QUESTION: I've just discovered that a Panama corporation that I formed is treated as a controlled foreign corporation and that I have to file a Form 5471 for that corporation. The corporation has incurred a loss but I've been told I can't deduct the loss on my taxes. It will probably be a few years before the corporation begins to have a profit. Can I make an S corporation election to be able to pass through the losses to my personal return?

REPLY: An S corporation can't be a foreign corporation, but there is a way to eliminate the tax treatment of a controlled foreign corporation. It is called an entity classification election, which many tax people refer to as a "check-the-box" election. By filing Form 8832, you can convert the foreign corporation into a disregarded entity for U.S. tax purposes. If you are the only owner, the income and losses of the entity will be reported on Schedule C of your personal tax return. If there are multiple owners, you will have to file a foreign partnership Form 8865 -- which is more difficult and more expensive than the Form 5471, but it does provide pass-through tax treatment.

But there is a catch. The election to be treated as a disregarded entity is only available for "eligible entities". Entities that are not eligible to make the election are listed in IRS Regulation 301.7701-2 and in the instructions to the Form 8832. In Panama, a corporation that is called an S.A. corporation (Sociedade Anonima) is NOT an eligible entity and can't be treated as a disregarded entity. It would therefore be necessary to liquidate the corporation and to form a limited liability company or a Panama SRL (Società a responsibilità limitata) which is the Panama equivalent of a limited liability company.

When the corporation is liquidated, the U.S. stock holders will realize a capital gain or loss on their investment in the corporation. 

Vern Jacobs
http://www.offshorepress.com/cfc-ibc-tax.htm

The comments in this memorandum are not intended to constitute an opinion regarding any specific tax issues because additional tax issues may exist that could affect the tax treatment of the tax issues addressed in this memo. This memorandum does not consider or reach a conclusion with respect to those additional issues and was not written and cannot be used for the purpose of avoiding penalties under code
section 6662(d). For further details see http://www.offshorepress.com/vkjcpa/disclosurerules.htm

Vern Jacobs

The Jacobs Report

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