On March 18, 2010, the “Hiring Incentives to Restore Employment Act” or “HIRE Act” was signed into law. Section 511 of the HIRE Act created I.R.C. § 6038D. This section requires specified individual taxpayers with an interest in “specified foreign financial assets” to file Form 8938 if the aggregate value of those assets exceeds the applicable reporting threshold. The applicable reporting threshold is generally $ 50,000, but higher asset thresholds apply to U.S. taxpayers who file a joint tax return or who live abroad.
Tax practitioners dread Form 8938 in large part because it means more, and often times duplicate, reporting. For example, a taxpayer with more than $ 10,000 in an offshore account already must file a Report of Foreign Bank and Financial Accounts (FBAR) with the IRS. But in a post-Form 8938 world, that same taxpayer must file a separate Form 8938 along with the annual return if his or her financial assets exceed $ 50,000.
Who Must File?
You must file Form 8938 if you are a “specified individual” that has an “interest in specified foreign financial assets” and the value of those assets “is more than the applicable reporting threshold.”
Reducing this rule to its core elements reveals that there are three main requirements:
• You are a specified individual;
• You have an interest in specified foreign financial assets required to be reported; and
• The aggregate value of your specified foreign financial assets is greater than the reporting threshold that applies to you.
Below is a brief overview of each of the requirements:
I. Specified individuals
A specified individual is any one of the following:
(1) A U.S. citizen;
(2) A resident alien of the United States for any part of the tax year;
(3) A nonresident alien who makes an election to be treated as a resident alien for purpose of filing a joint income tax return;
(4) A nonresident alien who is a bona fide resident of American Samoa or Puerto Rico.
II. Specified foreign financial assets
A specified foreign financial asset is:
(1) Any financial account maintained by a foreign financial institution. A foreign financial institution does not include: (a) a U.S. domestic financial institution, (b) the foreign branch of a U.S. financial institution, or (c) the U.S. branch of a foreign financial institution.
(2) Other foreign financial assets held for investment that are not in an account maintained by a U.S. or foreign financial institution. Examples of assets that must be reported if not held in an account include:
a. Stock or securities issued by a foreign corporation;
b. A note, bond, or debenture issued by a foreign person;
c. 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;
d. 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;
e. A partnership interest in a foreign partnership;
f. An interest in a foreign retirement plan or deferred compensation plan;
g. An interest in a foreign estate; and
h. Any interest in a foreign-issued insurance contract or annuity with a cash-surrender value.
To avoid a major headache, some practitioners suggest that taxpayers with investments consisting of foreign mutual funds and foreign life insurance replace them with U.S. mutual funds that invest in foreign securities.
A mistake that many taxpayers make is believing that IRAs and other retirement plans are included in the definition of “specified foreign financial assets.” However, to the extent that such an interest represents a social security, social insurance, or other similar program of a foreign government, that is incorrect. On the contrary, such accounts are not specified foreign financial assets and thus are exempt from the Form 8938 reporting requirements. This is an easy mistake to make in light of the fact that “specified foreign financial assets” has such a broad definition.
It is critical for taxpayers to understand that they have an interest in specified foreign financial assets even if there are no income, gains, losses, deductions, credits, gross proceeds, or distributions from holding or disposing of the asset for the tax year.
III. Aggregate value of specified foreign financial assets
The aggregate value of your specified foreign financial assets must be greater than the reporting threshold that applies to you. The reporting threshold depends on two main variables: first, whether the taxpayer lives in the United States or outside of the United States and second, whether the taxpayer is single or married. Assuming the taxpayer is married, the reporting threshold varies depending on whether the taxpayer is filing a joint income tax return with his or her spouse or a separate income tax return.
The reporting thresholds have been neatly divided into four categories and are as follows:
(1) Unmarried taxpayers living in the U.S.: The total value of your specified foreign financial assets is greater than $ 50,000 (USD) on the last day of the tax year or greater than $ 100,000 (USD) at any time during the tax year.
(2) Married taxpayers filing a joint income tax return and living in the U.S.: The total value of your specified foreign financial assets is greater than $ 100,000 (USD) on the last day of the tax year or greater than $ 150,000 (USD) at any time during the tax year.
(3) Married taxpayers filing separate income tax returns and living in the U.S.: The total value of your specified foreign financial assets is greater than $ 50,000 (USD) on the last day of the tax year or greater than $ 75,000 (USD) at any time during the tax year.
