The first of eleven episodes of The Form 5471 Series will go live next Friday, April 28, 2023, at noon Pacific time. People on the International Tax Lunch Mailing List get information on how to sign up (paid or free, your choice) and will get a PDF copy of the slide deck.
Email me if you are not on the list but want to get the monthly announcements of upcoming episodes.
The April 28, 2023 episode will be an overview of the key question everyone asks: “Who is a Form 5471 filer?” Three deeper dives will follow in May, June, and July.
The Big Dumb
The 2017 Tax Cuts and Jobs Act made a hash of international tax law, and one of the ways it did so was by making the Form 5471 filing categories (Categories 1 and 5, specifically) more complicated. Category 1 became Category 1a, 1b, and 1c. Category 5 became Category 5a, 5b, and 5c.
Congress spawned this complexity by making constructive stock ownership possible in exciting new ways, through the repeal of IRC §958(b)(4) and its anti-downward attribution rule.
Don’t worry about the implementation details or ideological motivation. Just understand that Congress did a Big Dumb. As usual, politicians did not understand that a thing called Second Order Effects is a thing.
But I am not bitter. And I do not judge.
Duct Tape Damage Mitigation: Rev. Proc. 2019-40
The IRS did what it must do when “blessed” with the job of enforcing Congressional ineptitude: redneck engineering. The IRS equivalent of duct tape – a Notice and a Revenue Procedure – arrived in due course. Notice 2018-13 gave some temporary and partial answers.
But the real solution came with Rev. Proc. 2019-40, which acknowledged that the repeal of the anti-downward attribution rule created practical difficulties: some people would be surprised to learn that they were U.S. shareholders of controlled foreign corporations, when the year before neither fact had been true.
The Instructions for Form 5471 took Rev. Proc. 2019-40 and labeled its duct tape solutions there as Categories 5a, 5b, and 5c.
Category 5a is the old regular Category 5.
Categories 5b and 5c are for people who inadvertently became Category 5 filers because of the Tax Cuts and Jobs Act repeal of IRC §958(b)(4). They were put into a position of filing a Form 5471 when they (probably) wouldn’t have access to the information needed to complete the form. The IRS recognized this and reduced the information reporting requirements for people who fall into Categories 5b and 5c.
Your Job: Select Category 5a, 5b, or 5c
Given all of that, your annual chore, when preparing a Form 5471, is to now determine which of nine filing categories might apply to you. It seems like only yesterday we had five (really, just four) filing categories. Paraphrasing a line from the book, “Over any considerable period, [it] gets worse, never better.”
Let’s look, for giggles, at Category 5, and go through a high-level explanation of how you figure out whether you are a Category 5 filer in general, and if you are, whether you are a Category 5a, 5b, or 5c filer.
Here is a flowchart that shows you the high-level steps to take to get to the correct answer.
I will explain each step below. As I walk you through the steps in your analysis, keep in mind how often it is necessary to know stock ownership in order to answer the questions correctly. And not just “what percentage do I own?” You need to know how you own the stock — directly, indirectly, or constructively.
Does Category 5 Even Apply?
Bro, do you even lift?
Before you get into the weeds of Categories 5a, 5b, and 5c, you need to know whether you are a Category 5 filer at all.
United States shareholders of controlled foreign corporations are Category 5 filers. IRC §6038(a)(4) says:
If any foreign corporation is treated as a controlled foreign corporation for any purpose under subpart F of part III of subchapter N of chapter 1, the Secretary may require any United States person treated as a United States shareholder of such corporation for any purpose under subpart F to furnish the information required under paragraph (1).
The Instructions for Form 5471 (rev. January 2023) says it like this:
In general, a Category 5 filer is a person who was a U.S. shareholder that owned stock in a foreign corporation that was a CFC at any time during the foreign corporation’s tax year ending with or within the U.S. shareholder’s tax year, and who owned that stock on the last day in that year in which the foreign corporation was a CFC.
I am ignoring the “when” part of the definition.
This can be seen in the two top diamond shapes. They ask you do analyze, in sequence, whether you are a United States shareholder of a foreign corporation (use IRC §951(b)) and whether that foreign corporation is a controlled foreign corporation (use IRC §957(c)).
If either answer is “no”, you are not a Category 5 filer. That is the answer in the red oval. Stop here, write a memo to the file for why your reporting position is “I am not a Category 5 filer” and grab a cup of coffee.
Both questions must be answered “yes” in order to make you a Category 5 filer. That is the answer in the gray oval, and this is just an interim conclusion. All we know is that you are described in IRC §6038(a)(4).
We still have to figure out whether you fit into Category 5a, 5b, or 5c in order to determine exactly which schedules you will attach to Form 5471 as a Category 5 filer.
Category 5 Applies . . . But 5a, 5b, or 5c?
From here onward, we abandon the Internal Revenue Code and Regulations and trudge forward on foot, guided by Rev. Proc. 2019-40 (which is hard reading) and the Instructions for Form 5471
(which is pretty damn good) to define Categories 5a, 5b, and 5c.
Category 5a is the Residual Category
I can’t say it better than the Instructions
A Category 5a filer is a Category 5 filer that is not a Category 5b or 5c filer.
We know that we have a Category 5 filer. So now it’s time to figure out whether Category 5b or Category 5c will apply. If not, Category 5a will be your filing category.
