International Practice Units are detailed instructions for IRS examiners on how to audit different international situations. With a tight budget and a short staff, it's important they use the IRS use its scarce resources to get the most bang for their buck in every audit. The IRS had publicly stated that they are going to be targeting international audits, and these IPU's focus on just that.
Determination of U.S. Shareholder and CFC Status
This IPU was created to determine if a taxpayer is a shareholder in a CFC, 'controlled foreign corporation.' The instructions state that a "major tax advantage of using a foreign corporation is income tax deferral." The IRS wants to see if you are following the rules and not trying to dodge paying your "fair share" of taxes.
Why is this CFC or non-CFC status so important?
The reason the status is so important is because once a CFC determination is made, this triggers the possibility of the dreaded "Subpart F income" — a very nasty tax treatment. For more about Subpart F income, click here. (Yet, even if the examiner determines you're not a U.S. shareholder in a CFC, they still have a list of items to go after).
How will the IRS decide if you should be audited?
This is not as official as I thought it would be. In my mind, there would be certain criteria listed to decide if you should be audited. But no. The IPU instructions state:
"This taxpayer has been linked to a foreign entity. Perhaps during an interview, the taxpayer is asked whether they own any stocks in a foreign entity and they say “yes,” or you notice deposits wired from a foreign company during your review of the taxpayer’s bank statements."
Is the corporation a CFC?
Step one for the auditor is to make this determination. The answer is yes, if more than 50 percent of its voting power or value is owned by "U.S. Shareholders" (note here that it's not 50 percent or more, it's more than 50 percent.)
*Note: A foreign insurance company that earns over 75 percent of its premiums from selling insurance on U.S. risks is a CFC if 25 percent or more of the company is owned by 10 percent U.S. Shareholders.
What is a "U.S. Shareholder"?
This is step two, and their definition is:
A taxpayer who owns 10 percent or more of the total voting power of that foreign corporation.
If you meet the criteria…
If they find that you are indeed a U.S. Shareholder of a CFC, then there is a list of other IPU’s to investigate (and notes which have monetary penalties associated with them, so they know to focus on these):
- Overview of Subpart F Income
- General Subpart F Computational Issues
- Failure to File the Form 5471 – Category 4 & 5 Filers – Monetary Penalty
- Failure to File the Form 5471 – Category 2 & 3 Filers – Monetary Penalty
- Failure to File the Form 926 – Monetary Penalty
- Determination of PFIC Status
- Check-The-Box Rules for Foreign Entities – What is this?
- Section 956 – Investments in U.S. Property
- Dispositions of a CFC – IRC1248
- Distributions from a CFC
- IRC 962 Election – Election by individuals to be subject to tax at corporate rates
- Issues associated with offshore bank accounts
- Foreign Personal Holding Company Income
- Foreign Base Company Sales Income
- Foreign Base Company Services Income
If you don’t meet the CFC criteria…
You’re not off the hook! Since the IRS has already invested time in investigating you, they’re going to see if they can find something else on you — including FBAR penalties. After every step of the process, if they find you don’t meet their criteria there is a list of other potential issues they can investigate.
“If the taxpayer does not own at least 10% of the voting power, it still may have certain filing requirements and other tax issues. Refer to the following IPS Practice Units” to see if any of the penalties will apply to them:
- Failure to File the Form 5471 – Information Returns of U.S. Persons With Respect to Certain Foreign Corporations –
- Failure to File the Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation
- Determination of PFIC Status
- Check-The-Box Rules for Foreign Entities
- FATCA Compliance – Form 8938
If you're concerned that perhaps you are a U.S Shareholder in a CFC and haven't met all of the reporting requirements, contact us to schedule a complimentary, confidential consultation. Call us at 888-727-8796 or email firstname.lastname@example.org. Learn more about our services here.
Watch our video about this IPU, where we may find some loopholes…