REPORTING FOREIGN INCOME AND ASSETS

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2 Hour(s) - Other Federal Tax
CTEC Provider #: 6209 CTEC Course #: 6209-CE-0035
IRS Provider #: UBWMF IRS Course #: UBWMF-T-00211-21-S
NASBA: 116347
The information provided in this publication is for educational purposes only, and does not necessarily reflect all laws, rules, or regulations for the tax year covered. This publication is designed to provide accurate and authoritative information concerning the subject matter covered, but it is sold with the understanding that the publisher is not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.
To the extent any advice relating to a Federal tax issue is contained in this communication, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.
COURSE OVERVIEW.............................................................................................................................................................. 7
Streamlined Filing Compliance Procedures.............................................................................................................................17
GLOSSARY .......................................................................................................................................................................... 27
COURSE OVERVIEW
COURSE DESCRIPTION Reporting of foreign assets, accounts, and income are now high on the agenda for the IRS, and severe penalties may be imposed, even for innocent missteps. The complex nature of the requirements, coupled with a lack of familiarity shared by many taxpayers and practitioners makes these issues particularly important today. This course is designed to provide you with the tools necessary to tackle these issues effectively and efficiently.
LEARNING OBJECTIVES In this course, you will learn about the various requirements for reporting foreign income and assets.
Recognize the basic rules for income tax reporting of foreign earned income.
Identify the foreign financial asset reporting requirements on IRS Form 8938.
Define the FBAR filing requirements for foreign financial accounts.
REPORTING FOREIGN INCOME, ACCOUNTS, AND ASSETS
INTRODUCTION: PREPARERS BEWARE The IRS has gotten serious about foreign income, account, and asset reporting. It is not just wealthy international financiers who need to be concerned – the average taxpayer with a small bank account in Canada could face penalties of up to $250,000 and five years in prison and even those whose failure to file is not “willful” are subject to substantial penalties. Furthermore, penalties may be imposed not only of the taxpayers who fail to adequately report their holdings, but also on the preparers who may not have been diligent enough in discovering this information.
The Office of Professional Responsibility (“OPR”) enforces the provisions of Circular 230, which requires that tax preparers use due diligence in preparing returns. Section 10.22 of Circular 230 specifically imposes a duty of due diligence not only in the preparation of returns, but also in determining the accuracy of representations, both oral and written, made to the IRS.
These provisions do not require a preparer to audit a return or physically examine the taxpayer’s documentation supporting the representations made on the return, but they do give rise to an obligation to make reasonable inquiries. Thus, when a client provides information that suggests the possible existence or offshore accounts or overseas transactions, the preparer may be exposed to penalties if he or she fails to appropriately investigate further.
The prudent preparer should realize that placing too much trust or confidence in the veracity of your client’s representations or their capacity for completeness might be risky business. OPR issued a statement in 2009 indicating that many foreign account holders who are penalized for failure to report these accounts place the blame squarely on the shoulders of their return preparers (surprise, surprise). Because a taxpayer may be able to eliminate or reduce penalties by claiming reasonable reliance on a qualified tax professional, turning on the preparer is a common occurrence. Commonly the taxpayer will claim that their return preparer did not inquire about or adequately explain the foreign account requirements.
Consequently, it is imperative that preparers not only understand the rules for reporting foreign income, accounts, and other assets, it is advisable that the inquiries and answers in this regard be documented in writing. This course provides a basic outline of the reporting requirements and suggests actions that preparers should take to not only ensure the compliance of their clients, but also to limit their own exposure to penalties for inadvertent errors.
8 Reporting Foreign Income, Accounts, and Assets
TAXATION OF FOREIGN INCOME U.S. CITIZENS
In General
Under Internal Revenue Code (“Code”) § 911, U.S. citizens are subject to federal income tax on their worldwide income, regardless of where they reside. Moreover, a U.S. citizen is subject to the same income tax filing requirements regardless of whether they live within the United States or abroad. This is true whether or not the U.S. citizen receives a Form W-2 Wage and Tax Statement, a Form 1099 Information Return, or the foreign equivalents. Additionally, the rules for making estimated tax payments are generally the same whether the taxpayer is living in the U.S. or abroad.
Despite the general similarity in application of the tax rules, there are some special considerations for U.S. citizens living abroad. For example, if a taxpayer meets certain requirements, he or she may qualify for the foreign earned income and foreign housing exclusions and the foreign housing deduction. Under these provisions, the taxpayer may be able to exclude from income up to $108,700 for 2021 (adjusted annually for inflation) of foreign earnings in addition to excluding or deducting certain amounts related to foreign housing.
There are three basic requirements that must be met to claim these exclusions or deduction. First, the taxpayer’s tax home must be in a foreign country. Second, the taxpayer must have received foreign earned income. Finally, the citizen or resident of the U.S. must have been a bona fide resident of a foreign country for the entire taxable year or present in a foreign country for at least 330 full days during any period of 12 consecutive months.
Qualified taxpayers can elect to take the foreign earned income election by filing Form 2555 with their tax return. Note, however, that the amount of foreign tax paid will be allocated based on total foreign source income, and any foreign tax allocated to the excluded foreign earned income cannot qualify for a tax credit. Thus, taxpayers are faced with the choice of excluding their foreign income or taking the full foreign tax credit.
Foreign Earned Income
In general, “earned income” includes pay for personal services performed, such as wages, salaries, or professional fees. Businesses in which the services of the taxpayer produce income will also give rise to earned income. Income generated solely from the investment of capital will not constitute earned income.
The source of a taxpayer’s income is the place where he or she performs the services for which the income is received. Thus, foreign earned income is income taxpayer receives for working in a foreign country. Where or how the taxpayer is paid has no effect on the source of the income. For example, income a taxpayer receives for work done in Austria is income from a foreign source even if the income is paid directly to the taxpayer’s bank account in the United States and the taxpayer’s employer is located in New York City.
