U.S. International Tax Compliance
Ensuring compliance with U.S. international tax regulations can be challenging.
American taxpayers with business operations overseas may need to report their business activities to the IRS using specific international tax forms:
-
Form 5471 "Information Return of U.S. Persons with Respect to Certain Foreign Corporations"
-
Form 8865 "Return of U.S. Persons with Respect to Certain Foreign Partnerships"
-
Form 8858 "Information Return of U.S. Persons with Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)"
The purpose of these forms is to inform the Internal Revenue Service (IRS) about the activities of foreign businesses that are operated by U.S. persons outside the United States. A crucial step in this process is converting accounting data and financial statements into U.S. Generally Accepted Accounting Principles (GAAP) in order to determine the earnings and profits (E&P) of the foreign entity or branch. Preparing these international tax forms requires a thorough understanding of both foreign accounting principles and U.S. GAAP. Typically, foreign income statements and balance sheets necessitate certain U.S. tax accounting adjustments before they can be used for U.S. international tax reporting purposes.
International taxpayers who are engaged in a U.S. trade or business and earn effectively connected income (ECI) from the United States are required to report this income on Form 1120-F (for foreign corporations) or Form 1040-NR (for foreign individuals). They must also pay any applicable U.S. income tax liabilities. Additionally, foreign corporations and individuals may need to register with the IRS to obtain either an Employer Identification Number (EIN) for corporations and other entities, or an Individual Taxpayer Identification Number (ITIN) for individuals.
If a foreign individual or entity does not earn income that is effectively connected to a U.S. trade or business but does earn U.S.-sourced income (known as FDAP income), they typically do not need to file a U.S. income tax return with the IRS. This is because FDAP income is usually subject to withholding tax at the source, generally at a flat rate of 30%, unless an International Income Tax Treaty specifies a lower withholding rate.
Foreign individuals and corporations receiving FDAP income from the United States are generally required to submit a withholding certificate (IRS Form W-8) to the withholding agent in the U.S. for tax withholding and FATCA compliance purposes.
-
Controlled Foreign Corporations (CFC Reporting)
Controlled Foreign Corporation (CFC) reporting is an essential component of U.S. international tax compliance. A U.S. person who owns at least 10% of the voting power or value of a foreign corporation is required to report if the foreign entity qualifies as a CFC. A CFC is generally defined as a foreign corporation in which U.S. shareholders own more than 50% of the total voting power or value..
CFC reporting is primarily conducted using Form 5471, which necessitates detailed disclosures about the foreign entity's income, ownership, and operations. Additionally, U.S. shareholders may be subject to Subpart F income inclusion and Global Intangible Low-Taxed Income (GILTI) rules.
These rules require shareholders to pay U.S. tax on certain types of income earned by the CFC, even if that income is not distributed.
U.S. shareholders of a Controlled Foreign Corporation (CFC) may have to meet specific reporting requirements and might also be subject to taxes on certain types of the CFC's income under the Subpart F and Global Intangible Low-Taxed Income (GILTI) regimes.
Subpart F income generally includes passive or easily movable income, such as dividends, interest, rents, and some types of insurance or service income.
This income must be reported in the U.S. shareholder’s income in the year it is earned, regardless of whether it has been distributed.
GILTI, introduced by the Tax Cuts and Jobs Act of 2017, addresses the perceived under-taxation of foreign profits. It requires U.S. shareholders to include in their income a portion of the CFC’s earnings that exceed a deemed return on tangible assets.
Both regimes (Subpart F and GILTI) aim to prevent base erosion and profit shifting, often necessitating complex calculations and careful planning to manage the resulting U.S. tax liabilities.
As a Certified Public Accountant specializing in international taxation, Andrea Ricci CPA offers a comprehensive range of services for individuals and corporations conducting business globally. Her goal is to ensure full compliance with complex U.S. tax laws and regulations. While international operations can present exciting business opportunities, it is essential to file the appropriate U.S. tax returns with the Internal Revenue Service (IRS). In the realm of international taxation, failing to file a tax return can lead to severe consequences, including hefty monetary penalties and an indefinite statute of limitations.
