Foreign Account Filing Rules

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The Internal Revenue Service may know more about those accounts than you think!

Perhaps no area of potential tax abuse is more frustrating to Congress and the Internal Revenue Service (IRS) than the omission of income associated with taxpayer assets held offshore in foreign bank accounts. Pursuing this income (and the taxpayers failing to report it) has long been the bane of the Service. To answer this problem, Congress passed the Foreign Account Tax Compliance Act (FATCA) several years ago. The FATCA seems to be meeting with some success in prompting foreign banks to disclose the holdings of U.S. taxpayers to the IRS.

FATCA was included as part of the Hiring Incentives to Restore Employment (HIRE) Act, enacted on March 18, 2010, and generally requires that foreign financial institutions reveal the assets of U.S. taxpayers to the IRS. Failure to do so may result in the imposition of stiff penalties of up to 30% of their income from U.S. sources. The controversial requirements initially met with resistance from many governments abroad. But the Treasury Department has negotiated a series of intergovernmental agreements with the tax authorities of many other foreign countries’ governments to smooth the way, allowing most of them to act as intermediaries before the information is turned over to the Service. In 2014, the IRS opened a portal to begin accepting the required taxpayer information, which has steadily flowed its way.

These agreements and the cooperation of foreign governments has increased the pressure on U.S. taxpayers with foreign accounts to come forward and report their holdings to the IRS, if they haven’t already participated in any of the Offshore Voluntary Disclosure Programs that the Service has offered over the years.

In a recent article published in Accounting Today, former IRS employee David Gannaway provided an update on the effects that the FATCA legislation has had on foreign account reporting.

“Since the advent of FATCA, the IRS has expanded its crackdown beyond traditional tax havens like Switzerland and the Cayman Islands”, according to Mr. Gannaway, a former IRS assistant special agent.

“As a result of FATCA, the banks in the nontraditional tax haven countries are now cooperating, which is kind of unprecedented before, because of this legislation,” he said. “Even though it’s been on the books for a few years, it’s really just now starting to be implemented.”

Mr. Gannaway noted that banks within those countries that are cooperating with the United States as part of FATCA are going through their accounts to see if depositors have U.S. connections.

He further noted, “Basically what’s happening now is that these banks, to comply with their country’s requirements and internationally with the United States, are going in and kind of scrubbing their own accounts. If they find someone or multiple account owners that have United States connections, the banks are sending letters to the clients in the U.S., saying we’ve identified that you are a U.S. citizen, and this is putting you on notice that under FATCA we are potentially going to turn your name over to the Internal Revenue Service, or you need to submit documentation showing that you’ve reported the income on your income taxes.”

“Ever since 9/11 (September 11, 2001), countries are more linked and cooperating more with each other in law enforcement,” he said. “Then you add in the economic crash in 2007, 2008 and 2009. Countries are looking for tax revenue as well.”

Gannaway believes accountants need to tell any clients with undeclared foreign accounts that now is the time to come forward and try to get into the Service’s Offshore Voluntary Disclosure Program, although he cautioned that the streamlined version of the program only applies to taxpayers who have not willfully hidden their bank accounts from the IRS.

“The main issue is if the bank has already turned over the client’s name to the IRS,” he said.

Currently, the IRS has a number of voluntary disclosure programs.  However, should the Service be made aware that any particular taxpayer has foreign assets holdings, before that taxpayer has requested participation in a voluntary program, it is significantly more tenuous as to whether the taxpayer will be accepted into that program. If the taxpayer is not allowed to participate in the voluntary disclosure program under such circumstances, he or she will then become subject to the very harsh penalty provisions of the Internal Revenue Code imposed under this Act.

The primary rules of FATCA, in general, require that if a taxpayer owns foreign assets of more than $50,000 ($100,000 jointly) at the end of a taxable year, Form 8938, Statement of Specified Foreign Financial Assets  will likely need completed and included with that taxpayer’s Form 1040, U.S. Individual Income Tax return.

A detailed analysis of those FATCA requirements under which taxpayers must report follows. Those topics set out below address:

  • Who must file Form 8938,
  • Reporting thresholds,
  • What must be reported on Form 8938,
  • When and how Form 8938 should be filed,
  • Limited relief from duplicate reporting, and
  • Penalties for failure to file.

Who Must File Form 8938

Individuals

The reporting obligation applies only to individuals who own any interests in SFFAs with an aggregate value that exceeds certain threshold amounts (See “Reporting Thresholds” below). The following individuals (“Specified Individuals”) are subject to the reporting and will be required to file Form 8938:

  • U.S. citizens (including those living abroad),
  • Resident aliens of the U.S.,
  • A nonresident alien that elects to be treated as a resident alien for purposes of filing a joint return, and
  • Residents of Puerto Rico and other possessions.

Specified Domestic Entities (“SDEs”)

The FATCA reporting requirement will also apply to domestic entities (trusts, partnerships, limited liability companies, corporations) which hold SFFAs. Currently, proposed regulations provide that an entity will be required to file Form 8938 if the entity meets all of the following criteria:

  1. Owns an interest in SFFAs with an aggregate value exceeding the reporting thresholds,
  2. Is closely held (80% constructively owned) by a person subject to FATCA reporting or, in the case of a domestic trust, a current beneficiary is a Specified Individual, and
  3. Either 50% or more of its income consists of passive income or over 50% of its assets consist of passive-type assets.

