It’s Not a Sequel: Form 8865, Return of U.S. Persons to With Respect to Certain Foreign Partnerships

This form is the worst James Bond movie title, but it describes so many Bond movie plots.

If you’re reaching for this form, you’re about to file a complicated return. Then again, you’re earning worldwide income and an international tax specialist would know the best routes for you to follow. 

Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, is an important tax form that U.S. persons must file to report their interests in foreign corporations. This form is used to fulfill reporting requirements under Sections 6038, 6038B, and 6046A of the Internal Revenue Code.

U.S. persons who are partners in foreign partnerships are required to file Form 8865 if certain criteria are met. These criteria include a certain level of ownership or control in the partnership, as well as certain reportable events, such as transfers of property to a foreign partnership, acquisitions or dispositions of foreign partnership interests, an income statement, and certain changes in foreign partnership interests.

Form 8865 provides information about the foreign partnership, including its name, address, and taxpayer identification number. It also includes details about the U.S. person’s ownership percentage, capital contribution of property, and distributive share of income, deductions, and credits.

Compliance with Form 8865 is crucial, as failure to file this form on time can result in significant penalties, including additional penalties for intentional disregard and potential criminal penalties. Or else you may lose 10% of foreign taxes available for foreign tax credit on your individual income tax return, among other penalties including 10% of the fair market value of the property when you contributed it to the foreign corporation.

What Does Form 8865 Do?

Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships, serves as an annual reporting tool for tracking U.S. persons who are partners in foreign partnerships. While this form is primarily informational, it is still a necessary requirement on your annual income tax return. It can complicate your expat taxes, so be sure to engage an international tax attorney at least the first time you find yourself in a financial operation happening in a foreign country.  

The purpose of Form 8865 is to gather information about the foreign entity in which the U.S. person is involved. This includes details such as the partnership’s name, address, and taxpayer identification number. Additionally, the form collects information about the U.S. person’s ownership percentage, capital contributions, and distributive share of income, deductions, and credits. You need to file this form to show any profits, foreign income and capital gains as well as any capital accounts to resolve, depending on which category of filer you are. 

By filing Form 8865, the IRS gains insight into these foreign partnerships and the income earned by U.S. persons through them. This helps ensure that all U.S. persons, regardless of their partnership involvement, accurately report and pay taxes on their foreign income and worldwide income. Furthermore, this form aids in the enforcement of tax laws related to foreign partnerships and compliance with tax regulations.

Who files IRS Form 8865? 

Form 8865 is typically filed with the original income tax return of U.S. persons who are involved in foreign partnerships. A U.S. person can include individuals, limited partnerships, and domestic corporations. There are four categories of filers for Form 8865, each with slightly different filing requirements. Which taxpayer category might you fall under? 

Category 1 filers are required to file Form 8865 if they had a direct or indirect interest in foreign business entities at any time during the tax year.

Category 2 filers are required to file if they had a reportable event during the tax year.

Category 3 filers are required to file if they are a partner in a domestic partnership that transferred property to a foreign entity.

Category 4 filers are required to file if they had a reportable event during the tax year as a result of being a partner in a foreign partnership.

It is important to review the instructions for Form 8865 to determine the applicable filing requirements and the information based on each of the filer categories available to see which category filer you might be. Failure to file Form 8865 or provide accurate information can result in penalties and potential criminal penalties. You may face international information return penalties on your annual income tax returns in the U.S. as well as any expat taxes you may owe. 

Who Qualifies as a Category 1 Filer?

If you are a US citizen and have control over a foreign partnership, or if you are a US transferor reporting Section 721(c) property, then you are required to file Form 8865. This form is used to report information about your foreign partnership and its activities to the Internal Revenue Service (IRS).

As a Category 1 filer, you must meet certain criteria to fulfill your filing obligations. First, you should be a US citizen. Additionally, you must have control over the foreign partnership, which means that you own more than 50% interest in the partnership.

Furthermore, if you are a US transferor reporting Section 721(c) property, you are also classified as a Category 1 filer. Section 721(c) property refers to the transfer of certain property to a foreign partnership in exchange for partnership interests. If you fall under this category, you are required to report the details of these transfers on Form 8865.

Who Qualifies as a Category 2 Filer?

If you don’t qualify as a Category 1 filer for Form 8865, don’t worry. There are other filing categories, including Category 2 filer, that apply to different circumstances.

A Category 2 filer is a US person who owned a 10% or greater interest in a foreign partnership during the current tax year. However, to be classified as a Category 2 filer, the foreign partnership must be controlled by US persons who each own at least 10% of the partnership.

It’s important to note that if any US person involved in the partnership qualifies as a Category 1 filer, then the partnership will not have any Category 2 filers. The Category 1 filer takes precedence and covers the reporting obligations for the partnership.

Who Qualifies as a Category 3 Filer?

