IRS Form 1065/1120

IRS Form 1065/1120

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A client has gone to do some work in the US via their UK company. They contacted me to say they have been sent form 1065 to complete, to which (after a Google) I replied 'no no no, you mean form 1120, 1065 is for partnerships; 1120 is for companies'.

The client has now sent me their EIN letter which says it encloses a form 1065. So is this some mix up, or are they meant to be sending in a partnership tax return when they are a Ltd company for some 'our crazy cousins over the sea' reason? More importantly I suppose, do they need to complete this form (marking 'other' where it asks what type of partnership they are) and/or will submitting this and this alone cause issues and penalties?

They have tried to call the IRS who apparently just have the one person answering their phones.

Help?

Replies (9)

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By aiwalters
21st Mar 2012 14:56

check the box

The confusion probably is due to the following:

The US has (for non tax purposes) two types of companies; a Corporation, and an LLC (limited liability company). The LLC doesn't exist for federal tax purposes; it needs to assume a tax status. The default tax status for a LLC with more than one member is that of a partnership, i.e. it is fiscally transparent (if only one member then it's a sole trader).

An LLC has the option to elect to be taxed as something else (e.g.as a C-Corporation (same as our LTDs) or an S-Corporation (which is a hybrid).

A UK Ltd company can be taxed in the US as a partnership, or as a corporation. The fact that in the UK that are opaque doesn't change the fact that they can be transparent in the US.

Be very careful though of HMRC v George Anson (http://www.bailii.org/uk/cases/UKUT/TCC/2011/B21.html), such that if US tax is paid by the partners on their share of the profits, no dual-taxation relief will be available in the UK.

The reason why the UK company has been "defaulted" to be taxed as a partnership is because (I suspect) when completing the application for an EIN (form SS-4), box 8a was ticked "Is this application for a limited liability company (LLC) (or a foreign equivalent)". 

The instructions for form 8832 (which is the form to change tax status of an entity) claims:

Quote:
Foreign Entities Classified as  Corporations for Federal Tax  Purposes: 

United Kingdom—Public Limited Company"

implying that a PRIVATE limited company is transparent (i.e. a partnership) for Federal Tax purposes.It also says (ibid):
Quote:
  Foreign default rule. Unless an election is made on Form 8832, a foreign eligible entity is: 1. A partnership if it has two or more members and at least one member does not have limited liability. 2. An association taxable as a corporation if all members have limited liability.
 So either file the 8832 to change into a corporation (and file 1120) or file the 1065 as a partnership. Be aware of dual taxation in either case. Depending on the situation, there is no right answer!
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Replying to Euan MacLennan:
Quack
By Constantly Confused
21st Mar 2012 08:49

Thanks!

aiwalters wrote:

So either file the 8832 to change into a corporation (and file 1120) or file the 1065 as a partnership. Be aware of dual taxation in either case. Depending on the situation, there is no right answer!

That is fantastic, many many thanks!  I've been spinning my wheels on this for a while now and was at a complete loss. 

So we could legitimatly file the 1065 based on each side of the pond having its own idea of what a partnership and a company is, or we can use form 8832 to tell the IRS our 'partnership' is in fact a 'company', then file 1120.

But (if I understand you correctly) if they pay tax as a partnership (i.e. if the individuals pay tax as the partnership is transparent) then they will not be able to deduct that from the UK CT liability, so they will be taxed twice on the same income.  But am I correct in thinking that if we DO change their status to a (C) company there will be some sort of double taxation relief availiable? 

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Replying to Manchester_man:
By aiwalters
21st Mar 2012 15:35

it depends

Constantly Confused wrote:

So we could legitimatly file the 1065 based on each side of the pond having its own idea of what a partnership and a company is, or we can use form 8832 to tell the IRS our 'partnership' is in fact a 'company', then file 1120.

This is correct. It is perfectly legitimate for the company to be taxed transparently (as a partnership) in the US, whilst at the same time to be taxed opaquely in the UK. 

Quote:
But (if I understand you correctly) if they pay tax as a partnership (i.e. if the individuals pay tax as the partnership is transparent) then they will not be able to deduct that from the UK CT liability, so they will be taxed twice on the same income.  But am I correct in thinking that if we DO change their status to a (C) company there will be some sort of double taxation relief availiable? 

