US Outbound: IRS issues final regulations on treatment of disregarded entities for employment tax purposes
The Internal Revenue Service (IRS) recently released final regulations clarifying that a disregarded entity, which is treated as a corporation for employment tax purposes, will also be treated as a corporation for tax administration purposes related to employment taxes (TD 9553).
The new regulations finalise proposed regulations that were issued in September 2009 and remove the corresponding temporary regulations. The final regulations are generally effective retroactively to the date of the proposed regulations; September 14 2009. A disregarded entity is an entity with a single owner that elects to be treated as a pass-through entity under Reg. Sec. 301-7701-3(a). A disregarded entity’s items of income, gain, loss, deductions, and credits are generally treated as those of its owner for federal income tax purposes. Before 2009, a disregarded entity’s owner was also permitted to withhold, report and pay the employment taxes of its disregarded entity. However, under regulations effective January 1 2009, a disregarded entity is now treated as a corporation for employment tax purposes, the related reporting requirements and for a few excise taxes. This means that under the 2009 regulations, disregarded entities are required to withhold, report and pay employment taxes under their own names and employer identification numbers (EINs). Under the 2009 regulations, the disregarded entity’s owner may no longer withhold and pay employment taxes on behalf of the disregarded entity but the owner can report most other payments, including Forms 1099-MISC reporting payments to independent contractors providing services to the disregarded entity.
The US tax treatment of a disregarded entity as a corporation for employment tax purposes, described above, has important implications in the international context, especially with regard to foreign subsidiaries that have checked-the-box to be treated as disregarded entities for US tax purposes. For example, under the 2009 regulations, a foreign disregarded entity with US employees is required to obtain an EIN and file employment tax-related US information and tax withholding returns (such as IRS forms W-2, 940 and 941), even if the disregarded entity has no other US activities.
Under the recently released regulations, the IRS further clarified disregarded entities’ treatment as corporations for tax administration purposes related to employment taxes. As a result, any IRS correspondence related to the employment tax obligations of a foreign disregarded entity will be directed to the foreign disregarded entity, and not its US owner. The new regulations also clarify that any federal tax liability related to employment tax obligations of the foreign disregarded entity will be the liability of the foreign disregarded entity, and not its US owner.
As these regulations place the burden of US employment tax compliance on a US taxpayer’s foreign disregarded entities, US taxpayers with foreign disregarded entities should ensure that appropriate processes are put in place to permit its foreign disregarded entities to comply with their US employment tax obligations. These requirements may include reporting on form W-2, withholding federal income tax and withholding and depositing social taxes (to the extent applicable) on form 941 and possibly other forms. Some companies faced with US reporting appoint a US payroll agent to do the reporting for a foreign employer with employees who are US taxpayers.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.
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