THIS “STATEMENT OF SPECIFIED FOREIGN FINANCIAL ASSETS” FORM MAY HAVE TO BE FILED WITH YOUR 2011 INDIVIDUAL TAX RETURN IF YOU OWN AN INTEREST IN SUCH ASSETS VALUED ABOVE VARIOUS THRESHHOLD AMOUNTS.
Were the tax code fiction, it might be “The Trial” by Franz Kafka for its hysteria generating propensity; or, perhaps, “As I Lay Dying,” by William Faulkner for its intermingling of anguish and farce and structural complexity: then again, it might be Leo Tolstoy’s “War and Peace” for its shear bulk; or, Joseph Heller’s, satirical “Catch 22” since we must file a tax return or be punished yet if we file, as almost all do lacking a real understanding of what we are filing, we may still be punished for the inevitable errors. The new Form 8938, gives me the feeling that were the tax law fiction it would be “Marathon Man,” by William Goldman made into the 1976 movie by the same name. I am thinking specifically of the harrowing scene where Nazi death camp dentist Dr. Christian Szell (Laurence Olivier) is torturing Babe Levy (Dustin Hoffman) by probing his exposed tooth nerve with a dental instrument while asking repeatedly, “Is it safe?” Bewildered Babe has no idea what he is talking about and as a result suffers excruciating pain. The scene is difficult to watch without squirming in one’s seat. The scene did nothing to help those already suffering from dental-fear phobias.
THE BIG HEADACHE FOR 2011 TAX FILERS WHO HAVE FOREIGN INVESTMENTS
We complain about the do nothing congress. But, we complain even more loudly when congress does do something like passing the Foreign Account Tax Compliance Act of 2010 (FATCA), now partially effective, which thrusts a two pronged spear at U.S. taxpayers who evade tax responsibilities. One prong, aimed at foreign financial institutions which harbor U.S. tax evaders, becomes fully effective in 2013 and is not discussed here. The second prong, enacted as Internal Revenue Code Section 6038D, is aimed at U.S. taxpayers and is effective for 2011 tax filings. This new statutory reporting requirement has been embodied in:
Form 8938, Statement of Specified Financial Assets (2 pages)
Form 8938 Instructions (10 pages).
Temporary and Proposed Regulations promulgated December 19, 2011 by IRS (14 pages in Federal Register).
IRS Explanation of Section 6038D Temporary and Proposed Regulations posted December 2011 (3 pages)
LINK TO IRS FATCA PAGE: http://www.irs.gov/formspubs/article/0,,id=248113,00.html
Will Rogers once said, “It is a good thing that we do not get a much government as we pay for.” Well, this law pays us back in spades and will add immensely to our tax filing burden and cost.
WHY ALL THE FUSS ABOUT ONE MORE TAX FORM?
Many with foreign contacts have long been filing the Report of Foreign Bank and Financial Accounts or TDF 90.22-1 (the FBAR) due on June 30 of each year. So, what’s the big deal? There are significant particulars that distinguish Form 8938 from the FBAR, some of which are:
Casts a much wider net over financial assets that must be reported. For example, FATCA requires taxpayers with investments in foreign entities, such as foreign hedge funds, private equity funds to report these investments. The FBAR regulations issued by FinCEN on Feb. 26, 2010, exempt these assets from FBAR reporting.
Requirement to provide fair market value of foreign entity and trust interests adds great complexity and consternation.
Different thresholds for filing.
Filed with Form 1040 by due date of extended due date, not by itself with the Department of the Treasury like the FBAR which is due absolutely on June 30.
Required by the IRC and its enforcement is therefore directly under jurisdiction of IRS. The FBAR is mandated by the Bank Secrecy Act and enforced by FinCEN (Financial Crimes Enforcement Network) which has delegated certain functions to IRS.
Different penalty structure under Section 6038D(d) of Title 26 of United States Code (IRC) and not Title 31 as with the FBAR penalties.
WHO MAY HAVE TO FILE?
The IRS loves colorless words that sometimes sound Orwellian. Those who may have to file are called, “Specified Persons.” In tax lexicon “person” includes non-natural persons such as corporations, partnerships and trusts, as well as individuals. This issue focuses solely on “specified persons” who are individuals. Specified individual include mainly U.S. Citizens and non-citizens who are treated as residents for U.S. tax purposes (which is not the same as immigration status). If you are in this group and own enumerated “specified financial assets” you must determine if you meet the threshold value for filing. If you do, you must file even if you also file an FBAR.
WHAT ARE THE FILING THRESHOLDS?
In its wisdom, IRS uses one set of values for determining if the filing threshold has been met and another set of valuation rules for reporting the value.
For threshold purposes there is a dual fair market value (FMV) test for total FMV of all specified foreign financial assets on the last day of the year or total FMV at any time during the year. These thresholds are:
STATUS/FILING LIVING YE FMV HIGH FMV
SINGLE IN USA $50,000 $75,000
SINGLE OUTSIDE USA $200,000 $300,000
MARRIED/ JOINT IN USA $100,000 $150,000
MARRIED / JOINT OUTSIDE USA $400,000 $600,000
MARRIED / SEP IN USA $50,000 $75,000
MARRIED/ SEP OUTSIDE USA $200,000 $300,000
There are some examples for married filing separate reporting in the instructions and temporary and proposed regulations. Values must first be calculated in foreign currency and converted to U.S. dollars generally using the quarterly conversion rates posted by the Treasury on its Financial Management Service website:
WHAT ASSETS MUST BE REPORTED?
