A School And Obamacare Penalties

 

How would you like to get the following notice in the mail?

 

Believe it or not, the IRS sent this to a public school system in Virginia. I am looking at the Tax Court petition as I write this.

This notice is for a Section 6721 penalty, assessed for failure to file certain information forms with the IRS. Common information forms include:

·      Form W-2 (Wage and Tax Statement)

·      Forms(s) 1099 (Interest, Dividends, and numerous others)

·      Form 8027 (Tip Income and Allocated Tips)

·      Forms(s) 1094 & 1095 (Health Insurance)

There is a virtually automatic companion to this penalty - Section 6722 – which assesses another penalty for failure to provide an information form to the recipient.

Combined we are talking over $2.2 million.

To a school?

Let’s go through this.

The school (Arlington) received the above notice dated June 13, 2022.

The second notice (for Section 6722 penalties) was dated June 27, 2022.

The IRS wanted payment by July 12, 2012.

COMMENT: Arlington had an issue. While they knew the IRS was assessing penalties for information returns, they had no idea which information forms the IRS was talking about.

The IRS Revenue Officer (RO) issued a Final Notice of Intent to Levy on July 12, 2022.

COMMENT: The same day?  I have been leaving messages with a Revenue Agent for over two weeks now concerning an individual tax audit, and this RO issued a FINAL on the same day stated in the notice?

COMMENT: There is also a procedural error here. The IRS must issue notices in a certain order, and the RO is not entitled to jump the line and go straight to that FINAL notice.

We learn that this specific RO had previously assessed penalties (without explanation) and filed liens (again, without explanation) on a middle school in the Arlington school system. These miraculously went away before an Appeals hearing could occur.

COMMENT: Sounds like something personal.

On August 10, 2022, Arlington requested a collection due process hearing on the June 13 and June 27 notices. It faced a formidable obstacle, however, as it did not know what the IRS was talking about.

The IRS sent a letter dated December 5, 2022, scheduling an Appeals conference on January 18, 2023. That letter also suggested that Arlington had not filed Forms 1042, which concerns withholding on payments to foreign persons.

COMMENT: Seems an odd one. I would have thought Forms W-2, if anything.

It turns out that the 1042 reference was mistaken.

COMMENT: Clown show.

Arlington (more specifically, Arlington’s attorneys) tried repeatedly to contact the Appeals Officer (AO). It appears that he inadvertently answered his phone one time, and the Appeals conference was moved to January 31, 2023. Arlington still wanted to know what form was costing them over $2.2 million.

The attorneys marched on. They contacted the IRS Practitioner Line, which told them that the penalties might relate to the Affordable Care Act (Obamacare). They also sent a written request to IRS Ogden for explanation and copies of any correspondence concerning the matter.

COMMENT: I’ve done the same. Low probability swing, in my experience.

The attorneys also contacted the Taxpayer Advocate.

Receiving nothing, the attorneys again requested to postpone the Appeals hearing. They learned that two additional penalties had been added. What were the two penalties about? Who knows.

The two late penalties were “abated” before the Appeals hearing on February 10, 2023.

The AO failed to show up to the Appeals hearing on February 10, 2023.

COMMENT: That sounds about right.

At the re-rescheduled hearing on February 24, 2023, the AO wanted to know what Arlington intended to do. Arlington replied that they were still trying to figure out what the penalties were for, and that a little help would be welcome.

That however would require the AO to – gasp – actually work, so he attempted to transfer the case to another AO. He was unsuccessful.

COMMENT: Fire the guy.

On June 30, 2023, the AO sent the attorneys re-generated IRS notices (not copies of originals) proposing $1,1113,000 in penalties for failure to send Forms 1094-C to the IRS and an additional $1,113,000 for failure to provide the same 1094-C to employees.

COMMENT: Finally, we learn the mystery form.

