FATCA, New Reporting Requirements for Offshore Accounts
Enacted as part of the 2010 HIRE Act, The Foreign Account Tax Compliance Act (“FATCA”) is an important development in U.S. efforts to improve tax compliance involving foreign financial assets and offshore accounts.
FATCA’s approach to foreign financial account compliance is twofold. First, U.S. taxpayers with specified foreign financial assets that exceed certain thresholds must report those assets to the IRS. This reporting will be made on Form 8938 (see http://www.irs.gov/pub/irs-pdf/f8938.pdf), which taxpayers attach to their federal income tax return. This filing is in addition to other filings a taxpayer may be required to file, including Foreign Bank Account Reporting (“FBAR”) forms.
Second, FATCA will require foreign financial institutions to report directly to the IRS information about financial accounts held by U.S. taxpayers, or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
Who Must File
Under FATCA, each: (1) specified person; (2) with an interest in a specified foreign financial assets; and (3) the value of those assets exceeds the appropriate reporting threshold, must file the new Form 8938. Each of these elements is discussed in more detail below.
A specified individual is defined as any: (1) U.S. citizen; (2) Resident alien of the United States for any part of the year (green card test or substantial presence test (SPT)); (3) Non-resident alien (“NRA”) who makes an election to be treated as a resident alien for purposes of filing a joint tax return (note, definition differs from that used for FBAR); (4) NRA who is a bona fide resident of American Possessions and Territories; Puerto Rico.
An exception from filing may exist if the US Citizen or Resident does not have a tax return filing requirement.
Under the current proposed regulations, there is no Form 8938 filing requirement for domestic entities at this time, as the filing requirement begins for tax years after December 31, 2011. The proposed regulations also provide the guidelines for which domestic entities will have a filing requirement, once applicable.
The proposed regulations apply to domestic entities formed or availed of for the purposes of holding, directly or indirectly, specified foreign financial assets. Such entities are referred to as specified domestic entities and include certain closely held corporations and partnerships that meet passive income or passive income tests. With exceptions, domestic trusts are included if they have a specified individual(s) as a current beneficiary and exceed the reporting threshold.
“Specified domestic entities” include certain domestic corporations, domestic partnerships and domestic trusts, but not domestic estates.
For a domestic corporation or partnership to be considered a specified domestic entity, three conditions must apply.
The corporation/partnership must have an interest in specified foreign financial assets with an aggregate value exceeding the $50,000/$75,000 reporting threshold.
It must be closely held (80 percent by vote or value at end of the taxable year) by a specified individual taking into account indirect and constructive ownership rules.
It must either meet an at least 50 percent passive income/assets test, or meet a 10 percent passive income/assets test and based on the facts and circumstances been formed or availed of with a principal purpose of avoiding reporting under Section 6038D.Two different aggregation rules apply to determine whether a domestic corporation or domestic partnership is a specified domestic entity.
First, in determining whether a domestic corporation or domestic partnership meets the reporting thresholds, domestic corporations and domestic partnerships that are closely held by the same specified individual are treated as a single entity.
Second, for purposes of determining whether a corporation or partnership meets the passive income/asset tests, domestic corporations and domestic partnerships that are closely held by the same individual and that are connected through stock or partnership interest ownership with a common parent corporation or partnership are treated as a single entity.
A domestic trust is considered a specified domestic entity if it has an interest in specified foreign financial assets (other than assets excepted from reporting) with an aggregate value exceeding the $50,000/$75,000 reporting threshold and at least one specified person as a current beneficiary.
A domestic entity is not considered to be a specified domestic entity if it is described in Section 1473(3) and the regulations thereunder as excepted from the definition of the term “specified United States person”. This exception does not apply to any trust that is exempt from tax under Section 664(c).
A domestic trust is not 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.
Foreign Financial Asset (“FFA”)
A specified person must file Form 8938 if they are deemed to hold a FFA. An FFA includes (1) any financial account maintained by a foreign financial institution; and (2) other foreign financial assets that are held for investment and not held in an account maintained by a financial institution.
The foreign financial account held by a foreign financial institution (“FFI”) includes bank accounts and brokerage accounts. An FFI does not include deposits at a domestic branch of a foreign bank or insurance company or deposits at a foreign branch or subsidiary of a U.S. financial institution.
Generally, to be treated as an FFI, the financial institution must provide one of the following: (1) Accepts deposits in the ordinary course of a banking or similar business; (2) holds financial assets for the account of others as a substantial part of its business; or (3) is engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests, or commodities or interests in such items.
The broad definition of an FFI will generally include many foreign mutual funds, hedge funds and private equity funds. An FFA also includes other specified foreign assets held for investment. Examples include:
Stock issued by a foreign corporation;
Capital or profits interest in a foreign partnership (Includes partnership or CFC used to own principal residence);
Note, bond, debenture or other form of indebtedness issued bya foreign person;
Interest in a foreign trust or estate;
Life insurance with cash value;
Option or derivative instrument entered into with any foreign counterparty or issuer.
The taxpayer is deemed to hold an interest in the financial account if any income, gains, losses, deductions, credits, gross proceeds, or distributions from holding or disposing of the asset are, or would be, reportable on the individual’s tax return. Note, an individual is considered to have an interest in the current year even if the current year’s activities do not result in any item being reported on the current year’s tax return.
The reporting threshold varies dependent on whether the taxpayer is living in the US or abroad. The reporting thresholds are as follows:
1. Taxpayer Living in the US:
Files Unmarried, Married Filing Separately: Must file if value of specified foreign assets is greater than $50,000 on the last day of the tax year or greater than $75,000 on any day during the tax year.
Files Married Filing Jointly: Must file if value of specified foreign assets is greater than $100,000 on the last day of the tax year or greater than $150,000 on any day during the tax year.
2. Taxpayer Living Abroad:
Files Unmarried, Married Filing Separately: Must file if value of specified foreign assets is greater than $200,000 on the last day of the tax year or greater than $300,000 on any day during the tax year.
Files Married Filing Jointly: Must file if value of specified foreign assets is greater than $400,000 on the last day of the tax year or greater than $600,000 on any day during the tax year.
Failing to file a timely and complete Form 8938 could expose a taxpayer to a potential penalty of $10,000. If the IRS notifies the taxpayer of reporting failure and failure continues for more than 90 days, an additional penalty of $10,000 may be assessed for each 30-day period that failure persists, up to an additional $50,000.
In addition, a taxpayer may face a 40% accuracy-related penalty on any underpayment of tax attributable to any transaction involving an undisclosed foreign financial asset (e.g., fail to report ownership of shares in a foreign company on Form 8938 and gain on sale of these shares is not reported on income tax return). However, a reasonable cause and good faith exception may apply under section 6664(c) may apply.
Penalties apply to tax years beginning after March 18, 2010.
FATCA & Offshore Voluntary Disclsoure Attorneys
FATCA & Offshore Voluntary Disclosure attorneys at Harlowe & Falk are based in the greater Seattle area and assist clients nationally understand FATCA, and can help determine whether you have a filing requirement.
IRS CIRCULAR 230 NOTICE: ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY HARLOWE & FALK LLP TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.