3 Things You Should Know About IRS Form 926

U.S. individuals who make outward investments in foreign corporations often have difficult federal reporting obligations. In addition to the commonly filed IRS Form 5471, Information on the refund of US citizens to certain foreign corporationsThese taxpayers may have separate requirements for filing IRS Form 926, Return of U.S. property transferring ownership to a foreign company. The penalties for failing to file IRS Form 926 on time and in full can be severe. This article discusses three important things you should know about IRS Form 926.

Who must apply?

Congress enacted Section 6038B as part of the Deficit Reduction Act of 1984. Under Section 6038B, U.S. persons must file an information return for each taxable year in which they transfer property to a foreign corporation in an exchange covered by sections 332, 351, 354, 355, 356, or 361 (the “tax-free provisions”). Thus, IRS Form 926 must be filed if: (i) a U.S. person (ii) transfers property to a foreign corporation (iii) in a transfer that qualifies under one of the tax-free provisions.

For these purposes, a U.S. person means a citizen or resident of the United States or any domestic corporation, trust, or estate. If a partnership transfers property to a foreign corporation, the U.S. partners (not the partnership) must file a separate form, with each domestic partner treated as the transferor of a proportionate share of the property.

The second element above requires a U.S. person to review the check-the-box provisions to determine whether U.S. tax law treats the acquiring entity as a corporation. Generally, a foreign entity is characterized as a corporation if it is: (i) in itself corporation or (ii) all its partners have limited liability.

Finally, the third element requires that the U.S. person make a transfer of ownership under one of the tax-free corporation provisions of section 6038B. These provisions can be divided into three groups. The first group, relating to section 351, applies when the U.S. person makes a transfer of ownership to a controlled foreign corporation—that is, one in which the transferor or transferors own at least 80 percent of the voting stock of the corporation and at least 80 percent of the total nonvoting stock of the corporation. The second group, relating to section 332, applies only when a U.S. subsidiary of the corporation is liquidated into the corporation’s foreign parent. The third group—consisting of sections 354, 355, 356, and 361—generally applies to corporate reorganizations and spin-offs. Readers should be aware that there are exceptions to the requirement to file IRS Form 926 for certain tax-exempt corporate reorganizations, which can be found in the instructions for IRS Form 926 (e.g.Type E summaries).

• Example: A US citizen, C, forms a Malta Public Limited Company (PLC). Upon formation, C transfers higher-than-expected real estate to the PLC in exchange for 100% ownership of the PLC. Because the transfer is governed by Section 351, C is required to file IRS Form 926.
• Example: Z lc (ZLC) is a New Zealand limited liability company. It owns 100% of all the shares of Y Corporation, a US corporation. On December 31, 2023, Y Corporation completely liquidates and distributes all of its assets to ZLC. Because the transfer is governed by Section 332, Y Corporation must file IRS Form 926 in connection with the liquidation of the corporation.

Cash transfers sometimes qualify

Importantly, under certain circumstances, a transfer of cash by a U.S. person may trigger the filing of IRS Form 926. Indeed, although Congress enacted the corporate tax-exempt provisions as a way for taxpayers to defer recognition of gains from appreciated assets, federal courts have long held that a transfer of cash also constitutes property under many of the corporate tax-exempt provisions. See, for example, Halliburton v. Comm’r.78 F.2d 265 (9th Cir. 1935).

Therefore, under the regulations, a U.S. person must file IRS Form 926 if the transfer of funds otherwise qualifies under the corporate exemption provisions and: (i) immediately after the transfer of funds, the transferor owns 10% or more of the voting power or value of the foreign corporation (directly, indirectly, or by attribution), or (ii) the amount of funds transferred to the foreign corporation by the transferor, including certain related parties, exceeds $100,000 during the 12-month period ending on the date of the transfer.

• Example: A, B, and C form a UK PLC. B is a US citizen. A, B, and C each transfer $50,000 to the PLC in exchange for an equal 33.33% interest in the PLC. B is required to file IRS Form 926 in connection with the transfer because he owns at least 10% of the voting rights and value of the PLC.
• Example: A, B, and C form a UK PLC. B is a US citizen. A and C each transfer $1.9 million to the PLC to obtain a combined 95% interest in the PLC. B transfers $200,000 for the remaining 5% interest. Although B does not meet the 10% vote/value test, he must still file IRS Form 926 because his cash transfer exceeds $100,000.

Consequences of not submitting an application

There are a number of negative consequences associated with failure to file IRS Form 926. First, the IRS may impose a monetary penalty on the taxpayer equal to 10% of the fair market value of the transferred property (not to exceed $100,000 unless the failure was due to willful disregard). As with other international information return penalties, U.S. individuals may be able to avoid the penalty altogether if they can show good cause.

Second, the statute of limitations for the agency to make an additional assessment of the tax remains open until the taxpayer files Form 926, and if filed, for three years thereafter. If the taxpayer failed to file the form for good cause, this open statute of limitations applies only to items that should have been included on the form. If the taxpayer does not have good cause, the open statute of limitations applies to the entire tax return.

Third, the IRS may impose increased accuracy penalties. Specifically, the general accuracy penalty of 20% increases to 40% if the transfer is not disclosed on IRS Form 926.

Application

Federal tax law requires U.S. individuals to file IRS Form 926 each year they make certain transfers to foreign corporations. Because failure to file IRS Form 926 can result in significant penalties and other negative consequences, taxpayers who miss the filing deadline should consult with a tax advisor to determine what steps they can take to mitigate penalties and regain compliance. In some cases, taxpayers may qualify for an IRS program such as Streamlined Filing Compliance Procedures (SFCP).