Arlington (really, its attorneys) learned that the IRS had listed a “Lang Street” address for correspondence. Lang Street was never Arlington’s address and was only one of the middle schools in the district. It was, however, the middle school which the RO had liened earlier in our story.

While talking to the AO on June 30, 2023, the attorneys requested additional time to submit a penalty abatement request.  The AO allowed 14 days.

COMMENT: Really? This is the school’s summer recess, no one is there, and you expect people to dig up years-old paperwork in 14 days?

Once again, the AO refused to answer numerous calls and faxes.

The attorneys – frustrated – contacted the AO’s manager. The manager gave them additional time.

On August 21, 2023, Arlington received a mysterious IRS letter about a claim filed on or about February 23, 2023. Problem: Arlington had not filed any such thing.

The attorneys sent a copy of the mystery notice to the AO.

On September 13, 2023, the AO told the attorneys that he had closed the case and issued a Notice of Determination.

COMMENT: This is the “90-day letter” and one’s entrance ticket to the Tax Court.

The attorneys asked why the NOD. The AO explained that he could not provide a penalty abatement while the underlying Obamacare forms remained unfiled.

Uh huh.

By the way, while the AO verbally communicated that a NOD had been issued, Arlington never received it. It appears - best I can tell – that the NOD is stuck at a processing facility.

COMMENT: Fits the rest of the story.

So, what happened with those forms?

It turns out that Arlington sent employees their copies of the Obamacare forms on or about February 28, 2020.

COMMENT: Well, there goes one of the two penalties.

Arlington was going to send the IRS copies on March 16, 2020.

What happened at this point in 2020?

The Governor of Virginia closed all schools for two weeks over COVID-19.

He then closed the schools through the rest of the school year.

On March 30, 2020, Arlington requested an extension of time to file those Obamacare forms with the IRS.

Virtually no one was at the school. People were working remotely, if possible. The school was trying to figure out how to even pay its employees when everyone was remote.

Yeah, I suspect those forms were never sent.

Heck of a reasonable cause, I would say.

And fire the guy.

A Too Rare Taxpayer Win Over Foreign Reporting

I have become cynical about IRS penalties.

Like many accountants, I initially learned that penalties were in the system as a deterrent. If one complies with reporting responsibilities, penalties should not enter the picture. If they do, they surely would be for ministerial causes (think late payment of an estimated tax) and minor, and – if somehow major – waivable upon showing reasonable cause for the mistake.  

Poppycock.

Congress has been raising and creating penalties for decades to “pay for” their tax bills. I would also argue that the IRS has used penalties as a backstop to its funding, especially during Republican budget stringency after the Lois Lerner fiasco.  

The IRS often assesses penalties automatically, without anyone even glancing at your return. This transfers tax administration from the IRS to you – and then by extension – to me. Say that you have a reportable interest in a foreign corporation. The IRS says you must file a certain information report. I get it: the IRS wants to know what is going on. You file the report, but you file it late. Why late? Who knows. Your accountant was on health leave. You were misadvised. You were never advised because you did not recognize it as a tax-sensitive issue. You will – soon enough – get an automatic IRS notice for a $10,000 penalty – or more. You complied, but not fast enough.

Reasonable cause?

Depends on who defines reasonable. As a practicing tax CPA for decades, I am much more open to reasonable cause. Why? I am closer to the day-to-day, so I do not have the anesthesia of distance and disinterest. Things ... just … happen. No one likes paying, but let’s not use that same brush to accuse one of gaming the system.

Let’s take a look at Wrzesinski.

We will call him “W” to keep our sanity.

W was born in Poland. He moved to the United States when he was 19 years old.

A few years later his mom, who still lived in Poland, won the Polish lottery.

Sweet.

Mom gifted him $830,000 over a couple of years.

W knew about U.S. tax. He contacted his tax advisor to ask what the consequences would be. His advisor (G) correctly told him that the gift would not be taxable, but incorrectly told him that no further reporting was required.

I know that G was wrong, but how could the IRS expect W to know that?

