More U.S. Persons Must File the Form 8858
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.