Form 5471 Category 2 Filing Requirements and Triggers

This article looks at Form 5471 filing requirements for Category 2 filers. These are United States persons serving as officers and directors of foreign corporations.

The lesson of this post is:

• Pure stock redemptions will not trigger a Category 2 filing requirement.
• Reorganizations might or might not trigger a Category 2 filing requirement, and it's not worth the work to try to figure it out -- just file if the threshold ownership levels are reached.
• Stock issuance by a foreign corporation to a U.S. person, or purchases by or gifts to a U.S. person, will be the type of transaction that can trigger a Category 2 filing requirement.

If you take only one lesson away from this article, it is this:

Reorganizations are treacherous and it takes a lot of work to determine whether they trigger Category 2 filing. Maybe you just file and be safe?

Introduction

Category 2 filing requirements are imposed on United States citizens and residents who serve as officers or directors of foreign corporations. When a United States person is a shareholder of that foreign corporation and acquires "enough" more stock, the officer or director must file Form 5471 to report the transaction.

A shareholder can reach that "enough" level of stock ownership in different ways. At least one of them does NOT trigger a Category 2 filing requirement for an officer or director.

These transactions always trigger Category 2 (And Create Form 5471 Filing Requirements)

The types of transactions that (assuming the ownership percentage increase is big enough) will always create a Form 5471 Category 2 filing requirement are:

• Issuance of stock from the foreign corporation to the United States person; or
• Transfer of issued and outstanding stock from another shareholder to the United States person; or
• A "reorganization" where "new stock" is issued to a United States person.

All three must be coupled with reaching a new threshold of stock ownership.

This transaction never triggers Category 2

The type of transaction that will not create a Category 2 filing requirement for an officer or director (regardless of the stock ownership percentage increase) is:

• A stock redemption by the foreign corporation of someone else's stock, which pushes a United States person's stock ownership percentage up, by any percentage amount.

This transaction might trigger Category 2

The type of transition that may or may not cause a Category 2 filing requirement for an officer or director (assuming the stock ownership percentage increase is big enough) is:

• A "reorganization" that does not result in issuance of "new stock" to the United States person.

This is such an ill-defined research question (what is a "reorganization" and what is "new stock"?) that you're probably better off just filing Form 5471 as a Category 2 filer.

Transactions that Matter: "Meets" vs. "Acquires"

The Code: "Meets"

The Internal Revenue Code imposes the Category 2 filing requirement on an officer or director when a United States person's stock ownership "meets" a threshold value.

IRC §6046(a)(1)(A) gives the general rule:

(a) Requirement of return

(1) In general. A return complying with the requirements of subsection (b) shall be made by—

(A) each United States citizen or resident who becomes an officer or director of a foreign corporation if a United States person (as defined in section 7701(a)(30)) meets the stock ownership requirements of paragraph (2) with respect to such corporation[.]

The phrase "requirements of paragraph (2)" refers to IRC §6046(a)(2), which sets the Category 2 reporting threshold at the first time the United States person "meets" the 10 percent threshold:

(2) Stock ownership requirements. A person meets the stock ownership requirements of this paragraph with respect to any corporation if such person owns 10 percent or more of—

(A) the total combined voting power of all classes of stock of such corporation entitled to vote, or

(B) the total value of the stock of such corporation.

In summary, Code's statement of the Category 2 filing requirement is simple:

If there is a United States person whose stock ownership "meets" 10 percent (or more) by vote or value, an officer or director must file Form 5471.

No transactional "acquire" verb, no time constraint. All that matters is that a shareholder exists who is a United States person and whose stock ownership "meets" (or presumably exceeds) 10 percent of the issued and outstanding stock of the foreign corporation.

And it would seem that if the shareholder "meets" the 10 percent threshold in 2022 and again in 2023 (even if no additional shares are acquired) the Category 2 filing requirement would exist in both years.

But let's skip past this interesting anomaly and the "Code vs. Regulations" smackdown and who wins if they are inconsistent.

The Regulations and the Instructions for Form 5471 make it clear that the Category 2 filing requirements are transaction-triggered and one-time. We will use the Regulations.