(4) Taxpayers living abroad:
a. You are a taxpayer living abroad if:
i. You are a U.S. citizen whose tax home is in a foreign country and you are either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year, or
ii. You are a U.S. citizen or resident, who during a period of twelve consecutive months ending in the tax year is physically present in a foreign country or countries for at least 330 days.
b. If you are a taxpayer living abroad, you must file if:
i. You are filing a return other than a joint return and the total value of your specified foreign assets is greater than $ 200,000 (USD) on the last day of the tax year or greater than $ 300,000 (USD) at any time during the year, or
ii. You are filing a joint return and the value of your specified foreign asset is greater than $ 400,000 (USD) on the last day of the tax year or greater than $ 600,000 (USD) at any time during the year.
Valuing Specified Foreign Financial Assets
The value of a specified foreign financial asset is the asset’s fair market value on the last day of the tax year. For purposes of figuring the total value of specified foreign financial assets, the value of a specified foreign financial asset denominated in a foreign currency must first be determined in the foreign currency and then converted to U.S. dollars.
Reporting Specified Foreign Financial Assets on other Forms Filed with the IRS
If you are required to file Form 8938 and you have already reported your specified foreign financial asset on any one of the following forms – Form 3520, Form 3520-A, Form 5471, Form 8621, Form 8865, or Form 8891 – you need not report the asset on Form 8938. However, you must identify on Part IV of your Form 8938 which and how many of these form(s) report the specified foreign financial assets.
Even if a specified foreign financial asset is reported on a form listed above, you must still include the value of the asset in determining whether the aggregate value of your specified foreign financial assets is greater than the reporting threshold that applies to you.
Penalties for Failing to File Form 8938
While the penalties for those who don’t follow the Form 8938 filing requirements might not be as severe as those for failing to file an FBAR, they are nothing to shake a stick at. Under I.R.C. § 6038D(d), the penalty for failing to file Form 8938 is $ 10,000. If the IRS notifies the individual regarding his failure to make the required disclosures, and the failure continues for more than 90 days after the mailing of the notification, there is an additional $ 10,000 penalty for each 30-day period that passes, up to a maximum of $ 50,000 per return. § 6038D(d)(2). This penalty went into effect beginning with the 2011 tax year.
Unfortunately, this is not the only penalty that exists for failing to report a foreign financial asset on Form 8938. Subsection (b)(7) of section 6662 provides a 20% penalty for “any undisclosed foreign financial asset understatement.”
Subsection (j) of section 6662 provides the following definitions:
(j) UNDISCLOSED FOREIGN FINANCIAL ASSET UNDERSTATEMENT
(1) IN GENERAL.–For purposes of this section, the term “undisclosed foreign financial asset understatement” means, for any taxably year, the portion of the understatement for such taxable year which is attributable to any transaction involving an undisclosed foreign financial asset.
(2) UNDISCLOSED FOREIGN FINANCIAL ASSET.–For purposes of this subsection, the term “undisclosed foreign financial asset” means, with respect to any taxable year, any asset with respect to which information was required to be provided under section 6038, 6038B, 6038D, 6046A, or 6048 for such taxable year but was not provided by the taxpayer as required under the provisions of those sections.
There is also a newly enhanced penalty for any “undisclosed foreign asset understatement.” § 6662(j)(3). This penalty is effective for taxable years beginning after March 18, 2010, the date of enactment. See HIRE Act, § 512(b).
Form 8938 raises delicate intra-family issues, none more sensitive than compromising the confidentiality of a person’s estate plan. For example, consider the grandfather with a $ 10 million dollar estate, who doesn’t want all of his family members to know exactly how much money he has, or what they stand to inherit.
All of a sudden, says tax attorney, Charles Kolstad, “you’re asking the grantor or trustee to open the kimono and reveal information they might regard as private and confidential.” While the grandfather’s reports to the IRS would be confidential, each beneficiary would have to report, too, Mr. Kolstad says. So the man would have to reveal information about his estate to each person who stood to inherit, he says.
The challenge that this presents to tax practitioners is daunting. They are put in the untenable position of balancing the need to let the U.S. government know where its taxpayers are keeping their money and earning income, without compromising the confidentiality of clients’ estate plans.
One French client who lives in the U.S. is so exasperated with all of the new reporting that he wants to give up his green card and return to France, says Leigh-Alexandra Basha, chairwoman of international private wealth services at law firm Holland and Knight LLP. But a move overseas can mean paying hefty U.S. exit tax, which can be a “Catch-22,” she says.
Below is a chart taken from the IRS website that compares the types of foreign assets that must be reported on Form 8938 with the types of assets that must be reported on the FBAR.
Original Post By: Michael DeBlis
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