A Guide to Form 8858 and Foreign Disregarded Entities for U.S. Taxpayers

Form 8858 explained

Form 8858: Information Return of US Persons with Respect to Foreign Disregarded Entities is a tax form must be filled by a certain US person who has a direct ownership control of a FDE (Foreign Disregarded Entity) or a FBO (Foreign Branch Operator)

This form itself only provides information to the IRS and doesn’t result in any additional tax but will be calculated in owner tax income. However, if you fail to file Form 8858 when required, you may face penalties and interest charges from the IRS. Therefore, it is important to file Form 8858 on time and accurately if you own or operate a foreign disregarded entity.

Foreign Disregarded definition

A foreign disregarded entity (FDE) is a non-US business entity that the IRS does not tax as a separate entity, unlike a corporation. Instead, the income and activities of the FDE are treated as those of its owner, who must report them on their US tax return using Form 8858.

The owner will report the entity income on their personal income tax return at their ordinary tax rate. This is opposite from a corporation which will be taxed on their separated income, while the owner only be taxed when they receive a dividend from the corporation or sell their shares.

Who Needs to File Form 8858?

If you are a US person who operates an FBO (Foreign Branch Operator) or owns an FDE (foreign disregarded entity) then you must fill form 8858. And remember if you haven’t turned in Form 8832, Entity Classification Election to the IRS yet, then you should fill it along with form 8858, if not then the IRS will classify your company as a corporation and will have much harder and different tax legislation.

However, there’s an exception: If your foreign entity is already automatically disregarded under US tax rules, such as a single-member entity, then you do not need to file Form 8832. This means that if you set up a foreign LLC and it has only one member/owner, the IRS will automatically treat it as a corporation, and you cannot choose the FDE classification for it.

Form 8858 and Its Impact on Self-Employment Tax

The foreign entity is disregarded for income tax purposes, so the income is reported on Schedule C of your Form 1040, and you may be liable for self-employment tax on any profits you earn. However, there is a positive aspect: if you reside in a country that has a totalization agreement with the USA, the likelihood of paying self-employment tax is low.
What is a totalization agreement?
A totalization agreement is a treaty between two countries that coordinates their social security systems to avoid double taxation and ensure individuals receive benefits from one or both countries based on their work history. You can visit the IRS site here for more information.

When is the deadline for filing Form 8858?

For most individuals, Form 8858 will be due on the same day as their federal tax return, which is typically around April 15. If an extension was filed, the deadline would be around October 15.

However, if you are a U.S. citizen or resident alien living abroad, you may qualify for an automatic two-month extension, which could extend the filing deadline to June 15, 2023.

Business entities, such as domestic partnerships and domestic corporations, should also comply with Form 8858 filing requirements as per IRS definitions.

See More: Schedule SE: Your Guide to Self-Employment Taxes

Required information for form 8858.

The required information for Form 8858 includes:

• The name, address, tax identification number, and functional currency of the FDE or FBO (lines 1a through 1i).
• For the tax owner of the FDE or FBO (if different from the filer), name, address, tax identification number, and functional currency (lines 3a to 3e)
• For the direct owner of the FDE or FBO (if different from tax owner), name, address, tax identification number, and functional currency (lines 4a to 4d)

• The income statement of the FDE or FBO (Schedule C).
• The balance sheet of the FDE or FBO (Schedule F).
• Other Information (Schedule G).
• Schedule H to report the FDE current Earnings and Profits or the FBO income.
• Schedule I should be completed if the FB or FDE is owned: Directly by a domestic corporation, or Indirectly by a domestic corporation through a tiered structure of FDEs or FBs (Schedule I).
• List income, war profits, and excess profits taxes (“income taxes”) paid or accrued to the United States and to each foreign country or U.S. possession for the foreign entity’s foreign tax year (Schedule J).
• Schedule M (Form 8858) (see Who Must File by IRS)

>>>You may also like: Form 8865: What You Need to Know About Reporting Foreign Partnerships

Form 8858 must be filed by the due date (including extensions) of the tax return of the U.S. person filing the form, and must be attached to the tax return or information return of the U.S. person, such as Form 1040, Form 1065, Form 1120, Form 5471, etc. Failure to file Form 8858 or to provide complete and accurate information may result in penalties under sections 6038 and 6679 of the Internal Revenue Code.

FAQ

Why is the likelihood of paying self-employment tax is low?

The likelihood of paying self-employment tax is low because of the totalization agreement between the United States and the country where you live and work. A totalization agreement is a treaty that prevents double taxation of income for social security purposes. It allows you to pay social security tax to only one country, instead of both. To claim this exemption, you need a certificate of coverage from the country where you work, which proves that you are paying social security tax there and not in the United States.

>>>You may also like: Owner’s Draw vs. Salary: Your Pay Decisions

The Penalties of Failing to File Form 8858 When Required

Failure to file Form 8858 can lead to substantial penalties – $10,000 per year per company for each year missed. Additionally, if the form isn’t filed within 90 days of receiving an IRS notice, you could face an extra $10,000 penalty for each 30-day period or fraction thereof after the 90-day period. If you have doubts about filing Form 8858 or need more information about the filing process, we have a group of Tax Expert here to help you.