11 Dec Foreign Financial Reporting IRC 6038D
In 2010, the Hiring Incentives to Restore Employment (HIRE) Act addedCode Sec. 6038Drequiring individual taxpayers with an interest in a specified foreign financial asset during the tax year to attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than a threshold amount. This law gives the IRS authority to apply these new rules to any domestic entity that is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if the entity were an individual. The 2011 individual tax returns were the first ones affected by the new law.
Although the nature of the information required under Code Sec. 6038D is similar to the information disclosed on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), it is not identical. For example, a beneficiary of a foreign trust who is not within the scope of FBAR reporting requirements because his interest in the trust is less than 50 percent may nonetheless be required to disclose the interest in the trust with his tax return under Code Sec. 6038D if the value of his interest in the trust together with the value of other specified foreign financial assets exceeds the aggregate value threshold.
Disclosures under Code Sec. 6038D are made on Form 8938, Statement of Specified Foreign Financial Assets. Failure to make the required disclosures can result in a penalty of $10,000 for the tax year. An additional penalty may apply if the individual is notified by mail of the failure to disclose and the failure to disclose continues. A maximum penalty of $50,000 can be assessed for one tax period.
Specified Foreign Financial Assets
Under Code Sec. 6038D(b), a specified foreign financial asset is any financial account maintained by a foreign financial institution and the following assets, to the extent not held in an account at a financial institution:
(1) stocks or securities issued by foreign persons;
(2) any other financial instrument or contract held for investment that is issued by or has a counter party that is not a U.S. person; and
(3) any interest in a foreign entity.
Specified Persons Required to File Form 8938
In Reg. Sec. 1.6038D-2T and Prop. Reg. Sec. 1.6038D-6, the IRS provides rules for determining if a specified individual or a specified domestic entity (i.e., a specified person) must file aForm 8938with the specified person’s annual return.
A specified individual is a U.S. citizen, a U.S. resident alien, or a nonresident alien who has elected under Code Sec. 6013(g) or (h) to be taxed as a U.S. resident. A resident alien who elects to be taxed as a resident of a foreign country pursuant to a U.S. income tax treaty’s residency tie-breaker rules is a specified individual for purposes of Code Sec. 6038D and the regulations. In addition, certain nonresident aliens who are treated as residents under other sections of the Code are specified individuals. For example, the rules under Code Sec. 6038D apply to a nonresident alien who is a bona fide resident of Puerto Rico or American Samoa in the same manner as they apply to a U.S. citizen or resident. Bona fide residents of Puerto Rico or a Code Sec. 931 possession (currently, American Samoa) generally are required to file a federal income tax return with the IRS only if they have income from sources without the relevant U.S. territory, because Code Sec. 931(a) and Code Sec. 933 generally exclude from gross income any income derived from sources within the relevant U.S. territory. Thus, the temporary regulations generally require only bona fide residents of Puerto Rico or a Section 931 possession that are required to file a federal income tax return with the IRS to file a Form 8938 with the IRS.
A specified person is not required to file Form 8938 if the specified person is not required to file an annual return with the IRS. With respect to bona fide residents of U.S. territories, this rule means that a bona fide resident of a U.S. territory has a filing requirement under Code Sec. 6038D and the temporary regulations only if he or she is required to file a federal income tax return for the tax year. In general, bona fide residents of the U.S. Virgin Islands and U.S. territories to which Code Sec. 935 applies (currently, Guam and the Northern Mariana Islands) are not required to file a federal income tax return provided they correctly report and pay tax on their worldwide income to their U.S. territory taxing authority.
A specified person’s annual return includes an annual federal income tax return of a specified individual or an annual federal income tax return or information return of a specified domestic entity filed with the IRS under Code Secs. 876, 6011, 6012, 6013, 6031, or 6037, and the regulations. For example, a partnership that is a specified domestic entity is required to attach Form 8938 to its Form 1065, U.S. Return of Partnership Income, for the tax year.
Filing Thresholds
A specified person must file Form 8938 if the person has an interest in one or more specified foreign financial assets and those assets have an aggregate fair market value exceeding either $50,000 on the last day of the tax year or $75,000 at any time during the tax year. Married specified individuals filing a joint annual return are not required to file Form 8938 unless the aggregate value of all of the specified foreign financial assets in which either spouse has an interest exceeds $100,000 on the last day of the tax year or $150,000 at any time during the tax year.
