US persons (e.g., US citizens, US green card holders) must make an information report to the IRS when making certain transfers to foreign (non-US) corporations. Specifically, when a US person transfers (or is treated under the tax rules as having transferred) property to a foreign corporation in certain “non-recognition” transactions (e.g., a contribution of capital to the company) a Form 926 must be filed and attached to that year’s income tax return. This is so, whether or not the property has appreciated in value. If cash is transferred to the corporation instead of property, the Form 926 must be filed when the cash transfers exceed US$100,000 over a 12-month period; or, regardless of amount, if immediately after the cash transfer, the transferor holds more than 10% of the total voting power or total value of the foreign corporation.
Expansive Information Required
Form 926 Part III, “Information Regarding Transfer of Property”, is designed to ensure that the information provided on the form is consistent with information reported on another tax form required of most US persons having interests in foreign corporations, Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations”. Thus, Form 926 provides the Internal Revenue Service (IRS) with a way to cross-check information (almost as easy as connecting the dots) and ensures greater tax compliance. The information provided by a taxpayer in Part III can also alert the IRS that an FBAR (Form 114, “Report of Foreign Bank and Financial Accounts”) should be filed. As can be seen, all of these related forms provide the IRS a simple way to assess penalties for IRS forms that may be required, but were not filed, by a particular taxpayer.
Taxpayers should carefully examine Part IV of the Form with its detailed sections for information regarding property transfers.
Form 926 must be filed with the US transferor’s income tax return for the tax year that includes the date of the transfer.
The IRS has compiled an International Practice Unit (IPU) to guide its agents with respect to Form 926. It can be accessed here.
Inadvertence Can Lead to Penalties
Vigilance is the order of the day when it comes to US tax issues involved in making foreign investments. Failure to file the Form 926 can result in harsh penalties. The penalty can be 10% of the fair market value of the property transferred. The penalty is limited to $100,000 unless the failure to file Form 926 was due to intentional disregard of the rules. The failure to file will also extend the statute of limitations until the information is provided to the IRS. So, failing to file the form can mean that your tax matters will never have closure. In addition, due to new rules enacted with FATCA, a 40% penalty can apply to any tax underpayment resulting from an undisclosed foreign financial asset.
Statute of Limitations Remains Open if Form 926 is not Filed
If Form 926 is required but is not filed, the period of limitations on assessment of tax (commonly referred to as the “statute of limitations”) for the taxable year which includes the date of the transfer remains open indefinitely. The open statute of limitations will apply to the ENTIRE tax return, not just the items to which the Form 926 might relate. Once the late Form is filed and the required information is furnished to the IRS, the assessment period will commence and generally run for a 3-year period. More information at IRC § 6501(c)(8); Treas. Reg. § 1.6038B-1(f)(1)(ii).
Foreign Funds – A Trap for the Unwary
Sometimes, investments by US persons in foreign funds can trigger the obligation to file the Form 926. This can occur by a direct purchase of a fund investment domiciled in a foreign jurisdiction, for example, in a Cayman Islands “exempted company” (often treated for US tax purposes as a “corporation”) if the cash investment exceeds US$100,000 over a 12-month period. It can also occur through indirect purchases of foreign corporations through US domestic partnerships or LLCs, assuming the US$100,000 threshold is exceeded. In the latter case, the relevant information regarding the investor’s proportionate amount of transfers to underlying foreign corporations is usually contained in the investor’s annual Schedule K-1 so he can track the dollar amount of his transfers to each foreign corporation.
Persons investing in foreign funds must also be aware of the so-called PFIC tax regime. More can be learned from my prior posting here and here.
Posted October 5, 2018
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