Every year, U.S. citizens who live or do work abroad have a number of forms they must file for compliance with the U.S. tax code. We are nearing the halfway point for the 2021 tax season, and at this time, it may be beneficial to take a quick internal audit of your assets and business dealings. Doing so will ensure that you are prepared for filing your tax returns next year and that you keep track of all relevant information to do so. If you are involved in any partnership that was formed abroad but is controlled by U.S. partners, you are required to file Form 8865. This form requires U.S. citizens to report their income and financial position within the partnership, as well as to report certain transactions involving the partner or the partnership. Our international tax lawyers at Evolution Tax and Legal are breaking down Form 8865: who needs to file it, how to file it, and what could happen if it is left unfiled.
What is Form 8865?
Form 8865 is an informational tax form that is required to be filed by U.S. persons who have an interest in a foreign partnership. The purpose of the form is to allow the IRS to record any U.S. persons who are involved with foreign partnerships. This form is required to be filed alongside other tax filings, during tax season each year.
What Is a Foreign Partnership?
Any business entity that was formed outside of the U.S. and its territories is considered a foreign entity. The entity is considered a partnership when the entity has two or more owners and at least one of the partners has unlimited liability in regards to the business entity. The partnership must be controlled by U.S. partners, which means that U.S. citizens own greater than 50% interest in the partnership. This can be five or fewer citizens, holding 10% or more of the interest each, which will aggregate to more than 50% ownership of the entity.
Who Files Form 8865?
Form 8865 is required to be filed by each U.S. citizen who controls the foreign partnership. Each owner must file an individual Form 8865, and attach it to their tax returns. In a controlled foreign partnership that has chosen to be taxed as a disregarded entity, the business must file Form 8865, and they must file a Form K-1 for each U.S. partner. There are different categories of filers classified under the required Form 8865 filers.
Category 1 Filer
A category 1 filer is any U.S. taxpayer who controlled the foreign partnership at any time throughout the current tax year. They had to have held at least 50% ownership in the partnership throughout this time.
Category 2 Filer
A category 2 filer is any U.S. taxpayer who held at least 10% ownership of the foreign partnership at any time throughout the year, while the partnership was controlled by U.S. taxpayers who each owned more than 10% stake in the company, with U.S. taxpayer ownership being at least 50% of the partnership. If the partnership has a category 1 filer concurrently, nobody will be considered a category 2 filer.
Category 3 Filer
A category 3 filer is any U.S. taxpayer who contributed property to a foreign partnership in exchange for a stake in the partnership. This includes any taxpayer who has either owned at least 10% interest in the company immediately after their property contribution or the value of the property contributed to the company is more than $100,000. A category 3 filer also includes a U.S. taxpayer that contributed property to a foreign corporation that appreciated over time and was ultimately disposed of, with the taxpayer still being a direct or indirect partner in the foreign partnership.
Category 4 Filer
A category 4 filer includes any U.S. taxpayer that had a reportable event during the calendar year under Section 6046A – an acquisition, disposition or change in proportional interest.
Form 8865 Filing Requirements
Form 8865 generally requires similar information to other foreign partnership and foreign corporation tax forms. This may include financial statements of the foreign partnership, depending on the category of filer. These financial statements must be converted into U.S. dollars from any foreign currency they are recorded in. There are schedules required, each of which is unique to the category the filer is classified as. Form 8865 also requires names, addresses and tax IDs of partners to be included, as well as records of any property transfers within the foreign partnership.
This tax form is to be filed and returned with the individual tax return of the U.S. partner who is filing. This date is typically April 15 of the year following the tax year that is being reported on.
Form 8865 Penalties
Failing to file or incorrectly filing Form 8865 can result in severe penalties, depending on the category a filer is classified as. These penalties include:
- A $10,000 penalty for each year that a Category 1 or Category 2 filer failed to provide the required information within the time provided. An additional $10,000 penalty will be issued for every 30 days that the taxpayer fails to pay the fine after the first 90 days of their awareness of the penalty.
- Any Category 1 or Category 2 filer who fails to provide the required information could face a 10% reduction in foreign taxes available for credit to them.
- A Category 1 or Category 2 filer could face criminal charges for failing to file or providing incorrect or fraudulent information upon filing Form 8865.
- Any Category 3 filer that fails to provide the required information is subject to a fine of up to 10% of the fair market value of the property they transferred to a foreign partnership.
- Any Category 4 filer who fails to provide the required information could face up to a $10,000 fine and criminal charges.
How Evolution Tax and Legal Can Help You File Form 8865
The IRS estimates that filing Form 8865 alone takes experienced international taxpayers 56 hours to complete each year. This form is complicated, and there are great penalties for those who file the form incorrectly, or fail to file the form at all. The best way to make sure you don’t face penalties and have a seamless tax season is by consulting with an international tax expert. The team at Evolution Tax and Legal has dually-licensed lawyers and CPAs, which allows us to combine our knowledge in both law and accounting to provide you with the expertise and service you need to handle your international tax forms. Let our team start early on your taxes, for a streamlined tax season next year. Contact the team at Evolution Tax and Legal today.