On the other hand, earned income does not include the value of meals or lodging that the taxpayer excludes from his income because the meals and lodging were furnished for his employer’s convenience, nor does it include pension, annuity, or social security payments. Wages the taxpayer receives as an employee of the U.S. Government are not considered foreign earned income regardless of the taxpayer’s post of duty. Other types of income are excluded as well; such as amounts the taxpayer includes in his or her income because of an employer’s contribution to a nonexempt employee trust or to a nonqualified annuity contract.
“Foreign earned income” generally includes income the taxpayer receives for services he or she performs during a period in which both the following requirements are met. First, the taxpayer’s tax home must be in a foreign country. A taxpayer’s tax home is the general area of his or her main place of business, employment, or post of duty, regardless of where he or she actually lives. Thus, the tax home is the place where the taxpayer is permanently or indefinitely engaged to work as an employee or self-employed individual.
However, it’s worth noting that having a “tax home” in a given location does not necessarily mean that the given location is the taxpayer’s residence or domicile for tax purposes. Furthermore, a taxpayer is not considered to have a
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tax home in a foreign country for any period in which his or her domicile is in the United States. For example, if the taxpayer is employed on an offshore oil rig in the territorial waters of a foreign country and works a 28-day on/28-day off schedule, returning to his family residence in the United States during his off periods, he is considered to be domiciled in the United States and does not satisfy the tax home test in the foreign country. Under these circumstances, the taxpayer could not claim either of the exclusions or the housing deduction.
Second, the taxpayer must meet either the bona fide residence test or the physical presence test. The bona fide residence test is met if the taxpayer establishes that he or she is a bona fide resident of one or more foreign countries for an uninterrupted period that includes an entire tax year. The bona fide residence status does not require that the taxpayer intend to remain abroad permanently or that he or she spends a specific number of days in the foreign country. Instead, this test is based on all of the facts and circumstances. For example, suppose the taxpayer goes to London to work for an indefinite period of time and sets up permanent quarters there for herself and her family. Under these circumstances, the taxpayer probably has established a bona fide residence in a foreign country, even though she may intend to return to the United States eventually.
Furthermore, brief or temporary trips back to the U.S. or to other countries during the tax year will not prohibit the taxpayer from being considered a bona fide resident, as long as their clear intention is to return to the foreign country from such trips without unreasonable delay.
Example:
Taxpayer A is the Lisbon representative of a U.S. employer. The taxpayer arrived with his family in Lisbon on November 1, 20x1. The taxpayer’s assignment is indefinite, and he intends to live in Lisbon with his family until the employer sends him to a new post of duty. Thus, Taxpayer A immediately establishes residence there. On April 1, 20x2, Taxpayer A arrives in the United States to meet with his employer, leaving his family in Lisbon. The taxpayer returns to Lisbon on May 1. On January 1, 20x3, Taxpayer A completed an uninterrupted period of residence for a full tax year (20x2) and may qualify as a bona fide resident of a foreign country.
On the other hand, if Taxpayer A is transferred back to the United States on December 15, 20x2, they would not meet the bona fide residence test. Although they may have been a bona fide resident for more than one year (November 1, 20x1 – December 15, 20x2), it was not the entire tax year of Taxpayer A (January 1 – December 31, 20x2).
In order to determine whether a taxpayer meets the bona fide residence test, the IRS will take into account all of the facts and circumstances reported on Form 2555. As such, the IRS cannot make this determination until the taxpayer files Form 2555.
Practice Tip:
Because a determination under the bona fide residence test will be based on the information contained on Form 2555, this form should be completed thoughtfully and thoroughly. Any fact that supports the conclusion that the taxpayer intended to remain abroad indefinitely or for an extended period should be included. Facts such as the purchase of real estate or the long-term lease of a home, obtaining a foreign driver’s license, and disposing of the taxpayer’s U.S. home should be emphasized, as appropriate.
Unlike the bona fide residence test, the physical presence test is based solely on how long the taxpayer remains in a foreign country. Specifically, a taxpayer meets the physical presence test if he or she is physically present in one or more foreign countries for at least 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive and do not have to occur in the same tax year. The physical presence test is thus a more mechanical measure than the bona fide residence test and is not determined by reference to other factors, such as the taxpayer’s intent. Also note that, although absences that result in a physical presence for less than the requisite 330 days will normally cause the taxpayer to fail the physical presence test, the taxpayer can be physically present in a foreign country for less than 330 full days and still meet the test if the absence is due to war or civil unrest.
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When a U.S. citizen meets the above requirements, he or she can choose to exclude any amount of his or her foreign earned income, up to a maximum that is adjusted annually for inflation. The 2020 maximum exclusion was $107,600; the amount increases to $108,700 for 2021. Because the foreign earned income exclusion is voluntary, the taxpayer must affirmatively elect the exclusion by completing the appropriate parts of Form 2555.
Once elected, the foreign earned income exclusion remains in effect for all later years unless and until revoked. Making the election prohibits the taxpayer from taking a foreign tax credit of deduction for taxes paid on the excluded income. Although the election is normally revoked by attaching a statement to the taxpayer’s return for the year of revocation, the election to use the exclusion is also considered revoked in any subsequent year the taxpayer actually claims a foreign tax credit or deduction. Once revoked, the election cannot be chosen again for five years unless the taxpayer obtains permission from the IRS.
Foreign Housing
In addition to the foreign earned income exclusion, a taxpayer can also claim an exclusion or a deduction from gross income for housing expenses. Like the foreign earned income exclusion, this benefit applies only if the taxpayer’s tax home is in a foreign country and he or she qualifies under either the bona fide residence test or the physical presence test.
The relevant amount for this benefit is the taxpayer’s total housing expenses for the year (including reasonable expenses paid or incurred for housing in a foreign country for the taxpayer and any spouse or dependents) minus the “base housing amount.” The “base housing amount” computation is tied to the maximum foreign earned income exclusion. The amount is 16% of the exclusion amount (computed on a daily basis), multiplied by the number of days in his qualifying period that fall within the taxpayer’s tax year.
