Is there a $10,000 penalty for failure to file Form 8858?

Hello and thanks for reading The Friday Edition. I am your humble scribe, Phil Hodgen, and this is yet another piece of international tax arcana for you.

Upcoming presentations on foreign disregarded entities

I have two presentations coming up about check-the-box elections for foreign entities:

April 25, 2025 – the International Tax Lunch will be a compliance-flavored hour about Form 8858, which is required for U.S. persons who own foreign disregarded entities or operate foreign branches. You are on this mailing list so you will get notification of how you can watch online for free. Or you can pay CalCPA a few bucks and get an hour of CPE credit.
May 14, 2025 – I am speaking at the Washington Society of CPAs International Tax Conference (attend in person) (attend online) about foreign disregarded entities, but less from a compliance point of view and more from a “how and when to use them” point of view.

That’s why you’re getting a Form 8858-flavored topic this week. I’m asking for your input because my brain is going around in a circle.

Summary

I’m failing to find the statutory authority for the IRS to impose a penalty on U.S. individuals operating a foreign sole proprietorship or owning rental real estate (that rises to the level of a trade or business).

The Instructions for Form 8858 say that these individuals have a Form 8858 filing requirement. But there appears to be no penalty if they fail to file.

The threatened penalties

The Instructions for Form 8858 warn you of two penalties for failure to file Form 8858:

$10,000 (with more if you don’t react with alactrity to the IRS’s requests); and
Loss of foreign tax credit.

From now on I’m just going to talk about the $10,000 penalty, just to keep the discussion brief.

If you read the Instructions carefully, you notice something curious. They do not mention foreign disregarded entities or foreign branches.

A $10,000 penalty is imposed for each annual accounting period of each CFC or CFP for failure to furnish the required information within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per CFC or CFP) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.

Isn’t that strange? “CFC” means controlled foreign corporation and “CFP” means controlled foreign partnership. A foreign disregarded entity is neither.

So, where does the IRS get the authority to impose a $10,000 penalty?

No explicit statutory penalty for Form 8858 filing failure

Penalties for failure to file Form 5471 (IRC §6038(b)) or Form 5472 (IRC §6038A(d)) are hardwired into the Internal Revenue Code by Congress. Other forms, too.

There is no such hardwired penalty in the Internal Revenue Code for Form 8858. Nowhere does the Code say “file Form 8858 or pay a penalty.”

Cobbled-together authority for Form 8858’s existence

The statutory authorization for Form 8858’s existence is found in the Instructions for Form 8858 (rev. 12-2024):

IRC §6001 – the IRS can create forms, require information, and require recordkeeping.
IRC §6011 – the IRS can create and require the filing of tax returns.
IRC §6031 – the IRS can create returns and require information from partnerships.
IRC §6038 – the IRS can create returns and require information from certain foreign corporations and foreign partnerships.

If there is a penalty authorized by Congress, we must surely find it in one of those Code sections. IRC §6001 and IRC §6011 do not contain penalty provisions. IRC §6031 is about partnerships, not disregarded entities.

Therefore, the last man standing is IRC §6038. We will have to find an authorization for penalties there.

The Internal Revenue Manual (CTRL-F and search for 8858) says that the Form 8858 penalties are applied under IRC §6038(b) and (c). So there is nowhere else to look for penalties. IRC §6038 is it.

No explicit penalty authorization for foreign disregarded entities

The $10,000 penalty in IRC §6038(b)(1) is imposed on “foreign business entities.”

If any person fails to furnish, within the time prescribed under paragraph (2) of subsection (a), any information with respect to any foreign business entity required under paragraph (1) of subsection (a), such person shall pay a penalty of $10,000 for each annual accounting period with respect to which such failure exists.

Emphasis added.

Is a foreign disregarded entity a “foreign business entity” for IRC §6038(b)(1) penalty purposes?

A “foreign business entity” is a foreign corporation or a foreign partnership. IRC §6038(e)(1). Note that the definition of “foreign business entity” does not include foreign disregarded entity.