If you’re a US person who contributed property to a foreign partnership in exchange for an interest in the partnership, you may qualify as a Category 3 filer under Form 8865. This category is designed to capture individuals who have made significant contributions to foreign partnerships and ensures their reporting obligations are met.

To qualify as a Category 3 filer, there are certain criteria that must be met. First, you must own at least a 10% interest in the partnership immediately after making the contribution. This ensures that direct partners with substantial involvement in the partnership are included in the reporting process. 

Alternatively, you may qualify as a Category 3 filer if the value of the property you contributed to the partnership exceeds $100,000. This threshold helps capture significant contributions that may have an impact on your tax liability and reporting obligations.

By identifying who qualifies as a Category 3 filer, Form 8865 helps the IRS gather comprehensive information on US persons’ interests in foreign partnerships. This information is crucial for accurately assessing tax liabilities and ensuring compliance with reporting requirements. 

Who Qualifies as a Category 4 Filer?

If you had any reportable event related to a foreign partnership during your tax year, such as acquisitions, dispositions, or changes in proportional interest, you may qualify as a Category 4 filer on IRS Form 8865. Category 4 filers are US persons who need to fulfill specific reporting obligations to the IRS.

To qualify as a Category 4 filer, there are various requirements and criteria that you need to meet. One scenario that would qualify you for this category of filer is if you acquired a 10% or greater interest in a foreign partnership through purchase or inheritance. This type of acquisition would trigger the reporting obligation as a Category 4 filer.

Other examples of reportable events that can lead to qualification as a Category 4 filer include dispositions of a partnership interest, changes in proportional interest, or any other significant event that affects your ownership or relationship with a foreign partnership.

By identifying who qualifies as a Category 4 filer, Form 8865 helps the IRS gather comprehensive information on reportable events related to foreign partnerships. This information is crucial for accurately assessing tax liabilities and ensuring compliance with reporting requirements.

What’s the Difference between Tax Forms 8865 and 8938?

If you have foreign assets or investments, it’s important to understand the reporting requirements and obligations imposed by the IRS. Two key tax forms that you may come across are Form 8865 and Form 8938. While both forms are related to reporting foreign financial interests, there are significant differences between them.

Form 8865, also known as the “Return of U.S. Persons With Respect to Certain Foreign Partnerships,” is used to report information about foreign partnerships in which U.S. persons have an interest. This form is specifically designed to capture details such as income, losses, and credits related to the foreign partnership.

On the other hand, Form 8938, known as the “Statement of Specified Foreign Financial Assets,” is used to report specified foreign financial assets that meet certain thresholds. These assets disclose your financial position with regards to foreign bank accounts, foreign stock holdings, and interests in foreign trusts or companies based in a foreign country.

One important distinction between the two forms is the scope of reporting. Form 8865 focuses on reporting the income and financial aspects of foreign partnerships, while Form 8938 is broader in scope and requires reporting of various types of foreign financial assets.

Additionally, the reporting thresholds for Form 8865 and Form 8938 are different. Form 8865 has its own set of thresholds based on ownership percentage and the United States dollar value of the partnership interest, while Form 8938 has separate thresholds based on filing status and residency.

What Are the Exceptions to Filing Form 8865?

U.S. persons with an interest in a foreign partnership are required to file Form 8865 to report the necessary information to the IRS. However, there are certain exceptions to filing this form that you should be aware of.

One exception is for Category 1 filers, which applies when there are multiple U.S. persons who are required to file Form 8865 for the same foreign partnership. In this case, only one U.S. person needs to file the form on behalf of all the qualifying individuals. However, it’s important to note that the Category 1 filer must provide each of the other U.S. persons with a copy of the filed Form 8865.

Another exception to filing Form 8865 is if you meet the Category 3 or Category 4 filing requirements. Category 3 applies to U.S. persons who acquire an interest in a foreign partnership during the tax year but do not have a reportable event. Category 4 applies to U.S. persons who are indirect partners in a foreign partnership and meet certain conditions.

What Penalties Hit If You Don’t File 8865 in a Certain Time Period?

If you fail to file Form 8865, a number of penalties can be imposed by the Internal Revenue Service (IRS). The penalties can accrue if the form is not filed within the specified time period. Additionally, there are additional penalties that can be imposed after receiving a notification of failure to file from the IRS.

For each 3-month period or fraction thereof that you do not file Form 8865, there can be a reduction of foreign tax credits by a certain percentage. The reduction percentage is related to a 90-day period and can vary depending on the length of the non-filing period.

In addition to the reduction in foreign tax credits, there are penalties for failing to meet the filing requirements of Form 8865. Failure to disclose the transfer of property to a foreign partnership may also result in penalties, as can an undisclosed financial asset understatement. 

It is important to be aware of the filing requirements and reporting obligations associated with Form 8865. Failure to comply with these requirements can result in significant penalties and additional financial burdens.

Make sure to file Form 8865 within the specified time period to avoid these penalties and to meet your reporting obligations. Stay compliant and avoid unnecessary penalties for non-compliance with the IRS.

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