Fast forward a few years and W wanted to make a gift to his godson in Poland. He did an internet search, at which time he realized that – while not taxable – reporting was still required. He realized this situation as his own years before, and he contacted an attorney with expertise in foreign tax matters.

W got into an IRS program for late filing of certain foreign-related returns. The IRS would tread lightly if one had reasonable cause, and both W and his attorney thought he had reasonable cause to spare.

I agree.

The IRS came back with its automatic penalties: they wanted $87,500 for one year and $120,000 for the second.

Their reason?

The Notices stated that …

… ignorance of the tax laws was not a basis for penalty abatement under the “reasonable cause” standard and that ordinary business care and prudence require that the taxpayers be aware of their obligations and file or deposit accordingly.”

I would argue the opposite: good faith “ignorance” of tax laws is exactly the basis for the reasonable cause standard. We have more than once huddled here at Galactic Command analyzing tax consequences, especially if planning a transaction. We sometimes disagree. We have run into gaps in tax law, as Congress is churning out this stuff faster than the IRS and the profession can interpret. We have run into contradictions in tax law, especially when the aforesaid gaps are working their way through the courts system. Did I mention that we are all CPAs with varying tax backgrounds? I am, for example, a tax specialist. It is all I do and have done for years.

Consider that there was no tax shelter here, no attempt to avoid reporting income or of claiming bogus deductions. There was a gift from a mother to a son. A gift unfortunately involving some of the most arcane reporting rules embedded in the tax Code. There was no need for the IRS to flog the guy.

W and his attorney protested the penalties.

The IRS lost W’s protest.

Yes, they “lost” his protest.

It took the Taxpayer Advocate to find it.

The IRS abated all but $40 thousand or so of penalties.

W paid it.

And he immediately filed claims for refund.

I like this guy.

The IRS bounced the first claim, saying he did not establish reasonable cause.

You may be figuring out the IRS schtick when in this situation. It is a one-play gamebook: nothing is reasonable. Boyle. Go away.

The IRS bounced the second claim, saying that it was “frivolous.”

Folks, never ever tell a tax practitioner that his/her position is “frivolous.” That is a loaded word in tax practice.

This thing … NO SURPRISE … went to Court.

Let’s fast forward.

In a too-rare taxpayer win, the DOJ conceded the case on February 7, 2023, and requested six to eight weeks to refund W his remaining penalties.

But look at the effort it took.

Our case this time was Krzysztof Wrzesinski v The United States, U.S. District Court, Eastern District of Pennsylvania.

Do You File An Accurate Return Or A Timely Return?

I have alerted the staff here at CTG command center that I prefer and expect to file all business returns, especially passthrough returns, on a timely basis, irrespective of whether we have all required information. Granted, there is some freeplay – we cannot file if we have no information, for example, or if so much information is missing that a filing would not be construed as substantially correct.

The reason?

Penalties for late filing.

Let’s say that you and a partner have an LLC. The return is due in March and can be extended to September. You file an extension but, for whatever reason, do not file the partnership return until December.

What just happened?

(1)  You might think that the return is only 2 months late, as it was extended until September. That is incorrect. You have until September 15 to file the return. Fail to do so, and it is as if you never filed an extension. That return is now late beginning March 16.

(2)  So what? Here is so what: the penalty is $195 per K-1 per month. There are two K-1s: you and a partner. The penalty is $390 per month. Multiply that by the number of months, and you can see how this gets expensive fast.

(3)  You might be able to get out of this penalty. Revenue Procedure 84-35 allows an avenue for small partnerships with 10 or fewer partners, for example. Depending on the facts, however, there may be no easy out. Like fire, you do not want to be playing with this.

There are a hundred variations on the theme. Let me give you one. This one involves an estate tax return. Let’s review the key points, and you decide whether there is cause for a late-filing penalty. 

