After my last blog posting on the new requirement for filing 5472 by foreign-owned disregarded entities, I got some interesting questions that led me to believe that lots of people don’t know the basic terminology associated with limited liability companies (LLCs), or even their own status with their LLCs.
One overseas party asked if he and his wife needed to file a Form 5472 since they were “trustees” of their LLC. Others asked me if they had elected for their LLC to be treated as a corporation for tax purposes. And still others thought they would file the Form 5472 with their state taxes.
Let’s delve into these questions and some underlying terminology that hopefully will clarify things for you. Most of these points are covered in my book, Buying America the Right Way, and I continue to stress the importance of buying and reading this book. Not because I want to sell books (of course I do, but that’s not the main reason), but because it answers most of the questions people might have about company structure and the terminology associated with it, and such issues as taxation and liability and asset protection.
At the outset, let me state that the new requirement to file Form 5472 pertains to disregarded entities (such as single-member LLCs and some other entities) that are owned by foreign persons. It does not apply to entities owned entirely by U.S. citizens or legal residents. Read the initial posting for more clarification. Now to the other questions.
The owners of an LLC are called Members (initial caps used for emphasis). There can be one, or more than one, Member. They are not trustees. In the case of the question posed to me, the parties were trustees of their family trust, but the family trust was the Member of the LLC. So in their case, since the LLC had but a single Member, by default it would be considered a “disregarded entity” by the IRS and, since it is foreign-owned, therefore would have to file a Form 5472 with its federal tax filings under the new rules.
Had the couple been the Members of their LLC, then the LLC would be treated by default as a partnership by the IRS, as LLCs with more than one Member are, and therefore would not be obliged to file a Form 5472 since it would file a partnership return.
Assuming the LLC in this case – by default a disregarded entity for tax purposes – had not elected to be treated as a corporation for tax purposes, it now would have to submit a partially completed Form 1120, the corporate tax return, as well, to help explain the information shown on the Form 5472. Of course, had the LLC made the election to be treated as a corporation, then it would have to file the full Form 1120, the corporate tax return, along with a Form 5472. That requirement has not changed.
On the subject of Members of an LLC, by default in most states LLCs are deemed to be managed by their Member or Members, whether the Member is an individual or another entity. And by default, all Members are considered Managers of the LLC. However, if an LLC’s operating agreement or other documentation states that the LLC is Manager-Managed, then it would have a third-party Manager – an individual or another entity – that would be responsible for managing the LLC.
I often see this mistake made by clients, where they list themselves as Manager of their entity when, in fact, they have another entity in between them and the LLC in question that is both the Member and, by default, the Manager (Member-Manager) of the LLC. This is an important legal distinction, and management of the LLC carries both responsibilities as well as potential liabilities.
Despite some commonly held misinformation – including promulgated by the IRS – LLCs can have officers, much like corporations do, but this is optional. As for contracting and banking authorities, these are normally spelled out in resolutions called contracting and banking resolutions giving signatory authority to the parties designated. These can be one or more of the LLC Members, officers, or the third-party Manager.
I was struck when people asked me if they had elected for their LLC to be treated as a corporation for tax purposes. While I might have registered the company, it is the principals’ obligation to decide how they want their LLC to be treated for tax purposes, either the default treatment or corporate treatment, which in the latter case they would elect through filing Form 8832 with the IRS. I can understand that sometimes people rely on outside consultants, like their accountants, to recommend courses of action, but I have to stress that it is up to the principals to monitor their consultants and make the final key decisions themselves. It will be the principals who have to face the consequences of a faulty decision or not properly meeting tax obligations, not the consultant.
Having a company and holding property or investments through one entails a level of responsibility. It’s called being in business. And any business demands the attention of the owner or owners, and can’t just be allowed to run on autopilot without risking serious negative consequences.
On the subject of consultants, I saw some accountants quote truly astounding rates for something as relatively simple as filing a Form 5472. Even the IRS estimates the average time for completing a Form 5472 at 3 ½ hours. While the IRS estimates more than 17 hours for recordkeeping, this is something that has to be done anyway, and has nothing to do specifically with completing the Form 5472. I think many people can probably tend to this chore on their own, once they have their records and numbers together, but entrusting it to an accountant should not incur thousands of dollars in excess charges. As I also stress in the book, as in life, it’s not how much you take in, it’s how much you get to keep that matters.
I want to say that the Form 5472 is a federal form. It is an IRS form, and not a state form, and it is filed with federal taxes, not state taxes.
Finally, there remains a question about what constitutes a “consolidated group.” I maintain, reading the IRS guidelines, that a group of LLCs with a common parent constitutes a consolidated group, for which only one Form 5472 has to be filed for the entire group, with a listing of the names, addresses, and EINs of the companies that are members of the group included with the filing. However, some states require separate filings for individual companies registered in them and don’t rely on the group’s federal filing, as other states do. In those cases, I think it is especially important to verify what is or is not required with those filings to avoid running afoul of both state and federal tax authorities.
I am not about to embark on specific tax guidance for every case and every state, and so in those cases where there might be an element of doubt, principals are advised to verify the requirements, and even to verify guidance given them by accountants and tax advisers, which may or may not be entirely accurate.
Given the severe penalty – $10,000 per instance – of failing to properly file the Form 5472, or to property keep records of income and expenses, company principals need to sit up and take notice.
Now go buy the book, if you haven’t already.
Comments and questions welcomed.