Disclosure of Foreign Financial Assets Under the Internal Revenue Code: Remember FATCA and Form 8938 Reporting Also Requires, Inter Alia, Disclosure of Interests in Foreign Trusts
Under Sections 1471-1474, the new FATCA provisions (when finally becoming operative next year (See model Form 8957 to be used by foreign financial institutions)) as well as under new Section 6038D, information with respect to foreign financial assets, a U.S. person, as defined, must directly disclose information to the IRS on his or her interest or interets in a foreign trust. A U.S. person must report an interest in (i) a foreign trust (and, in certain cases, in a U. S. trust) as a “grantor” under the grantor trust provisions; and (ii) a foreign trust as a beneficiary to the extent that the beneficiary is aware or is presumed to be aware of such status. Temporary Regulations set forth penalites that are quite substantial in amount with respect to undisclosed interests in foreign trusts.
FACTA, per Notice 2013-43, is generally effective with respect to payments made after June 30, 2014. At that time, in general, all foreign financial institutions (FFIs) will be required to enter into disclosure compliance agreements with the U.S. Treasury (unless an exemption or FATCA IGA (intergovernmental agreement) is applicable), and all non-financial foreign entities (NFFEs) that are not excepted under the regulations must report and/or certify their ownership or be subject to 30 percent withholdin regardless of whether the amount paid represents “income” or not.
Form 8938:Statement of Specified Foreign Financial Assets
In T.D. 9567, the Treasury and the Service last December issued Proposed and Tempoary Regulations under Section 6038D. Under Section 6038D(a), an individual who holds any interest in a “sepcified foreign financial asset” must attach to his or her income tax return the information required to be disclosed under Section 6038(D)(c) with respect to each asset where the aggregate value of all such assets exceeds $50,000 (or such higher amount set forth in regulations or other notice). Under Section 6038D(b) a “specified foreign fnancial asset” means any financial account matained by a foreign financial institution (as defined under the FACTA provisions, i.e., Sections 1471(d)(2) and 1471(d)(4) respectively, and any stock or security issued by a person other than a U.S. person, any financial insturment or contract held for investment which has an issuer or counterparty which is other than a U.S. person and any interest in a foreign entity per Section 1473.
The information required to be reported is set forth in Section 6038D(c) and as contained in Form 8938. The Form 8938 requirements began for tax years ending after December 19, 2011 although a taxpayer was allowed to elect to apply the rules to tax years ending prior to that date. See also Notice 2011-55, 2011-29 I.R.B. 53 (suspended requirement until Form 8938 released which occurred in November, 2012. A new draft of the form was issued on May 24, 2013.
The Temporary Regulations to Section 6038D (which expire on December 12, 2014, unless made final) generally apply to specified individuals and require reporting of information regarding a wide range of foreign financial assets. The foreign financial assets that must be reported include foreign financial accounts, foreign securities, interests in foreign entities and trusts, and interests in foreign pension funds.
A specified individual, i.e., a U.S. citizen, a resident alien of the U.S. for any portion of the tax year, or a resident spouse who has elected under Section 6013(g), or resident of the U.S. under a treaty tie-breaker rule, is required to file Form 8938 provided such person meets certain financial thresholds set forth in Temp. Regs. §§1.6038D-2T(a)(1)-4. A specified individual must file Form 8938 if he has an interest in “specified foreign financial assets,” the aggregate value of which exceeds (i) for individuals who live in the U.S. and are single or married filing separately, $50,000 on last day of the tax year or $75,000 at any time during the tax year; (ii) for individuals who live in the U.S. and are married and filing jointly, $100,000 on the last day of the tax year or $150,000 at any time during the tax year; (iii) for individuals who live abroad and are single or married filing separately, $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year; and (iv) for individuals who live abroad and are married and filing jointly, $400,000 on the last day of the tax year or $600,000 at any time during the tax year.
After a reporting obligation is triggered, the specified individual must disclose all assets that fall under the definition of financial assets for purposes of reporting on Form 8938.
Specified Foreign Financial Asset
The Section 6038D Temporary Regulations define specified foreign financial assets as (i) financial accounts at foreign financial institutions (except when the institution is a U.S. payor, such as a subsidiary of a U.S. entity or otherwise defined under Treas. Reg. §1.6049-5 (c)(5)(i)); (ii) other financial assets held for investment that are not held in an account at any financial institution, but only if the assets are (a) stocks; or (b) securities issued by a non-U.S. person; and (iii) any interest in a foreign entity and any financial instrument or contract with a non-U.S. issuer or counterparty. An asset is treated as held for investment for purposes of reporting under Section 6038D if it is not used in, or held for use in, the conduct of a trade or business.
