Why Treaty Nonresidents Must File Form 5471

The Punchline

Form 5471 is required for an individual who is a resident alien and claims U.S. nonresident status because of an income tax treaty.

This is true even though subpart F income and global intangible low-taxed income reported by way of that Form 5471 will not be subject to U.S. income tax.

Resident Aliens Can Choose to be Taxed as Nonresidents

Green card holders are automatically classified as resident aliens for U.S. income tax purposes. IRC §7701(b)(1)(A)(i). People who fall afoul of the substantial presence test by spending too many days in the United States are also resident aliens. IRC §7701(b)(1)(A)(i).

Maybe you have a resident alien client and filing a Form 1040 would be catastrophic. Well, maybe an income tax treaty will allow your client to be taxed as a nonresident of the United States and file Form 1040-NR. Much better, right?

I did a one-hour session for the Florida Bar Tax Section on June 12, 2024 about treaties and the tie-breaker rules. You can watch it for freebies on YouTube.

Nonresident for Some Purposes, Resident for Others

Just because the individual is a nonresident when you apply the tie-breaker rules in the treaty, don’t think you’re done. As far as the IRS is concerned, the individual is a nonresident in some ways and still a resident in other ways.

Here is how it breaks down:

Nonresident for computing income tax liability. Reg. §301.7701(b)-7(a)(1).
Resident for all other purposes. Regs. §301.7701(b)-7(a)(3).

The status (resident or nonresident) decides what forms you bolt onto that income tax return you are preparing. And we all know that resident aliens and citizens have a metric ton of fun when they prepare their income tax returns. Nonresidents, less so.

Sometimes, a Requirement is Waived

For some filing requirements, the IRS has decided that a treaty nonresident need not file a form required of a resident alien.

Form 8938, for instance. A treaty nonresident files only for the part of a year in which he or she was a resident, so a full-year treaty nonresident need not file Form 8938 at all. See Reg. §1.6038D-2(e).

But for Form 5471, the Filing Requirement Stands

But for some other forms, the IRS is silent. Form 5471 – my favorite form – is one of those. And silence means you’re in the happy position of preparing Form 5471 even if no passthrough income appears on the individual’s Form 1040-NR.

Form 5471 filing requirements are imposed by IRC §6038. Neither that Code Section nor the Regulations waive the filing requirements for treaty nonresidents.

(Well, there is a rule that says in limited circumstances you can submit audited financial statements. See Reg. §1.6038-2(j)(2)(ii). This is largely useless in my experience because most regular entrepreneurs running regular-sized businesses would be committing cash-flow malpractice by spending money on audited financial statements.)

An IRS internal memorandum, FAA 20223302F, discusses precisely this situation, and repeats the IRS’s position that a resident alien claiming nonresident status because of treaty tie-breaker rules must nevertheless file a Form 5471.

Download the IRS memorandum here: FAA_20223302F

Lots of Work, No Taxable Income

Form 5471, of course, is the carrier pigeon that delivers subpart F income and global intangible low-taxed income to the U.S. shareholder’s income tax return and taxes the U.S. shareholder accordingly.

The treaty nonresident’s U.S. income tax is computed as if the individual is a nonresident. Nonresidents are not subject to income tax on subpart F income or global intangible low-taxed income.

Therefore, you can prepare a full-blown Form 5471 and find that it passes no taxable income through to the treaty nonresident’s Form 1040-NR.

Resident for CFC Status Purposes

The Regulations say that a treaty nonresident is classified as a resident alien for purposes of determining whether a corporation is a controlled foreign corporation. Reg. §301.7701(b)-7(a)(3) says, in relevant part:

A treaty nonresident (green card holder or substantial presence person living in another country who can be classified by an income treaty as a resident of that other country) holds 100% of the stock of a foreign corporation that does no business in the United States and has no U.S. assets.

Result: this Regulation says that the corporation is a CFC, and necessarily this individual must be treated as a United States shareholder.

Nonresident for Taxation of Subpart F Income

The foreign corporation has income – subpart F income, let’s say. Reg. §301.7701(b)-7(a)(3) says to treat the treaty nonresident as a U.S. resident for purposes of CFC status and U.S. shareholder status, so IRC §951(a)(1)(A) says that the treaty nonresident must include the subpart F income in his or her gross income.

But wait. For purposes of determining income tax liability, the treaty nonresident computes U.S. income tax liability as a nonresident. Reg. §301.7701(b)-7(a)(1) says, in relevant part:

How is a nonresident taxed on subpart F income? Answer: not at all.

A nonresident individual’s exposure to U.S. income tax liability is dictated by IRC §871. The income must be:

U.S. source income, and
it must either be “fixed or determinable annual or periodical income” (IRC §871(a)) or it must be “effectively connected income” (IRC §871(b)).

Subpart F income is foreign source income. Therefore, it fails the first bullet point. And subpart F income is neither “fixed or determinable annual or periodical income” or “effectively connected income" (the second bullet point thus fails, too).

The subpart F income is not subject to tax – even though you spent many hours creating a gorgeously immaculate Form 5471 to compute the number. And you’ll get tagged with a $10,000 penalty if you do a slap-dash job on that Form 5471.

The same logic applies to global intangible low-taxed income. This type of income is included in a U.S. shareholder’s income by IRC §951A. But the income is foreign source and outside the taxing scope of IRC §871.

Conclusion: Useless Form 5471 Work Awaits You

Therefore, current reality is that the IRS wants to see that Form 5471, whether or not it results in any U.S. income tax liability for the treaty nonresident. And it is likely that it will be a lot of accounting work and tax return preparation work for nothing. This is not pleasant news for your client.

Of course, there is theoretical possibility that the foreign corporation – a controlled foreign corporation – could have some U.S. business activities or assets or U.S. source income, so there is a reason why the government could reasonably want to be sure that income from that corporation is reported – whether or not it creates a tax liability for the shareholder.