Example:
Assume the taxpayer’s total housing expenses were $18,800 in 2021 and that the qualifying period includes all of 2021. The maximum foreign earned income exclusion for 2021 is $108,700 per year. Sixteen percent of the 2021 maximum exclusion is $17,392 ($108,700 × 16%) or $47.65 per day ($17,392 ÷ 365). Thus, under these circumstances, the taxpayer’s maximum housing amount for 2021 would be $1,408 ($18,800 – $17,392).
There is a distinction between the housing exclusion and the housing deduction. The housing exclusion applies only to amounts that are considered paid with employer-provided amounts. If the taxpayer does not have any self- employment income, all of his or her earned income would be from employer-provided amounts, and thus the entire housing amount would be considered as being paid with those employer-provided amounts.
On the other hand, the housing deduction applies only to amounts that are considered paid with self-employment earnings. If the taxpayer does not have self-employment income, he cannot take a foreign housing deduction. If the taxpayer has both employee income and income from self-employment, both an exclusion and a deduction may be available.
Example:
Assume the taxpayer’s housing amount for the year is $12,000. During the year the taxpayer has total foreign earned income of $80,000 of which half is from services performed as an employee and half is from self-employment. Under these circumstances, the taxpayer could exclude $6,000 (half of his or her housing amount) and deduct $6,000.
The foreign housing exclusion is elected by completing IRS Form 2555 and is the lesser of the taxpayer’s total foreign earned income or the housing amount paid with employer-provided funds. The housing exclusion is determined before figuring the amount of the foreign earned income exclusion. Furthermore, the housing exclusion is an all-or- nothing proposition: the taxpayer must take the entire amount of the exclusion or none of it.
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The housing deduction is limited to the taxpayer’s foreign earned income reduced by the sum of his or her foreign earned income exclusion plus the housing exclusion. Any amount not allowed by this limitation can be carried over indefinitely. Like the foreign housing exclusion, the housing deduction is claimed using IRS Form 2555.
U.S. RESIDENTS
United States income tax is generally imposed on the worldwide income of U.S. citizens, as well as U.S. residents. As such, it is important to determine if a foreign citizen qualifies as a U.S. resident.
In General
A “U.S. resident” is defined as a foreign citizen or national who meets either of two tests: the green card test or the substantial presence test. Note, however, that this definition only applies for purposes of determining a foreign individual’s U.S. income tax liability; it does not apply for estate or gift tax purposes.
Residency Tests
Green Card Test
One way to qualify as a resident for U.S. income tax purposes is for the foreign citizen to be a lawful permanent resident (green card holder) under U.S. immigration laws. The green card test is based on the foreign citizen’s lawful presence in the United States, not on his or her physical presence. Thus, until such time as his or her permanent resident alien status under U.S. immigration law is officially revoked or abandoned, a green card holder will continue to be treated as a U.S. resident regardless of the amount of time he or she is physically present in the United States.
Substantial Presence Test
Unlike the green card test, the substantial presence test focuses on an alien’s physical presence in the United States and applies to individuals who are holders of nonimmigrant visas. In order to meet the substantial presence test, an alien must satisfy two requirements. First, the alien must be present in the United States for at least 31 days during the current calendar year. Second, the sum of (1) the number of days of U.S. presence during the current calendar year, plus (2) one-third of the U.S. days during the first preceding calendar year, plus (3) one-sixth of the U.S. days during the second preceding calendar year, must equal or exceed 183 days.
Example:
Individual A, a foreign citizen, was physically present in the United States on 120 days in each of the years 20x1, 20x2, and 20x3. To determine if the alien meets the substantial presence test for 20x3, count the full 120 days of presence in 20x3, 40 days in 20x2 (1/3 of 120), and 20 days in 20x1 (1/6 of 120). Because the total for the 3-year period is only 180 days (120 + 40 + 20), the alien is not considered a resident under the substantial presence test for 20x3.
There are two main exceptions to the substantial presence test: the exempt-individual exception and the closer- connection-to-a-foreign-country exception. Under the exempt-individual exception, an alien will not be treated as being present in the United States on any day in which the alien is considered an “exempt individual”. An exempt individual is anyone temporarily present in the United States as a foreign government-related individual, a teacher or trainee holding a “J” or “Q” visa, a student holding either an “F,” “J,” “M,” or “Q” visa, or a professional athlete temporarily in the United States to compete in a charitable sports event.
Under the closer-connection-to-a-foreign-country exception, an alien who would otherwise meet the substantial presence test is treated as not meeting the test for the current calendar year if: (1) the alien is present in the United States for fewer than 183 days during the current year, (2) the alien maintains a tax home in a foreign country during the current year, and (3) the alien has a closer connection during the current year to a single foreign country in which he or she maintains a tax home than to the United States.
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First-Year Election
If an alien arrived in the United States too late during the year to pass the substantial presence test, or if the alien was an exempt individual during the first part of the year and then the alien changed visas later in the year, the alien would be classified as a nonresident alien for the entire calendar year unless he or she makes a special election. Under this special election provision, the alien can be treated as a resident alien from his date of arrival if he or she satisfies the following five tests. First, the alien was not otherwise a resident alien for the year. Second, the alien was not a resident alien at any time in the immediately preceding year. Third, the alien is a resident alien under the substantial presence test for the immediately following year. Fourth, the alien is present in the United States during the election year for a period of at least 31 consecutive days. Finally, the alien’s days of U.S. presence must be 75% or more of the total days between the beginning of the earliest 31 consecutive day period and December 31 of the election year. If the alien meets the tests and makes this first-year election, he will be a dual-status alien.
Tax Treaties
It should be noted that the rules described above for determining U.S. residency do not override tax-treaty residency rules. Therefore, if an alien is a U.S. resident under the Code but is treated as a resident of a treaty country under the tie-breaker provisions of an income tax treaty, the alien may elect to be treated as a nonresident of the United States for matters within the scope of the treaty.