The Regulations: "Acquires"

The Regulations tie an officer or director's Category 2 filing requirements to a United States person's acquisition of stock of a foreign corporation.

The initial Category 2 reporting event is when a United States person achieves or exceeds the 10 percent threshold of stock ownership. The Regulations require the shareholder to "acquire" the stock.

And a specific person must "acquire" the additional stock: the United States person who owns the foreign corporation stock. Simplified for easy reading, and the critical words helpfully emphasized in italics, Reg. §1.6046-1(a)(2)(i)(a) says:

Each United States citizen or resident who is . . . an officer or director of a foreign corporation shall make a return on Form 5471 . . . with respect to each United States person who . . . [a]cquires (whether in one or more transactions) outstanding stock of such corporation. . . .

In summary, a Category 2 filing requirement exists when:

• there is an acquisition of stock and
• a United States person shareholder must acquire the stock.

Why Redemptions Are Different

A stock redemption is an acquisition of its own stock by the issuing corporation, from one or more (but not all) of its shareholders.

The shareholders whose stock is not redeemed just sit and watch their percentage ownership of the corporation's stock increase.

Stock redemptions do not trigger a Category 2 filing requirement because the shareholder did not acquire additional stock as required by Reg. §1.6046-1(a)(2)(i)(a).

Examples

Let's demonstrate why redemptions do not trigger a Category 2 filing requirement with two examples.

Example: stock purchase

Facts: Uncle Sam (a U.S. citizen and resident) owns 5% of ForeignCorp.'s issued and outstanding stock and John Bull (an unrelated U.K. citizen and resident) owns the remaining 95%.

Uncle Sam buys all of John Bull's stock. Now Uncle Sam is the 100% shareholder of ForeignCorp.

Analysis: Uncle Sam acquired stock of ForeignCorp. by purchase. That increased Uncle Sam's initial 5% ownership position to 100%. This is enough to push him past the magic 10 percent threshold. A U.S. officer or director of ForeignCorp. would have a Category 2 filing requirement under Reg. §1.6046-1(a)(2)(i)(a).

Example: stock redemption

Facts: Uncle Sam (a U.S. citizen and resident) owns 5% of ForeignCorp.'s issued and outstanding stock and John Bull (an unrelated U.K. citizen and resident) owns the remaining 95%.

ForeignCorp. redeems all of John Bull's stock and none of Uncle Sam's stock. Now Uncle Sam is the 100% shareholder of ForeignCorp.

Analysis: Uncle Sam did not acquire any stock of ForeignCorp. beyond his initial 5% ownership position. ForeignCorp. (not Uncle Sam) acquired John Bull's shares of stock, and Reg. §1.6046-1(a)(2)(i) requires Uncle Sam to acquire the shares in order to trigger a Category 2 filing requirement. A U.S. officer or director of ForeignCorp. would not have a Category 2 filing requirement under Reg. §1.6046-1(a)(2)(i)(a) or (b).

Redemptions: Conclusion

A stock redemption will not trigger a Category 2 filing requirement. A stock "acquisition" occurred, but by the issuing corporation and not by the United States person, which the Regulations require.

Two roads to the same destination. One carries a Category 2 filing requirement, and the other does not.

"Reorganization" vs. "Acquisition" Definitions

"Acquisitions" trigger a Category 2 filing requirement. "Reorganizations" might trigger Category 2 filing requirements, but only if the "reorganizations" are defined as "acquisitions" as well.

What's the difference between an acquisition and a reorganization? It's hard to tell. The words "acquisition" and "reorganization" are defined in the Regulations, but (cough) they aren't particularly useful definitions.

The best we can take away from the definitions is that some reorganizations are acquisitions, but it takes an enormous amount of pointless work to figure it all out.

Acquisition Defined

"Acquisition" is defined at Reg. §1.6046-1(f)(1) (emphasis added):

(1) Acquisition. Stock in a foreign corporation shall be considered acquired when a person has an unqualified right to receive such stock even though such stock is not actually issued. For example, when under the law of a foreign country, all the necessary steps for incorporation are completed but stock in the corporation will not be issued within 30 days, every United States citizen or resident who is an officer or a director of such corporation, provided a United States person has an interest of 10 percent or more in such corporation, and every such United States person shall, within 90 days of the date of incorporation, file the returns required under section 6046 and this section. In the case of a reorganization, new stock may be acquired, depending on the type of reorganization, whether or not any stock certificates are surrendered or exchanged or the designation of such stock is altered.

