Who files Form 5471? The grantor trust shareholder? The grantor? Both?

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This month’s topic deals with paperwork requirements: if a domestic grantor trust owns CFC stock, does the trust file Form 5471, or does the grantor—or both? It ain’t entirely clear.

But first . . .

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Domestic Grantor Trust Tax Returns

A domestic trust must file Form 1041 if it has gross income of $600 or more. IRC sec. 6012(a)(4).

A domestic grantor trust must file Form 1041, but reports items of income, deduction, and credit on a separate statement (let’s call it a grantor trust statement) rather than on Form 1041 itself. Reg. sec. 1.671-4(a).

There are three exceptions to the Form 1041 filing requirement for a domestic grantor trust (see Reg. sec. 1.671-4(b)), but they do not apply if the trust has “any of its assets located outside the United States.” Reg. sec. 1.671-4(b)(6)(ii).

Therefore, a domestic grantor trust that holds assets outside the United States must file Form 1041.

Domestic Grantor Trust Owns CFC Stock

Let’s assume that your domestic grantor trust owns stock of a CFC. To keep it simple, 100% of the CFC’s stock is owned by a domestic grantor trust and the grantor is a U.S. person.

The CFC stock is an asset “outside the United States” because the CFC is a foreign corporation (created or organized under the laws of a jurisdiction outside the United States—IRC sec. 7701(a)(5)) and its stock is “located” in the place of organization.

Therefore, a domestic grantor trust that owns CFC stock will be required to file Form 1041.

Domestic Grantor Trust Must File Form 5471

Information returns (such as Form 5471) are required to be filed by “United States persons” who meet certain criteria.

Category 4 (for example)

E.g., Category 4 filing requirements for Form 5471 apply to:

Every United States person shall furnish, with respect to any foreign business entity which such person controls, such information as the Secretary may prescribe relating to. . . .

IRC sec. 6038(a)(1). Emphasis added.

A foreign corporation is a foreign business entity. IRC sec. 6038(e)(1).

A domestic trust is a United States person. IRC sec. 7701(a)(30)(E). The Code makes no distinction between grantor trusts and nongrantor trusts. Thus, a domestic grantor trust is a United States person. See also, Textron Inc. v. Commissioner, 117 T.C. 67, 77 (2001).

Therefore, if a domestic grantor trust controls a foreign business entity (which includes a foreign corporation), it has a Form 5471 filing obligation. Reg. sec. 1.6038-2(a)(2).

Categories 1, 3, and 5

I won’t take the time to go through the analysis, but the same logic holds true for Categories 1 and 5. A domestic grantor trust is a U.S. person for those categories, and if the other criteria are satisfied, a domestic grantor trust will have a Form 5471 filing obligation for those categories, too.

Instructions for Form 5471

The Instructions for Form 5471 (rev. 12-2024) say that all U.S. persons who fit within one of the filing categories must file Form 5471. Instructions for Form 5471, p. 1.

For Form 5471 Category 4 purposes, a U.S. person includes a trust that is not a foreign trust. Instructions for Form 5471, p. 4. The Instructions do not make a distinction between a grantor trust and a nongrantor trust.

Impact of constructive ownership rules

The fact that the domestic grantor trust is treated as the owner of CFC stock can be seen from the constructive ownership rules. Reg. sec. 1.958-2(c)(ii)(b) says that the grantor is the constructive owner of stock owned by a grantor trust:

Stock owned, directly or indirectly, by or for a person who is considered the owner of any portion of a trust under sections 671 to 678 (relating to grantors and others treated as substantial owners) shall be considered as owned by the trust.

Reading this literally, the domestic grantor trust is the U.S. shareholder (actual owner of the stock) and the grantor is the constructive owner of the stock.

Conclusion

I reach the conclusion that a domestic grantor trust can have a Form 5471 filing requirement as the shareholder of a CFC under Categories 1, 3, 4, and 5.

The grantor must file Form 5471, too?

IRC sec. 671 says that a grantor can be treated as an “owner of the trust” if one or more of the rules in IRC sec. 673 – 677, 679 are satisfied. Note the implication of that phrase: the grantor owns the trust—not the trust assets.

Rev. Rul. 85-13 extends that logic:

“Because [the grantor] is treated as the owner of the entire trust, [the grantor] is considered to be the owner of the trust assets for federal income tax purposes.”

This sentence is then followed by a laundry list of citations to court opinions and administrative pronouncements.

This is similar to partnership tax principles: the “entity theory” and the “aggregate theory.” The Internal Revenue Code uses “entity theory” logic (the grantor owns the trust, just like a partner owns a percentage of the partnership), while Rev. Rul. 85-13 imposes the aggregate theory (the grantor owns the trust assets, just as the aggregate theory says a partner owns a pro rata percentage of the partnership’s assets).

I have opinions about whether Rev. Rul. 85-13 legitimately extends “owner of the trust” to “owner of the trust assets.” I have my doubts.

But if Rev. Rul. 85-13 is valid, then we have a redundancy problem:

A domestic grantor trust owns CFC shares, must file Form 1041, and must attach Form 5471, as explained above.
The grantor of that domestic grantor trust owns CFC shares under the logic of Rev. Rul. 85-13, and must file Form 5471.

Forms 8865, 8858, 8621, and 926

The same question—is an information return required for a domestic grantor trust that owns certain financial assets?—applies for situations where Forms 8865 (controlled foreign partnerships), 8858 (foreign disregarded entities), 8621 (PFICs), and 926 (contributions to foreign corporations) are required. The domestic grantor trust (if you believe the Code and Regulations) and the grantor (if you believe Rev. Rul. 85-13) both have potential reporting requirements.

Interesting Wrinkle for Form 8992

Global Intangible Low-Taxed Income for multiple CFC must be aggregated at the U.S. shareholder level. This is calculated on Form 8992. Then, the output from Form 8992 is transferred from Form 8992 to the U.S. shareholder’s income tax return.

If we follow the logic of the Code and Textron Inc. v. Commissioner, then all the aggregation should happen at the domestic grantor trust level. The resulting output will then be taken from the domestic grantor trust’s Form 8992 to the U.S. shareholder’s Form 1040.

If we follow the logic of Rev. Rul. 85-13, all the aggregation should happen at the U.S. shareholder level.

It is possible that the math might work differently depending on which theory you follow.

Action Plan?

This is a known problem, and the AICPA wrote a letter in February, 2024 to the IRS asking for a solution.

In the meantime, you and I live in the real world. What do we do? From most conservative to easy-breezy:

Attach Form 5471 to both the grantor’s tax return and the grantor trust’s tax return. Subpart F income is reported on the grantor trust statement attached to the trust’s Form 1041 and reported on the grantor’s Form 1040. Attach a statement on both returns referring to the duplicate filings. This follows the Code, Regulations, and Textron Inc. v. Commissioner, with extra additional excessive overkill paperwork redundancy for luck. Form 8992 aggregation happens at the trust level.
Attach Form 5471 to the grantor trust’s Form 1041 and attach a statement to the grantor’s Form 1040 referencing the existence of the Form 5471 on the trust’s tax return. Use the grantor trust statement to pipeline CFC income items through to the grantor’s Form 1040. Form 8992 aggregation happens at the trust level.
Attach the Form 5471 to the grantor’s Form 1040 on the theory that Rev. Rul. 85-13 is right and we should treat the grantor as the actual owner of the CFC stock. Form 8992 aggregation happens at the trust level.

Personally, I would take the Code and Textron Inc. v. Commissioner a lot more seriously than Rev. Rul. 85-13. I would pick number 1 or number 2.

Thank you

Thanks for reading. See you in a couple of weeks.