The IRS issued temporary and proposed regulations fleshing out the Code Section 6038D requirement for individuals to attach a statement to their income tax return to provide information on foreign financial assets in which they have an interest. The temporary regulations are effective for tax years ending after December 19, 2011 but taxpayers can apply them to earlier years. The IRS also recently released the final version of Form 8938 (Statement of Specified Foreign Financial Assets) and its Instructions, which individual taxpayers will use starting this coming tax filing season to report specified foreign financial assets for tax year 2011.
Background. For tax years beginning after March 18, 2010, the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, P.L. 111-147) provides that individuals with an interest in a specified foreign financial asset during the tax year must attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000, or a higher dollar amount as the IRS may prescribe. In addition, to the extent provided by IRS in regulations or other guidance, the reporting requirement applies to any domestic entity formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if the entity were an individual.
“Specified foreign financial assets” are: (1) depository or custodial accounts at foreign financial institutions, and (2) to the extent not held in an account at a financial institution, (a) stocks or securities issued by foreign persons, (b) any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and (c) any interest in a foreign entity.
A specified person who fails to provide required information for any tax year is subject to a $10,000 penalty. A failure continuing for more than 90 days after the day on which IRS mails a notice of the failure to the specified person subjects the specified person to an additional penalty of $10,000 for each 30-day period (or fraction thereof) during which the failure continues after the 90-day period has expired, up to a maximum penalty of $50,000 for each such failure. No penalty applies if the failure was due to reasonable cause and not willful neglect. The fact that a foreign jurisdiction would impose a civil or criminal penalty on the specified person, or any other person, for disclosing the required information isn’t reasonable cause.
In Notice 2011-55, 2011-29 IRB 53, IRS suspended the Code Sec. 6038D reporting requirements until it released Form 8938. Once the new Form 8938 is released in its final form, individuals for whom the filing of Form 8938 was suspended for a tax year will have to attach the form for the suspended tax year to their next income tax return required to be filed with IRS. Notice 2011-55 further stated that the Code Sec. 6501(c)(8) limitations period for tax assessments for periods for which reporting is required under Code Sec. 6038D won’t expire before three years after the date on which the IRS receives Form 8938.
In October of 2011, IRS released a draft version of Form 8938. The final version, which is used to by individuals to report specified foreign financial assets for tax year 2011, was released in December of 2011.
Overview of what the regs cover. The temporary regs define terms that apply for purpose of Code Sec. 6038D; provide rules to determine if a specified individual or a specified domestic entity (collectively, a specified person) must file a Form 8938 with their annual return; define what are specified foreign financial assets; detail what information needs to be reported; provide guidelines for valuing specified foreign financial assets; list exceptions to the reporting requirements; and describe the penalties that apply for failure to comply with the reporting requirements.
A specified person isn’t required to file Form 8938 for any tax year for which he isn’t required to file an annual return.
Who has an interest in specified foreign financial assets. Under the temporary regs, a specified person is generally considered to have 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 asset are or would be required to be reported, included, or otherwise reflected on the specified person’s annual return filed with IRS, even if no income, gains, losses, deductions, credits, gross proceeds, or distributions are attributable to the asset for a particular tax year. The owner of a disregarded entity or grantor trust is generally treated as having an interest in any specified foreign financial assets held by the disregarded entity or trust. A specified person isn’t generally treated as having an interest in any specified foreign financial assets held by a partnership, corporation, trust (with some exceptions), or estate solely as a result of the specified person’s status as a partner, shareholder, or beneficiary.
The new Form 8938 filing requirement does not replace or otherwise affect a taxpayer’s obligation to file an FBAR (Report of Foreign Bank and Financial Accounts).
Observation. Fortunately, the new requirement to report specified foreign financial assets should not significantly impact taxpayers who hold all their financial assets in domestic financial institutions. There are two categories of specified foreign financial assets: (1) financial accounts maintained by a foreign financial institution; and (2) certain other assets, including foreign stock, that are not held in an account maintained by a financial institution. Assets that customers hold in a domestic financial institution generally do not fall into either category. Therefore, such assets are not “specified foreign financial assets.” The customers will generally not have to report such assets.
Until IRS issues permanent regs in the future, only individuals, and not specified domestic entities, must file Form 8938. Under the proposed regulations, for tax years beginning after 2011, a domestic trust will be considered a specified domestic entity if it has an interest in specified foreign financial assets, other than certain excepted assets, with an aggregate value exceeding the reporting threshold and one or more specified persons as current beneficiaries. However, a domestic trust will not be considered a specified domestic entity if the trustee or executor is a bank, financial institution, or domestic corporation that is subject to certain examination, oversight or registration requirements, has supervisory authority over or fiduciary obligations with regard to the trust’s specified foreign financial assets, and files income tax returns and information returns on behalf of the trust. In addition, a domestic trust or any portion of the trust that is treated as owned by one or more specified persons under the grantor trust rules is not considered to be a specified domestic entity.