Form 8865 Foreign Partnership Reporting

Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, is an international information return used to report certain U.S. ownership, control, transfers, acquisitions, dispositions, and other relationships involving foreign partnerships.

A Form 8865 obligation can arise even when the foreign partnership itself owes no U.S. federal income tax. Different filing categories require different schedules, and the penalty rules differ depending on why the form was required.

Colorado Legal assists taxpayers with Form 8865 filing, controlled foreign partnership analysis, transfers to foreign partnerships, delinquent Forms 8865, reasonable-cause issues, Streamlined submissions, and international tax penalties. Philip M. Falco is both a Colorado attorney and Certified Public Accountant.

What Is Form 8865?

Form 8865 reports information required under several U.S. international tax provisions involving foreign partnerships.

The form can apply to:

• U.S. persons controlling foreign partnerships;
• certain significant U.S. owners of foreign partnerships;
• certain transfers of property to foreign partnerships;
• acquisitions of foreign partnership interests;
• dispositions of foreign partnership interests; and
• specified changes in proportional ownership interests.

Who Must File Form 8865?

The IRS currently divides Form 8865 filers into four principal categories.

A taxpayer can fall into more than one category for the same partnership. If so, the filing generally must include the schedules required by each applicable category, subject to the exceptions and coordination rules in the Form 8865 instructions.

Category 1 — Control of a Foreign Partnership

A Category 1 filer generally is a U.S. person who controlled the foreign partnership at any time during the partnership’s tax year.

For this purpose, control generally means ownership of more than a 50% interest in the foreign partnership.

The ownership test can involve interests in:

• partnership capital;
• partnership profits;
• partnership deductions; or
• partnership losses

under the applicable Form 8865 ownership rules.

Category 2 — Certain 10% Foreign Partnership Owners

A Category 2 filer generally is a U.S. person that owned a 10% or greater interest in a foreign partnership while the partnership was controlled by U.S. persons each owning at least a 10% interest.

The IRS instructions contain an important coordination rule: if the foreign partnership had a Category 1 filer during that tax year, no person is considered a Category 2 filer for that year.

Category 3 — Transfers of Property to a Foreign Partnership

Category 3 generally concerns certain transfers of property to a foreign partnership under Section 6038B.

A U.S. person can become a Category 3 filer when property is contributed to a foreign partnership in exchange for an interest and either:

• the person owns directly or constructively at least a 10% interest immediately after the contribution; or
• the value of property contributed by the person and related persons during the applicable 12-month period exceeds $100,000.

Additional rules apply to Section 721(c) property and specified transfers of appreciated property.

Category 4 — Acquisitions, Dispositions and Ownership Changes

Category 4 generally applies when a U.S. person has a reportable event under Section 6046A involving a foreign partnership interest.

Reportable events can include:

• acquiring a direct interest that reaches the 10% reporting level;
• increasing a previously reported direct interest by at least 10 percentage points;
• disposing of an interest so that ownership falls below 10%;
• decreasing a previously reported direct interest by at least 10 percentage points; or
• other reportable changes in proportional ownership.

What Is a Foreign Partnership?

Whether an organization is a foreign partnership for U.S. federal tax purposes depends on both its place of organization and its classification under U.S. tax law.

A business treated as a corporation under foreign law is not necessarily treated as a corporation for U.S. tax purposes, and an entity commonly described overseas as a company may potentially be classified as a partnership or disregarded entity under the U.S. entity-classification rules.

Entity Classification Matters

Before preparing Form 8865, the entity itself should be classified correctly for U.S. federal tax purposes.

Depending on the entity and any classification election, an overseas business could potentially create:

• Form 5471 reporting as a foreign corporation;
• Form 8865 reporting as a foreign partnership; or
• Form 8858 reporting as a foreign disregarded entity.

Constructive and Indirect Ownership

Form 8865 reporting is not always limited to partnership interests registered directly in the taxpayer’s name.

Direct, indirect, and constructive ownership rules can affect whether a taxpayer satisfies a control or ownership threshold.

Relevant ownership can potentially arise through:

• family relationships;
• corporations;
• partnerships;
• trusts;
• estates; or
• tiered international structures.

What Schedules Can Form 8865 Require?

The required schedules depend on the filing category.

Depending on the circumstances, Form 8865 can require:

• Schedule A — constructive ownership;
• Schedule A-1 — certain partners;
• Schedule A-3 — affiliation information;
• Schedule B — income statement;
• Schedule K — distributive share items;
• Schedule K-1;
• Schedules K-2 and K-3 for international tax information;
• Schedule L — balance sheet;
• Schedules M-1 and M-2;
• Schedule N — related-party transactions;
• Schedule O — transfers of property to a foreign partnership;
• Schedule P — acquisitions, dispositions, and changes in partnership interests;
• Schedule G relating to Section 721(c); and
• other applicable schedules and statements.

Form 8865 Schedule O

Schedule O is particularly important for Category 3 transfer reporting.

The taxpayer may need to disclose property transferred to the foreign partnership, adjusted basis, fair market value, ownership following the transfer, and other information required by the Section 6038B rules.

Form 8865 Schedule P

Schedule P generally addresses Category 4 acquisitions, dispositions, and specified changes in interests in foreign partnerships.

A taxpayer buying into, selling out of, or changing a substantial ownership percentage in a foreign partnership should determine whether a Schedule P event occurred.

Form 8865 and Section 721(c)

Transfers of appreciated property to certain foreign or domestic partnerships can implicate the specialized Section 721(c) anti-deferral rules.

