Explanation of Foreign Disregarded Entities and Form 8858
If you are an owner – whether full, partial, or just in name – of an FDE (Foreign Disregarded Entity), you have a minimum requirement of filing Form 8858. Depending on your level of involvement and other factors, you may be required to file additional forms such as Schedules C, H, and M (to name a few). Because of all the contingencies involved in determining which forms and sections to complete and which to disregard, Form 8858 – like many foreign asset reporting forms required by the IRS – is a common form on which numerous costly mistakes are made every year by taxpayers.
Definition of a Foreign Disregarded Entity (FDE)
An FDE is defined as a foreign entity (created outside of the United States) for which the entity and the owner are essentially regarded as one in the same by the IRS. When it comes to reporting an FDE with your US expat tax return, it’s vital that you know whether you’re regarded as a tax owner (holder of the FDE’s liabilities and assets) or the direct owner (legally documented owner of the FDE). The differences in ownership status will directly affect the additional forms required and the sections of Form 8858 you’ll be required to complete.
Penalties Associated with Form 8858
The mandate in the US Tax Code to report FDEs is taken very seriously by the IRS, and failure to comply with this requirement can result in extreme penalties of both a financial and criminal nature. The penalties that could potentially be assessed by the IRS include:
- $10K assessed for failure of each CFC or CFP to report financial information for the previous tax year: As indicated earlier, there may be multiple owners and associations with an FDE – primarily one or more CFCs (Controlled Foreign Corporations) or CFPs (Controlled Foreign Partnerships). Each has its own level of involvement with the FDE, and each is required to file Form 8858 along with any additional required forms. When the IRS takes notice of compliance failure, an immediate $10K Failure to File fine is assessed and a notice is sent out. If the required information isn’t received by the IRS within 90 days of having issued a notice of noncompliance, another $10K fine is assessed. The fines are applied separately to each CFC or CFP involved with the FDE, and the maximum for each failure identified by the IRS is $50K.
- Reduction of allowable FTC for reporting false or incomplete information: Like US expats, FDEs formed with US Persons are allowed to take advantage of the Foreign Tax Credit, through which foreign taxes paid to the host country may be credited against a taxpayer's US income tax liability. If your form 8858 has incomplete sections, false information, or any other possibility of a perceived discrepancy by the IRS, you will be fined in the form of the IRS reducing the amount of Foreign Tax Credits that you’re allowed to claim on your US income tax return. This fee also applies to the absence or misfiling of all forms associated with Form 8858. Upon issuing your first penalty, the IRS will send you a notice to which you must respond appropriately within 90 days to avoid a further reduction of allowable Foreign Tax Credits by 5%. This 5% rate continues if taxpayer noncompliance persists after the first 90 days and begins to be assessed on a monthly, prorated basis of around 1.66% until a complete and factual Form 8858 and all other required forms are submitted to the IRS.
If noncompliance remains an issue after the maximum of both the aforementioned penalties has been assessed, the IRS may seek criminal prosecution against those involved in what will - by that point - be perceived as willful noncompliance.
Don’t Take Your Chances; Seek Professional Assistance
FDEs themselves are extremely complicated – so much that even individuals involved are easily confused about their internal rights and responsibilities. This confusion is compounded when it’s time to file a US expat tax return. If you are not 100% sure of the explanations or instructions provided in the literature composed by the IRS, you should not complete the form without the assistance of a professional tax advisor. Unlike many competing tax consultation and preparation firms who have a base preparation fee and assess other fees per additional required form, Taxes for Expats charges a flat fee for US expat tax preparation – regardless of the amount of forms involved; so you always know exactly what you’re paying for US expat tax preparation that is guaranteed to be in accordance with the US Tax Code.