The Treasury Department recently released final regulations requiring U.S. single member LLCs owned by a foreign person to be treated as corporation for purposes of filing Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Previously, disregarded entities were not required to file Form 5472. This change to the Form 5472 reporting requirements under the regulations will require foreign owned disregarded entities to file Form 5472 and maintain records sufficient to establish the accuracy of the information reported on Form 5472 and the correct U.S. tax treatment of the reported transactions. In addition, the disregarded entities will be required to obtain an Employer Identification Number (“EIN”) and provide information about their responsible party. The final regulations will apply to taxable years beginning on or after January 1, 2017.

The final regulations provide that these entities have the same taxable year as their foreign owner if the foreign owner has a U.S. return filing obligation. If the foreign owner has no U.S. return filing obligation, then for ease of tax administration, the final regulations provide that the taxable year of these entities is the calendar year unless otherwise provided in forms, instructions, or published guidance.

Why the Change?

Under the “check-the-box” regulations, a business entity with a single owner can be disregarded as separate from its owner for various tax purposes and may not be required to file a U.S. tax return or obtain an EIN. As a result, the IRS may lack information about the disregarded entity potentially shielding foreign owners from U.S. and foreign tax liabilities. Many U.S. LLCs are viewed as tax havens by foreign jurisdictions.

In a letter to Speaker of the House Paul Ryan on May 5, 2016, Treasury Secretary Jacob (“Jack”) Lew described the current situation as a “loophole in our system that allows foreign persons to hide assets in U.S. accounts.”

The regulations will allow the IRS to obtain information about these entities that was previously unreported for purposes of determining whether there is any tax liability, and if so, how much, and to share information with other tax authorities. This information will enhance U.S. compliance with international standards of transparency and exchange of information for tax purposes and will strengthen the enforcement of U.S. tax laws.

This change will largely affect foreigners investing in U.S. real estate who frequently use single-member LLCs treated as disregarded entities for tax purposes. The structure is common among foreign cash buyers who purchase real estate as investment properties rather than residences in major U.S. cities, such as New York or Miami. Going forward, since the entities have to report information whether or not they incorporate in the U.S., foreign investors may opt to use a U.S. corporation for such investments so they can deduct and capitalize expenses.

With these additional reporting requirements, tax specialists should be involved in these deals going forward to ensure proper structuring, planning and compliance.