U.S. entrepreneurs have long recognized that a world of opportunities is available to them if they are willing to expand beyond domestic borders. Information technology has allowed the global economy to become considerably larger and has rendered lucrative markets abroad more accessible than ever.
While the U.S. government certainly does not want to stand in the way of global opportunities, recent efforts by the Treasury Department and IRS indicate that the government is more serious than ever about preventing U.S. businesspeople from utilizing foreign activities to avoid or defer paying federal taxes.
These efforts are reflected in the promulgation of new tax reporting rules and the strengthening of older ones. Following are five tax tips for doing business overseas and staying in compliance with recent tax reporting rules and reforms affecting U.S. entrepreneurs.
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1. Foreign bank account reporting
Expanding a business overseas may necessitate opening one or more foreign bank accounts. And that will likely trigger the requirement to file a Report of Foreign Bank and Financial Accounts (the “FBAR”). The FBAR is not a tax form and is not filed with the IRS. Instead, it is an informational report filed electronically as FinCEN Form 114 with the Treasury Department.
U.S. account holders with a financial interest in or signature authority over one or more foreign financial accounts, with more than $10,000 in aggregate value in a calendar year, must file the FBAR. Importantly, the FBAR requirement applies to both individuals and entities, including U.S. corporations, partnerships, LLCs and domestic trusts.
FBAR filers should be aware of a deadline change that started in tax year 2016. In prior years, the form was due on June 30 with no extensions. From this tax year, the FBAR is due April 15, a maximum extension for a six-month period ending on October 15.
2. Foreign entity reporting
Operating a business overseas through a foreign entity has logistical merits, but tax-reporting implications should not be ignored. IRS Form 5471, for instance, must be filed by U.S. individuals who own certain percentages of stock in a foreign company that is treated as a corporation for U.S. tax purposes. In general, Form 5471 assists the IRS in gauging the scope of a U.S. taxpayer's foreign holdings that may facilitate U.S. tax deferral.
Entities that are not considered corporations under foreign law may be considered corporations for U.S. tax purposes and thus may fall within the U.S. tax rules related to foreign corporations. Other IRS forms must be filed in the case of non-corporate foreign entities, such as foreign partnerships and trusts.
3. Foreign asset reporting
In addition to reporting foreign bank accounts and foreign entities, certain U.S. taxpayers doing business overseas must report their “specified foreign financial assets” to the IRS on Form 8938 (“FATCA form”) if they meet certain asset-value thresholds. The requirement to file Form 8938 was born of legislation known as FATCA (the “Foreign Account Tax Compliance Act”), enacted in 2010 with the goal of curtailing offshore tax evasion.
In order to give FATCA reporting extra bite, starting this year, the government has decreed that not only are individuals required to file the form, but also certain U.S. entities. Under new regulations, a U.S. corporation or partnership that is “closely held” (an 80 percent holding interest) by a U.S. individual may be required to file the form if more than 50 percent of the entity’s income or assets are “passive” items (e.g., dividends, interest, rent, royalties, annuities, etc. or assets that produce those types of income).
As such, U.S. entrepreneurs should review their corporate structure to ensure that any U.S. entity that falls into this new category properly files the expanded FATCA form.
Because a foreign bank account is a specified foreign financial asset, there is some overlap between the FBAR and FATCA forms. The IRS has a helpful webpage that compares the Form 8938 and FBAR requirements.
4. Tax withholding on foreign vendors
When doing business with foreign vendors, a U.S. entrepreneur may be required to withhold tax. It is not uncommon for U.S. entrepreneurs to allow the U.S. withholding tax rules to fall by the wayside. But, in practical terms, the withholding rules usually involve just simple documentary procedures rather than substantive tax implications.
For instance, before making any payments for services overseas, taxpayers should request a filled-out Form W-8 from the foreign vendor. The form is not filed with the IRS, but must be kept on file in the event that the IRS asks to see it. Without the form, the U.S. payer is required to assume that the vendor is a U.S. person and, as such, deduct backup withholding at the rate of 28 percent.
In the case of certain types of income where withholding is required (e.g., passive items such as licensing royalties), Form W-8 can be used to justify a reduced withholding rate or even an exemption under a relevant tax treaty. When withholding is required, the U.S. payer is required to file certain additional forms with the IRS (e.g., Forms 1042 and 1042-S).
5. IRS enforcement and FATCA
As the tax reporting of overseas activities has become increasingly complex, the penalties associated with non-compliance have become increasingly punitive. Penalties can be onerous even for taxpayers whose filing failures are due to negligence or otherwise non-willful behavior, with a typical penalty amounting to at least $10,000 per form per year.
On top of all this, the implementation of FATCA-related governmental agreements with partner countries worldwide means that your overseas account information will likely reach IRS hands in the near future if it hasn’t already. In today’s environment of increased scrutiny of activities abroad, U.S. entrepreneurs doing business overseas should make staying on top of their taxes a top priority.