Proposed Regulations regarding Foreign-Owned Domestic LLCs

Under current regulations, spanning from Treas. Reg. §§ 301.7701-1 through 301.7701-3, a domestic limited liability company (“LLC”) organized under the laws of the United States, with only one member is by default classified as a disregarded entity for tax purposes.

However, an election may be made to have it classified as a corporation for tax purposes.  Since a disregarded entity, also known as a flow-through entity, has its income reported and taxes paid through its owner, it generally does not need to file a tax return or obtain an Employer Identification Number (“EIN”).  When neither a return is filed nor an EIN requested, the information the government can track on these disregarded entities is relatively limited.

On the other hand, for corporations and partnerships, both foreign and domestic, most have annual tax reporting requirements even in years when no tax is due; this provides the U.S. government with a breadth of information concerning these entities.  Pursuant to IRC § 6038A, domestic corporations that are at least 25% foreign-owned are subject to specific reporting and record keeping requirements.  These include filing an annual Form 5472 Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business (Under Sections 6038A and 6038C of the Internal Revenue Code) with respect to each party with which the corporation had a reportable transaction during the tax year.  Reportable transactions subject to reporting on Form 5472 include but are not limited to sale of stock, sale of tangible property, rental income received, interest received, as well as the inverse, purchase of stock, purchase of tangible property, etc.  These corporations are also subject to record keeping requirements under IRC § 6001; they keep permanent books and records to sufficiently establish the accuracy of their federal income tax return.

New proposed regulations, REG-127199-15, seeks to amend § 301.7701-2(c) to treat a domestic disregarded entity that is wholly owned by a foreign person as a domestic corporation separate from its owner for record keeping purposes under IRC § 6038A.  This would: (1) allow for improved record keeping and tracking for information purposes of the Department of Treasury, therefore allowing the United States to satisfy its obligations under tax treaties; and (2) it would consequently require these entities to file Form 5472 information return with respect to reportable transactions between the entity and its foreign owner or other related foreign parties.  The Department of Treasury hopes that these newly proposed regulations will allow for broader reporting requirements for entities which are currently under-reported and have no record keeping obligations.