In Which Form 5472 is Required and not RequiredMarch 16, 2018 - Phil HodgenFriday Edition
Does a treaty election to be taxed as a nonresident of the United States trigger a Form 5472 filing requirement? The Schrödinger’s cat meme gives us the answer. Yes and no.
Imagine a green card holder living outside the United States. She is the sole shareholder of a domestic corporation.
For various good and valid reasons, our green card holder decides to make an election under the applicable income tax treaty’s tiebreaker rules to be treated as a resident of the foreign country where she lives, and thereby be treated as a nonresident of the United States for income tax purposes.
Must her corporation file Form 5472 to report that it has a foreign shareholder?
Form 5472: Who is a “Foreign Person”?
The filing requirement extends to disregarded entities as well,3 but let’s keep this discussion simple and only talk about corporations. The point of this discussion is about the definition of “foreign person”.
In deciding whether Form 5472 is required, then, you need to identify a “foreign person” who owns 25% or more of the company.
The term “foreign person” means any person who is not a United States person. For purposes of the preceding sentence, the term “United States person” has the meaning given to such term by section 7701(a)(30), except that any individual who is a citizen of any possession of the United States (but not otherwise a citizen of the United States) and who is not a resident of the United States shall not be treated as a United States person.4
OK. Not a United States person. When talking of humans, United States person is defined at IRC § 7701(a)(30)(A) as a citizen or resident of the United States.
What is a resident of the United States? Well, it’s an alien (i.e., noncitizen of the United States) who satisfies one of three criteria:5
- is a lawful permanent resident of the United States; or
- satisfies the requirements of the substantial presence test as that test is defined in IRC § 7701(b)(3); or
- makes an election to be a resident as permitted by IRC § 7701(b)(4).
A person who meets none of those criteria is a nonresident alien.6
Let’s circle back to Form 5472 filing requirements. We need a foreign person who owns enough stock. We need someone who:
- is not a lawful permanent resident, AND
- doesn’t spend too many days in the United States each year, AND
- doesn’t make a special election to be a resident in the first year of coming to the USA.
Let’s look at the lawful permanent resident requirement and ignore the other two.
A lawful permanent resident is someone who has been granted immigrant status (usually called “green card” status) and that status has not been terminated.7
Back to Form 5472. Ignore the substantial presence test, and ignore the first year election. If a person is a lawful permanent resident (has a green card), she is a resident of the United States. Therefore, she is NOT a foreign person as defined in IRC § 6038A(c)(3), and therefore the domestic company is not required to file Form 5472.
Conversely, if that person does NOT have a green card (and no substantial presence test and no first year election), then she is NOT a resident of the United States, and therefore is a foreign person as defined in IRC § 6038A(c)(3) and therefore the domestic company IS required to file Form 5472.
Wow. That was a journey. All of that meandering through the Code just to say “green card yes = no Form 5472” and “green card no = yes Form 5472”.
Except . . . .
Green Card Holders and Treaty Elections
A green card holder is, in the right circumstances, able to invoke rules in an income tax treaty to cause himself or herself to be a nonresident alien for calculating U.S. income tax liability.8
As you will see, this simple act will either trigger a Form 5472 filing requirement, or it will not–depending on which part of the tax law you look at.
The Lord Giveth . . .
A green card holder who makes a treaty election to compute U.S. income tax liability using the nonresident alien rules will, critically for this discussion, remain a resident alien for all other purposes of the Code.9
This seemingly answers our question: what to do about Form 5472 filing requirements when a green card holder is a 25%+ shareholder in a domestic corporation, and makes a treaty election to be a nonresident.
The answer is simple and logical:
- For everything else except math purposes in calculating tax, our green card holder remains a resident alien.
- Since our green card holder remains a resident alien, she is not a “foreign person” as defined in IRC § 6038A(c)(3).
- The Form 5472 filing requirements are not triggered.
Clean. Neat. Logical. No filing requirement.
And yet. . . .
The Lord Taketh Away
In 2008, our trusted servants in Washington DC enacted a new piece of the Internal Revenue Code, defining who is a lawful permanent resident and who is not.
The flush language says:
An individual shall cease to be treated as a lawful permanent resident of the United States if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment.12
What that says is pretty simple:
- If you are a lawful permanent resident of the United States (i.e., a green card holder), AND
- You make a valid treaty election (and file Form 8833 to tell the IRS about it) to be treated as a resident of a foreign country and nonresident of the United States, THEN
- You cease to be a lawful permanent resident.
This is where it gets weird, so let’s go slowly.
Ignore the Regulations we just read. Let’s just look at the effect of the flush language in isolation.
Our green card holder living abroad owns all of the stock of a domestic corporation. She makes a treaty election: resident of the foreign country, nonresident of the United States. Files Form 8833.
The Section 7701(b)(6) flush language says that she ceased to be a lawful permanent resident by filing that treaty election.
If she is no longer a lawful permanent resident (and we are ignoring the substantial presence test and the first year election), then she is no longer a resident alien.13
If she is not a resident alien, then she is no longer a resident, and is not a U.S. person as defined in IRC § 7701(a)(30).
If she is not a U.S. person as defined in IRC § 7701(a)(30), then she is a foreign person as defined in IRC § 6038A(c)(3).
