U.S. Income Tax Return of a Foreign Sales Corporation

Accounting Periods

A FSC must figure its taxable income on the basis of a tax year. The tax year is the annual accounting period the FSC uses to keep its records and report its income and expenses. Generally, FSCs can use a calendar year or a fiscal year. Personal service corporations, however, must generally use a calendar year.

For more information about accounting periods, see Temporary Regulations sections 1.441-1T, 1.441-2T, and Pub. 538.

Note: The tax year of a FSC must be the same as the tax year of the principal shareholder which, at the beginning of the FSC tax year, has the highest percentage of voting power. If two or more shareholders have the highest percentage of voting power, the FSC must have a tax year that conforms to any 1 tax year of the principal shareholders. See section 441(h)(1).

Calendar year. If the calendar year is adopted as the annual accounting period, the FSC must maintain its books and records and report its income and expenses for the period from January 1 through December 31 of each year.

Fiscal year. A fiscal year is 12 consecutive months ending on the last day of any month except December. A 52-53 week year is a fiscal year that varies from 52 to 53 weeks.

Adoption of tax year. A FSC adopts a tax year when it files its first income tax return. It must adopt a tax year by the due date (not including extensions) of its first income tax return.

Change of tax year. Generally, a FSC must get the consent of the IRS before changing its tax year by filing Form 1128, Application To Adopt, Change, or Retain a Tax Year. However, under certain conditions, a FSC (other than a personal service corporation) may change its tax year without getting the consent. See Regulations section 1.442-1 and Pub. 538.

Rounding Off To
Whole Dollars

A FSC may show amounts on the return and accompanying schedules as whole dollars. To do so, drop amounts less than 50 cents and increase amounts from 50 cents through 99 cents to the next higher dollar.

Recordkeeping

Keep the FSC's records for as long as they may be needed for the administration of any provision of the Internal Revenue Code. Usually, records that support an item of income, deduction, or credit on the return must be kept for 3 years from the date the return is due or filed, whichever is later. Keep records that verify the FSC's basis in property for as long as they are needed to figure the basis of the original or replacement property.

The FSC should keep copies of all filed returns. They help in preparing future and amended returns.

Payment of Tax Due

The FSC must pay the tax due in full no later than the 15th day of the 3rd month after the end of the tax year. The method for payment of the tax due depends upon whether the FSC has an office or place of business in the United States.

1. FSCs that do not maintain an office or place of business in the United States must pay the tax due directly to the IRS (i.e., do not use the depository method of tax payment described below). The tax may be paid by check or money order, payable to the United States Treasury. To help ensure proper crediting, write the FSC's employer identification number (EIN), Form 1120-FSC, and the tax period to which the payment applies on the check or money order. Enclose the payment when Form 1120-FSC is filed with the Internal Revenue Service Center, Philadelphia, PA 19255.
2. FSCs that do maintain an office or place of business in the United States must pay the tax due using a qualified depositary. The two methods of depositing corporate taxes are discussed below.

Electronic Deposit Requirement

The FSC must make electronic deposits of all depository taxes (such as employment tax, excise tax, and corporate income tax) using the Electronic Federal Tax Payment System (EFTPS) in 2002 if:

• The total deposits of such taxes in 2000 were more than $200,000 or
• The FSC was required to use EFTPS in 2001.

If the FSC is required to use EFTPS and fails to do so, it may be subject to a 10% penalty. If the FSC is not required to use EFTPS, it may participate voluntarily. To enroll in or get more information about EFTPS, call 1-800-555-4477 or 1-800-945-8400. To enroll online, visit www.eftps.gov.

Depositing on time. For EFTPS deposits to be made timely, the FSC must initiate the transaction at least 1 business day before the date the deposit is due.

Deposits With Form 8109

If the FSC does not use EFTPS, deposit FSC income tax payments (and estimated tax payments) with Form 8109, Federal Tax Deposit Coupon. If you do not have a preprinted Form 8109, use Form 8109-B to make deposits. You can get this form by calling 1-800-829-1040. Be sure to have your EIN ready when you call.

Do not send deposits directly to an IRS office; otherwise, the FSC may have to pay a penalty. Mail or deliver the completed Form 8109 with the payment to an authorized depositary (i.e., a commercial bank or other financial institution authorized to accept Federal tax deposits). Make checks or money orders payable to the depositary. If the corporation prefers, it may mail the coupon and payment to: Financial Agent, Federal Tax Deposit Processing, P.O. Box 970030, St. Louis, MO 63197. Make the check or money order payable to Financial Agent. To help ensure proper crediting, write the FSC's EIN, the tax period to which the deposit applies, and Form 1120-FSC on the check or money order. Be sure to darken the 1120 box on the coupon. Records of these deposits will be sent to the IRS.