You must report “Specified Foreign Financial Assets. Included are:
Financial Accounts with a foreign financial institution (generally not a U.S. entity and accepts deposits, holds financial assets or engages in business of investing, or trading in various kinds of securities (includes foreign: mutual funds, hedge funds, private equity funds).
o No double reporting: Report financial account value but not the assets held in the account.
Foreign Assets held for investment (not used in trade or business) but not in an account with a financial institution:
o Stock or securities in foreign entity, including disregarded entity (corporation, partnership, trust, estate). Stock not considered used in trade or business. Generally, report the interest in entity but not any interest in the entity’s underlying assets (No look through except for grantor trusts).
o Financial instrument of non U.S. issuer (note, bond, debenture, etc.)
o Various swap transactions with a foreign counterparty (e.g., interest rate or currency swap transaction).
o Excepted: Financial accounts with a U.S. based financial institutions need not be reported even if foreign assets are held in such accounts and accounts with certain dealers or traders required to follow mark-to-market accounting rules.
WHAT VALUE MUST BE REPORTED?
Unlike the threshold tests, here you must report the maximum fair market value during the year. How do you arrive at value?
Generally, appraisal not required.
If there is no positive value, value at zero.
Values must first be determined in foreign currency and converted using the Treasury website cited above using December 31 exchange rates even if asset has been sold during the year.
Examples are provided for splitting jointly owned assets.
Parents electing on Form 8814 to report a child’s unearned income must report the FMV of the child’s specified foreign financial assets.
Taxpayers may rely on periodic account statements not known to be accurate.
For non-financial account assets, taxpayer may value as of the last day of the year.
Foreign pension, estate or discretionary trust beneficiaries may, in the absence of readily accessible information, value beneficial interests as the amount of cash or property distributed to them, or, as zero, if no distributions have been received.
Trust beneficiaries with a right to mandatory distributions may value the foreign trust interest under IRC Section 7520.
TRUNCATED FORM 8938 WHEN CERTAIN OTHER FORMS FILED WITH YOUR RETURN
Those who file the forms listed below must still file Form 8938 but do not have to report details of foreign financial assets reported in the other forms which are:
Form 3520, Annual Return to Report Transactions with Foreign Trust and Receipt of Certain Foreign Gifts.
o Special rules apply to foreign grantor trusts.
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.
Form 8891, U.S. information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.
In addition to penalties that may apply to unreported income, penalties for non-compliance with the reporting requirements of Section 6038D, not based on reasonable cause, are serious:
Failure to file on time: $10,000.
Continuing failure to file within 90 days of IRS notice: additional $10,000 for each 30 period up to $50,000 maximum.
Failure to provide IRS with information: Specified foreign financial assets presumed to exceed filing thresholds and penalty will apply.
Exposure to felony criminal charges beyond the scope of this article.
Failure to file Form 8938 or report accurately: Statute of limitations as to total return or parts may remain open for 3 years from filing.
Failure to report income of more than $5,000 on foreign financial assets: Statute of limitations extended from 3 years to 6 years from date of filing.
TEA AND SYMPATHY
Unlike the protagonist in the Robert Anderson play, don’t get caught naked on the beach. The IRS in its Explanation of Section 6038D Temporary and Proposed Regulations states: “In developing the regulation IRS considered the potential burden this new self-reporting requirement could have on affected taxpayers.” Perhaps that is true and the onus goes to congress for inventing this scheme. Be that as it may, these reporting requirements are excruciatingly complex and will pose huge problems for honest taxpayers trying to file a tax return amidst an ever thickening fog of complexity.
The new Form 8938 reporting comes as IRS has reopened its Offshore Voluntary Disclosure Program for those who have not filed FBARS or reported foreign earnings. See my Tax Wars Blog post: “Another Offshore Voluntary Disclosure Window Opened by IRS,” at www.steinbergtaxlaw.wordpress.com. The new form piles on more woe and further complicates the tax life of those out of compliance.
This monogram merely scratches the surface of issues relating to evaluating the need to file and filing Form 8938. Ask your tax preparer to candidly assess whether he or she alone can adequately advise you regarding Form 8938 reporting. Form 8938 is a tax form but many of the decisions regarding what must be reported and how to report involve legal considerations. Many prepares will suggest obtaining the input of a tax lawyer to make certain that Form 8938 is being filed, if required, and that the filed form properly reports foreign financial assets and includes appropriate disclosures, limitations and disclaimers, if necessary, to clearly present facts, and not be susceptible of being interpreted as intended to mislead. The best result is often obtained when a preparer teams-up with a tax lawyer or the tax lawyer prepares an unusually complex or sensitive tax filing. In some cases, a need to preserve privileged communications or documents dictates how the legal advisor-preparer arrangement is structured, however.
Congress and the President keep talking about tax simplification and reform but every effort at reform seems to render the tax law even more confounding. Will progress towards real simplification ever occur? I can only quote Morgan Freeman’s indelible character Red from the wonderful film “The Shawshank Redemption,” as he finds the stone hiding a postcard and money left by his prison friend Andy Dufrense (Tim Robbins) and heads off to find him: I hope the Pacific is as blue as it has been in my dreams. I hope.”
To compensate all for suffering this important but less than scintillating issue, I’ll send a “Tax Season Sing Along” with some more parody tax lyrics to popular song melodies which many have said to enjoy.