Those members, unfortunately for the Treasury, whether they are corporations, partnerships, or individuals, also generally have no filing requirements unless they or their Foreign Single Owner LLC received U.S. source income or engaged in a U.S. trade or business during the taxable year.  Thus, the current approach to Foreign Single Owner LLCs often leaves the Treasury in the dark at the entity and member levels.  In order to combat this two-tiered information gap, the proposed regulations would subject Foreign Single Owner LLCs to filing requirements of § 6038A, a provision currently applicable to U.S. corporations that are at least 25% foreign-owned (“Foreign Corporations”).

Under § 6038A, Foreign Corporations that have “reportable transactions” with foreign or domestic “related parties” must, for each foreign “related party,” file a Form 5472 which discloses, among other things, their “reportable transactions” for the taxable year, including the “foreign related party” with whom they had such transactions.  In order to file Form 5472, the filing entity must obtain an EIN, which in turn requires the filing of Form SS-4.  When filing Form SS-4, the filing entity must identify a “responsible party” who is the individual who has the power, directly or indirectly, to manage and control the entity and the disposition of its assets. (For a publicly traded entity, the identity of a responsible party is determined by who holds certain positions.)  Importantly, the responsible party must provide its own EIN, social security number, or Individual Taxpayer Identification Number (and, if the responsible party does not have one, must obtain one).  Finally, the failure of the Foreign Corporation (or, in this case, the Foreign Single Owner LLC) to file a timely Form 5472 or to maintain required records can carry substantial penalties, including $10,000 for the taxable year, a $10,000 penalty for every month the Form remains outstanding after notice from the IRS, and potential criminal fines and imprisonment. 

Conclusion

As you can see, compliance with the proposed regulations would require a Foreign Single Owner LLC to reveal: (1) certain of its transactions; (2) with whom it had such transactions; and (3) the person controlling it.  While this may not seem like much, it is a stark departure from the anonymity owners of Foreign Single Owner LLCs currently enjoy under the Code.  Although the regulations are merely “proposed,” new or additional reporting requirements can be economically burdensome and time-consuming for any business.  Foreign Single Owner LLCs should immediately begin preparing to comply, or run the risk of heavy penalties, and unwanted scrutiny from the Treasury.  

Please contact A. Lee Lundy, Jr., or Jacob T. Byrne in the Business, Corporate, and Tax Department, if you have any questions or would like additional information on these proposed regulations.

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