Related-party transactions are one of the most heavily scrutinized areas in international taxation. Even routine transfers of money between commonly owned entities can trigger significant reporting obligations and penalties if not handled correctly. This guide explains what qualifies as a related-party transaction, what must be reported, and why these transactions frequently attract IRS attention.
What Is a Related Party in International Tax?
A related party generally includes individuals or entities with common ownership or control. This may include foreign parents, subsidiaries, affiliates, shareholders, and family members, depending on ownership structure.
Common Types of Reportable Related-Party Transactions
Reportable transactions may include capital contributions, loans, management fees, royalties, interest payments, reimbursements, and payments for goods or services between related entities.
How Related-Party Transactions Are Reported
Related-party transactions are commonly reported on Form 5472 for foreign-owned U.S. companies and on Form 5471 schedules for U.S. owners of foreign corporations. Accuracy and consistency are critical.
Why the IRS Focuses on Related-Party Transactions
The IRS closely monitors related-party transactions due to the risk of profit shifting, base erosion, and underreported income. Inconsistent reporting across entities often triggers audits.
Transfer Pricing Considerations (High-Level Overview)
Transfer pricing rules require that transactions between related parties be conducted at arm’s length. Even small and mid-size businesses may need to consider transfer pricing principles.
Common Reporting Mistakes
Common errors include failing to report routine transfers, mischaracterizing transactions, and inconsistent reporting between U.S. and foreign filings.
Penalties for Improper Related-Party Reporting
Penalties may apply for failure to disclose related-party transactions, incorrect reporting, or missing informational returns. These penalties can be substantial.
Best Practices for Managing Related-Party Transactions
Best practices include maintaining clear documentation, using formal agreements, and coordinating reporting across all entities involved.
Final Thoughts from Alberto Luna Jr., CPA
Related-party transactions are not inherently problematic, but they require careful handling. In my experience, the biggest issues arise when business owners treat intercompany transfers casually. Proper documentation and consistent reporting are essential to reducing audit risk and maintaining compliance.
