For domestic U.S. tax purposes, a Limited Liability Company (LLC) with one owner is considered “disregarded” for U.S. federal income tax purposes, and the LLC’s activities are reported directly by the owner. These entities are commonly referred to as “single-member LLCs”. For example, a landscaper who operates her business through a single-member LLC reports the profit and loss of the landscaping business directly on her personal income tax return. As a result, a single-member LLC usually does not have a separate federal income tax return filing requirement.
When Does Section 6038A Apply?
However, special rules apply when a domestic single-member LLC is wholly owned, directly or indirectly, by a foreign person. A foreign person, for this purpose, can be any type of taxpayer: individual, corporation, trust, etc.
Under Treasury Regulations issued under Internal Revenue Code sections 6038A and 7701, a domestic disregarded entity that is wholly owned by one foreign person is treated as a domestic corporation separate from its owner solely for purposes of the reporting and recordkeeping requirements of section 6038A. This treatment does not generally otherwise cause the entity to become subject to U.S. corporate income tax but does require extra tax reporting when a single-member LLC is foreign owned rather than domestically owned.
What Are the Compliance Requirements if Section 6038A Applies?
Obtaining an EIN
The LLC must obtain an Employer Identification Number (EIN), by filing Form SS-4 with the Internal Revenue Service.
Filing Form 5472
The LLC must file IRS Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business annually. Procedurally, Form 5472 is attached to a “pro forma” Form 1120, U.S. Corporation Income Tax Return, which contains limited information regarding the LLC.
Recordkeeping
The LLC must maintain sufficient books and records to substantiate its reportable related-party transactions.
Penalties for Noncompliance
Failure to file Form 5472 when required, or failure to maintain sufficient books and records to substantiate reportable transactions, may result in a $25,000 penalty for each taxable year. If the failure continues for more than 90 days after the IRS notifies the LLC, additional penalties of $25,000 for each 30-day period (or fraction thereof) may apply for as long as the failure continues. Given these steep penalties, this filing requirement can be a trap for the unwary, especially for those operating in the U.S. from abroad.
Given the significant penalties associated with Form 5472 noncompliance, foreign owners of U.S. single-member LLCs should make sure they understand and address these filing requirements. For more information, read our article, What is Form 5472?
If you have questions about Form 5472 or the reporting requirements for a foreign-owned single-member LLC, please contact your WG advisor.
