What is the Difference Between Category 5a, 5b, or 5c for 5471?

What is a Category 5 Filer (5a, 5b, and 5c) 

Form 5471 is one of the most complicated international information reporting forms required by the Internal Revenue Service for Taxpayers with foreign assets. And, while in the past we have summarized all of the different categories of 5471 filers, more recently, with the expansion of the Category 5 definition, we have been receiving many inquiries specifically about the Form 5471 Category 5 Filer definition. In general, Form 5471 is required to be filed by US Taxpayers who are considered to have an ownership interest in a foreign corporation. Depending on the Taxpayer’s ownership percentage, along with whether the foreign corporation is considered a controlled foreign corporation (CFC) or not will impact the extent of the reporting requirements required by the Taxpayer — as well as whether the Taxpayer has an ongoing requirement to file Form 5471 each year. Out of the five different categories of different filers, Category 5 is one of the more complicated of the five categories (aside from Category 1). Let’s slowly walk through the difference between the different types of Category 5 Filers.

Category 5 (TL;DR)

Typically, when it comes to individuals, if you are a U.S. shareholder (10% owner) of a controlled foreign corporation such as ownership in a Sociedad Anonima, GmbH, Canadian Corporation, etc. then you are probably going to be a Category 5a filer and have to file several different tedious and loathsome schedules to file — along with the main Form 5471. Some of these schedules are included as part of the form and other schedules are additional forms and you will have to separately download from the IRS website.

This All is Too Confusing for Me

We get it; this is not what you signed up for when your parents gifted you shares in their company — or when you created a small foreign corporation to hold foreign real estate holdings. If you are unsure and want to be on the safe side, you would file a Form 5471 as a category 5a Filer to make sure you have filed all the proper schedules since Category 5a is the most tedious and would presumably ensure you meet the ‘substantial compliance’ threshold requirement to avoid penalties – subject to the recent Tax Court ruling in Farhy.

General Category 5 Rule

As provided by the IRS:

• • • “In general, a Category 5 filer is a person who was a U.S. shareholder that owned stock in a foreign corporation that was a CFC at any time during the foreign corporation’s tax year ending with or within the U.S. shareholder’s tax year, and who owned that stock on the last day in that year in which the foreign corporation was a CFC.

      • There are three different types of Category 5 filers, each described below:

        • Category 5a filers

        • Category 5b filers, and

        • Category 5c filers.

U.S. Shareholder Definition

• • • For purposes of Category 5, a U.S. shareholder is a U.S. person who:

      1. Owns (directly, indirectly, or constructively, within the meaning of sections 958(a) and (b)) 10% or more of the total combined voting power or value of shares of all classes of stock of a CFC; or

      2. Owns (either directly or indirectly, within the meaning of section 958(a)) any stock of a CFC (as defined in sections 953(c)(1)(B) and 957(b)), unless the foreign corporation has an effective section 953(c)(3)(C) election in place for the tax year.

U.S. Shareholder: What’s the Difference in 1 v 2?

With 1. above, it refers to a person who owns 10% or more of the total voting power or value of the shares of the CFC. But, 2. Above refers to specific ownership of stock in conjunction with 953(c)(1)(B) and 957(b).

• • • 953(c)(1)(B): Insurance Income and CFCs

    • 957(b): Specifically for insurance.

*Most Taxpayers will fall into Category 1

U.S. Person Definition

• • • For purposes of Category 5, a U.S. person is:

      • A citizen or resident of the United States;

      • A domestic partnership;

      • A domestic corporation; or

      • An estate or trust that is not a foreign estate or trust, as defined in section 7701(a)(31). See section 957(c) for exceptions.

        • In general, a CFC is a foreign corporation that has U.S. shareholders that own (directly, indirectly, or constructively, within the meaning of section 958(a) and (b)) on any day of the tax year of the foreign corporation, more than 50% of:

          • The total combined voting power of all classes of its voting stock, or

          • The total value of the stock of the corporation.

            • For purposes only of taking into account income described in section 953(a) (relating to insurance income), a CFC also includes a foreign corporation that is described in section 957(b); and for purposes only of taking into account related person insurance income, a CFC includes a foreign corporation described in section 953(c)(1)(B). 

