Foreign disregarded entities will have to be reported each year to the IRS, under new rules announced in late January. The first reports are due when 2004 income tax returns are filed.

A “disregarded entity” is a company or other legal entity that a US company treats as if it does not exist. The United States has turned tax advisers into magicians. They can snap their fingers and cause whole companies to disappear as far as the US tax authorities are concerned. Their earnings are reported by their owners as if they were received directly. The IRS published a list of one type of legal entity in each country that cannot be treated as “disregarded.” All other types of companies in the country are eligible for such treatment. The use of disregarded entities helps in US tax planning. Such entities have been an important factor in the ability of US multinational corporations to reduce their worldwide effective tax rates. That is one reason the IRS wants to know about them.

Forms reporting foreign disregarded entities will have to be filed in the future by US persons who own such an entity directly or own it indirectly through certain other entities like a “controlled foreign partnership” or a “controlled foreign corporation.” A “controlled foreign partnership” is a foreign partnership controlled by US persons who own at least 10% interests. A “controlled foreign corporation” is an offshore corporation that is owned more than 50% by vote or value by US shareholders.

The IRS announcement requiring the reporting of disregarded entities is Announcement 2004-4.

Keith Martin