IRS form 8865 (PDF available here) deals with the deduction of a percentage of foreign or global income beginning in tax year 2018. As is the case with many other IRS forms, it can be difficult to know how to file the 8865—or if you’re even required to do so. The IRS requires four major categories of tax filers to complete the form, and the requirements are different for each group. It can be difficult to know if you meet one of the thresholds for filing form 8865, so we’ve broken out the four eligible groups here, categories 1 through 4.
- Category 1—Any U.S. Person who controlled a foreign partnership during the tax year.
- Category 2—Any U.S. Person who owned more than 10% of a foreign partnership (some exceptions).
- Category 3—Any U.S. Person who contributed property to a foreign partnership in exchange for an interest in the partnership.
- Category 4—Any U.S. Person who had a reportable event during their tax year under section 6046A.
Clear as mud, right? Don’t worry, we’ll do our best to cut through the IRS red tape.
Category 1 is the most straightforward category within the IRS Form 8865, believe it or not. This category covers anyone who controlled a foreign partnership, which the IRS defines as “greater than 50% interest”. This 50% can cover any of the following:
- 50% of the foreign partnership’s capital
- 50% of the foreign partnership’s profits
- 50% of the foreign partnership’s deductions
- 50% of the foreign partnership’s losses
When completing form 8865, Category 1 filers must complete the initial Identifying Information section on page 1 as well as Schedule A, A-1, A-3, and Schedules B, G, H, K, L, M, M-1, M-2, N, D, and K-1. Because the final two Schedules cover transfers and acquisitions, they’re not generally required for a Category 1 filer unless they also fall into Category 3 or 4.
Category 2 of IRS Form 8865 covers filers who owned a 10% or greater interest in a foreign partnership while there were other U.S. owners also possessing at least 10%. However, if any of those owners had more than 50%, they fall under Category 1. In the case that there is a Category 1 filer for a foreign partnership, there are no Category 2 filers for the year. Similar to Category 1’s rule, 10% is defined as any of:
- 10% of the foreign partnership’s capital
- 10% of the foreign partnership’s profits
- 10% of the foreign partnership’s deductions
- 10% of the foreign partnership’s losses
The most important part of Category 2 is that no partnership can have both a Category 1 and Category 2 filer, and the vast majority of partnerships with one Category 2 filer will have multiple. A Category 2 filer will need to complete Identifying Information along with Schedule A, A-3, N, and K-1.
As stated above, Category 3 of IRS Form 8865 covers U.S. persons who contributed property in exchange for an interest in the partnership. However, Category 3 only covers cases where the interest is at least 10% or the value of the property contributed over the course of a year is over $100,000. This also covers the case of a domestic partnership contributing over these thresholds to a foreign partnership. However, if the domestic partnership files form 8865 then the individual persons are not required to do so (unless they would be otherwise). Category 3 filers are required to complete Identifying Information and Schedules A, A-1, A-3, G, H, and O.
This category of IRS Form 8865 covers U.S. persons who had a reportable event during the tax year according to section 6046A. Three events fall under the section 6046A criteria: acquisitions, dispositions, and changes in proportional interest.
- Acquisitions: Because an acquisition wouldn’t generally trigger any of these four categories, it falls into Category 4 if it would take the person over a 10% threshold. For example, an 8% interest wouldn’t generally require form 8865 to be completed, but if the U.S. person in question acquired enough to make it an 15% interest, they would be required to file the form as part of their return. There is also a provision in 6046A for persons who previously filed 8865 but gained 10% more (e.g. from 14% to 25%) since their last qualifying event. They would need to file again during this year.
- Dispositions: The dispositions rule is basically the inverse of the acquisitions rule. If a person would fall below the 10% threshold and they were previously above it, they fall into Category 4 for the year. This additionally covers the 25% to 14% scenario. Anything greater than 10% or crossing the 10% threshold will require form 8865.
- Changes in proportional interest: Even if an acquisition or disposition isn’t explicitly occurring, proportional ownerships may shift during the year. If any of these interests shift by more than 10% of the total, the affected person will be required to file under Category 4. Category 4 filers must complete Identifying Information and Schedules A, A-3, G, H, and P.
There are multiple exceptions to being required to file form IRS Form 8865. The full list is available on the IRS website but here are two of the most common:
If a partnership has more than one person who would be required to file form 8865 under Category 1, only one is required to do so. However, the other(s) must complete a Controlled Foreign Partnership Reporting statement.
Additionally, partnerships that filed form 1065 for the tax year may attach a copy of the completed 1065 schedules in place of form 8865.
The Bottom Line About IRS Form 8865
IRS Form 8865 is required for most filers with a significant interest in a foreign partnership. For more information about each of the categories and what the IRS requires for each, visit the “About Form 8865“ page on irs.gov. The official IRS site goes into more detail about each of the criteria and is the best page for in-depth questions about eligibility and term definitions. If you’re looking for a partner to navigate the IRS maze with, check out Silver Tax Group. With more than forty years of experience, they’re the tax experts you need for any scenario. But don’t take our word for it, check out some of the glowing reviews.