Category 5a Filer

The Category 5a filer is the catchall filer; in other words, it is defined as “A Category 5a filer is a Category 5 filer that is not a Category 5b or 5c filer.” Category 5a requires the most reporting as compared to Categories 5b or 5c – but unfortunately this is where most CFC shareholders will qualify as.

Category 5b/5c involves Foreign Controlled CFCs

An important aspect for qualifying as either a Category 5b or 5c filer is that the taxpayer is a shareholder in what is referred to as a foreign-controlled CFC. The term foreign-controlled CFC has a specific definition as provided by the IRS, as follows:

Foreign Controlled CFC Definition

• • • • For purposes of Category 5b, a foreign-controlled CFC is a foreign corporation that is a CFC that would not be a CFC if the determination were made without applying subparagraphs (A), (B), and (C) of section 318(a)(3) so as to consider a U.S. person as owning stock that is owned by a foreign person.

      • For purposes of Category 5c, the term foreign-controlled CFC has the same meaning as defined in Category 5b filers, above. and 3. All other FSC income that is not foreign trade income or investment income or carrying charges.

This definition refers to the fact that a foreign-controlled CFC is a foreign corporation that is a controlled foreign corporation but would not be a controlled foreign corporation if the determination was made without applying subparagraphs A, B, and C of 318(a)(3) – which refers specifically to refers to “Attribution to partnerships, estates, trusts, and corporations.”

• • • • Section 318: Constructive Ownership of Stock

      • Section 318 (a): General Rule

Section 318 (a)(3): Attribution to partnerships, estates, trusts, and corporations

• • • (A) To partnerships and estates

      • • Stock owned, directly or indirectly, by or for a partner or a beneficiary of an estate shall be considered as owned by the partnership or estate.

    • (B) To trusts

      • • (i)Stock owned, directly or indirectly, by or for a beneficiary of a trust (other than an employees’ trust described in section 401(a) which is exempt from tax under section 501(a)) shall be considered as owned by the trust, unless such beneficiary’s interest in the trust is a remote contingent interest. For purposes of this clause, a contingent interest of a beneficiary in a trust shall be considered remote if, under the maximum exercise of discretion by the trustee in favor of such beneficiary, the value of such interest, computed actuarially, is 5 percent or less of the value of the trust property.

        • (ii)Stock owned, directly or indirectly, by or for a person who is considered the owner of any portion of a trust under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as owned by the trust.

    • (C) To corporations

      • • If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person.

Category 5b Filer

• • • “A person is a Category 5b filer if they are an unrelated section 958(a) U.S. shareholder of a foreign-controlled CFC. This type of Category 5 filer implements the relief for certain Category 5 filers announced in section 8.02 of Rev. Proc. 2019-40, 2019-43 IRB 982.

      • Unrelated section 958(a) U.S. shareholder. For purposes of Category 5b, an unrelated section 958(a) U.S. shareholder is a U.S. shareholder with respect to a foreign-controlled CFC who:

        • Owns, within the meaning of section 958(a), stock of a foreign-controlled CFC; and

        • Is not related (using principles of section 954(d)(3)) to the foreign-controlled CFC.”

Unrelated Section 958 shareholder

• • • Owns, within the meaning of section 958(a), stock of a foreign-controlled CFC; and

    • Is not related (using principles of section 954(d)(3)) to the foreign-controlled CFC.

Category 5c Filer

• • • “A person is a Category 5c filer if they are a related constructive U.S. shareholder of a foreign-controlled CFC. This type of Category 5 filer implements the relief for certain Category 5 filers announced in section 8.03 of Rev. Proc. 2019-40, 2019-43 IRB 982.

    • Related constructive U.S. shareholder.

      • For purposes of Category 5c, a related constructive U.S. shareholder is a U.S. shareholder with respect to a foreign-controlled CFC who:

1. 1. 1. 1. 1. Does not own, within the meaning of section 958(a), stock of the foreign-controlled CFC; and

            2. Is related (using principles of section 954(d)(3)) to the foreign-controlled CFC.”

Current Year vs Prior Year Non-Compliance

Once a taxpayer has missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.