The Internal Revenue Service has just published a first set of temporary regulations (T.D. 9567) under section 6038D requiring foreign financial assets of U.S. persons to be reported to the IRS for federal income tax purposes for tax years beginning after March 18, 2010. The text of the temporary regulations also serves as the text of concurrently issued proposed regulations applicable to domestic entities (REG-130302-10). Proposed regulations were also issued for application of section 6038D to domestic entities.
Effective December 19, 2011, the temporary regulations provide guidance regarding the requirement in section 6038D that individuals attach a statement to their income tax return to report required information on foreign financial assets in which they have an interest. The regulations affect individuals who must file Form 1040, "U.S. Individual Income Tax Return," and some individuals required to file Form 1040-NR, "Nonresident Alien Income Tax Return." The collection of information required by the regulations is generally satisfied by filing Form 8938, "Statement of Specified Foreign Financial Assets."
Again, as mentioned, the proposed regulations address the reporting requirements of domestic entities under section 6038D, i.e., certain domestic corporations, partnerships and trusts (but not estates), which are to be effective for taxable years beginning after December 31, 2011.
Form 8938 must be filed when the total value of specified foreign assets exceeds prescribed thresholds, but the thresholds for taxpayers who reside abroad are higher that those for taxpayers who reside in the United States. The instructions in Form 8938 are supposed to reflect the provisions in the temporary regulations on when is reporting required, what is a foreign financial asset, how to determine the total value of subject assets, exemptions and other information. The Form 3938 does not preempt or replace a taxpayer’s obligation to file an FBAR report. Still, a Form 8938 is not required to be filed by an individual is not required to file an income tax return.
The regulations should be carefully reviewed by tax counsel and tax professionals as well as return preparers. While this posting does not address the specific provisions contained in the temporary and proposed regulations, it does contain background information on the enactment of section 6038D which requires FBAR type disclosures to be made with annual income tax returns.
Congress’ Recent Move to Compel Tax Return Disclosure of Information Concerning Foreign Financial Assets in the Hiring Incentives to Restore Employment Act (“HIRE Act”), P.L. 111-147 (3/18/2010)
Prior to the HIRE Act, our domestic laws required U.S. persons who transfer assets to, and hold interests in, foreign bank accounts or foreign entities to be subject to self-reporting requirements contained under the Internal Revenue Code (26 U.S.C.) and under the Bank Secrecy Act of the United States Code (31 U.S.C.). While the Bank Secrecy Act, 31 U.S.C. §5311, originally targeted the reporting of large currency transactions for use in criminal, tax or regulatory investigations or proceedings, its reach has expanded to impose reporting obligations on both financial institutions and account holders. See, e.g., Title III of the USA PATRIOT Act, Pub. L. No. 107-56 (October 26, 2001) (sections 351 through 366 amended the Bank Secrecy Act as part of a series of reforms directed at international financing of terrorism).
With respect to account holders, a U.S. citizen, resident, or possibly a person doing business in the United States is required to keep records and file reports, as specified by the Secretary, when that person enters into a transaction or maintains an account with a foreign financial agency. 31 U.S.C. §5314. Regulations promulgated pursuant to broad regulatory authority granted to the Secretary in the Bank Secrecy Act provide additional guidance regarding the disclosure obligation with respect to foreign accounts which involves the filing of annual foreign bank and financial account statements.
Treasury Department Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts,” (the “FBAR”) must be filed by June 30 of the year following the year in which the $10,000 filing threshold set forth in the regulations is satisfied. 31 C.F.R. § 103.27(c). The $10,000 threshold is the aggregate value of all foreign financial accounts in which a U.S. person has a financial interest or over which the U.S. person has signature or other authority. The FBAR is filed with the Treasury Department at the IRS Detroit Computing Center. Failure to file the FBAR is subject to both criminal and civil penalties. See 31 U.S.C. §322 which provides that failure to willful failure to file the FBAR is punishable by a fine up to $250,000 and imprisonment for five years, which may double if the violation occurs in conjunction with certain other violations. Since 2004, the civil penalties are not to exceed (1) $10,000 for failures that are not willful and (2) the greater of $100,000 or 50% of the balance in each account for willful failures. 31 U.S.C. §5321(a)(5).
Although the FBAR is received and processed by the IRS, it is neither part of the income tax return filed with the IRS nor filed in the same office as that return. As a result, for purposes of Title 26, the FBAR is not considered “return information,” and its distribution to other law enforcement agencies is not limited by the nondisclosure rules of Title 26. The Bank Secrecy Act specifies only that such disclosure contain the following information “in the way and to the extent the Secretary prescribes”: (1) the identity and address of participants in a transaction or relationship; (2) the legal capacity in which a participant is acting; (3) the identity of real parties in interest; and (4) a description of the transaction.
Although the obligation to file an FBAR is not part of the Internal Revenue Code, the individual income tax return makes reference to this requirement, i.e., At any time during (tax year), did you have an interest in or signatory or any other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?” Then reference is made to Form TD F 90-22.1 and filing requirements. The Form 1040 instructions advise individuals who answer “yes” to this question to identify the foreign country or countries in which such accounts are located.