If she is a foreign person as defined in IRC § 6038A(c)(3), then the domestic corporation has a 25%+ foreign person as a shareholder, and the corporation and must file Form 5472.
Blessed Be the Name of the Lord
Yes, I am feeling a bit like Job right now.14
Let’s recap where we are.
- Regs Only: No Form 5472. If we look at Regs. § 301.7701(b)-7 alone, we come to a neat, unambiguous conclusion that a green card holder living abroad who makes a treaty election to toggle resident status to the foreign country does not cause a domestic corporation to trigger the Form 5472 filing requirements. Reason: the green card holder is still treated as a resident alien for “all other purposes of the Code”, which would include IRC § 6038A (the section that imposes the Form 5472 filing requirement).
- Code Only: Form 5472 Required. If we look at IRC § 7701(b)(6) and its flush language alone, we come to a neat, unambiguous conclusion that a green card holder living abroad who makes a treaty election to toggle resident status to the foreign country does cause a domestic corporation to trigger the Form 5472 filing requirements. Reason: the green card holder loses lawful permanent resident status, thereby ceasing to be a resident alien for all purposes of the Internal Revenue Code under IRC § 7701(b)(1)(A), and as a result is a foreign person as defined in IRC § 6038A’s mandate for filing Form 5471.
How do we square these diametrically opposite conclusions? Divine intervention won’t help. In the U.S. legal system, Ultimate Truth is a 5-4 decision of the Supreme Court. The Gods are not likely to look at this question. 🙂
Shan, I Told You So
I did a webcast for our International Tax Lunch last week–all about the treaty election to be treated as a nonresident.
One of the people attending asked about the Form 5472 filing requirement. He and I exchanged emails. I pointed to the Regs., and said I think this is the answer, but I’m nervous and not certain.
Why are you nervous, he asked? Well, just because that’s how my brain works, I replied.
Sure enough, Shan. Here is the evidence for my nervousness.
And Harriet, you asked the same question in a later email to me. I told you the answer probably lay in Regs. § 301.7701(b)-7.
Now I’m not sure. In fact, I come to the opposite conclusion.
How I Would Solve the Puzzle
Two completely opposite answers. How do you prepare a tax return?
Look at Regs. § 301.7701(b)-7 and note that it was last updated in 1997. Regulations are issued by the Treasury Department. Bureaucrats.
The IRC § 7701(b)(6) flush language was enacted in 2008. Enacted by Congress, signed by the President. This is the fountainhead of law.
When you find a conflict of laws, there are a couple of rules that tell us how to resolve the conflict:
- Code overrides Regulations. (I.e., high level governmental authority overrides lower level government action).
- More recent overrides older. (I.e., Congress knows what it’s doing and we assume by doing something today that is different from yesterday, they intended to override yesterday’s laws with today’s new laws).
The IRC § 7701(b)(6) wins. Congress said it and the President signed it. It is more recent than the Regulations (the Secretary of the Treasury said it, and said it years earlier).
Result: green card holder abroad who makes a treaty election will need to cause a corporation to file Form 5472.
Am I Confident? No
Am I going to tell Shan, Harriet and all of my smart and goodlooking readers that I think they should tell the IRS to go stick its nose up a dead bear’s bum and refuse to file Form 5472?
I’m going to say tax law is bullshit, then try to get through to the right lawyers in Chief Counsel’s office and see what they say.
And I’m going to appeal to the wisdom of the crowd and ask all of you if you know how to solve this conundrum.
- The filing requirement is imposed on the domestic corporation. IRC §6038A(a). ↩
- The 25% requirement is defined in terms of voting control or value of all classes of shares. IRC §6038A(c). ↩
- Single member LLCs are generally disregarded as separate taxable entities. Except!15 A disregarded entity is treated as if it is a corporation for IRC §6038A purposes. Regs. § 301.7701-2(c)(2)(vi). ↩
- IRC § 6038A(c)(3). ↩
- IRC § 7701(b)(1)(A). ↩
- IRC § 7701(b)(1)(B). ↩
- IRC § 7701(b)(6). ↩
- Regs. § 301.7701(b)-7(a)(1). ↩
- Regs. § 301.7701(b)-7(a)(3). ↩
- It’s not really run-on. It’s just long and Ernest Hemingway would have brought out his shotgun had he read a sentence like that. ↩
- Not for the reason you are thinking. And not because contemplating poor legislative craftsmanship reddens your face with ire, either. It’s because there is a whole bunch of indented stuff and you’re reading happily along, understanding what you’re reading and then . . . all of a sudden, there a block of text flush against the left margin of the page. I don’t like flush language, and I think people who do things like that are lazy. ↩
- IRC § 7701(b)(6), flush language. ↩
- She does not satisfy any of the criteria for being a resident alien as defined in IRC § 7701(b)(1)(A). Therefore, she is a nonresident alien as defined by IRC §7701(b)(1)(B). ↩
- Job 1:21. ↩
- Every decent tax law states a rule, and has at least one exception to the rule. Maybe even an exception to the exception. And how do you like the way I embedded a footnote in a footnote? It’s turtles all the way down, I tell you.16 ↩
- I need sleep. ↩