Reg. §1.6038-2(k) doesn’t help the government’s cause–it refers to foreign corporations, not foreign disregarded entities:

(k) Failure to furnish information—(1) Dollar amount penalty—(i) In general. If any person required to file Form 5471 under section 6038 and this section fails to furnish any information described in paragraphs (f) and (g) of this section within the time prescribed by paragraph (i) of this section, such person shall pay a penalty of $10,000 for each annual accounting period of each foreign corporation with respect to which such failure occurs.

Important words helpfully highlighted by me.

I don’t see how a Form 8858 penalty can be imposed on a foreign disregarded entity when the Regulation talks about Form 5471 failures for foreign corporations.

No inferred penalty authorization for foreign disregarded entities

Can we reason our way to application of the IRC §6038 penalty to failure to file Form 8858 using some kind of wordcel voodoo? Here is the logic:

A foreign disregarded entity, underneath the check-the-box election, is just a foreign corporation. Just as an S corporation is a corporation with a tax election on top, is a foreign disregarded entity just a foreign corporation with a tax election on top?
Foreign corporations are “foreign business entities” for IRC §6038 reporting and penalty purposes.
So foreign disregarded entities, being foreign corporations, are foreign business entities, too.
U.S. persons who fail their IRC §6038(a) reporting requirements for foreign business entities can get tagged with a penalty.
So, U.S. persons who fail their IRC §6038(a) reporting requirements for foreign disregarded entities can get tagged with a penalty.

I don’t think this works, but let’s try anyway.

“Associations” are corporations, but a foreign disregarded entity is not an association

A corporation is defined in IRC §7701(a)(3):

The term “corporation” includes associations, joint-stock companies, and insurance companies.

When a foreign eligible entity makes a check-the-box election, the association is deemed to be liquidated, and becomes a disregarded entity (if it has only one owner). Reg. §301.7701-2(g)(1)(iii).

That means a foreign disregarded entity is no longer, in the eyes of the Internal Revenue Code, an “association.” Therefore, it can no longer be considered to be a “corporation” under the general definition of corporation in IRC §7701(a)(3).

And if it is not a corporation, it cannot be a foreign corporation, and by extension it can’t be a “foreign business entity” as defined in IRC §6038.

No IRC §6038 penalties can be inferred by saying that after the check-the-box election a foreign corporation (in its legal structure) still is an “association” therefore a “corporation” for Internal Revenue Code purposes, therefore can be a foreign business entity for IRC §6038 purposes.

“Joint-stock companies” are corporations, but this can’t be decisive for foreign disregarded entities

A corporation might also be a joint-stock company under the definition of IRC §7701(a)(3). That means the company’s ownership is expressed in shares.

Some foreign entities (a Bahamas limited company, for instance) express ownership in shares. Other foreign entities express ownership in percentages, just like domestic LLCs – for example, an Italian S.r.l.

Both a Bahamas limited company and an Italian S.r.l will be eligible to make a check-the-box election and become a foreign disregarded entity.

If both can be classified as foreign disregarded entities, then the fact that ownership is expressed in shares rather than percentages cannot not make a difference as to whether the entity is a “foreign corporation” that is a “foreign business entity” (IRC §6038(e)(1)).

And therefore: a foreign disregarded entity is not a foreign business entity, no IRC §6038(a) reporting requirement exists, and consequently no penalties can be imposed for failure to file Form 8858.

It would be lunacy to say that a Bahamas limited company is a “corporation” for IRC §6038 penalties after making a check-the-box election just because its ownership is stated in shares, while an Italian S.r.l. is not a “corporation” for IRC §6038 penalties after making a check-the-box election just because its ownership is expressed in “quotas” rather than “azioni.”

What do you think?

So what do think? Is there a penalty imposed for failure to file Form 8858 if you are a U.S. owner of a foreign disregarded entity?

(Sometimes the bulbs in my chandelier don’t burn quite as brightly as they should. Help me out here. I’m confused.)

Phil