Preview Of Coming Attractions: Enhanced Foreign Asset Reporting Rules On The Horizon

Matthew D. Lee
January 17, 2012 — 1,052 views  

 

 

For past three years, much attention has been focused on offshore bank accounts and the obligation of U.S. taxpayers to report such accounts on the much-heralded Report of Foreign Bank and Financial Accounts or "FBAR" form. The FBAR rules require taxpayers to annually report whether they have a financial interest in, or signature or other authority over, foreign bank accounts, and impose substantial civil and criminal penalties for failing to do so. While the FBAR reporting rules have been in place since the 1970s, compliance has historically been dismal due to a lack of knowledge of the reporting requirements by taxpayers and return preparers, and a marked lack of enforcement by the Internal Revenue Service. Since 2008, however, the IRS and the Justice Department have embarked on an intense campaign to raise awareness of the FBAR reporting requirements using a carrot and stick approach. The "carrot" has been the highly-publicized and successful amnesty programs offered by the IRS in 2009 and 2011 through which 30,000 U.S. taxpayers voluntarily disclosed their secret foreign bank accounts and paid back taxes, interest, and penalties, and in exchange received amnesty from criminal prosecution. The "stick" has been a dramatic uptick in criminal prosecutions of taxpayers for failing to report foreign bank accounts, and income associated with such accounts, with more than 30 criminal cases against accountholders being filed since 2008 and numerous foreign banks under active criminal investigation now for allegedly aiding their customers in evading U.S. taxes.

On the heels of the U.S. government's global crackdown on the use of secret foreign bank accounts, the IRS is poised to impose additional reporting requirements that will obligate U.S. taxpayers to annually disclose "specified foreign financial assets" if their value exceeds $50,000. This new reporting requirement is contained in Internal Revenue Code section 6038D, which was enacted by Congress in 2010 as part of the Foreign Account Tax Compliance Act provisions of the Hiring Incentives to Restore Employment (HIRE) Act. Section 6038D generally provides that any individual required to file a U.S. income tax return and who holds a "specified foreign financial asset" must attach a new reporting form to such individual's income tax return if the taxpayer's aggregate interest in specified foreign financial assets exceeds $50,000 (or such higher dollar amount as the Secretary of the Treasury may prescribe). Section 6038D also applies to any domestic entity which is formed or used for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if such entity were an individual.

The term "specified foreign financial asset" includes the following:

  1. any financial accounts maintained by a foreign financial institution (e.g.,a foreign bank account);
  2. any stock or security issued by a non-United States person (e.g.,stock in a foreign corporation);
  3. any financial instrument or contract held for investment that has a non-United States issuer or counterparty; or
  4. any interest in a foreign entity (including a foreign trust).

While Section 6038D applies by its terms to taxable years beginning after March 18, 2010, the IRS suspended the filing requirement until it could issue a new reporting form, instructions, and regulations. Earlier this year, the IRS issued a draft form, entitled "Form 8938, Statement of Specific Foreign Financial Assets," and draft instructions for such form.1 On December 14, 2011, the IRS released Temporary Regulations providing guidance concerning the Form 8938 filing obligations for individuals.2 The Temporary Regulations have an effective date of December 19, 2011. On the same day, the IRS issued a Proposed Regulation addressing the Form 8938 filing requirements for domestic entities.3 Domestic entities are not required to File 8938 until a final regulation is issued, which is expected to occur sometime during 2012. In a companion news release, the IRS announced that the Form 8938 would be finalized shortly for use by individuals in the upcoming filing season for tax year 2011.

The Temporary Regulations provide the following reporting thresholds for filing the Form 8938:

  • A taxpayer living in the United States who does not file a joint income tax return must file Form 8938 if the total value of the taxpayer's foreign financial assets exceeds $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
  • Married taxpayers living in the United States and filing a joint income tax return must file Form 8938 if the total value of the their foreign financial assets exceeds $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.
  • A taxpayer not filing a joint return and who is a bona fide resident of a foreign country for either an uninterrupted period that includes an entire tax year or for at least 330 days during a 12 consecutive month period ending in the tax year (defined as a "Foreign Resident"), must file Form 8938 if the total value of the taxpayer's foreign financial assets exceeds $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.
  • Married taxpayers who are Foreign Residents must file Form 8938 if the total value of their foreign financial assets exceeds $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year.

