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How the new foreign asset reporting rules may affect your clients

The IRS has always been interested in taxpayers with offshore assets. The difficulty for the IRS has been finding out about those assets. In 2010, the IRS took one step closer to resolving this issue through the implementation of the Foreign Asset Tax Compliance Act (FATCA).1 Unfortunately for taxpayers, their problems may just be beginning.

BACKGROUND

Since the early 1970s, taxpayers have been required to report foreign bank account information on Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR).2 The regulations governing this filing are under Title 31 of the U.S. Code. Since the Internal Revenue Code is under Title 26,3 there is a disconnect between reporting bank account information on the FBAR form and reporting the income earned on those accounts on the taxpayer's income tax return.

FATCA was enacted in 2010 as part of the HIRE Act.4 On Dec. 19, 2011, the IRS issued temporary and proposed regulations under Code Section 6038D.5 The regulations set out the requirements for individuals to report "specified foreign financial assets" on a statement attached to their income tax return for tax years ending after Dec. 19, 2011.6

A final version of Form 8938, Statement of Specified Foreign Financial Assets, was also issued in December 2011 and will be required for individuals who meet the filing thresholds (discussed below) for calendar year 2011.7 FATCA also includes regulations relating to foreign financial institutions, which will generally be effective in 2013.8 A discussion of those rules is beyond the scope of this article.

FATCA COMPLIANCE FOR INDIVIDUALS

At first blush, the new Form 8938 looks similar to the FBAR. They are similar with respect to reporting foreign bank account information. Each form requires the name of the bank, the account number, the address of the bank, and the maximum value of the account during the year. That is where the similarities end. FATCA requires additional information which will require careful review of a client's holdings to determine whether or not reporting is required.

Generally, Form 8938 will be required to be filed by a U.S. citizen, permanent resident (green card holder) or resident alien of the United States, or a nonresident alien who makes an election to be treated as a resident alien for tax purposes.9

FATCA requires reporting of "specified foreign financial assets," which are generally defined as:10

• any financial account maintained by a foreign financial institution;

• stocks and securities issued by someone who is not a U.S. person and which are not held in a U.S. financial account;

• any interest in a foreign entity (partnership, corporation or trust); or

• any financial instrument or contract with an issuer or counterparty that is not a U.S. person.

Some examples of items which are considered to be "specified foreign financial assets" include:11

•    stock purchased directly on a foreign stock exchange;

• stock issued by a foreign corporation and held directly by a U.S. person;

• direct interest in a foreign mutual fund, foreign hedge fund and foreign private equity fund;

• a note, bond or other indebtedness issued by a foreign person;

• an interest in a foreign partnership, trust or estate;

• an interest in a foreign non-governmental pension or retirement plan; and

• an interest in a foreign disregarded entity which holds any of the above.

There are several items that are not required to be reported on Form 8938, including:

• interest in a social security, social insurance or similar program of a foreign government;12

• the value of real estate, unless the real estate is held in a foreign entity, in which case the interest in the foreign entity may be reportable;13

• assets used in a trade or business are excepted from filing under Reg. 1.6038D-3T(b);14 and

• assets reported elsewhere on the taxpayer's return, for example:15

o an interest in a foreign trust reported on Form 3520/3520-A

o an interest in a foreign corporation reported on Form 5471

o an interest in a passive foreign investment company (PFIC) reported on Form 8621

If an interest in a "specified foreign financial asset" has been reported elsewhere on the individual's U.S. income tax return, Form 8938, Part IV, should be completed to indicate the number of forms filed.16

The Form 8938 is required only if the taxpayer's interest in "specified foreign financial assets" meets certain thresholds described below:

1) Single individuals (and married individuals filing a separate return) living in the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $50,000 on the last day of the year or $75,000 at any point during the tax year.17

2) Married individuals, filing a joint income tax return, and living in the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $100,000 on the last day of the year or $150,000 at any point during the tax year.18

3) Single individuals (and married individuals filing a separate income tax return) living outside of the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $200,000 on the last day of the year or $300,000 at any point during the tax year.19

4) Married individuals, filing a joint income tax return, and living outside of the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $400,000 on the last day of the year or $600,000 at any point during the tax year.20

Valuing the foreign asset has its own challenges. The instructions to Form 8938 provide several examples for valuing trust interests, foreign pension plans and foreign deferred compensation plans.21 Special attention should be given to whether the assets are held jointly or separately and the exchange rate to use for currency conversion.22 In most cases, the exchange rate published by the U.S. Treasury Department's Financial Management Service for purchasing U.S. dollars must be used.23 The exchange rate on the last day of the year is to be used even if the asset was disposed of earlier in the year.

