When it comes to federal tax matters, an important aspect of risk management includes making sure that the statute of limitations on tax assessments will expire. This is particularly important for tax years where there is a potentially contentious issue or debatable reporting position taken on the treatment of a material item. However, increasing reporting burdens imposed on international activities coupled with exceptions to the statute of limitations heighten the risk that the period for tax assessments will remain open. Thus, to ensure certainty and closure for past tax years, proper compliance with filing obligations related to international activities is necessary to close the door on potential tax liabilities.
The usual statute of limitations for tax assessments is three years from the time of filing an income tax return, extended to six years for substantial understatements of income. In the case of fraud, the statute of limitations remains open indefinitely. For businesses and individuals whose operations or investments touch the international markets, further statute of limitations considerations come into play.
In particular, if reporting is required with respect to certain international provisions of the Tax Code, the statute of limitations for the assessment of any tax shall not expire until three years after the required international reporting forms are properly filed with the IRS (see IRC § 6501(c)(8)). If a required form is not filed, or is filed but not substantially complete, the statute of limitations for that tax year will never expire.
As originally enacted, the exception to the statute of limitations for international reporting applied only with respect to the assessment of taxes related to the transactions or entities for which the reporting obligation existed. Thus, for example, if a U.S. shareholder failed to properly report information required with respect to shares owned in a foreign corporation, the statute of limitations remained open only as to tax liabilities arising from the ownership of, or transactions with, that particular foreign corporation. The statute was expanded in 2010, however, to apply to the taxpayer’s entire tax return. As a result, if required international reporting is not fulfilled, the statute of limitations remains open and the IRS can assess tax with respect to any aspect of the taxpayer’s tax return for that year without regard to whether the tax assessment bears any relationship to the international reporting obligation. If the taxpayer can demonstrate that the compliance failure is “due to reasonable cause and not willful neglect,” the statute of limitations shall remain open only as to the item or items related to such failure.
Doing business beyond U.S. borders is now common, and extraterritorial operations implicate additional reporting obligations for U.S. tax purposes. For instance, operations conducted outside the United States through a foreign corporation, foreign partnership, or foreign branch trigger filing obligations that include Forms 5471, 8865, or 8858, respectively. Moreover, transaction specific reporting obligations may exist, such as the filing of Form 926 for transfers of assets to a foreign corporation. For foreign-parented U.S. corporations, Form 5472 must be filed. Apart from monetary penalties that may apply, the failure to file any of these international-related information reporting forms invokes the exception to the statute of limitations described above.
A recent addition to the international reporting requirements is Form 8975, Country-by-Country Report, which must be filed by multinational enterprises with at least $850 million of revenue in the previous annual reporting period. Treasury regulations issued in June 2016 detail these reporting requirements. Form 8975 will require disclosure, on a country-by-country basis, of information concerning a multinational group’s income and taxes paid, along with certain facts that indicate the location of the group’s economic activities. Form 8975 is yet to be finalized, and will apply at the earliest to filings made in September 2017. Failure to file Form 8975 when required will also keep the statute of limitations open.
For individuals, foreign reporting obligations may arise through the seemingly innocuous ownership of an interest in a foreign mutual fund. As added by the HIRE Act in 2010, any person who holds an interest in a passive foreign investment company (PFIC) is required to annually report such ownership on Form 8621 (see IRC § 1298(f)). Generally, foreign mutual funds are classified as PFICs. Thus, if an individual fails to file Form 8621 regarding the ownership of foreign mutual fund shares, the door is left open indefinitely for potential tax assessments by the IRS.
Individuals must also file Form 8938 to report the ownership of any interest in a “specified foreign financial asset” during the year (assuming certain asset value thresholds are met). Such assets include interests in a foreign bank account, stock in a foreign corporation, financial instruments or contracts (e.g., annuity contracts with a foreign issuer), or any interest in a foreign entity (including an interest in a foreign trust). A separate obligation to file Form 3520 arises for individuals who transfer assets to a foreign trust (also required to report the receipt of certain gifts or bequests from non-U.S. persons). Failure to file Forms 8938 or 3520 will similarly keep the statute of limitations open for the relevant year or years.
The prospect of exposing a tax year to future tax assessments without limitation greatly increases the need for strict compliance with international reporting obligations imposed under U.S. tax law. Each of these reporting obligations carry potential monetary penalties if not properly satisfied. Yet, it is the open-ended statute of limitations that ultimately could prove to be the most costly aspect of failing to comply.