For more information on deposits, see the instructions in the coupon booklet (Form 8109) and Pub. 583, Starting a Business and Keeping Records.

If the FSC maintains an office or place of business in the United States and it owes tax when it files Form 1120-FSC, do not include the payment with the tax return. Instead, mail or deliver the payment with Form 8109 to an authorized depositary, or use EFTPS, if applicable.

Estimated Tax Payments

Generally, the following rules apply to the FSC's payments of estimated tax.

• The FSC must make installment payments of estimated tax if it expects its total tax for the year (less applicable credits) to be $500 or more.
• The installments are due by the 15th day of the 4th, 6th, 9th, and 12th months of the tax year. If any date falls on a Saturday, Sunday, or legal holiday, the installment is due on the next regular business day.
• Use Form 1120-W, Estimated Tax for Corporations, as a worksheet to compute estimated tax.
• If the FSC maintains an office or place of business in the United States and it does not use EFTPS, use the deposit coupons (Forms 8109) to make deposits of estimated tax.
• If the FSC does not maintain an office or place of business in the United States, it must pay the estimated tax due directly to the IRS.

For more information on estimated tax payments, including penalties that apply if the FSC fails to make required payments, see Line 3, Estimated tax penalty, on page 8.

Overpaid estimated tax. If the FSC overpaid estimated tax, it may be able to get a quick refund by filing Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax. The overpayment must be at least 10% of the FSC's expected income tax liability and at least $500. File Form 4466 before the 16th day of the 3rd month after the end of the tax year, but before Form 1120-FSC is filed. Do not file Form 4466 before the end of the FSC's tax year.

Interest and Penalties

Interest. Interest is charged on taxes paid late even if an extension of time to file is granted. Interest is also charged on penalties imposed for failure to file, negligence, fraud, gross valuation overstatements, and substantial understatements of tax from the due date (including extensions) to the date of payment. The interest charge is figured at a rate determined under section 6621.

Penalty for late filing of return. A FSC that does not file its tax return by the due date, including extensions, may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. The minimum penalty for a return that is over 60 days late is the smaller of the tax due or $100. The penalty will not be imposed if the FSC can show that the failure to file on time was due to reasonable cause. FSCs that file late must attach a statement explaining the reasonable cause.

Penalty for late payment of tax. A FSC that does not pay the tax when due generally may be penalized ½ of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. The penalty will not be imposed if the FSC can show that the failure to pay on time was due to reasonable cause.

Trust fund recovery penalty. This penalty may apply if certain income, social security, and Medicare taxes that must be collected or withheld are not collected or withheld, or these taxes are not paid. These taxes are generally reported on Forms 941 or 945 (see Other Forms, Returns, Schedules, and Statements That May Be Required on page 4). The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for, and paying over these taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. See Pub. 15 (Circular E), Employer's Tax Guide, for details, including the definition of responsible person.

Other penalties. Other penalties can be imposed for negligence, substantial understatement of tax, and fraud. See sections 6662 and 6663.

A FSC may also be subject to a penalty (under section 6686) of $100 for each instance it fails to furnish the information required under section 6011(c), up to a maximum of $25,000. This penalty will not apply if the FSC can show that the failure to furnish the required information was due to reasonable cause.

Period covered. File the 2001 return for calendar year 2001 and fiscal years that begin in 2001 and end in 2002. For a fiscal year return, fill in the tax year space at the top of the form.

Note: The 2001 Form 1120-FSC may also be used if:

The FSC must show its 2002 tax year on the 2001 Form 1120-FSC and take into account any tax law changes that are effective for tax years beginning after December 31, 2001.

Name. Print or type the FSC's true name (as set forth in the charter or other legal document creating it).

Address. Enter the U.S. address where the FSC maintains the records required under section 6001. Include the suite, room, or other unit number after the street address. If the Post Office does not deliver mail to the street address and the FSC has a P.O. box, show the box number instead.

Item A. Foreign country or U.S. possession of incorporation. See Definition of a Foreign Sales Corporation (FSC) on page 2 of the instructions.

Item C. Employer identification number (EIN). Enter the FSC's EIN. If the FSC does not have an EIN, it must apply for one on Form SS-4, Application for Employer Identification Number. If the FSC has not received its EIN by the time the return is due, write Applied for in the space for the EIN. See Pub. 583 for details.

Item E. Total assets. Enter the FSC's total assets (as determined by the accounting method regularly used in keeping the FSC's books and records) at the end of the tax year of the FSC from page 6, Schedule L, column (d), line 15. If there are no assets at the end of the tax year, enter the assets as of the beginning of the tax year.

Item F. Final return, name change, address change, or amended return.

• If the corporation ceases to exist, file Form 1120-FSC and check the Final return box.
• If the FSC changed its name since it last filed a return, check the box for Name change. Generally, a FSC also must have amended its articles of incorporation and filed the amendment with the jurisdiction in which it was incorporated.
• If the FSC has changed its address since it last filed a return, check the box for Address Change.