FBAR REQUIREMENTS (FINCEN FORM 114) HISTORY AND BACKGROUND OF FBAR REQUIREMENTS
The foreign bank account reporting requirements (“FBAR”) dates back to the Bank Secrecy Act of 1970. The overall purpose of the FBAR requirement is to require records and reports that can assist various government agencies in criminal, tax or regulatory investigations or proceedings and in the conduct of intelligence or counterintelligence activities, including anti-terrorist activities. In keeping with the focus on money laundering, enforcement authority for the FBAR was delegated to the director of the Financial Crimes Enforcement Network (“FinCEN”), a government-wide financial intelligence and analysis network established within the U.S. Department of the Treasury.
In 2003, FinCEN re-delegated FBAR-related enforcement authority to the IRS in the context of the IRS’s investigations into offshore bank payment cards and its Offshore Voluntary Compliance Initiative. This re-delegation represented a significant step in the evolution of the FBAR, from a tool primarily used to combat money laundering to a weapon in the IRS’s tax enforcement arsenal.
In recent years, the IRS has increased efforts to crack down on offshore tax evasion. The Obama Administration and members of Congress have aimed at combating offshore tax avoidance and evasion after the controversy on bank secrecy in general and made some proposals relating directly to existing FBAR requirements. For example, the Obama Administration’s fiscal year 2010 budget proposal includes a provision requiring individual taxpayers to provide the information required by the FBAR on their individual income tax returns in addition to filing the FBAR itself. Failure to file the FBAR would remain subject to FBAR penalties and failure to disclose the same information on the tax return could be subject to additional penalties under the Code. In such an environment, taxpayers and tax practitioners must become increasingly sensitive to FBAR requirements that were not always fully understood or complied with in the past.
FILING REQUIREMENTS
U.S. persons that have a financial interest in or signature authority over at least one financial account located outside of the United States having an aggregate value exceeding $10,000 at any time during the calendar year must file IRS FinCEN Form 114, Report of Foreign Bank and Financial Accounts, otherwise known as the FBAR. Effective July 1, 2013, FBARs must be filed electronically.
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The Surface Transportation and Veterans Health Care Choice Act of 2015 modified the filing deadline for FinCEN Form 114. Specifically, the due date of the FBAR report has been changed from June 30 for all taxpayers to April 15 with an automatic 6-month extension until October 15, to coincide with the federal income tax filing season. Specific requests for the automatic 6-month extension are not required. This provision applies for tax years beginning after December 15, 2015.
According to IRS, “the FBAR is required because foreign institutions may not be subject to the same reporting requirements as domestic financial institutions.” The IRS uses the FBAR as a tool to help the United States government identify persons who may be using foreign financial accounts to circumvent United States tax law, as well as to help identify or trace funds used for illicit purposes or to identify unreported income maintained or generated abroad.
DEFINITIONS
United States Person
As indicated above, the FBAR filing requirements apply to U.S. persons. For this purpose, a U.S. person is defined to include: United States citizens; United States residents; entities (including but not limited to, corporations, partnerships, or limited liability companies) created or organized in the United States or under the laws of the United States; and trusts or estates formed under the laws of the United States.
Financial Interest
A U.S. person has a financial interest in a foreign financial account for which:
The United States person is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the United States person or for the benefit of another person; or
The owner of record or holder of legal title is one of the following:
An agent, nominee, attorney, or a person acting in some other capacity on behalf of the United States person with respect to the account;
A corporation in which the United States person owns directly or indirectly: (i) more than 50 percent of the total value of shares of stock or (ii) more than 50 percent of the voting power of all shares of stock;
A partnership in which the United States person owns directly or indirectly: (i) an interest in more than 50 percent of the partnership's profits (e.g., distributive share of partnership income taking into account any special allocation agreement) or (ii) an interest in more than 50 percent of the partnership capital;
A trust of which the United States person: (i) is the trust grantor and (ii) has an ownership interest in the trust for United States federal tax purposes. See 26 U.S.C. sections 671-679 to determine if a grantor has an ownership interest in a trust;
A trust in which the United States person has a greater than 50 percent present beneficial interest in the assets or income of the trust for the calendar year; or
Any other entity in which the United States person owns directly or indirectly more than 50 percent of the voting power, the total value of equity interest or assets, or interest in profits.
Signatory Authority
Signature authority is the authority of an individual (alone or in conjunction with another individual) to control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account.
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Financial Account
The term “financial account” includes, but is not limited to, a securities, brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution (or other person performing the services of a financial institution). A financial account also includes a commodity futures or options account, an insurance policy with a cash value (such as a whole life insurance policy), an annuity policy with a cash value, and shares in a mutual fund or similar pooled fund (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions).
The term also includes any accounts in which the assets are held in a commingled fund where the account owner holds an equity interest in the fund (including mutual funds). There has been some confusion regarding the term “commingled fund” and very little guidance. As a result, the IRS announced that it will not interpret the term “commingled fund” as applying to funds other than mutual funds with respect to FBARs for the calendar year 2009 and prior years. Additional guidance has not yet been issued.
One that is clear is that the FBAR requirements apply only to “accounts.” Individual bonds, notes, or stock certificates held directly by the taxpayer are not “accounts.” Furthermore, an unsecured loan to a foreign trade or business that is not a financial institution does not constitute a foreign financial account.
Foreign Financial Account
The instructions for filing the FBAR define a foreign financial account as a financial account located outside of the United States. For example, an account maintained with a branch of a United States bank that is physically located outside of the United States is a foreign financial account. On the other hand, an account maintained with a branch of a foreign bank that is physically located in the United States is not a foreign financial account.
EXCEPTIONS
Certain Accounts Jointly Owned by Spouses
The spouse of an individual who files an FBAR is not required to file a separate FBAR if the following conditions are met: (1) all the financial accounts that the non-filing spouse is required to report are jointly owned with the filing spouse; (2) the filing spouse reports the jointly owned accounts on a timely filed FBAR; and (3) both spouses sign the FBAR in Item 44. Otherwise, both spouses are required to file separate FBARs, and each spouse must report the entire value of the jointly owned accounts.
IRA Owners and Beneficiaries
An owner or beneficiary of an IRA is not required to report a foreign financial account held in the IRA.