PENALTIES

As with other foreign asset reporting requirements, the penalties for failure to file Form 8938 are significant:

• Failure to file a complete and accurate Form 8938 results in a $10,000 penalty.25

• Continuing failure to file results in an additional $10,000 for each 30-day period or part of a period up to a maximum of $50,000.26

• Accuracy-related penalty of 40 percent of any underpayment of tax on unreported income involving an undisclosed asset.27

• Penalty of 75 percent of any underpayment of tax on unreported income involving an undisclosed asset where the failure to report is due to fraud.28

• Criminal penalties may be applied.29

The statute of limitations is three years after the date on which you file Form 8938.30 The statute can be extended to six years if an asset is omitted and the amount omitted was more than $5,000.31

IRS VDP AND OVDI

What happens if a taxpayer realizes that they had unreported income or a requirement to file FBARs in prior years? The IRS 2009 Voluntary Disclosure Program (VDP) and 2011 Offshore Voluntary Disclosure Initiative (OVDI) were implemented to provide a system for delinquent taxpayers to come forward.32 A taxpayer in this situation should consult their tax advisor for guidance on whether or not to enter the OVDI program. The OVDI has been reopened and currently has not published a closing date.33

WHAT'S NEXT

Unfortunately, it is expected that the rules relating to foreign asset reporting will continue to become more complex and invasive as the IRS fully implements FATCA in 2013. For example, this past February, the United States, France, Germany, Italy, Spain and the United Kingdom announced that they are "exploring a framework to share information on bank accounts across borders." Just as the United States is gathering information on its taxpayers' overseas holdings, other jurisdictions will expect similar reporting from the United States.

CONCLUSION

In today's global economy, taxpayers need to consider whether they have any foreign reporting requirements. When looking into new investments, taxpayers need to enquire about any special reporting. A discussion with their tax advisor will help them avoid penalties and meet any compliance obligations.    

LAURA K. BAROOSHIAN AND STEPHEN A. COLELLA
work in the Private Clients Group at DiCicco, Gulman & Company LLP, a full-service CPA and business advisory firm in Woburn.
Barooshian is a partner with specialized expertise in tax planning for wealthy individuals, international taxation for individuals, stock option planning and philanthropic planning alternatives. She can be reached at [e-mail lbarooshian].
Colella is a principal with specialized expertise in tax matters related to high net worth individuals and their various entities, including the transfer of wealth to minimize estate and gift taxes. He can be reached at  [e-mail scolella].

1FATCA is part of the Hiring Incentives to Restore Employment Act of 2010 Public Law No. 111-147 (2010).

2
The Bank Secrecy Act provides, "[T]he Secretary of the Treasury shall require a resident or citizen of the United States or a person in, and doing business in, the United States, to keep records, file reports, or keep records and file reports, when the resident, citizen, or person makes a transaction or maintains a relation for any person with a foreign financial agency." See 31 U.S.C. §5314(a) (West 2012).

3
See Internal Revenue Code, 26 U.S.C. § 1 et seq.

4
Hiring Incentives to Restore Employment Act of 2010 Public Law No. 111-147 (2010).

5
I.R.C. §6038D (West 2012).

6
Treas. Reg. §§1.6038D-1T, §1.6038D-2T, §1.6038D-3T, §1.6038D-4T, §1.6038D-5T, §1.6038D-7T, §1.6038D-8T.

7
Treas. Reg. §1.6038D-1T, §1.6038D-2T.

8
IRC Section 1471.

9
Treas. Reg. §1.6038D-1T.

10
Treas. Reg. §1.6038D-2T, §1.6038D-3T.

11
Treas. Reg. §1.6038D-3T.

12
2011 Form 8938 instructions, Page 4.

13
Treas. Reg. §1.6038D-3T(b)(iii).

14
Id. at §1.6038D-3T(b).

15
Id. at §1.6038D-7T.

16
Id. at §1.6038D-7T.

17
Id. at §1.6038D-2T(a)(1).

18
Id. at §1.6038D-2T(a)(2).

19
Treas. Reg. §1.6038D-2T(a)(3).

20Treas. Reg. §1.6038D-2T(a)(4).

21
2011 Form 8938 instructions, Pages 2-6.

22
Financial Management Service, Treasury Reporting Rates of Exchange, www.fms.treas.gov/intn.html.

23
Id.

24
2011 Form 8938 instructions, Page 5.

25
Treas. Reg. §1.6038D-8T, 2011 Form 8938 instructions, Pages 6 and 7.

26
Id.

27
Id.

28
Id.

29
Id.

30
Id.

31
Id.

32
I.R.S. News Release IR IR-2011-14, (Feb. 8, 2011).

33
I.R.S. News Release IR 2012-5, (Jan. 09, 2012); IRC Sec(s). 7201.

34
Press Release, U.S. Department of Treasury, (Feb. 2, 2012) available at www.treasury.gov/press-center/press-releases/Pages/tg1412.aspx.

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