Individuals and corporations may have an obligation to file U.S. tax returns based on their status. Generally, U.S. persons, including corporations, LLCs, U.S. citizens, and resident aliens, must report their worldwide income on their tax returns. Additionally, outbound transactions (transactions conducted outside of the United States) must be reported on Form 1120 or Form 1040.
Conversely, foreign corporations and individuals are required to file U.S. tax returns with the IRS only if they engage in inbound transactions (transactions sourced within the United States). Such transactions are typically reported on Form 1120-F or Form 1040-NR.
U.S. Tax Compliance for European Banks & Investors
Ensuring compliance with U.S. tax laws is crucial for European banks and investors engaged in financial activities within the United States. The importance of U.S. tax compliance can be understood through the following key points:
1. Legal Obligations and Avoidance of Penalties
Foreign entities and individuals conducting business or earning income in the U.S. are subject to specific tax regulations. Non-compliance can result in substantial penalties, fines, and legal actions.
2. Prevention of Double Taxation
The U.S. has established tax treaties with numerous countries to prevent double taxation and promote cross-border trade and investment. These treaties often provide reduced tax rates or exemptions for certain types of income. By complying with U.S. tax laws and understanding applicable treaties, foreign entities can benefit from these provisions and avoid being taxed twice on the same income.
3. Market Access and Business Opportunities
Adherence to U.S. tax regulations is often a prerequisite for accessing the U.S. market. Companies that maintain compliance are better positioned to establish partnerships, attract investors, and operate seamlessly within the U.S. Non-compliance can lead to reputational damage and hinder business prospects.
In summary, U.S. tax compliance is essential for foreign companies and individuals to operate legally, avoid punitive measures, benefit from tax treaties, and maintain favorable business relationships within the United States.
-
FIRPTA & U.S. Real Property Investments
The Foreign Investment in Real Property Tax Act (FIRPTA) imposes U.S. tax on gains realized by foreign individuals and corporations when they sell U.S. real property interests (USRPI), which include land, buildings, and shares in U.S. real property holding companies. Under FIRPTA, these gains are considered effectively connected income linked to a U.S. trade or business, making them subject to U.S. income tax.
To ensure compliance, FIRPTA requires the buyer or transfer agent to withhold a flat rate of 15% of the gross sales price at the time of the transaction. Foreign sellers must file a U.S. tax return to report their actual gain and may claim a refund if the amount withheld exceeds their tax liability. Certain exemptions and reduced withholding rates can apply, such as in cases where the sale involves a residence priced under $300,000 and the buyer plans to use the property as their home.
Usually, foreign taxpayers can recover a substantial part the withholding tax applied by the buyer of the real property by filing an accurate U.S. income tax return with the IRS and by disclosing the actual amount of the capital gain realized upon the disposition of the U.S. real property interest.
-
U.S. Tax Compliance for Financial Institutions
The Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions (FFIs) to report information about financial accounts held by U.S. persons or U.S.-owned foreign entities. Its primary aim is to combat offshore tax evasion by enhancing transparency in cross-border financial activities. FFIs must register with the Internal Revenue Service (IRS) and agree to identify and disclose U.S. account holders. If they fail to comply, they may incur a 30% withholding tax on certain U.S.-source payments, such as interest, dividends, and gross proceeds from the sale of U.S. securities.
Many countries have formed intergovernmental agreements (IGAs) with the U.S., allowing local FFIs to report to their own tax authorities, which then share the information with the IRS.
Compliance with FATCA involves implementing due diligence procedures, conducting annual reporting, and, in some cases, assuming withholding responsibilities.
-
U.S. Withholding Tax Returns
U.S. withholding tax returns, primarily filed using Form 1042 and Form 1042-S, are required when a U.S. withholding agent makes payments of U.S.-source income to foreign individuals or entities. These payments can include interest, dividends, royalties, rents, and other types of fixed or determinable annual or periodic (FDAP) income.
Generally, a 30% withholding tax must be applied unless there is an applicable income tax treaty or exemption.
The withholding agent—whether an individual, corporation, partnership, or trust—is responsible for deducting and remitting the tax to the IRS. They must also file Form 1042 annually to report the total tax withheld and issue Form 1042-S to each foreign payee.
These forms ensure proper reporting and compliance with withholding regulations for cross-border payments and typically must be filed by March 15 of the year following the payments.
Are you seeking assistance for your international business journey?