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Failure to File a “Timely” U.S. Return May Cause Loss of Deductions for Foreign Corporations

February 26, 2015

What you need to know about U.S. filing requirements for foreign corporations.

We are frequently asked about the tax filing requirements of U.S. LLCs and partnerships that have a foreign corporation as a member. It is important that these U.S. LLCs or partnerships seek assistance with various U.S. tax reporting and withholding obligations, particularly with respect to the foreign corporation member.

Almost as frequently, however, we learn that the foreign corporation has not understood that it, too, may be required to file a foreign corporation tax return in the U.S. Instead, the foreign corporation often treats U.S. tax withheld by the partnership as a final tax.

This is a dangerous trap for the unwary. If the foreign corporation fails to file a “timely” tax return, it may lose its ability to take deductions against its gross income. Instead of being taxed on a net basis in the U.S., it may find itself taxed on a gross income basis – and the withholding tax may not cover the liability.

Depending on the facts, this could be financially disastrous to the foreign corporation. In a not uncommon example, consider a foreign corporation that is allocated a loss from a U.S. partnership. The loss represents gross income that is completely offset by otherwise deductible expenses. Because the partnership allocates a loss to the foreign corporation member, it does not withhold any federal tax on the member’s behalf. If the foreign corporation fails to file a “timely” return, the IRS may assess tax on the gross income and deny the deductions to the member. As a result, rather than owing no U.S. federal income tax, the foreign corporation may find itself with a tax liability of 35 percent of the allocated gross income plus potential interest and penalties.

If you are responsible for the tax function of a U.S. LLC or partnership with a foreign corporation as a member, knowledge of the U.S. tax compliance of the foreign corporation may be of interest to you. For example, this may be a consideration to be weighed if the foreign corporation requests a reduction of partnership withholding. If you need assistance with understanding these rules and how they affect the foreign corporation, please contact us.

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