These rules can require additional Forms 8865 and Schedules G or H and can affect whether gain otherwise deferred on a partnership contribution remains deferred.

Form 8865 and Foreign Partnership Income

A Form 8865 filing obligation is an information-reporting requirement, but foreign partnership ownership also can create substantive U.S. income-tax consequences.

Depending on the facts, a U.S. partner may need to report:

• ordinary business income or loss;
• interest;
• dividends;
• capital gains or losses;
• rental income;
• foreign taxes;
• separately stated items;
• Section 704 allocations;
• basis adjustments; and
• international tax information reflected through Schedules K-2 and K-3.

Form 8865 and Form 8938

A foreign partnership interest can also be relevant to Form 8938.

The forms have different purposes. Form 8938 contains coordination rules for assets reported on certain other international information returns, including Form 8865.

Form 8865 and FBAR

Owning a foreign partnership does not by itself determine whether an FBAR is required.

However, a partner can separately have a financial interest in or authority over foreign bank or financial accounts associated with the partnership or other foreign assets.

Form 8865 and Form 8858

A controlled foreign partnership can itself own a foreign disregarded entity or operate a foreign branch.

In those cases, Form 8858 can be required in connection with the Form 8865 filing.

When Is Form 8865 Due?

Form 8865 generally is filed with the U.S. person’s income-tax or information return for the applicable year and follows that return’s filing deadline, including applicable extensions.

Category 1 and Category 2 Form 8865 Penalties

For failures subject to Section 6038, an initial $10,000 penalty can apply for each tax year of each foreign partnership for which required information is not timely furnished.

If the failure continues for more than 90 days after the IRS mails notice, additional penalties can apply at $10,000 for each 30-day period or fraction of a period during which the failure continues after the 90-day period.

The additional continuation penalty is generally limited to $50,000 for each failure.

The Section 6038 rules can also affect otherwise available foreign tax credits.

Category 3 Transfer Penalties

The penalty structure for an unreported transfer to a foreign partnership is different.

A person who fails to properly report a contribution required under Section 6038B can generally face a penalty equal to 10% of the fair market value of the transferred property.

The penalty generally is limited to $100,000 unless the failure is due to intentional disregard.

In addition, the transferor can potentially be required to recognize gain as though the contributed property had been sold for fair market value.

Category 4 Penalties

Failure to properly report information required under Section 6046A can generally produce a $10,000 penalty.

Continuation penalties can apply if the failure remains uncorrected more than 90 days after IRS notice, subject to the applicable $50,000 continuation-penalty ceiling.

Reasonable Cause

Applicable Form 8865 penalty provisions contain reasonable-cause exceptions.

Reasonable cause depends on the particular reporting provision and the taxpayer’s facts.

Potentially relevant circumstances can include:

• how the foreign partnership interest was acquired;
• how the entity was classified for U.S. tax purposes;
• ownership percentages;
• professional advice;
• information provided to prior return preparers;
• availability of foreign books and records;
• prior filing history;
• when the taxpayer discovered the omission; and
• corrective steps taken after discovery.

Delinquent Form 8865

Under the IRS’s current delinquent international information-return procedures, taxpayers who discover a delinquent Form 8865 generally file the missing information return through normal filing procedures.

A delinquent Form 8865 generally is attached to the appropriate amended income-tax or information return for the affected year.

Penalties may still be assessed.

See our Delinquent International Information Returns guide.

Can a Reasonable-Cause Statement Be Included?

A taxpayer asserting reasonable cause may attach a reasonable-cause statement to a delinquent Form 8865.

Current IRS procedures caution that penalties may be assessed during processing without the attached reasonable-cause statement first being considered, and the taxpayer may need to respond to later IRS correspondence.

Form 8865 and Streamlined Filing Compliance

A missing Form 8865 frequently appears as part of a broader offshore-compliance problem.

Where failures resulted from non-willful conduct, the Streamlined Filing Compliance Procedures may need to be considered.

That analysis can include Forms 8865, Forms 8858, Forms 8938, FBARs, foreign income, and other international filings.

What If the Foreign Partnership Was Intentionally Concealed?

Potentially willful noncompliance requires a different analysis from an ordinary delinquent information-return filing.

See our Willful vs. Non-Willful FBAR Violations resource and IRS Voluntary Disclosure Practice page.

Frequently Asked Questions

Do I need Form 8865 because I own part of a foreign partnership?

Not necessarily. The filing categories depend on control, ownership percentage, transfers, acquisitions, dispositions, and other reportable events.

What ownership percentage creates Category 1?

Category 1 generally involves ownership of more than a 50% interest in the foreign partnership under the applicable control rules.

What is the Category 2 threshold?

Category 2 generally involves a 10% or greater interest while the foreign partnership is controlled by qualifying U.S. persons, subject to the important exception when a Category 1 filer exists.

Can contributing $100,000 to a foreign partnership trigger reporting?

Category 3 can apply when the value of property contributed by the taxpayer and related persons during the applicable 12-month period exceeds $100,000, or when the taxpayer owns at least 10% immediately after the contribution.

Is the Form 8865 penalty always $10,000?

No. Different filing categories arise under different statutory provisions. Category 3 property-transfer failures, for example, use a percentage-of-property penalty structure.

Can Form 8865 be required even if no additional U.S. tax is due?

Yes. Form 8865 is an international information return, although ownership of a foreign partnership can separately create U.S. income-tax consequences.

Official IRS Resources

• IRS — About Form 8865
• IRS — Instructions for Form 8865
• IRS — International Information Reporting Penalties
• IRS — Delinquent International Information Return Procedures