The problem is that the shareholders will pay tax twice on any distributions. That is, the shareholders will pay US income tax on profits as they arise (regardless whether or not the profit is distributed). They will then pay UK income tax on profits when they are distributed (as dividends). HMRC will not allow a tax credit against the US Income tax paid, on the grounds that there was (from a UK perspective) no US liability on the shareholders; the shareholders were effectively paying the pecuniary liability of the company. See the UT decision HMRC v George Anson (which overruled FTT in HMRC v Swift).

The decision as whether it is better (fiscially) to elect to be taxed as a partnership or as a corporation in this case is going to depend on the following factors:

1) If shareholders are US resident (US Citizens/Green Card Holders are always tax-resident in the US)

2) If shareholders are UK resident

3) If shareholders are human or corporate

4) Which US State the company is in (each state has different tax rates/rules in addition to Federal taxation)

5) Whether the directors intend to distribute profits

6) Whether profits are material enough to warrant the effort of changing corporate structure for the sake of taxation.

One option which is frequently very tax efficient (BUT NOT ALWAYS) is to ensure the company has only corporate shareholders/members, which themselves are non US resident.

 

IRS CIRCULAR 230 NOTICE:

To ensure compliance with requirements imposed by the United States Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

 

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Replying to lionofludesch:
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By Constantly Confused
22nd Mar 2012 11:37

Thanks

aiwalters wrote:

1) If shareholders are US resident (US Citizens/Green Card Holders are always tax-resident in the US)

2) If shareholders are UK resident

3) If shareholders are human or corporate

4) Which US State the company is in (each state has different tax rates/rules in addition to Federal taxation)

5) Whether the directors intend to distribute profits

6) Whether profits are material enough to warrant the effort of changing corporate structure for the sake of taxation.

I'm digging a little further, but I suspect the US income will be 'minimal' (they haven't branched out over there, purely arranged to do some work).  To answer your points, the shareholders are both UK resident with no US ties (other than a work visa I assume) and are both people.  I'm not sure as to whether profits will be distributed or held, though I would lean towards the former.  The main bulk of the company's income is in the UK.  I'm not sure of the State, but I take your point that this could have a major effect.

If I was to fill in 1065, it would be US income only wouldn't it?  Or are we expected to declare UK income too?

Many thanks again.

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By aiwalters
22nd Mar 2012 11:55

worldwide income

You'll need to declare worldwide income. See http://www.irs.gov/instructions/i1065/ch01.html#d0e393

Quote:
 Generally, a foreign partnership that has gross income effectively connected with the conduct of a trade or business within the United States or has gross income derived from sources in the United States must file Form 1065, even if its principal place of business is outside the United States or all its members are foreign persons. A foreign partnership required to file a return generally must report all of its foreign and U.S. source income.

If not too late, why not consider forming a new company (a US LLC/Corp) for the US side, fully owned by the UK Ltd.

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Quack
By Constantly Confused
22nd Mar 2012 12:20

Hmmm

That complicates things... If they were being taxed twice on their US income it might have been worth the hit from the double tax, but I imagine their worldwide income will mean we need to be more drastic.

I think I need to bring this to a partner as it is getting too rich for my blood.  Hmmm, and it is a March year end, so we wont have any figures for April 2011 onwards for months yet, certainly not in time to do the accounts and submit by the 15th of next month.  Think I'd better try for the 5 month extension.

Many thanks for you help aiwalters, though you've made my life much more complex :)

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By aiwalters
22nd Mar 2012 12:44

not so bad

it's not as bad as that; a partnership is not taxed per se; it just passes through to the partners (i.e. shareholders) who will need to file a 1040-NR (if non resident in US) or a 1040 (if resident); dependant on how many days they are there. If resident they will get credit for UK Corp Tax paid, by filing form 1116. In non-resident they'll only be taxed on US connected income.

 

Still better to establish a separate entity for this. 

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By aiwalters
22nd Mar 2012 12:48

extension

just to point out that filing for an extension just extends the time to file; it does not extend the time to pay!

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Replying to Justin Bryant:
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By Constantly Confused
22nd Mar 2012 12:55

!

aiwalters wrote:

just to point out that filing for an extension just extends the time to file; it does not extend the time to pay!

 

!

A point I had read but not really took in!  Thanks, I'll crunch a number or two in time for the payment deadline.

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