Let’s start with a simple immutable fact. For the average businessperson or entrepreneur, the IRS is hard to deal with and has plenty of complex rules that you must be aware of. Subsequently here at the Roving Entrepreneur we are going to do our best to provide you some in depth Form 8858 Instructions so that you can confidently complete the necessary filing.
Firstly, it’s important to understand why the IRS requires this ‘information’ when they have your complete financial statements and details in your actual tax filings. The reality is that this is an intelligence gathering exercise for the agency and the information that you provide in this filing is used for both manual and automated risk scorings which are used to highlight audit candidates. This is a key reason why it is important that you understand Form 8858 in detail and how to answer the specific questions.
Am I Liable to File Form 8858
(I promise this is the only technical area in the guide)
Unfortunately, the IRS has taken a very broad view of who is required to file these information forms and, as such, if you have offshore interests then you may very well fall under the auspices of this dreaded piece of paper.
The IRS Requires Form 8858 to be filed in the following circumstances:
1. If you are a U.S. Person who is a tax owner of a Foreign Disregarded Entity or a Foreign Branch that was operated at any time during the financial tax year or annual accounting period, then you MUST file a Form 8858 along with Schedule M. This includes transactions between the FDE or FB and the filer and any other related entities.
2. If you are a U.S Person that either directly or indirectly is a tax owner of an FDE or FB or you operate an FB. Then you must complete the entire Form 8858 including the separate Schedule M. Also note that this includes multiple tiers of FDE so don’t think that you can simply pyramid entities together to somehow avoid being the tax owner.
3. U.S. Persons who are required to fil form 5471 in connection with a controlled foreign corporation (CFC) that is an owner of a FB or FDE. Additionally, category 4 filers of form 5471 are also required to lodge this information form and the full Schedule M. Category 5 filers also fall into the catchall but only need to complete the identifying information sections.
4. Certain U.S. Persons that are required to file form 8865 which relates to controlled foreign partnerships (CFP’s).
5. A U.S. Person or partnership that directly or indirectly, through a tier of FDE’s or FB’s retains tax ownership.
6. A U.S. Corporation that is a partner in a U.S. Partnership which must file form 8858 due to a foreign FDE or FB, despite not being the tax owner in this case, must complete the entire form.
The full and complete description of who must file is at: https://www.irs.gov/pub/irs-pdf/i8858.pdf
Subsequently, you can see that the IRS has crafted a complex set of criteria for who must file this document and that most of the clause’s act as a catch all for anyone holding interests in foreign entities. In short, Uncle Sam wants to know exactly what business and potential tax liabilities you have offshore whilst you remain a U.S. Tax Resident.
What is a Foreign Disregarded Entity or a Foreign Branch
After all that legal mumbo jumbo you are probably left wondering what in the hell is a Foreign Disregarded Entity or a Foreign Branch. In short, the IRS is really just highlighting any entity that is organized offshore and not created in the United States.
In other words, they are suggesting it doesn’t fall under their direct control and they therefore ‘disregard’ it as an entity that is separate from the owner’s tax affairs. It is really just a long-winded way of saying that the company/partnership doesn’t file its own tax return with the IRS.
What this means in practice for U.S. owners is that Form 8858 must be filed along with the regular 1040F tax return. Thankfully, it may also mean that you can seek a foreign tax credit for any tax paid overseas at the source on a dollar-for-dollar basis for the FDE’s owners’ income.
What are the Basic Steps for Completing Form 8858
Firstly, there is nothing basic when completing IRS forms and even a single wrong entry or box ticked can cause administrative nightmares for you. So, I would be bereft in my professional responsibility if I didn’t advise you to either speak with me prior to completing it or indeed engage your own professional to complete the form.
Form 8858 Instructions
1. Probably the first thing you need to do is determine what sort of foreign ownership interest you currently have. In particular:
Direct Ownership – means you would normally hold the stock of the foreign entity directly.
Indirect Ownership – as the name implies, suggests that you hold the stock of the foreign entity through either ETF’s or a Mutual Fund structure.
Constructive Ownership – This was abused as a loophole in the past and normally involves foreign shares being held in the name of a child/minor that you effectively exercise control over. It’s ‘constructive’ based on your relationship with the individual and the scope is quite broad in nature.
2. The next thing you really need to assess is whether the offshore entity is an FDE or a FB or a controlled foreign company etc.
Please note that a CFC is a foreign company that hold more 50% or more of the vote or value is held by U.S. shareholders that have a minimum equity position of 10%. This is very each to trip this provision and something that you have to be aware of when you are setting up offshore and remaining a U.S. tax resident.
3. You will also need to consider your accounting procedures for the offshore entity as the IRS requires these amounts to be given in US Dollars and not the local or chosen currency. It’s not as simple as doing a conversion on the day that you complete the form as accounting procedures require daily rates to be used at the point of transaction.
If you are facing the above situation then it may be advantageous to actually undertake your accounts in USD as it is much simpler to report to the IRS in the long run. Especially if your company is based in a no-tax jurisdiction with limited bookkeeping requirements.
Finally, once you have worked out where you fall under the provisions of Form 8858, and what your accounting requirements are, you can go ahead and start completing the form using your derived information. Believe it or not, the hardest part is making sure you understand all the definitions because the IRS loves to use legal jargon to make it harder for potential self-filers. You will also need to keep working papers and records to ensure you have something on hand if you are asked to justify your decision process.
Please Note: There are plenty of exceptions for filing contained within the regulations and instructions for Form 8858. The reality is that they are too numerous to be listed here and revolve around the use of DASTM method of accounting. It is likely if you fall into that area, you would be aware that you may be subject to an exception. Again, this is a good reason to speak with us about your circumstances or to retain another professional.
Will the IRS Penalize Me for Non-Filing and What Are the Fines
Everyone knows that the IRS LOVES to penalize people so why would the lodgment of Form 8858 be any different? The form is required to be filed along with your tax return and falls due when your tax return is. Subsequently, late filing of the document is a bad idea and can lead to some incredibly steep fines.
At the time of writing, the penalty for late filing was $10,000 for each separate accounting period of each CFC or CFP that you hold. Additionally, the IRS will mail you out a reminder demand and failure to respond to that within 90 days could cause an additional $10,000 fine as set out above and continues accruing every 30 days to a maximum of $50,000 per case. In fact, I spoke with a client some time back that had racked up approximately $200,000 in fines by ignoring the notices for his offshore companies.
So, the tip today is to make sure your filings are up to date, and you do not miss a single one without seeking an extension. Otherwise, you could end up with a very costly surprise and/or potential criminal penalties if the non-compliance continues.
Financial Conclusions and Further Help
The actual filing of the form and requisite schedules is relatively easy as you can do it electronically online along with your normal return. However, all that I’ve discussed in this guide should have provided you some pause for thought at this stage.
The reason why this is a complex filing is because it requires self-assessment as to your offshore circumstances and this is why you should be using a professional to help you understand your structure. Also, the time requirements to gather all the required information and documentation should not be underestimated and can easily exceed 10+ hours of collation, assessment, and completion. Otherwise, failure to complete it properly could lead to a major problem with the IRS and future nightmares that no one wants!
Feel free to reach out to us at [email protected] if you have any questions or need any help.