Reorganization Defined

"Reorganization" is lazily defined in the astonishingly unhelpful Reg. §1.6046-1(f)(2).

(2) Reorganization. With respect to a foreign corporation, the term “reorganization” shall mean not only a transaction described in section 368(a)(1) and the regulations thereunder but also any other transaction or series of transactions which has the same effect.

When is a "Reorganization" also an "Acquisition?"

Note that reorganization can (but need not) include an "acquisition" of new stock.

In the case of a reorganization, new stock may be acquired, depending on the type of reorganization, whether or not any stock certificates are surrendered or exchanged or the designation of such stock is altered.

Look especially at that word "new." The Regulations imply that an "acquisition" means additional--or at least different--shares of stock are issued to a shareholder.

If the effect of the reorganization (with "new stock" to the shareholder) is to increase the shareholder's percentage to the thresholds listed in the Regulations, then a Category 2 filing requirement exists.

What a Waste of Time Looks Like to Me

Here is your task, if you are trying to decide whether an officer or director has a Category 2 filing requirement as a result of a "reorganization."

• Go to IRC §368(a)(1) and examine all of the reorganization types, from (A) to (F), and all of the Regulations. Does your transaction look like one of these? Reg. §1.6046-1(f)(2) tells you to do this.
• Next, put on your Creative Thinker cap. Does your transaction have "the same effect" as reorganization described in IRC §368(a)(1)? Reg. §1.6046-1(f)(2) tells you to do this.
• Finally, if you have decided that this is a "reorganization," try to figure out if "new stock" was issued to your United States person. Reg. §1.6046-1(f)(1) tells you to do this.

If you have "new stock", then your "reorganization" is an "acquisition" and officers and directors face a Category 2 filing requirement if the threshold values (10 percent overall, then additional 10 percentage point increment increase) are reached.

If you don't see any "new stock", then your "reorganization isn't an "acquisition," and your officers and directors are safe from the Category 2 filing requirement.

Frankly, I wouldn't blame you if you just defaulted to "Eh, I'm reporting a Category 2 acquisition" and skipped all of that pointless work. You'll meet the form 5471 filing requirements pretty easily.

What To Do?

So let's wrap this up.

Recall that we are just looking at the transaction type to see if it falls within the type of transaction that can trigger a Category 2 filing requirement.

Other conditions still apply (is the shareholder a United States person, did the shareholder acquire enough additional stock to push past a threshold, etc.).

Easy Answers (File as Category 2)

The types of transactions that trigger a potential Category 2 filing requirement (I say "potential" because we haven't looked at the percentage requirements yet) are:

• Transfer of issued and outstanding foreign corporation stock to a United States person (e.g., by purchase or gift). This is clearly an "acquisition" of stock.
• Issuance of stock by a foreign corporation to a United States person (e.g., in return for a capital contribution). This, too is clearly an "acquisition" of stock.

Uncertainty (Protect Yourself by Filing as Category 2)

For these types of transactions, Category 2 filing will apply if the stock percentages hit the required thresholds.

The types of transactions that might (or might not) cause a Category 2 filing requirement are:

• A reorganization (as that term is defined in IRC §368(a)(1)) or something that behaves like a reorganization, if it results in "new stock" being issued to the United States person.

For these types of transactions, you are welcome to analyze your facts in light of Reg. §1.6046-1(f)(1)'s last sentence and the entirety of Reg. §1.6046-1(f)(2), but I would take the easy exit and do a Category 2 filing if the stock percentage thresholds are satisfied.

Easy Answer (No Category 2 Filing)

The type of transaction that will not be an "acquisition" of stock by the United States person and will therefore never trigger a Category 2 filing is:

• A stock redemption by the foreign corporation that results in the United States person owning an increased percentage of the total foreign corporation stock, regardless of how much that percentage increases.

As always, you can send me a question. If you're truly interested, I'm working with CalCPA and offering a webinar on this fairly soon. You can get that here.