Applying Form 5472 Attribution Rules to Example 2 from Rev. Proc. 91-55

There is a family attribution example in Rev. Proc. 91-55 that I do not understand—I don’t reach the same conclusion as the IRS. Join me as I show my work. Tell me what you think.

Who Files Form 5472?

A domestic corporation or domestic disregarded entity will be a reporting corporation (an entity that that files Form 5472) if it is “25% foreign-owned.” IRC §6038A(a).

(A foreign corporation can also be required to file Form 5472, but that is not relevant to my discussion of the attribution rules here).

Who is a 25% Foreign Shareholder?

“25% foreign-owned” means that at least one foreign person owned 25% or more of the stock of the entity during the year. IRC §6038A(c)(1). Such a person is called a “25% foreign shareholder.” Reg. §1.6038A-1(c)(3).

To keep this discussion brief(er), let's skip the definition of “foreign.” Go look at IRC §1.6038A-1(f) if this is important to you.

Indirect 25% Foreign Shareholder: Use IRC §318(a)

A 25% foreign shareholder whose name is on the stock certificate is a “direct 25% foreign shareholder.” Reg. §1.6038A-1(c)(3)(iii)). No discussion necessary.

And a 25% foreign shareholder can be an “indirect 25% foreign shareholder.” This is where constructive ownership rules come into play. Reg. §1.6038A-1(c)(3)(iv) says:

The Regulations that modify the IRC §318 attribution are modified slightly. IRC §6038A(c)(5) says:

The "except that" stuff just means that for upward attribution of stock ownership from a corporation, there is a threshold 10% ownership requirement for attribution to apply, and there is no downward attribution if the effect is to attribute a foreign person’s stock to a U.S. person.

Indirect 25% Foreign Shareholder: Use IRC §267(c), Too

If the attribution rules of IRC §318(a) do not cause another person to be treated as the owner of a shareholder’s stock, there is a fallback: apply IRC §267(c).

IRC §1.6038A-1(e)(1) says (emphasis added):

Example 1. Family Attribution Using IRC §318(a) and IRC §267(c)

Let's apply IRC §318(a) and IRC §267(c) to a family-owned structure to identify the “indirect 25% foreign shareholders.” This example is from Rev. Proc. 91-55, Example 2. All individuals are nonresident aliens.

Foreshadowing the conflict: I think C2 and GC own 80% of FC stock, directly and constructively, while the IRS thinks they own 100%.

Family Tree

Here is the family tree. Example 2 does not identify the parent of Grandchild, so I arbitrarily picked Child 1.

The family owns 100% of the stock of FC (a foreign corporation) as follows:

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Husband and Wife: 100% Each (IRC §318(a) Attribution Only)

Section 318(a)(1)(A) attributes stock ownership among family members up the bloodline to parents, down to grandchildren, and sideways to a spouse.

Husband is treated as constructively owning Wife’s stock (IRC §318(a)(1)(A)(i)), as well as the stock of the children and grandchild (IRC §318(a)(1)(A)(i)). Husband therefore owns 20% of the stock directly and 80% constructively, for a total of 100%.

Wife also owns 100% of FC stock: 20% directly, 20% by attribution from her spouse, 40% by attribution from her children, and 20% by attribution from her grandchild, all because of IRC §318(a)(1)(A) attribution rules.

Rev. Proc. 91-55, Example 2 says they each own 100%, and I agree with that math. So far so good.

Child 1: 100% (IRC §§318(a), 267(c) Attribution)

Child 1 owns 20% of FC stock directly, 40% from Husband and Wife (attribution from parents), and 20% from Grandchild. That’s 80%.

Child 1 is not considered as owning Child 2’s stock because there is no attribution of ownership between siblings under IRC §318(a)(1)(A). This is where IRC §267(c) fills the gap.

We are instructed to use IRC §267(c) if IRC §318(a) does not attribute ownership. Reg. §1.6038A-1(e)(1) says:

Since IRC §318(a)(1)(A) does not provide sibling attribution, we turn to IRC §267(c), which says:

• An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family. IRC §267(c)(2).
• The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants[.] IRC §267(c)(4), emphasis added.

Therefore, Child 1 will be treated as the constructive owner of Child 2’s 20% because of the constructive ownership rules of IRC §267(c). Added to the 20% directly-owned stock and the 60% constructively-owned stock because of the IRC §318(a)(1)(A) rules, and we see that Child 1 is the direct and constructive owner of 100% of FC’s stock.

Rev. Proc. 91-55, Example 2 says Child 1 owns 100% of FC stock, and I agree.

Child 2: 80% (IRC §§318(a), 267(c) Attribution)

Child 2 does not have a descendant (our assumption is that Grandchild is the child of Child 1). Child 2’s stock ownership in FC is 80%, calculated as follows:

• 20% directly-owned stock;
• 40% constructively-owned stock from Husband and Wife (Child 2’s parents) because of IRC §318(a)(1)(A)(ii);
• 20% constructively-owned stock from Child 1 under the sibling attribution rule of IRC §267(c)(2), (4); and
• 0% constructively owned stock from Grandchild, because there is no niece/nephew to aunt/uncle attribution rule anywhere.

That’s enough stock ownership for Child 2 to be an indirect 25% foreign shareholder of RC. But it's not the 100% stock ownership that Rev. Proc. 91-55, Example 2 says.

Grandchild: 80% (IRC §§318(a), 267(c) Attribution)

Remember that Grandchild is Child’s 1’s child. Both constructive ownership rules are in play to give Grandchild an 80% ownership (direct and constructive) in FC.

• 20% directly owned.
• 40% from Husband and Wife. There is no grandparent-to-grandchild attribution rule in IRC §318(a)(1)(A), but there is attribution of ownership from ancestors in IRC §267(c)(2), (4). Grandparents are ancestors.
• 20% from Child 1, Grandchild’s parent, under IRC §318(a)(1)(A)(ii).
• 0% from Child 2, who is Grandchild’s aunt/uncle, for which there is no attribution of ownership.

My Numbers Don’t Match Rev. Proc. 91-55, Example 2

By my analysis, Child 2 and Grandchild each has an 80% ownership of FC (20% direct ownership and 60% constructive ownership), yet Rev. Proc. 91-55, Example 2 claims 100% stock ownership for both of them.

Furthermore, Rev. Proc. 91-55, Example 2 claims that 100% ownership is achieved purely by application of IRC §318(a)(1). I could only reach 80% by invoking IRC §267(c) to fill in gaps in the IRC §318(a) attribution rules, as required by Rev. Proc. 1.6038A-1(e)(1).

This is an anomaly I cannot solve, and I will see if I can get an answer from Chief Counsel’s office. I am a midwit.

Key Insight

The key insight is that IRC §318(a) and IRC §267(c) attribution rules working together will maximize attribution of stock ownership among family members up and down the bloodline, as well as sideways to spouses.

In short—don’t forget IRC §267(c). It fills in gaps left by IRC §318(a).

Conclusion

In this little example, the answer to the question remains the same—all of the family members easily exceed the 25% ownership threshold to become indirect 25% foreign shareholders of RC. Their names go into Form 5472, Part III.

Attribution rules are hard. But you know what’s harder? Thinking you can remember the attribution rules and do this stuff in your head.

And it bugs me that I cannot get my answer to match Rev. Proc. 91-55, Example 2. Ah well. I will ping someone at IRS Chief Counsel's office and hopefully get an answer. I will update you when I do.