IRS releases new form to report specified foreign financial assets - International Law Office

Background
Individuals to file Form 8938 for tax year 2011
Specified foreign financial assets
Valuation of specified foreign financial assets
Reportable interest in a specified foreign financial asset
Reporting of foreign trusts
Duplicate reporting
Penalties
Comment


The Internal Revenue Service (IRS) has released Form 8938 – Statement of Specified Foreign Financial Assets.(1) Certain US taxpayers must now use the form to report information about specified foreign financial assets for the 2011 tax year. On the finalisation of proposed regulations, specified domestic entities will be required to file Form 8938; however, currently, only individual taxpayers need to file. Advisers to international families should bring this filing requirement to the attention of US beneficiaries of foreign trusts, as certain interests in foreign trusts are considered specified foreign financial assets.

Background

The Foreign Account Tax Compliance Act provisions of the Hiring Incentives to Restore Employment Act 2010(2) added a new section to the Internal Revenue Code requiring individuals to report interests in specified foreign financial assets when filing their federal income tax returns. This new filing requirement applied to tax years beginning after March 18 2010; however, IRS Notice 2011-55 suspended the filing requirement until the final version of Form 8938 was released. In December 2011 the IRS released regulations detailing the requirements for reporting specified foreign financial assets and Form 8938 in its final form. The new code section also applies to any domestic entity formed or used for the purpose of holding specified foreign financial assets, but there is no reporting requirement until the IRS issues regulations governing such domestic entities.

Individuals to file Form 8938 for tax year 2011

With the release of Form 8938, the following individual taxpayers are required to report specified foreign financial assets with an aggregate value exceeding certain thresholds by filing the form with their 2011 income tax return, due on April 15 2012, unless the individual requests an extension:

• US citizens;
• non-citizens who are income tax residents of the United States for any part of the tax year (for further details please see "Overview (August 2011)");
• non-resident aliens who make an election to be treated as a resident alien for purposes of filing a joint income tax return; and
• non-resident aliens who are bona fide residents of American Samoa or Puerto Rico.

Various reporting thresholds apply based on marital status and whether the individual is living in the United States or abroad. For example, an unmarried individual who is living in the United States must file Form 8938 if the aggregate value of his or her specified foreign financial assets exceeded $50,000 on the last day of the year or $75,000 at any time during the year.

Individuals who are not required to file an income tax return for a particular tax year are not required to file Form 8938, even if the value of their specified foreign financial assets is more than the appropriate reporting threshold.

Specified foreign financial assets

There are two broad categories of specified foreign financial assets:

• financial accounts maintained by a foreign financial institution; and
• other assets that qualify as foreign financial assets.

Accounts with foreign financial institutions
The first category includes depository and custodial accounts, as well as any equity or debt interest in the institution (other than the institution's publicly traded stock). 'Foreign financial institutions' include foreign hedge funds, foreign private equity funds, foreign mutual funds and financial institutions organised under the laws of US possessions (American Samoa, Guam, Northern Mariana Islands, Puerto Rico and the US Virgin Islands). This category does not include accounts held by a US payer, such as a US branch of a foreign bank, a foreign branch of a US financial institution or a controlled foreign corporation.

Other foreign financial assets
The second category includes the following assets, if they are held for investment and are not held in a US or foreign financial account:

• stocks/securities issued by a non-US person;
• financial instrument or contract with a non-US issuer or counterparty; and
• any interest in a foreign entity.

Some examples of other assets not held in a foreign financial account that are considered specified foreign financial assets are:

• stock of a foreign corporation;
• swap agreements, options or other derivative instruments with a foreign issuer or counterparty;
• debt instruments issued by a foreign person (eg, bond, note);
• capital/profits interest in a foreign partnership;
• beneficial interest in a foreign pension plan or foreign deferred compensation plan; and
• interests in a foreign trust or foreign estate.

Although not specifically stated in the regulations, it appears that foreign real estate owned directly by the taxpayer is not a specified foreign financial asset for purposes of Form 8938 reporting. An interest in a social security or similar programme of a foreign government is specifically excluded from reporting.

Valuation of specified foreign financial assets

An individual taxpayer will be required to file Form 8938 if the total value of all specified foreign financial assets in which the taxpayer has an interest exceeds the applicable threshold. Fair market value is to be used in determining the total value of such assets. The full value of any jointly held assets is attributed to each owner (with some exceptions), both for determining whether the owner has reached the reporting threshold and for reporting the asset (if necessary) on Form 8938. Once the threshold is exceeded, even specified foreign financial assets with a zero or negative value must be reported. The instructions to Form 8938 contain details on converting foreign currency to US dollars.

Form 8938 asks for detailed identifying information on each specified foreign financial asset being reported and its maximum value during the tax year. A taxpayer may rely on periodic account statements in determining maximum value, provided that there is no reason to believe that the statements do not reflect a reasonable estimate of that value. For assets not held in an account, the maximum value may be considered to be its value on the last day of the taxable year, unless the taxpayer has reason to know that this value is not a reasonable estimate. The instructions to Form 8938 explicitly state that an appraisal by a third party is not necessary in determining maximum value.

