The U.S. tax system has a uniquely broad reach. U.S. citizens, lawful permanent residents, and certain resident aliens must report all of their worldwide income to the IRS—no matter where it is earned. This rule applies even more strictly when taxpayers own or participate in foreign business entities.
Compliance involves understanding both the substantive tax rules and the many formal reporting obligations under the Internal Revenue Code (IRC), Treasury Regulations, and FinCEN. For tax professionals and U.S. taxpayers with international business activities, this framework is essential.
1. Worldwide Taxation: Legal Foundations
U.S. taxpayers are taxed on their worldwide income. Key authorities include:
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- IRC §1 – establishes liability for federal income tax.
- IRC §61(a) – defines gross income as “all income from whatever source derived.”
- IRC §7701(b) – sets the rules for determining tax residency.
Under this framework, income from foreign business activities is taxable in the U.S. even if it is never distributed or brought into the country.
2. Controlled Foreign Corporations (CFCs)
Under IRC §§951–965, §957, and §951(b), a foreign corporation is considered a CFC when U.S. shareholders own more than 50% of its voting power or value.
Form 5471: Reporting Obligations
Reporting requirements arise from:
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- IRC §6038(a) – information reporting for foreign entities.
- IRC §6046(a) – reporting changes in ownership or control.
- 26 C.F.R. §1.6038-2 – regulations governing Form 5471.
Noncompliance penalties are outlined in IRC §6038(b).
3. Subpart F Income: Required Inclusions
Subpart F rules prevent U.S. taxpayers from deferring certain types of income in low-tax jurisdictions. U.S. shareholders must include this income even without a dividend.
Primary authorities:
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- IRC §951(a) – mandatory inclusion.
- IRC §952 – defines Subpart F income.
- IRC §954 – covers Foreign Base Company Income (including passive and mobile income).
4. The GILTI Regime (Global Intangible Low-Taxed Income)
Created under the Tax Cuts and Jobs Act, GILTI is now a central component of U.S. international taxation.
Key provisions:
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- IRC §951A – determines GILTI.
- IRC §250 – provides corporate deductions.
- IRC §960 – applies foreign tax credits.
Individual taxpayers may elect IRC §962 treatment to access corporate tax benefits.
5. Foreign Partnerships and Form 8865
Ownership interests in foreign partnerships are governed by:
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- IRC §6038 – information reporting.
- IRC §6046A – reporting certain transfers.
- 26 C.F.R. §1.6038-3 – Form 8865 regulations.
Filings may require partnership financials, related-party transactions, and ownership-change disclosures.
6. FATCA and FBAR Reporting
FATCA – Form 8938
FATCA requires reporting of specified foreign financial assets under:
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- IRC §§6038D(a)–(d)
- 26 C.F.R. §§1.6038D-2 through 1.6038D-8
FBAR – FinCEN Form 114
Administered by FinCEN under:
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- 31 U.S.C. §5314
- 31 C.F.R. §1010.350
An FBAR is required if foreign financial accounts exceed $10,000 in aggregate at any time during the year.
7. Penalty Structure: Consequences of Noncompliance
Penalties can be severe and include:
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- IRC §6038(b) – $10,000 penalty for failing to file Forms 5471 or 8865.
- IRC §6038D(d) – FATCA penalties.
- 31 U.S.C. §5321(a)(5) – FBAR penalties (up to 50% of the account balance for willful violations).
- IRC §§7201 and 7206 – criminal consequences for tax evasion or false statements.
Relevance for Taxpayers with Foreign Business Interests
The combined rules of the IRC, FATCA, and FBAR create a robust enforcement system. Documented, verifiable compliance is critical.
Legal risks include:
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- Mandatory income inclusions under Subpart F and GILTI.
- Expansive IRS access to foreign financial data.
- Exposure to steep civil penalties—and potentially criminal liability.
Importance of International Tax Planning
Taxpayers must evaluate:
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- Entity classification under check-the-box rules (26 C.F.R. §§301.7701-1 to -3).
- Foreign tax credit availability (IRC §§901–909).
- Interaction with tax treaties (IRC §894).
Proper planning reduces risk and strengthens compliance.
Conclusion
The U.S. international tax system is complex, with substantive income-inclusion rules, extensive reporting obligations, and strict penalties. Taxpayers with foreign business interests must understand these requirements to avoid disputes and maintain IRS compliance. Because of the system’s sophistication—especially with multinational or multi-jurisdictional structures—professional legal and tax analysis is often essential.
Have questions or need advice? JH Tax Law can help! Contact our office for a confidential consultation today.
