Americans now required to disclose all foreign financial assets
Background
A little known new law was enacted for the year 2011 that requires, that once certain minimum amounts are exceeded, any specified person that holds any interest in a specified foreign financial asset during the taxable year to attach a statement to that person’s U.S. tax return and report information that identifies the value of those specified foreign financial assets in which the individual holds an interest. Form 8938. 1/
Specified foreign financial assets include financial accounts maintained by foreign financial institutions, as well as certain other financial assets or instruments. An asset or instrument may be a specified foreign financial asset even if the asset or instrument does not have a positive value.
A specified foreign financial asset is (i) any financial account maintained by a foreign financial institution; (ii) any stock or security issued by any person other than a United States person; (iii) any financial instrument or contract held for investment that has an issuer or counterparty that is not a United States person; and (iv) any interest in a foreign entity.
A specified person is defined as a specified individual who is a U.S. citizen, a resident alien or a nonresident who elects to be taxed as a U.S. resident filing Form 1040; and U.S. entities required to file an annual tax returns such as a 1041 (Trust and Estate), 1120 (U.S. Corporation), 1120-S and 1065 (Partnership).
A specified person that is the owner of an entity disregarded as an entity separate from its owner is treated as having an interest in any specified foreign financial assets held by the disregarded entity. In addition, a specified person that is treated as the owner of a trust or estate or any portion of a trust under certain sections of the Internal Revenue Code is treated as if that person holds an interest in any specified foreign financial assets held by the trust or estate or by the portion of the trust or estate that the specified person owns.
Interest in a Specified Foreign Financial Asset
A specified person has 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 specified foreign financial asset are or would be required to be reported, included, or otherwise reflected by the specified person on an annual return. A specified person has an interest in a specified foreign financial asset even if no income, gains, losses, deductions, credits, gross proceeds, or distributions are attributable to the holding or disposition of the specified foreign financial asset for the taxable year.
A beneficial interest in a foreign trust or a foreign estate is not a specified foreign financial asset of a specified person unless the specified person knows or has reason to know of the interest based on readily accessible information of the interest. Receipt of a distribution from the foreign trust or foreign estate is deemed for this purpose to be actual knowledge of the interest.
The Minimum Reporting Requirements.
Unmarried Taxpayer Living in the United States.
Unmarried individuals living in the U.S. have a reporting threshold only if the total value of their specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
Married Taxpayers Filing a Joint Income Tax Return and Living in the United States.
Married persons filing a joint income tax return that do not live abroad, satisfy the reporting threshold only if the total value of their joint specified foreign financial assets are more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.
Married Taxpayers Filing Separate Income Tax Returns and living in the United States.
Married persons filing a separate income tax return from their spouse, living in the U.S. satisfy the reporting threshold only if the total value of each person’s specified foreign financial assets are more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
Taxpayers Living Abroad.
Taxpayers whose tax home is in a foreign country that meets a presence test in that foreign country, satisfy the reporting threshold if they are not filing a joint return if the total value of their specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.
Married and file a joint income tax return satisfy the reporting threshold only if the total value of all specified foreign financial asset the couple owns is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year.
Penalties
There are penalties for the failure to disclose the information required to be reported. If the failure to comply continues for more than 90 days after the day on which the failure is reported to the individual, the individual must pay an additional penalty of $10,000 for each 30-day period (or fraction thereof) during which the failure to disclose continues after the expiration of the 90-day period, to a maximum of $50,000.
However, no penalty will be imposed for any failure to report that is shown to be due to reasonable cause and not due to willful neglect. But one cannot excuse the failure to disclose assets just because disclosing the information required could lead to violations of foreign laws. There also can be criminal penalties for the failure to file the report.
Helpful Definitions
Financial Account maintained by a Foreign Financial Institution
A financial account is defined as respect to any financial institutions –
Any depository account maintained by such financial institution;
Any custodial account maintained by such financial institution; and
Any equity or debt interest in such financial institutions (other than interests which are regularly traded on an established securities market).
Any equity or debt interest which constitutes a financial account with respect to any financial institution shall be treated for purposes of this section as maintained by such financial institution.
A Foreign Financial Institution
A foreign financial institution is a financial institution that is a foreign entity that:
Accepts deposits in the ordinary course of a banking or similar business;
Holds financial assets for the account of others as a substantial portion of its business; or
Is engaged, or holds itself out as being engaged, primarily in the business of investing, reinvesting, or trading in securities, or any other financial interest such as forward contracts or options on securities, partnership interests, or commodities
An asset held in a financial account maintained by a foreign financial institution is not required to be reported separately from the reported financial account in which the asset is held. The value of an asset held in a financial account maintained by a foreign financial institution is included in determining the maximum value of that account.
Other Financial Assets
Examples of other specified foreign financial assets include the following, if they are held for investment and not held in a financial account.
Stock issued by a foreign corporation.
A capital or profits interest in a corporation.
A note, bond, debenture, or other form of indebtedness issued by a foreign person.
An interest in a foreign trust of foreign estate.
An interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty.
An option or other derivative instrument with respect to any of these examples or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer.
An asset is held for investment if that asset is not used in, or held for use in, the conduct of a trade or business of a specified person. Personnel who are actively involved in the conduct of the trade or business exercise significant management and control over the investment of such asset.
There are also certain Exclusions for Assets Not Subject to Reporting
These include:
(1) Assets such as those which specified persons, such as traders and others in the securities business use mark-to-market accounting method and
(2) Interests in a social security, social insurance, or other similar program of a foreign government. However, this generally does not include similar programs that are funded by the Taxpayer’s voluntary payments such as I.R.A.’s,
(3) Foreign assets used in a trade or business are not subject to the reportingrequirements. An asset is used in, or held for use in, the conduct of a trade or business and not held for investment if the asset is:
(A) Held for the principal purpose of promoting the present conduct of a trade or business.