  Note: If a change of address occurs after the return is filed, use Form 8822, Change of Address, to notify the IRS of the new address.

• If the FSC is amending its return, check the box for Amended return.

FSC Information

Line 1. Principal shareholder. Complete lines 1a through 1h for the shareholder (individual, corporation, partnership, trust, or estate) that was the principal shareholder at the beginning of the FSC's tax year. See the note on page 6 under Accounting Periods.

Foreign address. Enter the information in the following order: city, province or state, and country. Follow the country's practice for entering the postal code. Do not abbreviate the country name.

Line 2. Parent-subsidiary controlled group. If the FSC is a subsidiary in a parent-subsidiary controlled group and the principal shareholder is not the common parent of the group, complete lines 2a through 2g for the common parent. Enter the consolidated total assets on line 2d for a group that files a consolidated return; otherwise, enter only the common parent's total assets.

Note: Check the Yes box on line 2 if the FSC is a subsidiary in a parent-subsidiary controlled group. This applies even if the FSC is a subsidiary member of one group and the parent corporation of another.

The term parent-subsidiary controlled group means one or more chains of corporations connected through stock ownership (sections 927(d)(4) and 1563(a)(1)). Both of the following requirements must be met.

1. More than 50% of the total combined voting power of all classes of stock entitled to vote or more than 50% of the total value of all classes of stock of each corporation in the group (except the parent) must be owned by one or more of the other corporations in the group.
2. The common parent must own more than 50% of the total combined voting power of all classes of stock entitled to vote or more than 50% of the total value of all classes of stock of at least one of the other corporations in the group.

Stock owned directly by other members of the group is not counted when computing the voting power or value.

See sections 927(d)(4) and 1563(d)(1) for the definition of stock for purposes of determining stock ownership above.

Tax and Payments

Line 2h. Backup withholding. If the FSC had income tax withheld from any payments it received due to backup withholding, include the amount withheld in the total for line 2h. Show the amount withheld in the blank space in the right-hand column between lines 1 and 2h, and write backup withholding.

Note: Do not include backup withholding amounts on line 2g (i.e., include on line 2g only amounts withheld under Chapter 3 of the Code).

Line 3. Estimated tax penalty. A FSC that does not make estimated tax payments when due may be subject to an underpayment penalty for the period of underpayment. Generally, a FSC is subject to the penalty if its tax liability is $500 or more and it did not timely pay the smaller of:

• Its tax liability for 2001 or
• Its prior year's tax.

See section 6655 for details and exceptions, including special rules for large corporations.

Use Form 2220, Underpayment of Estimated Tax by Corporations, to see if the FSC owes the penalty and to figure the amount of the penalty. Generally, the FSC does not have to file this form because the IRS can figure the amount of any penalty and bill the FSC for it. However, even if the FSC does not owe the penalty, complete and attach Form 2220 if:

• The annualized income or adjusted seasonal installment method is used or
• The FSC is a large corporation computing its first required installment based on the prior year's tax. (See the Form 2220 instructions for the definition of a large corporation.)

If Form 2220 is attached, check the box on line 3, page 1, Form 1120-FSC, and enter the amount of any penalty on this line.

Schedule A

Cost of Goods Sold Related To Foreign Trading Gross Receipts

Complete Schedule A only for the cost of goods sold deduction related to foreign trading gross receipts reported on lines 1 through 5 of Schedule B.

Complete column (a) to show the cost of goods sold for inventory acquired in transactions using the administrative pricing rules. Complete column (b) to show the cost of goods sold for inventory acquired in transactions that did not use the administrative pricing rules. For details on the administrative pricing rules, see the Instructions for Schedule P (Form 1120-FSC).

If the FSC acts as another person's commission agent on a sale, do not enter any amount on Schedule A for the sale.

Small FSCs will have to make two separate computations for cost of goods sold if their foreign trading gross receipts exceed the limitation amount on line 6e of Schedule B. In this case, a deduction for cost of goods sold will be figured separately for the income on line 6h of Schedule B, and separately for the income on line 7 of Schedule F.

Generally, inventories are required at the beginning and end of each tax year if the production, purchase, or sale of merchandise is an income-producing factor. See Regulations section 1.471-1.

However, if the FSC is a qualifying taxpayer, it may adopt or change its accounting method to account for inventoriable items in the same manner as materials and supplies that are not incidental. A qualifying taxpayer is a taxpayer (a) whose average annual gross receipts for the 3 prior tax years is $1 million or less and (b) whose business is not a tax shelter (as defined in section 448(d)(3)). In addition, for tax years ending on or after December 31, 2001, this rule applies to an eligible business of a qualifying small business taxpayer. A qualifying small business taxpayer includes a corporation with average annual gross receipts of more than $1 million but less than or equal to $10 million and that is not prohibited from using the cash method under section 448. For more details, including the definition of an eligible business, see Notice 2001-76.