Participants in and Beneficiaries of Tax-Qualified Retirement
A participant in or beneficiary of a retirement plan described in Code § 401(a), 403(a), or 403(b) is not required to report a foreign financial account held by or on behalf of the retirement plan.
Certain Persons Having Signature Authority
The instructions for filing the FBAR state that individuals who have signature authority over, but no financial interest in, a foreign financial account are not required to report the account. The following specific situations are addressed:
An officer or employee of a bank that is examined by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, or the National Credit Union Administration is not required to report signature authority over a foreign financial account owned or maintained by the bank.
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An officer or employee of a financial institution that is registered with and examined by the Securities and Exchange Commission or Commodity Futures Trading Commission is not required to report signature authority over a foreign financial account owned or maintained by the financial institution.
An officer or employee of an Authorized Service Provider is not required to report signature authority over a foreign financial account that is owned or maintained by an investment company that is registered with the Securities and Exchange Commission. Authorized Service Provider means an entity that is registered with and examined by the Securities and Exchange Commission and provides services to an investment company registered under the Investment Company Act of 1940.
An officer or employee of an entity that has a class of equity securities listed (or American depository receipts listed) on any United States national securities exchange is not required to report signature authority over a foreign financial account of such entity.
An officer or employee of a United States subsidiary is not required to report signature authority over a foreign financial account of the subsidiary if its United States parent has a class of equity securities listed on any United States national securities exchange and the subsidiary is included in a consolidated FBAR report of the United States parent.
An officer or employee of an entity that has a class of equity securities registered (or American depository receipts in respect of equity securities registered) under section 12(g) of the Securities Exchange Act is not required to report signature authority over a foreign financial account of such entity.
Trust Beneficiaries
A beneficiary of a trust in which a U.S. person has a greater than 50 percent present beneficial interest in the assets or income of the trust for the calendar year is not required to report the trust's foreign financial accounts on an FBAR if the trust, trustee of the trust, or agent of the trust: (1) is a United States person, and (2) files an FBAR disclosing the trust's foreign financial accounts.
Accounts on Military Installations
A financial account maintained with a financial institution located on a United States military installation located outside of the United States is not required to be reported.
PENALTIES
There are a variety of penalties that may be imposed for failures related to the FBAR reporting and recordkeeping requirements. The FBAR penalties include both civil penalties and criminal penalties.
Civil Penalties
A person who fails to comply with the FBAR reporting and recordkeeping requirements may be subject to civil penalties (civil penalty maximums are adjusted annually for inflation). For example, a person who is required to file an FBAR and fails to properly file may be subject to a civil penalty. Note that the amount of civil penalty imposed depends on if the violation is willful or non-willful. Like penalties imposed under the Code, however, if there is reasonable cause for the failure and the balance in the account is properly reported, no penalty will be imposed. Of course, it is up to the taxpayer to convince the IRS that reasonable cause exists.
Civil Penalty for Willful Violation
There are several circumstances under which a person may be subject to a civil monetary penalty up to the greater of $134,806 (Willful Violation of Transaction, maximum for penalties assessed on or after 2/19/2020) or 50 percent of the amount in the foreign financial account at the time of the violation. These penalties apply to any person who willfully fails to report an account or account identifying information or fails to file FBAR or retain records of account. They
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also apply if a person willfully fails to file FBAR or retain records of account while violating certain other laws, or if a person knowingly and willfully files a false FBAR.
The Federal District Court for the Eastern District of Virginia had an opportunity to review the parameters of the “willful” requirement in a 2010 case. The court noted that, while “willfully” is a word of many meanings whose construction is often dependent on the context in which it appears, the Supreme Court has clarified that “where willfulness is a statutory condition of civil liability, it is generally taken to cover not only knowing violations of a standard but reckless ones as well.” Importantly, the court noted that a single, or even a few, inadvertent errors would not amount to a “willful” violation. At some point, however, a repeated failure to comply with known regulations can transform conduct from inadvertent neglect into reckless or deliberate disregard (and thus willfulness).
Civil Penalty for Non-Willful Violation
On the other hand, if a person commits a negligent, though not willful, violation for not complying with the FBAR reporting and recordkeeping requirements, he or she may be subject to a civil penalty up to $13,481 (Non-Willful Violation of Transaction, maximum for penalties assessed on or after 2/19/2020) for each negligent violation. Note that negligence does not involve any intent, and is in fact defined as an unintentional violation. Furthermore, a federal district court has held that the FBAR penalties are not dischargeable in bankruptcy, rejecting the taxpayer’s argument that the penalties, in fact, constitute a tax.
Criminal Penalties
Generally speaking, a person who willfully fails to comply with the FBAR reporting and recordkeeping requirements can also be subject to criminal penalties. The criminal penalty for a willful failure to file FBAR or retain records of account is a fine of up to $250,000 or 5 years in prison or both. If a person willfully fails to file the FBAR or retain records of account while violating certain other laws, he or she may face criminal fines of up to $500,000 or 10 years in prison or both. Also, if a person knowingly and willfully files a false FBAR, criminal fines are $10,000 or 5 years in prison or both. Note that the civil and criminal penalties are not mutually exclusive and may be imposed together.
OFFSHORE VOLUNTARY DISCLOSURE INITIATIVE
On February 8, 2011, the Internal Revenue Service announced its second Offshore Voluntary Disclosure Initiative (“OVDI”), which was designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts become current with their taxes. The OVDI covered calendar years 2003 to 2010 and was available through September 9, 2011, for individuals as well as entities such as corporations, trusts, and partnerships.
U.S. taxpayers with undisclosed foreign financial assets now have three options for complying: (1) the offshore voluntary disclosure program; (2) streamlined filing compliance procedures; and (3) delinquent FBAR submission procedures.
In order to encourage participation in the OVDI, the OVDI eliminates the risk of criminal prosecution for taxpayers that are accepted into the program and provides for reduced civil penalties compared to those that would apply if the IRS were to discover the taxpayer’s noncompliance. Generally speaking, taxpayers who took advantage of the program paid any taxes due on account earnings and a penalty of 25% of the highest aggregate account balance in the taxpayer’s foreign bank accounts during the years 2003 through 2010. This penalty was in lieu of all other penalties that might apply, except for the failure to file, failure to pay, and accuracy-related penalties. Taxpayers with offshore accounts of less than $75,000 in each calendar year covered by the OVDI qualified for a 12.5% penalty rate. In some circumstances, such as where the taxpayer was a foreign resident and unaware they had a filing obligation, the taxpayer could qualify for a 5% penalty rate.
