While many individuals are now aware that they are obligated to report and make certain disclosures regarding certain offshore accounts, many people do not realize the full extent of this duty. Report of Foreign Bank Accounts (FBAR) and Foreign Account Tax Compliance Act are two of the disclosure obligations that receive the most attention and therefore compliance focus. There is good reason for concerns about these two particular disclosure obligations because even an accidental instance of noncompliance can lead to large fines and penalties.
However, these two disclosure duties are far from the only informational reporting duties a taxpayer with foreign assets may have. In addition, U.S. taxpayers who control one or more foreign corporations must also make certain additional disclosures. The failure to do so can result in significant penalties and tax consequences.
Who is Required to Report an Interest in a Controlled Foreign Corporation (CFC)?
Under CFR Section 6038(a)(1), U.S. taxpayers who hold certain interests in controlled foreign corporations are required to report this interest as part of their annual tax filing. Generally, an individual needs to have a controlling interest in a CFC before he or she is required to report a CFC. A controlling interest in a CFC exists when the individual has a fifty percent or greater aggregate voting power across all classes of stock. Individuals who have a controlling interest in a CFC are required to report the existence of this interest along with additional information about the entity.
Additional American taxpayers can also come under this duty to disclose. All U.S. taxpayers who receive treatment as a U.S. shareholder of a CFC for an uninterrupted period of 30 days during its annual accounting period and who owned stock in the CFC on the last day of the CFC’s annual accounting period, are obligated to report their interests. An individual is considered a shareholder when he or she owns 10-percent or more of the combined voting power of all classes of stock.
How Can Taxpayers Violate this Duty to Disclose an Interest in a CFC?
To understand how a taxpayer can run afoul of this duty to disclose, the events that unfolded in U.S. v. Flume. In Flume, the taxpayer was a category 5 filer due to his interest in a CFC for an uninterrupted period of 30 days or more during the 2001 tax year. Flume also failed to file disclosures in 2002 and, for a different foreign company, failed to file disclosures for the tax years 2001 through 2009. Flume was obligated to file IRS Form 5471 to satisfy this obligation.
Flume did not address this deficiency until 2013. In 2013, Flume completed and filed delinquent Forms 5471. However, Flume never corrected noncompliance regarding the second controlled foreign corporation. Flume was penalized for both failures to disclose his ownership stake in a CFC.
Flume’s arguments regarding the inappropriateness of the penalties stemmed from a belief that he and his wife had reduced their ownership shares in the CFC to such a level that CFC reporting requirements no longer applied. The court did not find this argument particularly convincing due to the transactions and business activities of Flume and his wife.
In assessing the merits of the taxpayer’s argument, the court first noted that little in the record supported the Flume’s contention that the taxpayer’s had reduced their ownership interest sufficiently to avoid the disclosure duty. Rather, the court determined that Flume had only produced “self-serving
testimony and a backdated document.” Furthermore, the court noted that, despite what the records might purport, the court found that Flume and his wife “continuously” directed funds into and out of the account. Flume and his wife were the only individuals with signature authority over the accounts. Finally, Flume provided no evidence regarding when, exactly, alleged reductions in ownership occurred. Since the taxpayer provided no evidence that would justify or excuse non-compliance, the court upheld the penalties for the failures to file IRS Form 5471.
Questions About CFC Reporting Obligations?
If you are a U.S taxpayer and own or control a CFC, then you should make a comprehensive assessment of all disclosure and tax payment obligations to avoid penalties for non-compliance. The tax lawyers and tax professionals at the Tax law Offices of David W. Klasing can assess whether you are required to file IRS Form 5471 or make other foreign disclosures through FBAR or FATCA. To schedule a confidential, reduced rate initial consultation at our Los Angeles or Irvine tax law offices, call 800-681-1295 or contact us online today.
