DAVIS: A refresher on foreign asset reporting requirements

Recently, the Internal Revenue Service announced the exchange of financial account information with certain foreign tax administrations as the next step in efforts to combat offshore tax evasion.

This is a significant portion of the IRS’s efforts to enforce FATCA, the Foreign Account Tax Compliance Act, which was enacted in 2010. One of the provisions of FATCA, Code Sec. 6038D, requires reporting to the IRS about foreign financial assets. This reporting is satisfied, in part, by filing Form 8938 (Statement of Specified Foreign Financial Assets).

Taxpayers have a variety of guidance and information to evaluate in order to correctly and accurately prepare Form 8938. Final Regulations in December 2014 provided additional guidance from the IRS, but some issues remain unclear.

As you gather your tax documentation each year, you should consider any potential reporting required on your tax return under FATCA, as Form 8938 is an annual filing requirement to be attached to your individual income tax return (Form 1040 or Form 1040NR).

Keep in mind the Form 8938 is informational only, and all foreign income is still required to be reported on Form 1040 or 1040NR.

Sec. 6038D explains the filing requirement as:

Any individual who, during any taxable year, holds any interest in a specified foreign financial asset shall attach to such person’s return of tax imposed by subtitle A for such taxable year the information described in subsection (c) with respect to each such asset if the aggregate value of all such assets exceeds $50,000 (or such higher dollar amount as the Secretary may prescribe).

By understanding the definitions of a few key terms of this complex description we can determine any filing requirement each year based on your individual circumstances.

Who must file?

A specified individual (SI) is:

• A U.S. citizen or a U.S. resident for any portion of the year;

• A nonresident who elects to be treated as a U.S. resident for the year;

• A nonresident alien who is a bona fide resident of Puerto Rico or American Samoa.

Filing thresholds:

• Unmarried SI living in the U.S. — SFFAs at the end of the year must exceed $50,000 or $75,000 at any time during the year;

• Unmarried SI living outside the U.S. (qualifies under Sec. 911 tests of bona fide residence or physical presence) — SFFAs at the end of the year must exceed $200,000 or $300,000 at any time during the year;

• Married (filing separate) SI living in the U.S. — SFFAs at the end of the year must exceed $50,000 or $75,000 at any time during the year;

• Married (filing separate) SI living outside the U.S. — SFFAs at the end of the year must exceed $200,000 or $300,000 at any time during the year;

• Married (filing joint) SI living in the U.S. — SFFAs at the end of the year must exceed $100,000 or $150,000 at any time during the year;

• Married (filing joint) SI living outside the U.S. — SFFAs at the end of the year must exceed $400,000 or $600,000 at any time during the year.

What is reportable?

Specified Foreign Financial Asset (SFFA):

• Foreign financial accounts held at a foreign financial institution;

• Other foreign financial assets, held for investment purposes;

• Examples: depository accounts, custodial accounts, cash-value life insurance contracts, tax-favored foreign retirement, pension and nonretirement savings accounts, stock issued by a non-U.S. person, any interest in a foreign entity, including foreign partnerships;

• Excepted: certain term life insurance contracts, accounts held by an estate, certain escrow accounts, accounts held with U.S. payors (i.e., U.S. mutual funds, 401(k) plans, IRA’s), foreign Social Security and Social Insurance, foreign real estate.

How are values calculated?

Aggregate value:

• In general, fair market value is determined from a reasonable estimate.

• Use periodic account statements, received at least annually.

• If beneficiary of a foreign trust, valuation is based on FMV of all distributions received during the year plus the FMV of the SI’s right to receive mandatory distributions from the trust.

• If foreign estates, pension plans or deferred compensation plans, use the FMV at the end of the year, or, if not available, use the FMV of the amounts distributed to the participant for the year.

What other filings are required?

The IRS relieves taxpayers from providing duplicated information regarding certain SFFAs that have been reported elsewhere on other forms included in the tax return. However, this does not include the FBAR, or FinCEN Form 114, Report of Foreign Bank and Financial Accounts.

The requirements, definitions and thresholds for filing the FBAR differ significantly from Form 8938, and, if required, information must be reported on both forms. The IRS has published a comparison chart that is useful in determining the difference between Form 8938 and FBAR reporting. It can be found at IRS.gov.

Consequences for not filing?

• Failure to file a timely Form 8938 can result in a $10,000 initial penalty.

• Failure to report taxable income related to SFFA may result in a 20 percent penalty on the underpayment of tax.

• Violations can lead to criminal penalties.

• Failure to file Form 8938 (or filing of an incomplete Form 8938) allows the IRS to leave the assessment period open indefinitely with regard to the entire tax return (instead of the normal 3 year statute of limitation to examine a return).

As you can see, the reporting regarding foreign income and assets is complex and detailed and can present challenges for filing your income tax returns each year. As the IRS is receiving more tax reporting information from around the world, it is important to assess your individual situation and the effect these rules have on your tax situation.