Generally, a specified individual who is a qualified individual under Code Sec. 911(d)(1) (i.e., living abroad) for the tax year is required to attach a Form 8938 to the specified individual’s annual return and report the required information if the aggregate value of the specified foreign financial assets in which the specified individual has an interest exceeds $200,000 on the last day of the tax year or $300,000 at any time during the tax year. For married individuals meeting the same requirements, the threshold amounts are $400,000 on the last day of the tax year or $600,000 at any time during the tax year.
Interest in a Specified Foreign Financial Asset
For Code Sec. 6038D purposes, a specified person is generally considered to have an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross proceeds, or distributions attributable to the holding or disposition of the asset are or would be required to be reported, included, or otherwise reflected on the specified person’s annual return filed with the IRS (even if no income, gains, losses, deductions, credits, gross proceeds, or distributions are attributable to the asset for a particular tax year).
For purposes of Code Sec. 6038D and the regulations, a parent that makes an election under Code Sec. 1(g)(7) to include certain unearned income of a child in the parent’s gross income has an interest in any specified foreign financial asset held by the child.
A specified person that is the owner of an entity disregarded as an entity separate from its owner (disregarded entity) is treated as having an interest in any specified foreign financial assets held by the disregarded entity. Generally, a specified person that is treated as the owner of a trust or any portion of a trust under Code Sec. 671 through 679 is treated as having an interest in any specified foreign financial assets held by the trust or by the portion of the trust that the specified person owns. However, a specified person that is treated as an owner of a domestic liquidating trust created pursuant to a court order issued in a bankruptcy under Chapter 7 or a confirmed plan under Chapter 11 of the Bankruptcy Code, a domestic widely held fixed investment trust, or any portion of such a trust under Code Sec. 671 through 679 is not required to file Form 8938 to report any specified foreign financial asset held by the trust.
A specified person is not treated as having an interest in any specified foreign financial assets held by a partnership, corporation, trust (except as described in this explanation), or estate solely as a result of the specified person’s status as a partner, shareholder, or beneficiary.
Joint Interests in Specified Foreign Financial Assets
A joint interest in a specified foreign financial asset is subject to reporting by each specified person that is a joint owner of the asset. In general, each joint owner includes the full value of the jointly owned asset for purposes of determining whether the aggregate value of all specified foreign financial assets in which the joint owner has an interest exceeds the reporting thresholds.
Married specified individuals who file a joint annual return for the tax year must fulfill their reporting requirements by filing a single Form 8938 that reports all of the specified foreign financial assets in which either married specified individual has an interest. A specified foreign financial asset that is jointly owned by married specified individuals or a specified foreign financial asset held by a child for which the married specified individuals have made an election under Code Sec. 1(g)(7) is reported once on the single Form 8938. Married specified individuals who file a joint annual return include the value of a specified foreign financial asset that they jointly own together or a specified foreign financial asset held by a child for which they have made an election under Code Sec. 1(g)(7) only once in determining whether the aggregate value of all the specified foreign financial assets in which either married specified individual has an interest exceeds the appropriate reporting threshold.
A married specified individual who files a separate annual return for the tax year must fulfill the reporting requirements by filing a separate Form 8938 that reports all the specified foreign financial assets in which the married specified individual has an interest, including assets jointly owned with the married specified individual’s spouse. A married specified individual that files a separate annual return and whose spouse is a specified person includes only one-half of the value of a specified foreign financial asset that the married specified individual jointly owns with his or her spouse in determining whether the married specified individual has an interest in specified foreign financial assets the aggregate value of which exceeds the appropriate reporting threshold.
Specified Domestic Entities
The proposed regulations would apply to domestic entities formed or availed of for the purposes of holding, directly or indirectly, specified foreign financial assets. Such entities are referred to as specified domestic entities and include certain closely held corporations and partnerships that meet passive income or passive income tests. With exceptions, domestic trusts are included if they have a specified individual(s) as a current beneficiary and exceed the reporting threshold.
Under Prop. Reg. Sec. 1.6038D-6, specified domestic entities include certain domestic corporations, domestic partnerships and domestic trusts, but not domestic estates.