Enactment of Code Section 6038D Under the HIRE Act
Section 6038D was enacted by section 511 of the HIRE Act. Section 6038D(a) requires an individual who holds any interest in a specified foreign financial asset during the taxable year to attach a statement to that individual’s income tax return to report the information identified in section 6038D(c), where the aggregate value of the specified foreign financial assets in which the individual holds an interest exceeds $50,000 for the taxable year, or such higher dollar amount as the Secretary may prescribe by regulation or other pronouncement.
Section 6038D(b) defines specified foreign financial assets for this purpose as any financial account maintained by a foreign financial institution and, to the extent not held in an account at a financial institution: (i) any stock or security issued by any person other than a United States person; (ii) any financial instrument or contract held for investment that has an issuer or counterparty that is not a United States person; and (iii) any interest in a foreign entity.
Section 6038D(c) sets forth the information an individual must include on the statement reporting specified foreign financial assets. For a financial account, the name and address of the financial institution in which the account is maintained as well as the account number must be reported. As to stock or securities, 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 counterparties 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 taxable year also must be reported.
An individual who fails to disclose the information required to be reported by section 6038D(c) is subject to a $10,000 penalty under section 6038D(d)(1). Section 6038D(d)(2) provides that if the failure to comply continues for more than 90 days after receipt of notice of such failure, 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 up to a maximum of $50,000 with respect to any such failure.
Under section 6038D(e), the aggregate value of any specified foreign financial assets in which an individual has an interest is presumed to exceed the reporting thresholds set forth in section 6038D(a) if the Secretary determines that the individual has an interest in one or more specified foreign financial assets and has not provided sufficient information to demonstrate the aggregate value of the assets. This presumption applies for purposes of assessing the penalties imposed under section 6038D.
Section 6038D(f) authorizes the Secretary to issue regulations or other guidance applying the provisions of section 6038D to any domestic entity as if the domestic entity were an individual, if the domestic entity is formed or availed of for the purposes of holding, directly or indirectly, specified foreign financial assets. (italics added for emphasis).
Section 6038D(g) provides that no penalty will be imposed by section 6038D for any failure to report that is shown to be due to reasonable cause and not due to willful neglect. A foreign law restriction, whether civil or criminal, on disclosing the information required to be reported is not reasonable cause. This means that an U.S. individual may not use the rationale of a foreign bank secrecy statute or similar provision to excuse non-filing.
Section 6038D(h) authorized the Secretary to issue regulations or other guidance as may be necessary or appropriate to carry out the purposes of section 6038D which is reported in this post. This guidance may include appropriate exceptions from reporting for nonresident aliens, bona fide residents of U.S. possessions, and classes of assets identified by the Secretary. Section 6038D is effective for taxable years beginning after March 18, 2010 (the date of enactment of the HIRE Act). IRS Notice 2011-55, 2011-29 IRB 53 (July 18, 2011), provides that an individual that has a taxable year that begins after March 18, 2010, and is required to attach a statement of specified foreign financial assets to an annual return to be filed prior to the issuance of Form 8938, "Statement of Specified Foreign Financial Assets," is to satisfy his or her obligation under section 6038D for such taxable year by attaching Form 8938 for such taxable year to his or her next annual return required to be filed after the issuance of Form 8938.
Other Related Reporting Requirements
In addition to the FBAR requirements, additional reports are required by the Internal Revenue Code to be filed with the IRS by U.S. persons engaged in foreign activities, directly or indirectly, through a foreign business entity. Upon the formation, acquisition or ongoing ownership of certain foreign corporations, U.S. persons that are officers, directors, or shareholders must file a Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations.” IRS Form 8865, “Return of U.S. Persons with Respect to Certain Foreign Partnerships,” must be filed with respect to certain interests in a controlled foreign partnership. IRS Form 3520, “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts,” must be filed with respect to certain foreign trusts. IRS Form 8858, “Information Return of U.S. Persons With Respect To Foreign Disregarded Entities” must be filed with respect to a foreign disregarded entity. To the extent that the U.S. person engages in such foreign activities indirectly through a foreign business entity, other self-reporting requirements may apply. In addition, a U.S. person that capitalizes a foreign entity generally is required to file an IRS Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation.
The section 6038D filings will presumably be closely monitored and compared with the foreign financial institution and foreign non-financial institution reporting and witholding requirements to become operative in accordance with Chapter 4 of HIRE otherwise known as the FATCA provisions.
CAVEAT. THE INFORMATION CONTAINED IN THIS POSTING IS INTENDED FOR INFORMATIONAL PURPOSES ONLY AND NEITHER CONSTITUTES, NOR MAY BE RELIED UPON AS, LEGAL ADVICE. PERSONS READING THIS POST WHO ARE POTENTIALLY SUBJECT TO THE REPORTING REQUIREMENTS UNDER TITLE 26 OR TITLE 31 OF THE UNITED STATES CODE REFERRED TO HEREIN ARE STRONGLY ENCOURAGED TO SEEK THE ADVICE OF A QUALIFIED TAX LAWYER