Reportable interest in a specified foreign financial asset

Generally, if any tax items (eg, income, gains, losses, deductions) generated by a specified foreign financial asset would be attributable directly to the individual taxpayer, then the taxpayer is considered to have a reportable interest in the specified foreign financial asset, even if the asset generated no such items during the tax year. For example, a taxpayer has a reportable interest in foreign financial assets that are held by:

• the taxpayer directly, whether individually or jointly;
• a child of the taxpayer, if the taxpayer parent makes a so-called 'kiddie tax' election; or
• a disregarded entity which the taxpayer owns.

Reporting of foreign trusts

Advisers to international families must be aware that "any interest in a foreign entity" also includes an ownership interest in a foreign trust as grantor under the US grantor trust rules (for further details please see "Taxation of offshore trusts and impact of new lower tax rates") and an interest in a foreign trust as a beneficiary.

An individual taxpayer has a reportable interest in a grantor trust (whether US or foreign) of which he or she is considered the owner under the grantor trust rules, with the exception of grantor trusts which are US widely held investment trusts or certain US liquidating trusts. A taxpayer also has a reportable interest in a foreign trust or foreign estate of which the taxpayer is a beneficiary, provided that the taxpayer knows - or has reason to know - of the interest based on readily accessible information. An individual taxpayer who receives a distribution from the trust or estate has knowledge of the interest.

The value of a beneficiary's interest in a foreign trust is the sum of:

• the value of all trust property distributed to the taxpayer beneficiary during the tax year; and
• the value using specified IRS valuation tables of the taxpayer beneficiary's right (if any) to receive mandatory trust distributions.

The taxpayer beneficiary reports only his or her interest in the trust on Form 8938 and need not report any specified foreign financial assets held by the trust itself. On the other hand, a taxpayer who is treated as the owner of any portion of a foreign grantor trust under the grantor trust rules may be required to file Form 8938 to report specified foreign financial assets held by the trust, unless the taxpayer grantor reports the trust for the tax year on Form 3520 (Transactions with Foreign Trusts) and the trust files Form 3520-A (Annual Information Return of Foreign Trust with a US Owner).

Duplicate reporting

Where the individual is already reporting a specified foreign financial asset on another form in the same tax year, he or she must still file Form 8938, but rather than completing the entire form, he or she need simply indicate on Form 8938 which of the following other forms are being filed:

• 3520 – regarding transactions with foreign trust and receipt of certain foreign gifts;(3)
• 5471 – regarding certain foreign corporations;
• 8621 – regarding passive foreign investment companies/qualified electing funds;
• 8865 – regarding foreign partnerships; or
• 8891 – regarding certain Canadian retirement plans.

The new requirement to file Form 8938 does not replace or otherwise affect a taxpayer's obligation to file Form TD F 90-22.1 – Report of Foreign Bank and Financial Accounts (FBAR). A US person is required to file the FBAR with the US Treasury Department (not with his or her income tax return) if he or she has a financial interest in or signature authority over at least one financial account located outside the United States, and the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year (for more details please see "New guidance and forms to report foreign accounts and use of trust property"). Many individuals will be required to file both Form 8938 and the FBAR to report substantially the same information.

Penalties

Failure to file Form 8938 results in an initial penalty of $10,000. There is also potentially an additional $10,000 monthly penalty (up to a maximum $50,000) levied for continued failure to file after receiving a notice from the IRS, for a maximum total penalty of $60,000. A reasonable cause exception may mitigate such penalties. The statute of limitations for an IRS inquiry may remain open for all or part of a taxpayer's income tax return until three years after the filing of a Form 8938 that discloses all reportable specified foreign financial assets.

Comment

US beneficiaries of foreign trusts may now be required to report interests in foreign trusts that were never required to be reported before enactment of the FATCA rules. Knowledge of the trust and that the individual is a beneficiary is enough to raise the reporting issue, although questions remain as to the reporting requirements for beneficiaries other than current beneficiaries (eg, contingent beneficiaries or revocably excluded beneficiaries).

For further information on this topic please contact Jennie Cherry at Kozusko Harris Duncan's New York office by telephone (+1 212 980 0010 ), fax (+1 212 751 0084) or email (jcherry@kozlaw.com). Alternatively, contact Richard Fava at Kozusko Harris Duncan's Connecticut office by telephone (+1 203 562 0426), fax (1 203 907 1945) or email (rfava@kozlaw.com).

Endnotes

(1) All tax forms and the full text of any notice referred to can be found at www.irs.gov.

(2) Known in the United States as the HIRE Act.

(3) If the taxpayer is the owner of a foreign trust under the grantor trust rules, the trust must also timely file Form 3520 A to qualify for the lesser reporting on Form 8938.

Copyright in the original article resides with the named contributor.