For a domestic corporation or partnership to be considered a specified domestic entity, three conditions must apply:
(1) The corporation/partnership must have an interest in specified foreign financial assets with an aggregate value exceeding the $50,000/$75,000 reporting threshold.
(2) The corporation/partnership must be closely held (80 percent by vote or value at end of the tax year) by a specified individual taking into account indirect and constructive ownership rules.
(3) The corporation/partnership must either meet an at least 50 percent passive income/assets test, or meet a 10 percent passive income/assets test and based on the facts and circumstances been formed or availed of with a principal purpose of avoiding reporting under Code Sec. 6038D.
Two different aggregation rules apply to determine whether a domestic corporation or domestic partnership is a specified domestic entity:
(1) In determining whether a domestic corporation or domestic partnership meets the reporting thresholds, domestic corporations and domestic partnerships that are closely held by the same specified individual are treated as a single entity.
(2) For purposes of determining whether a corporation or partnership meets the passive income/asset tests, domestic corporations and domestic partnerships that are closely held by the same individual and that are connected through stock or partnership interest ownership with a common parent corporation or partnership are treated as a single entity.
A domestic trust is considered a specified domestic entity if it has an interest in specified foreign financial assets (other than assets excepted from reporting) with an aggregate value exceeding the $50,000/$75,000 reporting threshold and at least one specified person as a current beneficiary.
A domestic entity is not considered to be a specified domestic entity if it is described in Code Sec. 1473(3) and the related regulations as excepted from the definition of the term specified United States person. This exception does not apply to any trust that is exempt from tax under Code Sec. 664(c).
A domestic trust is not considered a specified domestic entity if the trustee or executor is a bank, financial institution, or domestic corporation that is subject to certain examination, oversight, or registration requirements, has supervisory authority over or fiduciary obligations with regard to the trust’s specified foreign financial assets, and files income tax returns and information returns on behalf of the trust.
A domestic trust or any portion of the trust that is treated as owned by one or more specified persons under Code Secs. 671 through 679 and the regulations issued under those sections is not considered to be a specified domestic entity.
Information Required to be Disclosed
Under Code Sec. 6038D(c), the information required to be disclosed depends on the type of asset involved. For a financial account, the name and address of the financial institution in which the account is maintained must be reported, as well as the account number. For any stock or security, the name and address of the non-U.S. issuer, as well as information necessary to identify the class or issue of which the stock or security is a part, must be reported. In the case of any other instrument, contract, or interest, the names and addresses of all issuers and counter parties must be reported, together with the information necessary to identify the instrument, contract, or interest. The maximum value of each specified foreign financial asset during the tax year also must be reported.
Penalty for Failing to Disclose
Individuals who fail to make the required disclosures are subject to a penalty of $10,000 for the tax year. An additional penalty may apply if the Secretary notifies an individual by mail of the failure to disclose and the failure to disclose continues. If the failure continues beyond 90 days following the mailing, the penalty increases by $10,000 for each 30-day period (or a fraction thereof), up to a maximum penalty of $50,000 for one tax period. The computation of the penalty is similar to that applicable to failures to file reports with respect to certain foreign corporations under Code Sec. 6038. Thus, an individual who is notified of his failure to disclose with respect to a single tax year under this provision and who takes remedial action on the 95th day after the notice is mailed incurs a penalty of $20,000 comprising the base amount of $10,000, plus $10,000 for the fraction (i.e., the five days) of a 30-day period following the lapse of 90 days after the notice of noncompliance was mailed. An individual who postpones remedial action until the 181st day is subject to the maximum penalty of $50,000: the base amount of $10,000, plus $30,000 for the three 30-day periods, plus $10,000 for the one fraction (i.e., the single day) of a 30-day period following the lapse of 90 days after the notice of noncompliance was mailed.
No penalty is imposed under the provision against an individual who can establish that the failure was due to reasonable cause and not willful neglect. Foreign law prohibitions against disclosure of the required information cannot be relied on to establish reasonable cause. To the extent the IRS determines that the individual has an interest in one or more foreign financial assets but the individual does not provide enough information to enable the IRS to determine the aggregate value thereof, the aggregate value of such identified foreign financial assets will be presumed to have exceeded $50,000 for purposes of assessing the penalty.