Short answer: A disregarded entity is a business entity with one owner that the US ignores for income tax: its income, assets and liabilities are treated as its owner's. When that entity is foreign, such as a Luxembourg S.à r.l. or a Dutch B.V. that has elected disregarded status under check-the-box, or when a US person runs a foreign branch, the income is already on the owner's return, but the IRS still wants to see the entity. That disclosure is Form 8858. It is filed with the owner's own return, and missing it can cost $10,000 a year plus a cut in foreign tax credits.

Disregarded entities in plain terms

  • US single-member LLCs are disregarded by default. They need no separate income tax return and no Form 8858.
  • Foreign single-owner entities are disregarded only if they are eligible and either default into that status (an owner with unlimited liability) or elect it on Form 8832. Most foreign companies whose owners have limited liability are corporations unless they elect.
  • Disregarded is not invisible. The entity is still a separate legal person. It can still owe local tax, employ people, and, for US employment and certain excise taxes, be treated as a corporation.

What Form 8858 is for

Form 8858 is filed by certain US persons that operate a foreign branch (FB) or own a foreign disregarded entity (FDE), directly or indirectly. Key terms:

  • FDE: an entity not created in the US that is disregarded for US income tax.
  • FB: a foreign branch as defined in the regulations, broadly a business operation a US person carries on outside the US.
  • Tax owner: the person treated as owning the FDE's assets and liabilities, the one whose return includes its income.

Who must file

The instructions group filers into six categories:

  • Category 1: a US person that is directly the tax owner of an FDE or operates an FB.
  • Category 2: a US person that owns an FDE or FB indirectly, through tiers of FDEs.
  • Categories 3 and 4: US persons that must file Form 5471 or Form 8865 for a foreign corporation or foreign partnership that itself owns an FDE or operates an FB.
  • Categories 5 and 6: certain partners in partnerships that own FDEs or operate FBs.

Some categories file reduced versions. For example, certain Form 5471 filers complete only page 1 and a few schedules, and a Category 2 filer of Form 8865 does not need to file if a Category 1 filer already covers the same FDE or FB.

What goes on the form

  • Identifying information about the FDE or FB and its tax owner, including country and functional currency.
  • Financial statements: an income statement and balance sheet, generally in the entity's functional currency and in US dollars.
  • Foreign income taxes paid or accrued.
  • Schedule M: transactions between the FDE or FB and its owner or related parties, such as loans, fees, sales and royalties. It must be filed whenever there are such transactions.
  • Schedule C-1: section 987 currency gain or loss, where the FDE or branch uses a different functional currency from its owner.

When, where and penalties

Form 8858 is attached to the filer's own return, Form 1040, 1120 or 1065, and is due with it, including extensions. There is no separate filing.

Failing to file required information can trigger a $10,000 penalty per year, with more if it continues after an IRS notice, and a 10% reduction in the foreign taxes available for credit, with further reductions for continued failure. Missing information returns can also keep the statute of limitations open.

Worked example

A US real estate fund, organised as a partnership, owns 100% of a Luxembourg S.à r.l. that owns an office building in Amsterdam. The S.à r.l. elected on Form 8832 to be disregarded from the day it was formed.

  • For US tax, the fund is the tax owner. The building's rent and expenses are the fund's own income and expenses, and they flow to the partners on their K-1s.
  • The fund is a Category 1 filer and attaches Form 8858 for the S.à r.l. to its Form 1065, with the S.à r.l.'s income statement and balance sheet in euros and US dollars.
  • If the fund lent money to the S.à r.l. or charged it fees, those go on Schedule M.
  • Because the S.à r.l. keeps its books in euros and the fund uses dollars, Schedule C-1 reports any section 987 gain or loss.
  • On the international side, the fund's partners may need related information, such as foreign source income and foreign taxes, on Schedules K-2 and K-3.

If the S.à r.l. had not elected, it would be a foreign corporation, and the fund would be looking at Form 5471 and the CFC rules instead.

What this means for funds

  • Every foreign holding vehicle that elected disregarded status needs a Form 8858 each year, usually from the fund that owns it. Keep a list of them and their functional currencies.
  • Intercompany flows matter. Loans and fees between the fund and its FDEs drive Schedule M and can create section 987 gain or loss.
  • Check the election history. The 8858 assumes the FDE really is disregarded, which depends on a valid, timely Form 8832.

This explainer is general information, not tax advice.

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This explainer is analysis and general information, not tax, legal or investment advice.