Under this accounting method, inventory costs for merchandise purchased for resale are deductible in the year the merchandise is sold (but not before the year the corporation paid for the merchandise, if it is also using the cash method). Enter amounts paid for merchandise during the tax year on line 2. The amount the FSC can deduct for the tax year is figured on line 8. For additional guidance on this method of accounting for inventory items, see Rev. Proc. 2001-10 and Pub. 538.

Note. All FSCs not using the cash method of accounting should see the uniform capitalization rules of section 263A discussed in the instructions for Schedule G on page 13. See those instructions before completing Schedule A.

If the FSC uses intercompany pricing rules (for purchases from a related supplier), use the transfer price figured in Part II of Schedule P (Form 1120-FSC).

Line 1. Inventory at beginning of year. If the FSC is changing its method of accounting for the current tax year, it must refigure last year's closing inventory using its new method of accounting and enter the result on line 1. If there is a difference between last year's closing inventory and the refigured amount, attach an explanation and take it into account when figuring the FSC's section 481(a) adjustment (explained on page 6).

Line 4. Additional section 263A costs. An entry is required on this line only for FSCs that have elected a simplified method of accounting.

For FSCs that have elected the simplified production method, additional section 263A costs are generally those costs, other than interest, that were not capitalized under the FSC's method of accounting immediately prior to the effective date of section 263A but are now required to be capitalized under section 263A. For details, see Regulations section 1.263A-2(b).

For FSCs that have elected the simplified resale method, additional section 263A costs are generally those costs incurred with respect to the following categories.

• Off-site storage or warehousing.
• Purchasing; handling, such as processing, assembling, repackaging, and transporting.
• General and administrative costs (mixed service costs).

For details, see Regulations section 1.263A-3(d).

Enter on line 4 the balance of section 263A costs paid or incurred during the tax year not includible on lines 2, 3, and 5.

Line 5. Other costs. Enter on line 5 any costs paid or incurred during the tax year not entered on lines 2 through 4.

Line 7. Inventory at end of year. See Regulations section 1.263A-1 through 1.263A-3 for details on figuring the amount of additional section 263A costs to be included in ending inventory.

If the FSC accounts for inventoriable items in the same manner as materials and supplies that are not incidental, enter on line 7 the portion of its raw materials and merchandise purchased for resale that are included on line 6 and were not sold during the year.

Lines 9a through 9f. Inventory valuation methods. Inventories can be valued at:

• Cost;
• Cost or market value (whichever is lower); or
• Any other method approved by the IRS that conforms to the requirements of the applicable regulations cited below.

However, if the FSC is using the cash method of accounting, it is required to use cost.

FSCs that account for inventoriable items in the same manner as materials and supplies that are not incidental may currently deduct expenditures for direct labor and all indirect costs that would otherwise be included in inventory costs.

The average cost (rolling average) method of valuing inventories generally does not conform to the requirements of the regulations. See Rev. Rul. 71-234, 1971-1 C.B. 148.

FSCs that use erroneous valuation methods must change to a method permitted for Federal income tax purposes. To make this change, use Form 3115.

On line 9a, check the method(s) used for valuing inventories. Under lower of cost or market, the term market (for normal goods) means the current bid price prevailing on the inventory valuation date for the particular merchandise in the volume usually purchased by the taxpayer. For a manufacturer, market applies to the basic elements of cost - raw materials, labor, and burden. If section 263A applies to the taxpayer, the basic elements of cost must reflect the current bid price of all direct costs and all indirect costs properly allocable to goods on hand at the inventory date.

Inventory may be valued below cost when the merchandise is unsalable at normal prices or unusable in the normal way because the goods are subnormal due to damage, imperfections, shopwear, etc., within the meaning of Regulations section 1.471-2(c). The goods may be valued at the current bona fide selling price, minus direct cost of disposition (but not less than scrap value) if such a price can be established.

If this is the first year the Last-in, First-out (LIFO) inventory method was either adopted or extended to inventory goods not previously valued under the LIFO method provided in section 472, attach Form 970, Application To Use LIFO Inventory Method, or a statement with the information required by Form 970. Also check the LIFO box on line 9c. On line 9d, enter the amount or the percent of total closing inventories covered under section 472. Estimates are acceptable.

If the FSC changed or extended its inventory method to LIFO and had to write-up the opening inventory to cost in the year of election, report the effect of the writeup as other income (as appropriate on Schedule F, line 16), proportionately over a 3-year period that begins with the year of the LIFO election (section 472(d)).

For more information on inventory valuation methods, see Pub. 538, Accounting Periods and Methods.

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