The Temporary Regulations provide certain exceptions in order to prevent duplicative reporting of foreign assets where such assets are reported on other information returns, such as Forms 3520, 5471, 8621, 8865, and 8891. However, the Temporary Regulations make clear that the filing of a Form 8938 does not relieve a taxpayer of the requirement to file the FBAR form. Thus, taxpayers with foreign bank accounts, in certain circumstances, may be required to file both Form 8938 and the FBAR.

With regard to the filing obligations of a "domestic entity," the Proposed Regulation clarifies that a domestic corporation or domestic partnership will have to file Form 8938 if it satisfies three conditions:

  • The domestic corporation or domestic partnership must have an interest in specified foreign financial assets with an aggregate value exceeding $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year;
  • The domestic corporation or domestic partnership is "closely held" by one U.S. individual taxpayer. Generally, "closely held" refers to a domestic corporation that has 80 percent of its voting stock or 80 percent of the value of its stock held by one U.S. individual taxpayer, or a domestic partnership that has 80 percent of its capital or profits interest held by one U.S. individual taxpayer; and
  • Either of the following two conditions are met:
    1. at least 50 percent of the corporation's or partnership's gross income for the taxable year is passive income or at least 50 percent of the assets held by the corporation or partnership at any time during the taxable year are assets that produce or are held for the production of passive income; or
    2. at least 10 percent of the corporation's or partnership's gross income for the taxable year is passive income or at least 10 percent of the assets held by the corporation or partnership at any time during the taxable year are assets that produce, or are held for the production of, passive income, and the corporation or partnership is formed or availed of by a specified individual with a principal purpose of avoiding the reporting obligations under section 6038D.

The Temporary Regulations provide that taxpayers who fail to file the Form 8938 may be subject to a broad array of penalties. A failure to file Form 8938 can yield a $10,000 civil penalty as well as an additional $10,000 penalty for each 30-day period after the taxpayer is notified by the IRS of the failure to file Form 8938. Penalties may be avoided if the taxpayer demonstrates that the failure to file was due to reasonable cause and not due to willful neglect. Notably the fact that a foreign jurisdiction would impose a civil or criminal penalty for disclosing the required information is not reasonable cause. The Temporary Regulations specify that the failure to comply with these reporting requirements, or any underpayment related to such failure, may result in criminal penalties under Title 26 or other federal law. Finally, the failure to file the Form 8938, or report certain foreign assets on a Form 8938, may operate to keep the statute of limitations open for all items on the tax return until three years after the Form 8938 is filed. This means that the IRS can audit a filed return even after the normal three year statute of limitations has expired under certain circumstances.

With the implementation of the Temporary Regulations, and the release of the final version of Form 8938 expected imminently, it is clear that individual taxpayers must be prepared to begin filing the Form 8938 to report assets for the 2011 tax year. As noted, however, the reporting requirement for domestic entities is postponed until the Proposed Regulation addressing such entities is issued as a final regulation. The IRS has stated that it anticipates that a final regulation will be issued during 2012 and will apply to taxable years beginning after December 31, 2011.

These new foreign asset reporting rules signal a new era in foreign asset reporting by U.S. taxpayers, and significantly expand the disclosure requirements in scope and type well beyond what was previously required to be reported on the FBAR form. With its focus on international tax evasion, the IRS can be expected to carefully scrutinize foreign assets being disclosed on Forms 8938 and to utilize these new filings as an additional source of information about foreign assets maintained by U.S. taxpayers.

Matthew D. Lee

Blank Rome LLP

Matthew D. Lee is a partner in the Philadelphia office of Blank Rome LLP where he specializes in tax controversy litigation and white collar crime defense. He can be reached at [email protected]