• The decedent died February 24, 1986.
• On May 6, 1986 the estate was admitted to probate.
• The wife was appointed executrix.
• The estate hired an attorney.
• The estate tax return was due November 24, 1986 (nine months after death). No extension was filed.
• In January, 1987 the executrix filed an inventory with the probate court. Four assets were listed but given no value. One of those assets was an interest in a trust, which asset took on a life of its own. 
• The assets which were valued - that is, excluding the four which were unvalued - were enough the require the filing of a federal estate tax return.
• In 1991 (five years later) the estate filed suit concerning the trust.
• In 1994 the common pleas court entered judgement.
• In 1996 the executrix filed a revised and final accounting with the probate court.
•  In 1997 the estate finally filed a federal estate tax return. 

     The IRS immediately went after late filing penalties. Why wouldn’t it? The tax return was filed more than 10 years after the decedent died.

The gross estate was over $2 million. Those items that could not initially be valued came in around $200 grand.

The IRS charged in and chanted its standard wash-rinse-repeat hymn: the taxpayer cannot escape penalties for the non-extension or late filing of a return pursuant to the Supreme Court’s Boyle decision.

But the estate punched back with reasonable cause: the executrix did not have values for some of the assets that were eventually distributable from the estate. Heck, they had to sue to even get to some of those assets!

What do you think? Is there reasonable cause?

Let me give you a clue: the disputed assets were about 10% of the final estate.

And we come back to a phrase I used early on: “substantially correct.” Tax Regulations require only that the estate return be “as complete as possible.” There are numerous cases where pending litigation – even if the outcome is expected to materially affect the estate’s final tax liability – has not been considered reasonable cause for not filing a return.

The Court pointed out two things:

(1)  The executrix knew (or should have known) early on that the estate was large enough – even excluding the disputed items – to require filing a return.

(2)  She could have paid at least the tax on that amount, or estimated and also included tax on the disputed items.

a.     The Court pointed out that disputed assets were only 10% of the estate.

The executrix did not have reasonable cause. She should have filed and paid something, even if she later had to amend the estate tax return.

My thoughts?

I agree with the Court. I believe the estate was ill-advised. 

There is a sub-story in here concerning the attorney (who thought the accountant was taking care of the estate tax return) and the CPA (who was never told to prepare an estate tax return, at least not until years after the return would have been due). Why didn’t the attorney reach out earlier to the CPA, at least for peace of mind? Who knows? Why didn’t the long-standing CPA – who would have known the decedent - ask about an estate return? Again, who knows?

Our case this time was Estate of Thomas v Commissioner.

COMMENT: I am looking (translation: I printed but have not yet read) a case where a taxpayer did use estimates but still got nailed with penalties. We may come back to that one in the near future.

Issuing 1099s As Retaliation

I continue to be surprised when people use IRS forms as retaliation.

The form of choice tends to be a 1099. The intent – of course – is to provoke an IRS audit.

There was an incessant legal battle several years back at a Cincinnati CPA firm that detonated. I happen to know the parties involved, and I was interested in the use of 1099s as weapons of war. The senior partner in the imbroglio however was not amused with my interest, seemed surprised that so much of the combat was available to one who could search legal records, and told me where to take a long walk. Quite the charmer.

I am reading a case involving doctors in Illinois. There was an anesthesiologist (Nicholas Angelopoulos - “Nick”) who went into business with an orthopedist (Hall).  Hall owned a company (Keystone) which employed Nick and two other doctors.

There was a cost-sharing arrangement among the doctors, which is common enough but which seemed to change without much explanation.

There was question whether Nick and the other two doctors were ever owners of Keystone (an S corporation). There were e-mails, draft shareholder agreements and meeting agendas, and the doctors were charged for equipment purchased by the practice.  Dr Hall, however, maintained that he was the only shareholder.

OK.

There was an LLC called WACHN, comprised of our four doctors plus another and which purchased medical condominiums. Each of the doctors kicked-in $110,000 and the LLC borrowed the rest, although the doctors had to personally guarantee the debt. Nick said that he never signed the operating agreement and that his signature was forged by use of a signature stamp.

