Foreign Income & Taxpayers
Effective for tax years starting after March 18, 2010, new Sec. 6038D, added by the Foreign Account Tax Compliance Act (FATCA) provisions of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147, requires individual taxpayers to report any interest in “specified foreign financial assets” if the value of these assets in aggregate exceeds an applicable threshold amount. The amount of the threshold varies depending on the taxpayer’s filing status and where the taxpayer lives. This reporting is required even if the assets do not generate gains or other investment income during the reporting period. In Notice 2011-55, the IRS suspended the reporting requirement until Form 8938, Statement of Specified Foreign Financial Assets, is finalized with appropriate instructions.
This form will not replace Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), but is in addition to it. Form 8938 will be attached to the annual tax return, which, according to the draft instructions, includes Forms 1040, U.S. Individual Income Tax Return; 1120, U.S. Corporate Income Tax Return; 1065, U.S. Return of Partnership Income; 1041, U.S. Income Tax Return for Estates and Trusts; 1120-F, U.S. Income Tax Return of a Foreign Corporation; 1120S, U.S. Income Tax Return for an S Corporation; and 1040NR, U.S. Nonresident Alien Income Tax Return.
The IRS released a draft of Form 8938 on June 21, 2011, and its instructions in draft form on September 28, 2011. As of this writing, neither has been released in final form, but the IRS is expected to do so in time for the 2012 filing season for 2011 individual tax filings.
Preparers are advised to become familiar with the filing requirements and to educate their clients on information required to prepare Form 8938. Some taxpayers will be relieved of filing responsibilities if they already file Forms 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts; Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner; Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations; Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund; Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships; or Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans. Therefore, preparers need to review when these other forms are required.
The presumption under Sec. 6038D(e) is that, unless the taxpayer provides sufficient evidence of the value of a specified financial asset, the value exceeds the threshold. Worse still, until Form 8938 is filed, the statute of limitation “may remain open for all or a portion of your income tax return” (p. 6, draft instructions), so the normal three-year statute does not start until the form is filed, even if the Form 1040 was filed timely. This can result in substantial continuing tax exposure. In addition, omissions of gross income exceeding $5,000 attributable to foreign financial assets reportable under Sec. 6038D can extend the statute of limitation to six years.
In phone conversations with the author, the IRS Office of Chief Counsel stated that filing only when required will improve efficiency in administration. However, in view of preparer liabilities, some preparers will elect to file unless they can clearly show the asset value to be less than the threshold because the presumption will be that the asset is valued at more than $50,000 unless the taxpayer proves otherwise. Penalties for failure to file the form or furnish the information it requires are significant: $10,000 for each tax year, plus, if the failure continues more than 90 days after IRS notification, an additional $10,000 for each ensuing 30-day period, up to a total penalty of $50,000 (Sec. 6038D(d)). There is a reasonable cause exception, but be aware that civil or even criminal penalties from foreign laws that prohibit disclosure will not be accepted as reasonable cause, according to the Form 8938 draft instructions.
Specified Foreign Financial Assets
Specified foreign financial assets include deposits in foreign financial accounts, stocks held in foreign firms not held by a U.S. securities or banking firm, and other foreign financial assets such as trusts, including grantor trusts. The latter category may create the most uncertainty because many assets such as real estate may be held in trust. In some cases they will require reporting, but there are substantial exceptions because of the formulas for valuing trust assets.
Taxpayers That Must Report
The form must be filed by “a specified person that owns specified foreign financial assets” with a value in excess of the applicable threshold (p. 1, draft instructions). This includes any U.S. citizen, resident alien, nonresident alien who elects to be treated as a resident alien for a joint tax return, or any nonresident alien who is a resident of American Samoa or Puerto Rico. In other words, just about everyone who files a U.S. tax return is included.
Editor's note: The reporting thresholds were changed in the final version of Form 8938. See "Foreign Financial Asset Reporting Form Finalized."
The reporting threshold is met for single taxpayers (or married taxpayers filing separately) living in the United States if their total specified foreign assets at year end exceed $50,000 or exceed $100,000 at any time during the year. For taxpayers living abroad, the corresponding amounts are $100,000 and $200,000.
Married taxpayers filing a joint return and living in the United States must file if the value of their foreign financial assets is more than $100,000 at the end of the tax year or more than $200,000 at any time during the year. The corresponding amounts for taxpayers who are living abroad are $400,000 and $600,000. The IRS provides examples in the draft instructions (beginning on p. 2) of when married taxpayers filing separate returns must submit a Form 8938.
The IRS cautions that the value of any assets with a negative value must be recorded as zero. For example, if Asset 1 has a value of $50,000, Asset 2 has a value of $10,000, and Asset 3 has a negative value of ($20,000), a preparer should assign a $0 value to Asset 3, resulting in $60,000 total qualifying assets. Conversion to U.S. dollars, if required, is generally done as of the year-end conversion rate as shown in Treasury’s Financial Management Service foreign currency exchange tables.
Assets held in a foreign trust create some interesting reporting questions. For instance, real estate frequently is held in trust in some countries for liability reasons or because of requirements in the host country. The draft instructions state that trusts are a specified foreign financial asset but:
If you are a beneficiary of a foreign trust, the maximum value of your interest in the trust is the sum of the following amounts.
- If you receive distributions at the discretion of the trustee, the value of all of the cash or other property distributed during the tax year from the trust to you as beneficiary, and
- If you receive mandatory distributions, the value using the valuation tables under section 7520. [Form 8938 draft instructions, p. 5]
It appears that in some cases the maximum value under the Form 8938 reporting requirement for beneficiaries of trusts holding only real estate may exclude the trust real estate asset from reporting even if the underlying asset may be worth far more than the various thresholds, if there is little or no distribution.
For example, if a client owns a building worth $3 million that is rented out when not used, if the property is held in a trust of which the client is a beneficiary and the trust does not make any distributions during the year, reporting on Form 8938 does not appear to be required, especially if the taxpayer has filed Form 3520. However, a reader of the draft instructions could conclude that foreign trusts that hold real estate may cause a reporting requirement, and the IRS has not issued guidance on whether there is a reporting requirement in this situation. Readers are encouraged to monitor the guidance on when trusts holding real estate must report. The IRS may make changes to the draft instructions before they become final, so taxpayers should be sure to check the final instructions when they are issued.
Valrie Chambers is a professor of accounting at Texas A&M University–Corpus Christi in Corpus Christi, TX. Joseph Brophy is with Joseph D. Brophy, CPA, P.C., in Dallas, TX. Prof. Chambers is a member and Mr. Brophy is a past member of the AICPA Tax Division’s IRS Practice and Procedures Committee. For more information about this column, contact Prof. Chambers at firstname.lastname@example.org.