On January 9, 2012, the IRS announced that it was reopening its voluntary disclosure initiative for the third time, in response to the US government's continuously widening investigation of foreign banks relating to unreported offshore
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accounts of U.S. persons. Generally speaking, the new initiative is similar to the 2011 program with a few key differences. First, unlike the earlier programs, there was no set deadline for people to apply. However, the IRS has stated that it may change the terms of the program at any time. For example, the IRS retained the right to increase the penalties in the program or to end the program entirely. The second key difference is that individuals had to pay a penalty of 27.5% of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period. This is increased from 20% in the first program and 25% in the 2011 program. Some taxpayers will be eligible for 12.5% or 5% penalties, similar to the 2011 program. Participants in the OVDI also must pay back-taxes and interest for up to eight years, as well as paying accuracy-related and/or delinquency penalties.
The Offshore Voluntary Disclosure Program (OVDP) launched in 2012, followed voluntary disclosure programs offered in 2011 and 2009. The 2012 OVDP went through another round of minor modifications and was further continued in 2014. The 2014 OVDP began as a modified version of the 2012 OVDP. The 2014 OVDP, effective July 1, 2014, followed essentially the same path as the 2012 OVDP and was open-ended in its duration. The 2014 OVDP has closed, effective September 28, 2018. Pursuant to the Updated Voluntary Disclosure Practice, issued on November 20, 2018, the IRS announced the closing of the Offshore Voluntary Disclosure Program (2014 OVDP) effective September 28, 2018.
STREAMLINED FILING COMPLIANCE PROCEDURES On June 26, 2012, the IRS announced new streamlined filing compliance procedures for non-resident U.S. taxpayers that went into effect on September 1, 2012. These procedures were implemented in recognition that some U.S. taxpayers living abroad have failed to timely file U.S. federal income tax returns or FBAR reports, but have recently become aware of their filing obligations and now seek to come into compliance with the law. These new procedures are for non-residents including, but not limited to, dual citizens who have not filed U.S. income tax and information returns.
This streamlined procedure is designed for taxpayers that present a low compliance risk. All submissions will be reviewed, but, as discussed below, the intensity of review will vary according to the level of compliance risk presented by the submission. For those taxpayers presenting low compliance risk, the review will be expedited and the IRS will not assert penalties or pursue follow-up actions. Submissions that present higher compliance risk are not eligible for the streamlined processing procedures and will be subject to a more thorough review and possibly a full examination, which in some cases may include more than three years, in a manner similar to opting out of the Offshore Voluntary Disclosure Program.
Taxpayers utilizing this procedure will be required to file delinquent tax returns, with appropriate related information returns (e.g. Form 3520 or 5471), for the past three years and to file delinquent FBARs for the past six years. Payment for the tax and interest, if applicable, must be remitted along with delinquent tax returns. In addition, retroactive relief for failure to timely elect income deferral on certain retirement and savings plans where deferral is permitted by relevant treaty is available through this process. The proper deferral elections with respect to such arrangements must be made with the submission.
The streamlined procedure was originally only available for non-resident U.S. taxpayers who have resided outside of the U.S. since January 1, 2009 and who have not filed a U.S. tax return during the same period. These taxpayers must also present a “low level of compliance risk” (described below). In 2014 the program was expanded to certain U.S. taxpayers residing in the United States. The changes included:
Eliminating a requirement that the taxpayer have $1,500 or less of unpaid tax per year;
Eliminating the required risk questionnaire;
Requiring the taxpayer to certify that previous failures to comply were due to non-willful conduct.
Individual U.S. taxpayers, or estates of individual U.S. taxpayers, seeking to use the Streamlined Domestic Offshore Procedures must: (1) fail to meet the applicable non-residency requirement (for joint return filers, one or both of the spouses must fail to meet the applicable non-residency requirement); (2) have previously filed a U.S. tax return (if
required) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed; (3) have failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR (FinCEN Form 114, previously Form TD F 90-22.1) and/or one or more international information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) with respect to the foreign financial asset, and (4) such failures resulted from non-willful conduct.
U.S. taxpayers (U.S. citizens, lawful permanent residents, and those meeting the substantial presence test of Code section 7701(b)(3)) eligible to use the Streamlined Domestic Offshore Procedures must: (1) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed (the “covered tax return period”), file amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621); (2) for each of the most recent 6 years for which the FBAR due date has passed (the “"covered FBAR period”), file any delinquent FBARs (FinCEN Form 114, previously Form TD F 90-22.1); and (3) pay a Title 26 miscellaneous offshore penalty. The full amount of the tax, interest, and miscellaneous offshore penalty due in connection with these filings should be remitted with the amended tax returns.
The miscellaneous offshore penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer’ foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period. For this purpose, the highest aggregate balance/value is determined by aggregating the year-end account balances and year-end asset values of all the foreign financial assets subject to the miscellaneous offshore penalty for each of the years in the covered tax return period and the covered FBAR period and selecting the highest aggregate balance/value from among those years.
A foreign financial asset is subject to the 5-percent miscellaneous offshore penalty in a given year in the covered FBAR period if the asset should have been, but was not, reported on an FBAR (FinCEN Form 114) for that year. A foreign financial asset is subject to the 5-percent miscellaneous offshore penalty in a given year in the covered tax return period if the asset should have been, but was not, reported on a Form 8938 for that year. A foreign financial asset is also subject to the 5-percent miscellaneous offshore penalty in a given year in the covered tax return period if the asset was properly reported for that year, but gross income in respect of the asset was not reported in that year.
