Form 8865 is a form related to Tax Returns for Foreign Partnerships. It is to be filed annually by all US citizens and legal permanent residents who have an interest in a foreign partnership.
According to the IRS, a partnership is a relationship that exists between two or more people who come together for the purpose of trade or business. The coming together involves each person contributing money, property, skill, or labor. The “partners” also enjoy the profits of the business or partnership or bear the losses from the business.
A partnership is treated by the IRS as a “pass-through” entity. This basically means that the partnership itself does not pay taxes for the income generated. Rather, the partners who form the partnership have to report the income in their personal tax returns.
A foreign partnership that has not been created within the US might be outside the jurisdiction of US law. However, such a foreign partnership is still treated as a pass-through entity by the IRS for tax purposes.
Hence, any US citizens or legal permanent residents are required to update the IRS about their foreign partnership’s activity and pay taxes on any income which such partnerships generate. The taxes to be paid by the US person will be in proportion to the share that such a person holds in the foreign partnership.
Form 8865 filer categories
Form 8865 is to be filed by those who come under one of the following four categories.
Category 1, which includes:
1) A US citizen who holds more than 50% interest in a foreign partnership.
2) Any person who files taxes as a US transferor required to report information regarding Section 721 (c) property in the current as well as subsequent tax years.
Category 2, which includes:
1) Any US person who owns 10% or more interest in a foreign partnership which is being controlled by US persons each of whom also own 10% or more in that partnership.
If either of the partners in the partnership has filed Form 8865 under Category 1, then the rest of the people connected with that partnership will not be considered as Category 2 filers.
Category 3, which includes:
1) A US person who has a 10% or more interest in a foreign partnership immediately after having contributed property to that partnership in exchange for a share in that partnership.
The value of the property contributed should be $100,000 or more. The $100,000 valuation also includes any contributions made by that person or a related person during a 12-month period before the transfer date.
The person/entity as cited above has to be a US transferor who contributes a Section 721 (c) property to a Section 721 (c) partnership AND has to follow reporting as per regulations 1.721 (c)- 6T (b).
Category 4, which includes:
A US person with a reportable event in connection with the foreign partnership during the current tax year. Reportable events can be dispositions, acquisitions, or changes in the share/interest in the partnership.
Information to be included on Form 8865
You have to include basic information about your partnership and yourself in Form 8865. You also have to report the functional currency of the partnership and then convert the financial results into US dollars.
The functional currency is one which the partnership uses to conduct its day-to-day business. There is no official IRS mandated exchange rate, but you can use websites like xe.com, x-rates.com, and oanda. The US treasury also has exchange rates listed on its website.
In addition to the information specified above, you also have to submit a bunch of tax schedules. There are a maximum of 14 different schedules that can be submitted with Form 8865. Around 9 of these 14 schedules are the same ones that are needed for filing Form 1065 or the “US Return of Partnership” form.
The timing of filing Form 8865
The best time to file Form 8865 is with your income tax return or your partnership/organization’s tax return. Otherwise, filing Form 8865 by mid-April is always a good bet because that is the time when tax returns are generally due with the IRS.
Are there any penalties for not filing Form 8865?
Yes, the penalties for not filing Form 8865 (or filing it late) are quite steep. IRS does not like it when tax returns are not filed correctly. The penalties for non-filing of Form 8865 are levied as per the category under which the form is to be filed.
For Category 1 filers, a hefty $10,000 fee is levied on anyone who has not filed Form 8865. This penalty is levied each year. However, things get worse the longer you wait.
For example, if you do not file the form even 90 days after receiving a notice for non-filing from the IRS, then that 10,000 becomes 20,000. Every 30 days after the 90-day period, a $10,000 penalty gets added to your account till the total penalty for the year reaches $50,000. That is the cap or limit on the penalty for non-filing of Form 8865.
Besides the monetary penalty, there is also the possibility of criminal penalties and loss of tax credits.
Category 3 filers are subject to a 10% penalty based on a Fair Market Value of the property that is contributed to the partnership. The upper limit of this 10% penalty is $100,000.
For Category 4 filers, a $10,000 penalty is imposed for not disclosing a reportable event. As with category 1 offenders, another $10,000 penalty is added progressively every 30 days for not responding to the IRS notice for non-compliance. The cap with Category 4 offenders is $50,000.