Beginning with the tax year 2018, the IRS now requires U.S. taxpayers to file the U.S. federal Form 8858 to report foreign branch activity. The Form 8858 is filed by attaching it to the U.S. taxpayer’s U.S. federal income tax return. The filing due date of the Form 8858 is the same as the due date of the tax return.
There is a $10,000 USD penalty that may apply to some U.S. taxpayers for the failure to file the Form 8858 on time. The U.S. taxpayer also may be at risk for the penalty if the Form 8858 is not substantially complete and accurate when it is filed. An additional continuation penalty of $10,000 USD also may apply for each month that the noncompliance continues for more than 90 days after the IRS sends a notice. The additional continuation penalty is limited to $50,000 USD. Other possible penalties include an initial 10% reduction of foreign tax credits and an additional 5% reduction of foreign tax credits for each three-month period that the noncompliance continues for more than 90 days after the IRS sends a notice. Criminal penalties also may apply for intentional or willful noncompliance.
There are two definitions that the IRS relies on to determine if a U.S. taxpayer has a foreign branch that is reportable on the Form 8858. The first definition is based on a facts and circumstances analysis. The definition refers to a business operation that a U.S. person carries on outside of the United States. A U.S. taxpayer must report a foreign branch if they engage in business activity overseas and maintain a separate set of books and records, have an office or fixed place of business where employees or officers work overseas, or have a permanent establishment (PE) in a treaty country. The second definition of a foreign branch applies when the activities of the U.S. taxpayer constitute a trade or business in a foreign country and a separate set of books and records is maintained. The second definition is referred to as a “qualified business unit” or “QBU”. A U.S. corporation, partnership, trust, estate, and individual are all U.S. taxpayers that may be considered to have a reportable foreign branch under these definitions.
Form 8858 foreign branch reporting may be required for a U.S. individual working in a foreign country as a sole proprietor, an active foreign rental activity, and certain foreign investment activity.
The IRS rules and regulations do not specifically carve out any clear exceptions for U.S. government contractors that engage employees to work on U.S. military bases or at U.S. embassies located in foreign countries. A U.S. government contractor could be considered to have a foreign branch if it has an office or a fixed place of business where its employees or officers work overseas. It is also clear that business activity in a foreign country will require Form 8858 foreign branch reporting if the U.S. taxpayer is considered to have a taxable presence in a foreign country through a permanent establishment under a U.S. income tax treaty. When there is not a clear case of an office, fixed place of business, PE, or QBU in a foreign country, the decision to file or not file the Form 8858 depends on a careful risk management analysis. In these situations, the decision to file would mitigate the risk of penalty but it also necessitates consistency from year to year. Alternatively, the decision not to file may not be specifically contrary to the IRS rules and regulations but a clear exception is currently lacking to substantiate the authority for the position.
For more information, please contact Alison Dougherty at 301.222.8262 or ADougherty@aronsonllc.com or your Aronson LLC tax advisor.