Leigh–Alexandra Basha a Partner in the firm's Northern Virginia office.
Effective in 2012 for the tax year ending 2011, the IRS now requires individuals with a specified foreign financial asset (SFFA) to file IRS Form 8938, Statement of Specified Foreign Financial Assets, in addition to the Report of Foreign Bank and Financial Accounts (FBAR), Form TD F 90-22.1). Temporary and proposed regulations were issued in late 2011.
What is a Specified Foreign Financial Asset?
An SFFA includes not only foreign financial accounts but foreign financial assets such as:
- foreign contract rights
- any interest in stocks, other securities and other financial instruments issued by non-U.S. persons
- interests in foreign entities such as foreign partnerships, corporations and limited liability companies
- a U.S. beneficiary's interest in a foreign estate or foreign trust
Is an individual's interest in a foreign trust or estate an SFFA?
An individual's interest in a foreign trust or estate is not an SFFA unless the individual knows or has reason to know of the interest. A person is deemed to have actual knowledge of the interest if he or she receives a distribution from a foreign trust or estate. In valuing the interest in a foreign trust, it is equal to the amounts actually received during the taxable year plus the value on the last day of the taxable year or any mandatory distributions.
Who must file Form 8938?
Currently, Form 8938 must be filed by U.S. citizens, U.S. resident aliens including resident aliens who elect to be taxed as a resident of a foreign country under the treaty tie breaker rules and non-resident aliens who elect to be treated as resident aliens for purposes of filing joint income tax returns. Until the proposed regulations are finalized, only individuals, not domestic entities, must file Form 8938. Currently there are two look-through rules applicable to individuals. Firstly, the owner of a disregarded entity (such as a single-member limited liability company) is treated as having an interest in foreign financial assets owned by the entity for purposes of the Form 8938 filing requirement. Secondly, the grantor of a grantor trust is treated as owning the foreign financial assets of the trust.
Beginning with 2012 tax returns, closely held domestic partnerships and corporations which earn predominately investment income will also be subject to Form 8938 filing requirements. Some domestic nongrantor trusts will also be required to file.
Form 8938 is due with an individual's tax return and has a minimum filing threshold of $50,000 of the aggregate value of all foreign financial assets for individuals, however the filing thresholds vary depending on the individual's filing status and whether he or she is living in the United States or abroad. Taxpayers must file Form 8938 if the aggregate value of their specified foreign financial assets is more than the following reporting thresholds:
How are assets to be valued?
Assets must be valued using both of the following tests:
- Test 1: Value the assets as of the end of the taxable year and convert the value of assets denominated in a foreign currency into U.S. dollars using the U.S. Treasury Department's Financial Management Service exchange rates (http://www.fms.treas.gov/intn.html).
- Test 2: Value the assets as of the maximum fair market value of the asset at any time during the taxable year and again converting it using the exchange rate as of the end of the taxable year.
The regulations specifically state that third-party appraisals are not required in order to obtain a reportable value. Taxpayers can rely on values from publicly available information.
What information must be reported?
Information to be reported includes the date the asset was acquired or disposed of and the income, deductions and credits resulting from each asset including a listing of where those amounts were reported on the income tax return field by the individual.
However, there are special rules for reporting the value of interests in foreign trusts, estates, pension plans and deferred compensation plans. The maximum value of a beneficiary's interest in a foreign trust is the sum of the fair market value of his or her trust distributions for the year, plus the value of that person's right as a beneficiary to receive mandatory distributions from the trust. The maximum value of an interest in a foreign estate, pension plan, or deferred compensation plan is the fair market value of the person's beneficial interest in such estate's or plan's assets determined as of the last day of the taxable year. If this information is unavailable, the maximum value to be reported is the distribution received during the taxable year.
In order to minimize duplicative filings, assets reported on the certain forms (Forms 3520, 5471, 8621, 8865 and 8891) need not be reported on Form 8938, but the individual still must file Form 8938 to report that fact.
What are the penalties and statute of limitations associated with Form 8938?
The penalty for failing to file Form 8938 is $10,000 per failure and increases by $10,000 for each 30-day period following notification from Treasury, and caps at a maximum of $50,000. The penalty will not be imposed if the failure to file was due to reasonable cause and not willful neglect. A separate accuracy-related penalty equal to 40 percent of the underpayment applies if an individual underpays his or her U.S. tax liability as a result of a transaction not disclosed on Form 8938.
The statute of limitations is three years from the time that the Form 8938 is filed. If it is not filed, the "clock" does not begin to run. Additionally, if amounts relating to one or more specified foreign financial assets are not included in gross income, then the tax on that unreported income can be assessed at any time within six years from the date the income tax return was filed (instead of the normal three-year statute). This statute of limitations is extended to six years if an income tax return omits more than $5,000 of income attributable to a foreign financial asset, even if the asset is not required to be reported on Form 8938 (due to dollar threshold or the exception for duplicate filings).
Evaluation of foreign financial assets in light of the new SFFA rules is important for individuals with an SFFA - even if filing an FBAR is not required. Since the scope of Form 8938 disclosure is broader than the FBAR, some taxpayers that do not have to file an FBAR may be required to file Form 8938. For example, Form 8938 includes investments in foreign mutual funds, foreign hedge funds, and foreign private equity funds, which are exempted from FBAR reporting.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
