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Filing your US taxes as an expat can get complicated – even more so if you start a business while you’re abroad. As a US citizen who owns a foreign business, you have additional tax reporting requirements.
US taxes are based on citizenship status, not residency. Therefore, Americans living abroad who own businesses (even sole proprietorships) have to report their business income on their US tax returns, in many cases on Form 8858.
You’re required to complete Form 88581, which the IRS calls the “Information Return of US Persons With Respect To Foreign Disregarded Entities,” along with your tax return if you own a Foreign Disregarded Entity (FDE).
But what is a Foreign Disregarded Entity? And how do you even know if you own one? Don’t worry. We’ll walk you through everything you need to know about Foreign Disregarded Entities and Form 8858 in this article.
What is a foreign disregarded entity?
By US law, an FDE is a company formed outside of the United States that is separate from the individual who formed it. Essentially, if you own a company outside of the US such as a single-member limited company (similar to a US LLC), sole proprietorship, or partnership, and it is not taxed as a corporation, there is a good chance it qualifies as an FDE.
The US treats both the owner and the FDE as a single taxpayer entity. This means the IRS considers the income your FDE makes as your own taxable income. So, if you made $40,000 outside of your FDE in 2021 and your FDE brought in $60,000, the IRS would view your taxable income as $100,000.
How to report a foreign disregarded entity
If you have a foreign disregarded entity, you will need to report it to the IRS using Form 8858. This form is used to provide information about the entity, its activities, and its ownership. You will also need to attach any required schedules to the form, such as the balance sheet, income statement, and tax reconciliation schedules.
What is Form 8858?
Owners of FDEs must submit Form 8858 along with their US tax returns each year. Tax day for US expats typically falls on June 15th, unless you file for an additional extension. The purpose of Form 8858 is to disclose the ownership of an FDE and provide the US with financial information about your foreign company.
Who’s required to fill out Form 8858?
Americans living abroad who own an FDE will submit Form 8858 with their US tax return every year. But there are other instances when you may need to submit this form:
- If you own or operate a Foreign Branch (FB), which refers to a company that is US-based but conducts business through a foreign legal entity or branch
- If you have an interest in a Foreign Branch (FB) through another foreign entity that you own (ex. an entity for which you file Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations, or Form 8865, Return of US Persons with Respect to Certain Foreign Partnerships)
When is Form 8858 due?
Typically, Form 8858 is due on the same date as the taxpayer’s annual income tax return, including extensions. For most individual taxpayers, the deadline to file Form 8858 for the 2022 tax year will be April 18, 2023. However, if you are living abroad on the due date of your tax return, you may be eligible for an automatic two-month extension to file your tax return and Form 8858 by June 15, 2023.
Form 8858 Instructions: How to File a Foreign Disregarded Entity
Form 8858 is a fairly straightforward four-page document, particularly if you’ve got a handle on the accounting details of your FDE. The first page of the form deals with identifying information.
In addition, Form 8858 contains an additional eight sections, also called schedules. This is where it can get tricky for an individual taxpayer to ascertain their obligations – depending on your circumstances, you may not need to complete every section.
Read on for a guided overview of how to fill out Form 8858.
Page 1: Identifying Information
In this section, you’ll provide key information about your FDE. This includes
- Name and address of the person filing the return
- Name and address of the FDE and its EIN (Employer Identification Number)
- Filer’s tax year
- Country where the FDE is incorporated
- Functional currency of the FDE
- Direct and tax owner of the FDE
If the person filing Form 8858 isn’t the FDE’s owner, its owner(s) must include their personal information.
For clarity, a tax owner may or may not be the legal owner of an FDE, but they are the person responsible for reporting and paying taxes on the FDE’s income.
The direct owner is the person who’s the legal owner of the FDE and is responsible for the management and the FDE’s legal obligations.
To illustrate this, consider the following example:
Emma is a US citizen living in Canada. Caleb is the owner of Ottawa Inc., a Canadian sole proprietorship.
A contract between Caleb and Emma allows Emma to operate Ottawa Inc. fully and, in return, receive 100% of the profits, losses, and tax reporting.
In this case, Emma is the tax owner, and Caleb is the direct owner.
Below is a complete example of Form 8858 based on this hypothetical example, which we break down fully throughout the rest of the article. If it’s helpful, you can print out the following document to cross-reference with the different section explanations.
🚨 It’s important to note that you must complete Form 8858 in English.
Schedule C of Form 8858
Schedule C2 is the income statement of the Foreign Disregarded Entity. In this section, you’ll summarize the FDE’s income and expenses for the tax year, include the foreign income tax expense, and indicate the net income or loss.
You must enter the income statement accounts in your functional currency and translate them into US dollars. For translating currency, you should follow US GAAP (generally accepted accounting principals) translation rules or an acceptable exchange rate like published rates from major banks or financial institutions, rates provided by the US Federal Reserve, or rates published by the IRS3.
A little later, you’ll include your chosen exchange rate on Schedule H.