A taxpayer who is eligible to use these Streamlined Domestic Offshore Procedures and who complies with all of the instructions will be subject only to the miscellaneous offshore penalty and will not be subject to accuracy-related penalties, information return penalties, or FBAR penalties. Even if returns properly filed under these procedures are subsequently selected for audit under existing audit selection processes, the taxpayer will not be subject to accuracy- related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original return was fraudulent and/or that the FBAR violation was willful. Any previously assessed penalties with respect to those years, however, will not be abated. Further, as with any U.S. tax return filed in the normal course, if the IRS determines an additional tax deficiency for a return submitted under these procedures, the IRS may assert applicable additions to tax and penalties relating to that additional deficiency.
For returns filed under these procedures, retroactive relief will be provided for failure to timely elect income deferral on certain retirement and savings plans where deferral is permitted by the applicable treaty. The proper deferral elections with respect to such plans must be made with the submission. See the instructions below for the information required to be submitted with such requests.
Failure to follow the instructions or to submit the items described below will result in returns being processed in the normal course without the benefit of the favorable terms of these procedures. Below are the specific steps that must be followed:
First, for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the taxpayer must submit a complete and accurate amended tax return using Form 1040X, Amended U.S. Individual Income Tax Return, together with any required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) even if these information returns would normally not be submitted with the Form
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1040 had the taxpayer filed a complete and accurate original return. The taxpayer may not file delinquent income tax returns (including Form 1040, U.S. Individual Income Tax Return) using these procedures.
Second, the taxpayer musty include at the top of the first page of each amended tax return "Streamlined Domestic Offshore" written in red to indicate that the returns are being submitted under these procedures. This is critical to ensure that the returns are processed through these special procedures.
Third, the taxpayer must complete and sign a statement on the Certification by U.S. Person Residing in the U.S. certifying: (1) that he or she is eligible for the Streamlined Domestic Offshore Procedures; (2) that all required FBARs have now been filed; (3) that the failure to report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non-willful conduct; and (4) that the miscellaneous offshore penalty amount is accurate. The taxpayer must maintain the foreign financial asset information supporting the self-certified miscellaneous offshore penalty computation and be prepared to provide it upon request. The taxpayer must submit an original signed statement and attach copies of the statement to each tax return and information return being submitted through these procedures. However, they should not attach copies of the statement to FBARs. Failure to submit this statement, or submission of an incomplete or otherwise deficient statement, will result in returns being processed in the normal course without the benefit of the favorable terms of these procedures.
Fourth, the taxpayer must submit payment of all tax due as reflected on the tax returns and all applicable statutory interest with respect to each of the late payment amounts. The taxpayer’s taxpayer identification number must be included on the check. The taxpayer will receive a balance due notice or a refund if the tax or interest is not calculated correctly.
Fifth, the taxpayer must submit payment of the miscellaneous offshore penalty.
In addition, if the taxpayer seeks relief for failure to timely elect deferral of income from certain retirement or savings plans where deferral is permitted by an applicable treaty, they must submit:
a statement requesting an extension of time to make an election to defer income tax and identifying the applicable treaty provision;
a dated statement signed by the taxpayer under penalties of perjury describing:
the events that led to the failure to make the election,
the events that led to the discovery of the failure, and
if the taxpayer relied on a professional advisor, the nature of the advisor's engagement and responsibilities; and
for relevant Canadian plans, a Form 8891 for each tax year and each plan and a description of the type of plan covered by the submission.
The documents listed above, together with the payment, must be sent in paper form (electronic submissions will not be accepted) to:
Internal Revenue Service 3651 South I-H 35Stop 6063 AUSC Attn: Streamlined Domestic Offshore Austin, TX 78741
This address may only be used for returns filed under these procedures. For all future filings, the taxpayer must file according to regular filing procedures.
Finally, for each of the most recent 6 years for which the FBAR due date has passed, the taxpayer must file delinquent FBARs according to the FBAR instructions and include a statement explaining that the FBARs are being filed as part of the Streamlined Filing Compliance Procedures. The taxpayer is required to file these delinquent FBARs electronically at FinCen. On the cover page of the electronic form, select “Other” as the reason for filing late. An explanation box will appear. In the explanation box, enter “Streamlined Filing Compliance Procedures.” If the taxpayer is unable to file
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electronically, they may contact FinCEN’s Regulatory Helpline at 1-800-949-2732 or 1-703-905-3975 (if calling from outside the United States) to determine possible alternatives to electronic filing.
Practice Tip: The IRS has noted six common problems with streamlined submissions: (1) certifications with “patently insufficient or completely missing” statements of facts; (2) the use of nonstandard certifications with missing terms; (3) the presence of only one signature on the certification of married taxpayers who file joint returns; (4) taxpayers attempting to use the alternate mark-to-market method for passive foreign investment companies, an option available only under the offshore voluntary disclosure program; (5) filing of paper foreign bank account reports; and (6) attempts to make pre-clearance requests or other placeholders in anticipation of providing a streamlined submission (there is no such thing as pre-clearance for streamlined submissions). Also, if a taxpayer relied on a professional adviser, it is critical that the taxpayer identify in the streamlined submission the adviser and any advice received. Failure to identify the professional adviser will prompt a follow-up letter from the IRS.
Note that the 5-percent penalty for Streamlined Domestic Offshore filers is not intended to reach foreign financial assets in which the taxpayer has no personal financial interest or only a partial interest. Read literally, the third paragraph of the description of the scope of the Streamlined Domestic Offshore Procedures says that the penalty applies to all reportable but unreported foreign financial assets. However, the penalty is not intended to reach assets in which the taxpayer had no financial interest, such as an employer’s account over which the taxpayer had only signature authority, or portions of assets in which the taxpayer had no personal financial interest.
Also, real estate is not included in the Streamlined Domestic Offshore penalty base. Any asset (tax compliant or non- compliant) that was not the kind of asset reportable on either FBAR or Form 8938 is not included in the penalty base for the Streamlined Domestic Offshore Procedures. However, assets delinquently reported on Forms 3520 or 5471 are not excluded from the 5-percent penalty base. All assets that meet the definition of "foreign financial asset" in the instructions for Form 8938 and not reported on that form should be included in the 5-percent penalty base, unless the taxpayer reported them on timely filed Forms 3520 or 5471.
