Form 8865 is used by U.S. persons to report information regarding controlled foreign partnerships (IRC section 6038), transfers to foreign partnerships (IRC section 6038B), and acquisitions, dispositions, and changes in foreign partnership interests (IRC section 6046A). There are four categories of U.S. persons required to file. U.S. persons who would fall into one of these categories at any point during their tax year must file Form 8865, unless an exception applies. The form must be filed with the appropriate information, statements, and schedules (such as balance sheets, reports of profits and capital gains, and reconciliations of capital accounts) applicable to the category that the filer falls under. If a filer falls under multiple categories with respect to a single foreign partnership, that filer can file a single Form 8865, but she must provide all additional items for each category. The filer must complete a separate form 8865 for each foreign partnership. The form must be filed annually with the filer’s income tax return—or, if an income tax return is not filed, at the time an income tax return would normally be filed.
Penalties for deficient filings vary depending on which category the filer falls under. Deficient Category 1 and 2 filings result in criminal penalties, partial loss of foreign tax credits, and $10,000 fines per foreign partnership for each tax year, with a maximum additional penalty of $50,000 for continued failure to rectify the filing after notice from the IRS. Category 3 filers that fail to properly and timely file must pay a penalty of 10% of the fair market value of the contribution, not to exceed $100,000 unless the deficiency is a result of intentional disregard. Category 4 filers that fail to properly and timely file are subject to criminal penalties and a fine of $10,000, with the possibility of additional penalties of up to $50,000 for continued failure to rectify the deficiency after notice from the IRS. Category 4 penalties will not apply if there is reasonable cause for the deficiency. In addition to these category-specific penalties, failure to comply with a requirement of the gain deferral method in Form 8865 schedules, and underpayment attributable to undisclosed foreign financial asset understatements, will result in penalties. To rectify a deficient filing, a filer can submit a corrected Form 8865 with her amended tax return.
Categories of Filers:
- Category 1 – Controllers: U.S. persons who control a foreign partnership. Control is established by ownership of more than a 50% interest in the partnership. Multiple Category 1 filers in a partnership can file a single joint Form 8865. Although each partner need not file an individual form, each partner must still provide separate schedules and other information normally required of Category 1 filers. This includes a Controlled Foreign Partnership statement that must be filed with a non-filing Category 1 filer’s income tax return. A Category 1 filer who is relying on another partner to file the form is still subject to penalties for a deficient filing.
- Category 2 – Shareholders of U.S.-controlled foreign partnerships: U.S. persons who hold at least a 10% interest in a foreign partnership while the partnership is under the control of U.S. persons also holding at least a 10% interest each in the partnership. The exception is that no one shall be considered a Category 2 filer if the foreign partnership has a Category 1 filer.
- Category 3 – Contributors: U.S. persons who contributed property to a foreign partnership in exchange for interest in the partnership. Such persons are only required to file if (1) the person owned at least a 10% interest in the partnership immediately after the contribution, or (2) the value of the property contributed exceeded $100,000. Domestic partnerships that transfer property to foreign partnerships need only file one Form 8865 for the entire partnership; each domestic partner is need not file a separate Form 8865. Persons who qualify as filers under both Category 3 and 4 need only file under Category 3.
- Category 4 – Acquisitions, Dispositions, and Changes in Proportional Interest: U.S. persons that engage in a reportable event (i.e., acquisitions, dispositions, and changes in proportional interest).
- There are two types of acquisitions. One occurs when a person who owned less than a 10% interest in the partnership acquires a 10% or greater interest as a result of a transaction. The other occurs when a person’s ownership interest increases by 10%, or more, as the result of a transaction.
- There are two types of dispositions. One occurs when a person who owned at least a 10% interest in the partnership relinquishes enough interest to fall below 10% ownership. The other occurs when a person’s ownership interest decreases by 10%, or more, as the result of a transaction.
- A change in proportional interest occurs when a person’s direct proportional interest has increased or decreased by at least the equivalent of a 10% interest in the partnership.
Exceptions to Filing:
- Multiple Category 1 filers filing a joint return need not file separate forms; however, they must still file separate schedules and statements.
- Constructive ownership: Category 1 and 2 filers that do not own a direct interest in the partnership, and would only be required to file Form 8865 due to constructive ownership, are exempt from filing when they file a Controlled Foreign Partnership Reporting statement with their income tax returns, and (1) the U.S. person through which they constructively own partnership is herself a constructive owner, or (2) the form is filed by another Category 1 filer under the multiple Category 1 filers exception.
- Trusts relating to state and local government retirement plans.
- Filing of Form 1065 by the foreign partnership allows Category 1 and 2 filers to use the schedules from the Form 1065 filing in place of the equivalent schedules required under Form 8865.