Our example assumes that Emma’s Ottawa, Inc. earned CAD 800,000 in revenue, CAD 50,000 as other income and that the FDE incurred CAD 350,000 as expenses.
Schedule C-1 of Form 8858
If this section applies, you must report foreign currency gains or losses on certain payments to the owner. Known as Section 987 gains or losses, these calculations can be complicated. Consult with your expat tax professional for assistance with this section.
Schedule F of Form 8858
Schedule F4 is a summary of the balance sheet of the FDE at the beginning of the year and the end of the year. Total assets will be the sum of the FDE’S cash and other assets. And you only need to show total liabilities and total owner’s equity.
Here’s a snapshot using the same example from above.
Note: You need to report amounts in US Dollars in Schedule F. Functional currency reporting is not allowed.
(Functional currency reporting means to report financial transactions and financial statements in the currency that is considered the primary economic environment in which an entity operates and generates cash flows. This is usually the currency of the country where the entity is located or conducts its primary business operations. In our example, the functional currency would be Canadian dollars.)
Schedule G of Form 8858
Entitled “Other Information,” Schedule G5 asks several questions about the FDE. Most of these are simple Yes/No questions for which financial information may only be required if your answer is “Yes.”
Schedule H6 of Form 8858
You use this section to report the FDE’s earnings and profits in its functional currency.
You’ll enter the FDE income on line 1. You can pick this figure up from line 14 on Schedule C you already prepared. You’ll then incorporate certain tax adjustments on lines 2 and 3, such as depreciation, amortization, and capital gains.
You’ll make the US Dollar translation on lines 7 and 8.
Schedule I of Form 8858
Note: Schedule I7 is only required if a US corporation directly or indirectly owns the FDE.
Schedule J8 of Form 8858
Here’s where you finally report foreign taxes paid or accrued by the FDE. Information in this section may help you claim any foreign tax credit you’re eligible for.
Remember, there’s also Schedule M9 you should separately attach with Form 8858 if you’re the tax owner of the FDE.
IRS penalties for failure to file Form 8858
If you do not submit Form 8858 with your tax return in a timely manner, you may face IRS penalties. If the IRS requires you to file this form, the IRS will send you a failure to file letter. At this point, you could receive a penalty of $10,000. You then have 90 days to submit Form 8858. After 90 days, if you have not submitted it, the IRS may charge you additional penalties of $10,000 for every additional month the form is late.
Not submitting this form can also impact your individual tax return. The IRS could also penalize you by reducing the amount of applicable foreign tax credits by 10%. This could eliminate your tax refund or land you with a tax bill. Additional monthly credit reductions of 5% could follow after the 90-day period.
Finally, the IRS could also charge you with criminal penalties for not submitting this form. These penalties could lead to additional fines or time in prison. Bright!Tax can help you ensure you meet all of your US tax requirements, offering you peace of mind during tax season.
US expats can catch up on taxes penalty-free with the Streamlined Filing Procedures
If you weren’t aware you needed to file tax returns as a US expat, then you could qualify for penalty relief through the Streamlined Procedures10. This is a good option to explore if you did not submit your tax returns including business disclosure forms, such as Form 8858.
The Streamlined Procedures can help US expats and other Americans, who did not realize they had to submit past returns, to catch up on their taxes without penalty.
To qualify, you must have lived outside of the US for at least 330 days of the Streamlined filing period (the previous three past-due tax years). You also must have missed the filing deadline because you were unaware of your tax filing requirements or the tax due date.
For example, if you lived in Argentina for most of 2021 and only returned to the US for three weeks, you would meet the residency requirement for this amnesty program. If you didn’t realize you needed to file US taxes since you lived out of the country, you could qualify for the Streamlined Procedures.
Reduce the stress of filing Form 8858 and foreign business taxes by teaming up with Bright!Tax
Keeping track of your tax requirements as a US expat can feel overwhelming – and it’s even more challenging when business taxes get thrown into the mix.
Bright!Tax makes filing simple by walking you through all of the forms you need to file and helping you secure the best tax breaks and amnesty programs along the way. We’ll take the burden off of you, so you can rest easy knowing that your taxes are compliant.
References
- 2022 Form 4868 (irs.gov)
- 2022 Schedule C (Form 1040) (irs.gov)
- Yearly Average Currency Exchange Rates | Internal Revenue Service (irs.gov)
- 2022 Instructions for Schedule F (irs.gov)
- 2022 Instructions for Schedule G (Form 990) (irs.gov)
- 2022 Schedule H (Form 1040) (irs.gov)
- 2022 Schedule I (Form 1041) (irs.gov)
- 2022 Instructions for Schedule J (2022) | Internal Revenue Service (irs.gov)
- 2022 Schedule M (Form 990) (irs.gov)
- Streamlined Filing Compliance Procedures | Internal Revenue Service (irs.gov)
- Delinquent International Information Return Submission Procedures | Internal Revenue Service (irs.gov)