(B) Acquired and held in the ordinary course of a trade or business, as, for example, in the case of an account or note receivable arising from that
(C) trade or business; or
(D) Otherwise held in a direct relationship to the trade or business.
In determining whether an asset is used in a trade or business, principal consideration will be given to whether the asset is needed in the trade or business of the specified person. An asset shall be considered needed in a trade or business, for this purpose, only if the asset is held to meet the present needs of that trade or business and not its anticipated future needs. An asset shall be considered as needed in the trade or business if, for example, the asset is held to meet the operating expenses of the trade or business.
However, stock is never considered used or held for use in a trade or business for purposes of applying this test
(4) Elimination of duplicate reporting of assets. . A specified person is not required to report a specified foreign financial asset if the specified person reports the asset on at least one of the following forms timely filed with the Internal Revenue Service for the taxable year. Form 3520, Form 5471, Form 8621, Form 8865, Form 8891.
(5) Residents of U.S. Possessions. There is also an exclusion for a specified person who is a bona fide resident of a U.S. possession. They are generally not required to report the specified foreign financial assets that are situated, sourced or reported in the Possession of which they are a bona fide resident.
Required Information
There are different disclosure requirements based upon the character of the asset.
Stocks and Securities
In the case of stock or a security, the name and address of the issuer must be supplied and information that identifies the class or issue of which the stock or security is a part.
Financial Instruments
In the case of a financial instrument or contract held for investment, information that identifies the financial instrument or contract, including the names and addresses of all issuers and counterparties
Foreign Entities
In the case of an interest in a foreign entity, information that identifies the interest, including the name and address of the entity;
The maximum value of the specified foreign financial asset during the portion of the taxable year in which the specified person has an interest in the asset will be determined by the asset class.
Depository/Custodial Accounts
In the case of a financial account that is a depository or custodial account, whether such financial account was opened or closed during the taxable year;
The date, if any, on which the specified foreign financial asset, other than a financial account that is a depository or custodial account was either acquired or disposed of (or both) during the taxable year;
Income
The amount of any income, gain, loss, deduction, or credit recognized for the taxable year with respect to the reported specified foreign financial asset, and the schedule, form, or return filed with the Internal Revenue Service on which the income, gain, loss deduction, or credit, if any, is reported or included by the specified person;
Valuation Guidelines
The value of a specified foreign financial asset must be determined (i) for purposes of determining if the aggregate value of the specified foreign financial assets in which a specified person holds an interest exceeds the minimum and (ii) whether minimum year end reporting requirements are exceeded. The value of a specified foreign financial asset for both of these purposes generally is the asset’s fair market value. The maximum value of a specified foreign financial asset generally is the asset’s highest fair market value during the taxable year.
Valuing financial accounts
The maximum value of a financial account means a reasonable estimate of the maximum value of the holdings of the financial account at any time during the taxable year. Periodic account statement provided at least annually may be relied upon for reporting a financial account’s maximum value absent actual knowledge or reason to know based on readily accessible information that the statement does not reflect a reasonable estimate of the maximum account value during the taxable year.
Valuing other specified foreign financial assets
For purposes of determining the maximum value of a specified foreign financial asset other than a financial account maintained with a foreign financial institution, a specified person may treat the asset’s fair market value on the last day during the taxable year on which the specified person has an interest in the asset as the maximum value of the asset.
Special Valuation Rules for Beneficial Interests in Foreign Trusts, Estates, Pension Plans, and Deferred Compensation Plans
The maximum value of a specified person’s interest in a foreign estate, foreign pension plan, or a foreign deferred compensation plan is the fair market value, determined as of the last day of the taxable year, of the specified person’s beneficial interest in the assets of the foreign estate, foreign pension plan or foreign deferred compensation plan.
Entities
For purposes of reporting an individual’s interest, generally a specified person is not treated as having an interest in any specified foreign financial assets held by a corporation, partnership, trust, or estate solely as a result of the specified person’s status as a shareholder, partner, or beneficiary of such entity. However, though the entity itself may be a specified person that is required to report its holdings and indirectly that of its U.S. partners, beneficiaries and shareholders.
Furthermore, a specified person that is treated as the owner of a trust or any portion of a trust under certain circumstances is treated as having an interest in any specified foreign financial assets held by the trust or the portion of the trust.
A Foreign Currency Conversion
For purposes of meeting the reporting requirements, all values denominated in a foreign currency for purposes of determining both the aggregate value of specified foreign financial assets in which a specified person holds an interest and the maximum value of the specified foreign financial asset must be converted into U.S. dollars at the taxable year-end spot rate for converting the foreign currency into U.S. dollars (that is, the rate to purchase U.S. dollars). The U.S. Treasury Department’s Financial Management Service foreign currency exchange rate is to be used to convert the value of a specified foreign financial asset into U.S. dollars.
ARTICLE REFERENCES:
1/ FATCA provides for even more financial reporting commencing in the year 2014 when all foreign financial institutions are going to be required to diligently search for and report annually to the U.S. on financial accounts held by U.S. taxpayers.
ABOUT THE AUTHOR:
Richard S. Lehman, Esq., is a graduate of Georgetown Law School and obtained his Master’s degree in taxation from New York University.
He has served as a law clerk to the Honorable William M. Fay, U.S. Tax Court and as Senior Attorney, Interpretative Division, Chief Counsel’s Office, Internal Revenue Service, Washington D.C.
Mr. Lehman has been practicing in South Florida for more than 38 years. During Mr. Lehman’s career his tax practice has caused him to be involved in an extremely wide array of commercial transactions involving an international and domestic client base. He has served clients from over 50 countries.
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