Reporting Thresholds

For individuals residing in the United States, Form 8938 must be filed when the aggregate value of SFFAs exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year ($100,000 and $150,000, respectively, for married taxpayers filing jointly).

For individuals residing outside the United States, relief is provided by increasing the reporting thresholds to $200,000 on the last day of the tax year or $300,000 at any time during the tax year ($400,000 and $600,000 for married individuals filing jointly). Generally, to be eligible for this relief, the individual must qualify for the foreign earned income exclusion.

Jointly Owned Property

Please be aware that there are special rules for reporting jointly owned SFFAs. For determining whether the reporting thresholds have been met, all joint owners generally use the entire value of jointly held SFFAs. However, married individuals who file joint returns only need to include the value of jointly held SFFAs once in determining whether the reporting threshold has been met. When married individuals file separate returns and both are Specified Individuals, then each only includes one-half of the value of the jointly owned SFFA in determining whether the aggregate value of SFFAs exceed the threshold.

What Must Be Reported on Form 8938

SFFAs subject to reporting include:

  1. A financial account maintained by a foreign financial institution,
  2. Any stock or security held for investment that is issued by a foreign person,
  3. Any financial instrument or contract held for investment that has a foreign counterparty, and
  4. An interest in any foreign entity when such interest is held for investment.

The types of reportable assets under FATCA are broader than those covered by the FBAR reporting requirements, which apply only to certain accounts. FATCA reporting extends to direct holdings of stock in foreign entities, interests in foreign funds (including hedge funds and venture capital funds), and certain financial instruments or contracts with foreign counterparties. Accounts potentially subject to reporting include depository accounts, custodial accounts, or interests in financial institutions. Direct ownership of foreign real estate generally is not required to be reported on Form 8938.

An individual owner of an entity disregarded for tax purposes (i.e, a one-member limited liability company, grantor trust, etc.) is treated as owning the SFFA of the disregarded entity; thus, the individual owner of a one-member limited liability company which owns an SFFA would be required to file Form 8938 (assuming that the applicable reporting thresholds are met). Please note, however, that an individual owner of an interest in a domestic entity is not required to report the SFFAs held by that domestic entity (so long as such domestic entity is not a disregarded entity).  As investors diversify their holdings to include physical precious metals, the application of these rules to such assets can be uncertain and may require an analysis of the facts and circumstances. For instance, gold held in a safety deposit box should not be considered an SFFA since safety deposit boxes typically are not financial accounts for FATCA purposes. However, gold held in a custodial account maintained by an FFI would be considered an SFFA.  Gold held in a storage facility should not be considered an SFFA as long as either (i) such facility is not an FFI or (ii) the storage arrangement is not a financial account. The IRS is currently reviewing gold investments and is expected to provide further guidance at some point in the future.

Form 8938 requires information on foreign deposit and custodial accounts, including, among other items, the name and location where the account is maintained, the maximum value of the account during the year, and the account number. Of particular note, Form 8938 also requires the taxpayer to provide a summary of income tax return items attributable to the SFFAs (i.e., interest income, dividends, royalties, gains, deductions, and credits).

When and How to File

An individual taxpayer subject to reporting must file Form 8938 with their Form 1040. Form 8938 must be filed by the due date for the return to which it is attached, including extensions.

Limited Relief from Duplicate Reporting

If a taxpayer already reports an SFFA on one of the forms listed below, then that asset does not need to be reported on Form 8938; however, the individual must still file Form 8938 indicating which forms such assets are reported on as well as the number of such forms filed for the tax year. Assets reported on the following forms are eligible for this limited relief:

  • Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts,
  • Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations,
  • Form 8621, Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund,
  • Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, and,
  • Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.

SFFAs reported on the above forms must be included in the calculation of the aggregate value of reportable assets when determining whether the Form 8938 reporting threshold is met.

Note that for FBAR purposes, both the Form 8938 and the FBAR must be filed even though the same accounts are reported on both forms.  Therefore, duplicate reporting is practically inevitable in the case of these two forms.

Penalties

The most daunting element of the FATCA provisions may be the penalties assessed for noncompliance.

Individuals that fail to furnish the required information in a taxable year could face a penalty of $10,000 for such taxable year. Additionally, if a delinquency continues after 90 days of the individual receiving notice of such delinquency, the individual will incur a $10,000 penalty for each 30-day period after the 90-day period following the notice. This additional penalty is capped at $50,000. Also, accuracy related penalties are doubled to 40% for understatements of tax liabilities associated with unreported foreign financial assets.

Concluding Remarks

There are no good options for circumventing these rules. Continued communications on the topics of FBAR and FATCA are intended to reinforce the importance of complying with these rules as soon as possible. It is our recommendation that if you find you have qualifying interests on which the income has not been reported, that you take steps to remedy the situation as soon as possible. However, the rules for compliance are quite complex and determining what the necessary disclosures are can be an arduous task.

Should you have questions regarding the Form 8938 document or how it may apply to you, whether you are required to file the form and what the specific filing requirements are for your return, please contact Bob Grossman or Mike Weber at 412-338-9300.