The 5b vs 5c Pivot: Section 958(a) Shareholder?
The pivotal question is whether you are a section 958(a) shareholder or not. If you own stock directly or indirectly through a foreign entity, you are a section 958(a) shareholder. A “yes” answer puts you on the path to potential Category 5b status, while a “no” answer puts you on the path to potential Category 5c status.
Direct and Indirect Ownership – IRC §958(a)
Section 958 defines what it means to own stock of a foreign corporation for the purpose of Subpart F — where controlled foreign corporation rules exist.
Section 958(a)(1) says you own stock of a foreign corporation if you own it directly
. Your name is on the stock certificate or in the corporation’s share registry.
Section 958(a)(2) says you own stock of a foreign corporation indirectly
if you have ownership of a foreign entity (corporation, partnership, trust, or estate) and the foreign entity owns stock of a foreign corporation.
The classic parent/subsidiary structure is an example of how IRC §958(a)(2) works. You own all of the stock of a foreign parent corporation, which owns all of the stock of a foreign subsidiary corporation. You are treated as owning all of the stock of the foreign subsidiary corporation.
If “Yes”, Category 5b or 5a Will Apply
A Category 5b filer is describe in the Instructions
A person is a Category 5b filer if they are an unrelated section 958(a) U.S. shareholder of a foreign-controlled CFC. This type of Category 5 filer implements the relief for certain Category 5 filers announced in section 8.02 of Rev. Proc. 2019-40, 2019-43 IRB 982.
The elements needed to become a Category 5b filer are:
- You are “unrelated“,
- You are a “section 958(a) U.S. shareholder” (which we just answered in the affirmative),
- the foreign corporation in which you own shares is not only a controlled foreign corporation — it is a foreign-controlled controlled foreign corporation.
Category 5b Status is Not Certain
We have only determined the answer to one of the three criteria needed to establish Category 5b status. It is possible that one of the other two criteria may be answered “no”, thereby denying Category 5b status. We don’t know yet.
But if the answer to one of the other two criteria is “no”, then we will have to categorize you as a Category 5a filer — because that’s the only alternative available if you fail to be classified as a Category 5b filer. Remember that Category 5a is the residual classification, if neither Category 5b nor Category 5c apply.
So we ask the two questions in succession:
- Is this a foreign-controlled controlled foreign corporation?
- Are you related to the foreign-controlled controlled foreign corporation?
Two “yes” answers will result in Category 5b status. A “no” answer to either (or both) will result in Category 5a status.
Note: Careful Analysis of Stock Ownership Did Most of the Work
What I want to emphasize here is how much heavy lifting is done by the hard, careful work you put in at the very beginning: identifying the shareholders, including all of the excruciatingly tedious stock attribution stuff that you worked your way through. Your work solves these questions:
- Whether you are a United States shareholder or not (do you own 10% or more of the stock?).
- Whether the foreign corporation is a controlled foreign corporation or not (do U.S. shareholders own more than 50% of the stock?).
- Whether you are a section 958(a) U.S. shareholder or not. (Do you own any shares directly or indirectly through foreign entities?).
- Whether the controlled foreign corporation is a foreign-controlled controlled foreign corporation. (Apply the attribution rules two ways, one reflecting reality and one make pretend, and see how the two analyses match up with what Rev. Proc. 2019-40, Section 3.03 tells you).
There’s that pesky “related” question left, of course.
But with a bit of luck, you won’t even have to figure out whether you are “related” to the foreign-controlled controlled foreign corporation or not. (“Related” is defined at Rev. Proc. 2019-40, Section 3.06).
Stock ownership alone might be enough to tell you the answer: you might be forced into Category 5a even before you get to the question of “Am I related to the foreign-controlled controlled foreign corporation?”
If “No”, Category 5c or 5a Will Apply
Similarly, if you are NOT a section 958(a) U.S. shareholder, the analysis now will decide whether you fit into Category 5c or will fall back to the default Category 5a.
The same logic and questions that we used for Category 5b will apply here. Is this foreign corporation a foreign-controlled controlled foreign corporation? Are you related to the foreign-controlled controlled foreign corporation?
Two “yes” answers put you into Category 5c territory. A “no” answer to either (or both) will put you into the default Category 5a status.
Shameless Promotion, Part II
Rev. Proc. 2019-40 will be discussed at length in the July, 2023 episode of The Form 5471 Series
You’re not finished yet. After you have put yourself into one of the three buckets (Category 5a, 5b, or 5c), you must file Form 5471 . . . unless a filing exception swoops in to save you from the work.
I will not go into the details of the filing exceptions (that will be Episode 4 of The Form 5471 Series in July). More shameless promotion.
That’s a quick overview of how you figure out whether Category 5a, 5b, or 5c will apply. The correct answer is important because it dictates how much work you need to do when preparing Form 5471.
The hard work is in knowing the stock ownership and applying attribution rules to the bitter end of their reach.
The reason this is important to know which Category applies is because you file less information for Categories 5b and 5c. A quick glance at the Table of Required Information from the Instructions for Form 5471
That’s all for me. Happy Friday and see you next week, when you get a double-barrelled dose of international tax: this newsletter and the inaugural episode of The Form 5471 Series.