Odd.

Each of the four doctors was required to contribute $100,000 towards a “cash reserve” in Keystone’s bank account. Hall argued that it was necessary to avoid paying checking fees, and that – eventually – there would be more money to distribute to everyone. Nick thought that he was paying for his ownership in Keystone.

COMMENT: Folks, if your bank requires hundreds of thousands of dollars to avoid fees, you really need to consider another bank.

There were questions about how the numbers were calculated and allocated among the doctors in Keystone, but Hall assured the doctors that the practice manager (Hall’s brother in law, by the way) had assured him everything was in order.

I feel better.

In 2007 two of the doctors left.

Later in 2007, Nick told Hall that he too was leaving.

In March, 2008 Hall gave Nick a hand-written sheet stating that Nick owed $151,769. Hall, being a good sport, said that he would offset the $110,000 that Nick had put into WACHN, but Nick had to transfer his interest to Hall. Hall would then – back to that good sport thing – “forgive” the remaining $40,769. Hall did not address removing Nick as a guarantor for WACHN’s debt, though.

Nick told Hall where to go.

Keystone issued Nick a 1099 for $159,577.

Hall said that Nick still owed $100,000 toward the Keystone cash reserves and $28,000 towards the WACHN buy-in. There was also a $38,010 bonus that Hall was paying Nick on the way out, being a good sport and all. Nick responded that he had paid everything he was supposed to pay, and – by the way – what bonus?

Sure enough, in 2011 the IRS swooped in on Nick.

Mission accomplished.

Turns out the $38,010 bonus was right. That however left a bogus $121,567 on the 1099.

Let’s fast forward through the rest.

Nick sued Hall and Keystone. There were several lawsuits, but we are concerned here with the tax-related lawsuit.

The Court decided that Keystone and Hall filed a fraudulent 1099 because of “spite arising out of the larger disputes between the parties.” Code Section 7434 allows for damages in this circumstance, and the Court gets to decide.

The Court awarded Nick damages of $178,954.

Our case this time was Angelopoulos v Keystone Orthopedic Specialists.

An Attorney, A CPA and Confidentiality

Do you have privacy protection if you tell me something as your CPA?

Your first thought might be yes, as your CPA might be the financial doppelganger to an attorney.

Then again, the answer might be no, as your CPA is not in fact an attorney – unless he/she is one of those rare birds that pairs-up a JD/CPA.

What got me thinking along these lines is the recent case US v Galloway.

Let’s travel to 2006. The IRS notifies Galloway that his 2003 return has been pulled for audit.

Audit starts.

In the middle of the audit Galloway’s CPA fires him. Why? Galloway did not pay his fees.

In 2008 Galloway gets sent to CID (Criminal Investigation Division), the part of the IRS that carries badges and guns.

As a heads-up: you NEVER want to deal with CID. It is one thing to argue with regular IRS, appeal penalties, stretch out a payment plan and so on. All that crowd wants is your money. CID investigates criminal conduct and they have a different goal: to put you in jail.

CID agents went to his business offices in Bakersfield, California. Upon their approach, a man in the office locked the door and called the police.

The CID agents also called the police and informed them there were two plain clothed and armed federal agents waiting for them to arrive.

The man stepped out of the building and provided them with the name of an attorney. The CID agents cleared out before the police arrived.

Nothing. Suspicious. There.

Since that visit went so well, CID next issued a summons for production of documents to the former CPA.

The CPA met with them, explained his relationship with Galloway and answered questions on how he prepared Galloway’s 2003 return. No great surprise: Galloway had forwarded QuickBooks information; the CPA asked a few questions, massaged a few numbers and produced a tax return. Happens in a thousand CPA offices every day.

There was a smidgeon of a problem, though.