The required “interest” in a specified foreign financial assetis present with respect to a specified individual 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.
Assets that are subject to the mark-to-market regime of Section 475 are not subject to reporting under Section 6038D if they fall under the obligatory mark-to-market rules of Section 475(a) or if an election was made under Sections 475(e) or (f).
The definition of specified foreign financial assets under Section 6038D has a wider reach than under the Report of Foreign Bank and Financial Accounts (FBAR) provisions in that more types of assets are reportable on Form 8938. Also, the FBAR rules require reporting assets over which the reporting individual does not have direct ownership but only signatory authority. Section 6038D does not require reporting unless there is direct ownership of the asset.
The filing requirement for Form 8938 does not replace the requirement to file Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts) under the FBAR rules. In many instances a specified U.S. person must file both forms.
Under Section 6038D(f), regulations may be issued that would extend the reporting obligation to any domestic entity that is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, the same as if the entity were an individual. The Section 6038D Proposed Regulations would require such domestic entities to report the information in question but the proposed rules would not be effective for tax years beginning before 2012. The IRS announced in Notice 2013-10, 2013-8 IRB 503, that when final Regulations are issued under Section 6038D, reporting by domestic entities of interests in specified foreign financial assets will not be required earlier than tax years beginning after December 31, 2012.
Application to Interest in a Foreign Trust
For purposes of Section 6038D, a U.S. person having in a foreign trust must report such interest as a “specified foreign financial asset”. An interest in a foreign trust or a foreign estate is a specified foreign financial asset of a specified person only if the person knows or has reason to know of the interest based on readily accessible information. Receipt of a distribution from the foreign trust or foreign estate constitutes actual knowledge for purposes of Form 8938 reporting.
In reporting the interest in a foreign trust, the value of such interest in a foreign trust is the fair market value of the interest as of the last day of the tax year on which the specified person has an interest in the trust. If the fair market value of the beneficiary’s interest in a foreign trust is not readily ascertainable, the “deemed value” is the sum of the value of: (i) all trust property distributed to the taxpayer beneficiary during the tax year; and (ii) the taxpayer beneficiary’s right to receive mandatory trust distributions established using specified IRS valuation tables under Section 7520. It is unclear whether a contingent interest in a trust must be reported and if so how is its value reflected?
The taxpayer-beneficiary is required to report his or her “interest” in the foreign trust for purposes of completing Form 8938 and is not required to detail any and all specified foreign financial assets held by the trust unless the U.S. person is the grantor of a foreign grantor trust unless the taxpayer grantor reports the trust for the tax year on Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) and the trust files Form 3520-A (Annual Information Return of Foreign Trust with a U.S. Owner).
Under the Temporary Regulations to Section 6038, i.e., Temp. Reg. §1.6038D-7T(a), where a taxpayer is already reporting or disclosing specified foreign financial assets on another form, the information does not need to be reported on Form 8938. See Form 3520 (for a specified person who is the beneficiary of a foreign trust); Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations); Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or 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). Temp. Reg. §1.6038D-7T(a).
Under Temp. Reg. §1.6038D-7T(a)(2), a specified person who is treated as an owner of a foreign trust or any portion of a foreign trust under Sections 671-679 is not required to report on Form 8938 any specified foreign financial assets held by the foreign trust, to the extent that for the tax year (i) the specified person reports the trust on a timely filed Form 3520; (ii) the trust timely files Form 3520-A; and (iii) the specified person reports the filing of Forms 3520 and 3520-A on Form 8938.
Under Temp. Reg. §1.6038D-8T a specified person can be penalized $10,000 for failing to file Form 8938. Where the failure to comply continues for more than 90 days after IRS mails a notice of failure to the specified person, an additional penalty of $10,000 applies for each 30-day period (or fraction thereof) during which the failure continues but the total penalty that may be imposed under this section is limited to $50,000 for each such failure. Under Section 6662(j), accuracy-related penalties may apply in the case of an underpayment that is attributable to any undisclosed foreign financial assets. See also Temp. Regs. §§1.6038D-8T(f)(1), (f)(2).
With respect to interests in foreign trust, a U.S. person must report transfers to and distributions from foreign trusts, and also have foreign grantor trusts of which they are treated as owners (in whole or in part) file reports. The penalties for failure to report under these rules are generally based on a percentage of the contribution or distribution or the portion of the trust that the U.S. person is treated as owning.
Upon a showing of “reasonable cause” for not disclosing specified financial assets on Form 8938, the penalty may be abated.