Understanding Foreign Disregarded Entities & Form 8858
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.
Since the US taxes are based on citizenship status, rather than on residency, 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 8858, 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?
In order to know if you’re on the hook to file Form 8858, you first need to know if you own 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 and it is not taxed as a corporation, such as a single-member LLC, sole proprietorship, or partnership, there is a good chance it qualifies as an FDE.
The US treats both the owner and the FDE as a single 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 in income, the IRS would view your taxable income as $100,000.
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 this form is to disclose if you do own 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 taxes 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 that 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 for)
Form 8858 Instructions: How to File
You’ll submit Form 8858 when your taxes are due. You must submit it to the IRS along with your tax return. You can find detailed instructions on how to complete Form 8858 on the IRS website.
Penalties for Not Filing 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 foreign taxes you can use to apply as credits by 10%. This could eliminate your tax return or land you with a tax bill. Additional monthly credit reductions of 5% could follow after the 90-day period.
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.
Can expat business owners avoid penalties?
The best way to avoid tax penalties is to submit all of your required forms on time. A Bright!Tax CPA can help identify all of the forms you need to file and walk you through the filing process.
In some cases, you can avoid penalties if you weren’t aware you needed to file Form 8858, either through the Delinquent International Information Return Submission Procedures or the Streamlined Filing Compliance Procedure. In order to qualify for either of these procedures and avoid penalties, the IRS must not have already reached out to you. The IRS also cannot have an open criminal or civil investigation against you.
How the Delinquent International Information Return Submission Procedure Works
If you realized after tax day that you should have filed Form 8858, you can file it through the Delinquent International Information Return Submission Procedure.
But you can’t just submit this form to avoid penalties. Instead, you should submit a written statement that explains why you did not file this form on time. If you don’t submit a statement, you could face penalties.
The IRS reviews each statement under this procedure on a case-by-case basis. There’s no guarantee you won’t face penalties, but a thorough statement will improve your chances of receiving penalty-free relief.
You can submit statements for any past due Forms 8858 – unless the IRS has already notified you of your failure to file.
To submit your statement and Form 8858, you’ll need to file an amended tax return.
Bright!Tax can guide you through creating a statement that will improve your chances of avoiding penalties and help you file your amended tax return. If you’ve already received a notice from the IRS, a Bright!Tax CPA can walk you through your next steps to clean up your tax requirements.
How the Streamlined Procedure Works
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 Procedure. This is a good option to explore if you did not submit your tax returns or business disclosure forms, such as Form 8858.
The Streamlined Procedure can help US expats and other Americans, who did not realize they had to submit past returns, catch up on their taxes without penalty, by encouraging them to come forward and file.
To qualify for this procedure, you must have lived outside of the US for at least 330 days of the Streamlined filing period (the previous 3 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 Procedure.
Bright!Tax can walk you through the steps needed to complete your missing tax returns and file Form 8858, so you can avoid IRS penalties.
The IRS has a Limited Window of Time to Charge Penalties
While there is no promise that the IRS will not bring penalties against you for filing Form 8858 late, there is a statute of limitations during which the IRS can take action.
If you have never filed Form 8858 and you’re required to, then the IRS can proceed with penalties or legal action at any time.
If you do file, however, the IRS has three years to charge you with penalties or legal action. Three years after you file this form, the IRS cannot charge you with a new penalty.
So, not filing means the IRS could come after you for penalties at any time. It’s best to catch up now and see if you qualify for amnesty, and, if not, do what you can to reduce your chances of higher penalties.
Filing Foreign Business Taxes is Easy 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 find 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.