Remember that the CPA had started the Galloway audit. As part of the audit, Galloway had provided him more paperwork, including additional and replacement QuickBooks runs. No big deal - usually.

What was unusual was that the new QuickBooks runs did not match-up to the earlier run the CPA used for the tax return.  

Galloway was charged with four counts of attempting to evade tax.

What to do?

Galloway sought to suppress all evidence obtained from his prior CPA. Why? Code Section 7609. The AICPA Code of Professional Conduct. Equitable authority. Applebee’s 2 for $20 menu.

You get it: kitchen sink. Galloway was throwing everything he had.

And this brings us to the Couch case from 1973. It was a Supreme Court case, so it is big-time precedent.

Couch owned a restaurant. At issue was unreported income. Cash. Pocket. Wink. You understand.

The IRS issued a subpoena to Couch’s accountant for books, records, bank statements, cancelled checks, deposit ticket copies, Sunday newspaper coupons and unexpired S&H green stamps.

Couch said: hold up. She had provided all that stuff to her accountant, so subpoenaing her accountant rather than her personally was nonetheless a violation of her Fifth Amendment right against self-incrimination.

I like her argument.

Ultimately – as Captain Picard would say – her argument was futile.

The Court was short and swift: Couch had no “legitimate expectation of privacy” upon providing information to a third-party with the goal of processing, straining and compressing that same information onto a government tax return.

Back to Galloway.

As you can see, he was taking a low-probability swing on a high-and-tight fastball.

He struck out. He could not make enough separation between his situation and Couch to avoid the precedent.

How do tax CPAs handle situations like Galloway in practice?

First of all: interaction with CID is rare. One can have a long career and never see the criminal side of the IRS.  

I have run into CID once or twice over 30+ years, most recently in connection with a fraudulent tax preparer in northern Kentucky. I also recently (enough) represented a client whose file was submitted by Exam to CID, but CID rejected the matter. The client was eye-rollingly negligent, but Exam hyperventilated (I thought then and now) and started seeing intent where only stupidity abounded.  

Anyway, here is what the CPA should recommend:

(1) Have the client hire an attorney

(2) Have the attorney hire the CPA

Under this arrangement, the CPA works for the attorney. He/she is protected under the attorney’s confidentiality privilege and cannot be compelled to testify unless the attorney releases him/her. The attorney will not – of course -  do any such thing.

This set-up is called a “Kovel,” by the way. Not surprisingly, it refers to a case by the same name.

What did Galloway’s accountant do wrong?

To be fair: nothing. Galloway was no longer a client. He was under no obligation to chase Galloway down.

Galloway really should have thought of that before stiffing the CPA for his fee.

Let’s however say Galloway was still a client. 

Folks, at the first hint or whiff of a criminal investigation I am (1) firing you or (2) you are providing me with a Kovel. Those are the only two options.

But it requires the accountant to recognize the danger signs.

Like a combined civil-criminal IRS examination, for example. Those are borderline unfair, as the IRS will pretend there is no criminal side to it. They introduce an unsettling miasma of entrapment, and they require the tax practitioner to realize that he/she is being played.

But that is not what happened with Galloway. CID went to his office, for goodness’ sake.

There was not a lot of subtlety there.

The Cause of Action Lawsuit

Something caught my attention this week. You know how this blog works: if it catches my attention, we likely will talk about it.

So let’s talk.

Do you remember when a senior White House official blabbed-out the following in August, 2010?

"In this country we have partnerships, we have S corps, we have LLCs, we have a series of entities that do not pay corporate income tax," said the senior administration official. "Some of which are really giant firms, you know Koch Industries is a multibillion dollar businesses."

The problem is that this comment implies direct knowledge of Koch’s tax status, which – if offered up by a White House official – is a violation of federal law. You know, the kind of law you or I would go to jail for breaking.

