My Biggest Fear Has Come True: The IRS is Cracking Down on Foreign-Owned LLCs (FODEs) with Huge Penalties

For years, I’ve warned clients about the risks, and now my worst fear has materialized- foreign-owned disregarded entities (FODEs) are under fire from the IRS. We’re talking about penalties that could crush your business if you’re not careful- $25,000 per missed filing. I’ve recently seen posts from other tax professionals on social media sharing horror stories of their clients receiving these massive bills in the mail. What’s even more troubling? Some of these penalties date back to the 2018 tax year for returns that were missing Form 1120 and 5472 filings.

If you own an LLC and have a foreign owner, you need to be paying attention. The IRS isn’t playing games, and it’s time to understand why these penalties are happening and how you can avoid them in the future.

Why Are LLCs With Foreign Owners Being Penalized?

If you’re not familiar with the rules around foreign-owned disregarded entities (FODEs), here’s a quick rundown:

LLCs with foreign owners have special tax reporting requirements, and these rules apply whether your LLC is active, inactive, or even just holding real estate. When an LLC has only one foreign owner, it’s required to file Form 5472 annually. This form is used to report financial transactions between the LLC and its foreign owner or other related parties. But here’s the kicker- this filing isn’t optional, even if your LLC had no income during the year or was completely dormant.

In fact, you’re required to file both Form 1120 and Form 5472 every single year, regardless of whether your LLC made a single dollar or not. Unfortunately, many tax professionals were unaware of this requirement and wrongly advised their clients that no filing was necessary. The result? IRS penalties piling up, and I can only imagine how many more of these bills are on the way, especially with the FinCEN BOI filing requirement now that will give the IRS a database to look for non-compliant foreign-owned LLCs!

The $25,000 Penalty: A Nightmare for Foreign LLC Owners

Here’s the painful part: the IRS isn’t offering a lot of wiggle room when it comes to these penalties. The penalty for failing to file Form 5472 with your 1120 return is a staggering $25,000 per missing form. Let’s break this down—if you missed your filings for 2018, 2019, 2020, and 2021, that’s $100,000 in penalties for a single LLC. I’ve seen clients facing bills like this, and it’s devastating, especially when they didn’t even know they were supposed to file in the first place.

These penalties aren’t easily waived either. While C-Corporations can potentially argue that they had no reportable transactions, FODEs aren’t that lucky. The IRS requires all foreign-owned LLCs to file these forms annually, no matter what. So even if you had zero reportable transactions, you’re still on the hook for filing—and if you didn’t, the penalties still apply.

The relevant final regulations can be found on the IRS website under TD 9796, which clarifies that FODEs must report every year, regardless of their activity level. The IRS wants to know what’s going on with these entities, even if they’ve been dormant or used only to hold assets like real estate.

Can You Fight These Penalties?

After the Supreme Court’s recent decision in Loper Bright, I’ve been thinking a lot about potential avenues to challenge these penalties. While that case doesn’t directly relate to tax issues, it raises some interesting questions about the extent of regulatory authority. Could we make a similar argument that the IRS is overstepping its bounds with these harsh penalties? Maybe. But it’s a long shot, and I’m not holding my breath for a solution on that front.

For now, the reality is that the lack of reportable transactions isn’t enough to get the penalties waived for FODEs. The IRS is pretty clear on this—all foreign-owned LLCs must file, no exceptions.

Can You Get a Penalty Waiver?

The first year of missed filings might be waivable under the IRS’s “reasonable cause” grounds. There’s a bit of flexibility here, especially under the First-Time Abatement (FTA) policy, which is designed to be more lenient for first-time offenders. That said, I’ve seen mixed results in practice. The IRS doesn’t always grant these waivers, and even if you can get a first-year penalty waived, it’s unlikely they’ll be as forgiving for multiple years of noncompliance.

If you’ve missed filings for multiple years, the best option might be to go through the Delinquent International Information Returns Submission Procedures. In my experience, this process can offer some relief and has worked well for clients who need to catch up on their filings. It’s a way to show the IRS that you’re serious about becoming compliant and that the missed filings were an honest mistake.

What You Need to Do Now

If you’re a foreign owner of an LLC, even if it’s just being used to hold real estate or another asset, you need to get compliant- right now. The IRS is clearly starting to crack down on these filings, and you don’t want to be one of the unlucky LLC owners hit with a $25,000 penalty letter in the mail.

Here are your next steps:

• File Form 5472 and 1120: If you haven’t filed these forms in the past, it’s time to catch up. Even if your LLC hasn’t been active, these forms are required.
• Consider the Delinquent International Information Returns Procedures: If you’re behind on multiple years of filings, this could help you avoid some of the harsher penalties and get back in the IRS’s good graces.
• Get Professional Help: This isn’t something you want to tackle on your own. A tax professional who understands the ins and outs of FODEs can help you navigate the process and possibly minimize the penalties you face. We offer a service for this filing here.

Don’t Let This Happen to You

As a tax professional, I’ve seen the consequences of these penalties firsthand. It’s frustrating to watch clients get blindsided by $25,000 penalties for something they didn’t even know they had to file. The IRS is ramping up enforcement, and it’s only a matter of time before more foreign-owned LLCs start receiving these penalty notices.

If you want to avoid this nightmare scenario, get your LLC compliant today. Whether you need to catch up on past filings or just want to make sure you’re on the right track moving forward, reach out. I’m here to help, and I can guide you through the process so you don’t have to face the IRS alone.

And remember, even if your LLC is just sitting there holding real estate or other assets with no income, you still need to file. Don’t wait for the IRS to come knocking—by then, it’ll be too late.

If you’ve received one of these penalty letters or want to talk about how to avoid them, let’s set up a call. Together, we can figure out the best way to get your LLC compliant and keep you from getting hit with any more penalties.

Need Help with Foreign-Owned LLC Tax Filings?

Foreign-owned LLCs come with unique tax reporting requirements, and the penalties for missing those filings are steep. If you’re the owner of a foreign LLC, make sure you’re filing Form 5472 and 1120 every year, even if the LLC has no activity. Don’t fall into the trap of thinking that because there’s no income, there’s nothing to report, there is. The IRS is cracking down, and the consequences are real. Schedule a call with one of our team members to understand your filing needs.