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Thursday, October 23, 2008

PENALIZE FIRST, ASK QUESTIONS LATER

U.S. persons and entities with interests in non-U.S. corporations take heed – noncompliance with information reporting requirements will soon lead to automatic imposition of substantial U.S. penalties. The reporting at issue is for Form 5471, which must be filed by U.S. persons with certain stated interests in foreign corporations. The persons who must file are listed in the instructions to the form, which can be reviewed at http://www.irs.gov/pub/irs-pdf/i5471.pdf

The penalties for nonfiling are significant, especially since they do not relate to any specific amount of tax being due and are imposed even if the taxpayer owes no U.S. income tax.  Each failure to file results in a $10,000 penalty, and a 10% reduction in available foreign tax credits.

In the past, such penalties were typically imposed only at the discretion of a tax auditor after a return is audited. Now, starting January 1, 2009, all late filed returns will automatically be assessed penalties. Taxpayers will then need to be able to show reasonable cause for nonfiling to be able to get the penalties removed.

Perhaps this wouldn’t be such a big deal, if there weren’t so many taxpayers that did not file the Forms due to ignorance of the filing requirement. Of course, the larger taxpayers who have and can afford knowledgeable tax advisors, will likely not run afoul of the rules. Thus, it is likely that the penalties will disproportionately fall on smaller taxpayers who can ill afford such substantial penalties.

Anyone with interests in foreign corporations who may be subject to the reporting should check immediately with their tax advisors to determine if it is advisable whether filings should be undertaken prior to January 1, 2009, especially as to returns due for prior years.

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