In November, 2011 the New York Times opened its front-page guns on Ronald Lauder, a Reagan administration official and the chairman of the Jewish National Fund and of the World Jewish Congress.  The Times picked on Mr. Lauder for using aggressive techniques to minimize his taxes - the kind you and I might review if you hired me. There may be a point where it is too aggressive for us, but that is a different issue. None of us has a obligation to pay more tax than necessary. I would know your taxes because you would have hired me. However, how would the Times know about Mr. Lauder’s taxes? Point is… they shouldn’t. If I talked about his taxes I would lose my license, have a malpractice claim, likely be sued and who knows what else.

The irony that the Sulzbergers – the owners of the New York Times – probably used the same or similar techniques did not seem to occur to the Times.

Frank VanderSloot is a wealthy businessman who wrote a sizeable check to a PAC which supports Mitt Romney. For this he - and seven other donors - were named on an Obama campaign website as "wealthy individuals with less-than-reputable records." Are you kidding me? This summer he was pulled for audit by the IRS. So was his wife. For two years. Mr. VanderSloot and his accountants do not recall ever being audited. Not bad, considering that (1) he is uber-wealthy and (2) he is 63 years old.

Where are we going with this? In April a watchdog group named Cause of Action filed a Freedom of Information Act request for a listing of tax returns the White House has requested. How does the White House get them? Take a look at Section 6103(g) of the Internal Revenue Code:

6103(g) Disclosure to President and Certain Other Persons.—

 

6103(g)(1) In general.—

Upon written request by the President, signed by him personally, the Secretary shall furnish to the President, or to such employee or employees of the White House Office as the President may designate by name in such request, a return or return information with respect to any taxpayer named in such request. Any such request shall state—

6103(g)(1)(A)  the name and address of the taxpayer whose return or return information is to be disclosed,

6103(g)(1)(B)  the kind of return or return information which is to be disclosed,

6103(g)(1)(C)  the taxable period or periods covered by such return or return information, and

6103(g)(1)(D)  the specific reason why the inspection or disclosure is requested.

The IRS rejected the request, stating that it could not disclose information “specifically exempted from disclosure by another law.” The IRS appears to be referencing the fact that tax returns are confidential and cannot be released pursuant to the FOIA. The IRS has not explained however how a listing of returns requested by the White House is the same as releasing the tax returns themselves.

So this Tuesday Cause of Action filed a lawsuit against the Internal Revenue Service.

I am uncomfortable that a lawsuit was even necessary.

Be Careful With Foreign Tax Information Returns

Today we filed an extension for a client company with a foreign subsidiary. I was recently reading a Chief Counsel’s Advice concerning the same type of tax return that our client will be filing in a few months.

There is an additional form to file when one owns a foreign corporation. That is Form 5471 “Information Return of U.S Persons with Respect to Certain Foreign Corporations.” The common ownership threshold for filing is 10 percent. There is a twist in which an officer or director has a responsibility to file, even if the officer or director owns no shares directly, as long as a US citizen owns at least 10 percent.

Frankly, this is a confusing return. There are four types of “filers,” and each has to fill-out – or not fill-out- certain sections of the return. One may have to provide an income statement for the foreign company, for example, or track its earnings and profits.

The 2010 HIRE Act amended the tax Code (Section 6501(c )(8)) so that the statute of limitations for an income tax return to which an international “information return“ relates does not start until the information return is filed.

What does this mean? Well, Form 5471 is considered an “information return.” This means that it has numbers on it, but there is no line that says “tax due.” There is a similar form (Form 8865) for foreign partnerships and another (Form 3520) for foreign trusts.

So you own (enough of) a foreign corporation to file Form 5471. The accountant doesn’t think about it and files the corporate return without it.  The IRS in CCA 201104041 clarified that the statute of limitations on the corporate return does not begin to run until the Form 5471 is filed.

The client referred to above is new to the firm. One of the reasons that they switched firms? Their former CPA had not been filing Forms 5471.

If you remember, there are also penalties for not filing foreign information returns, including Form 5471. That however is for another blog post.