Suppose a U.S. resident making a Streamlined Domestic Offshore submission is the 100-percent owner of an incorporated business with various assets, including financial accounts. The 5-percent penalty base includes the stock in the corporation, not just the underlying financial accounts unless it is a disregarded entity for federal income tax purposes. Under the instructions for Form 8938, stock in a foreign corporation is a specified foreign financial asset. Whether the stock in the foreign corporation or the underlying foreign financial accounts are reportable on Form 8938, and therefore are included in the penalty base, depends on whether the corporation is a disregarded entity. If it is, the instructions require the reporting of the underlying foreign financial accounts, which would then be included in the penalty base. However, if the corporation is not a disregarded entity, then the instructions provide that the taxpayer is not considered the owner of the underlying assets solely as a result of the taxpayer's status as a shareholder. The same principle would apply to assets that are held in a foreign partnership or trust.
Any reasonable method of valuing the stock, such as using the balance sheet on the Form 5471, for purposes of calculating the 5-percent penalty. No valuation discounts may be taken on foreign financial assets subject to the 5- percent penalty.
DELINQUENT FBAR SUBMISSION PROCEDURES
Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who: (1) have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1) and (2) are not under a civil examination or a criminal investigation by the IRS, and have not already been contacted by the IRS about the delinquent FBARs, should file the delinquent FBARs according to the FBAR instructions.
Those taxpayers should use the following steps to resolve delinquent FBARS
Review the instructions
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Include a statement explaining why you are filing the FBARs late
File all FBARs electronically at FinCEN
On the cover page of the electronic form, select a reason for filing late
If the taxpayer is unable to file electronically, they should contact FinCEN's Regulatory Help line at 1-800-949-2732 or 1-703-905-3975 (if calling from outside the United States) to determine possible alternatives to electronic filing.
The IRS will not impose a penalty for the failure to file the delinquent FBARs if the taxpayer properly reported on their U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and they have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.
FBARs will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.
STATEMENT OF SPECIFIED FOREIGN FINANCIAL ASSETS (FORM 8938) BACKGROUND
The IRS recently issued temporary and proposed rules relating to the provisions of the Hiring Incentives to Restore Employment (HIRE) Act that require foreign financial assets to be reported to the IRS for taxable years beginning after March 18, 2010. The regulations, which are effective for tax years ending after December 19, 2011, provide guidance under Code §6038D relating to the disclosure of ownership interests in “specified foreign financial assets.” The IRS has also released the final version of Form 8938, Statement of Specified Foreign Financial Assets, which taxpayers started using with the 2011 tax year reporting.
DEFINITION OF SPECIFIED FOREIGN FINANCIAL ASSET
“Specified foreign financial assets” include financial accounts maintained by a foreign financial institution and stock or securities issued by someone that is not a U.S. person, any interest in a foreign entity, and any financial instrument or contact that has an issuer or counterparty that is not a U.S. person.
A taxpayer required to file Form 8938 must report all financial accounts maintained by a foreign financial institution. Examples of financial accounts include:
Savings, deposit, checking, and brokerage accounts held with a bank or broker-dealer.
And, to the extent held for investment and not held in a financial account, the taxpayer must report stock or securities issued by someone who is not a U.S. person, any other interest in a foreign entity, and any financial instrument or contract held for investment with an issuer or counterparty that is not a U.S. person. Examples of these assets that must be reported if not held in an account include:
Stock or securities issued by a foreign corporation;
A note, bond or debenture issued by a foreign person;
An interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap or similar agreement with a foreign counterparty;
An option or other derivative instrument with respect to any of these examples or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer;
A partnership interest in a foreign partnership;
An interest in a foreign retirement plan or deferred compensation plan;
An interest in a foreign estate;
Any interest in a foreign-issued insurance contract or annuity with a cash-surrender value.
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A taxpayer does not need to report a financial account maintained by a U.S. financial institution or its holdings. Examples of financial accounts maintained by U.S. financial institutions include:
U.S. Mutual fund accounts
IRAs (traditional or Roth)
401 (k) retirement plans
Qualified U.S. retirement plans
FILING REQUIREMENTS
In General
For tax years beginning after March 18, 2010, individuals must file Form 8938 to report the ownership of specified foreign financial assets if the total value of those assets exceeds an applicable threshold amount. The reporting threshold varies depending on whether an individual lives in the United States or files a joint income tax return with his or her spouse.
The IRS anticipates issuing regulations that will require a domestic entity to file Form 8938 if the entity is formed or availed of to hold specified foreign financial assets and the value of those assets exceeds the appropriate reporting threshold. Until the IRS issues such regulations, only individuals must file Form 8938.
Note that, if the value of taxpayer’s specified foreign financial assets is more than the appropriate reporting threshold and no exception applies, a taxpayer must file Form 8938 even if none of the specified foreign financial assets affect taxpayer’s tax liability for the tax year.
Practice Tip:
Unlike the FBAR form, which is filed separately, Form 8938 is filed along with the taxpayer’s federal income tax return. Thus, if a taxpayer does not have to file an income tax return for the tax year, he does not have to file Form 8938, even if the value of his specified foreign financial assets is more than the appropriate reporting threshold.
Filing Thresholds
Taxpayers who are not required to file an income tax return are not required to file Form 8938. Form 8938 must be filed with the taxpayer’s federal income tax return if certain reporting thresholds are met. These reporting thresholds can be divided into four categories.
If the taxpayer is unmarried and lives in the United States, he or she satisfies the reporting threshold only if the total value of the specified foreign financial assets is more than $50,000 on the last day of the tax year, or more than $75,000 at any time during the tax year.
Likewise, if the taxpayer is married, files separate income tax return and lives in the United States, he or she satisfies the reporting threshold only if the total value of the specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
If the taxpayer is married, files a joint income tax return and lives in the United States, he or she satisfies the reporting threshold only if the total value of the specified foreign financial assets is more than $100,000 on the last day of the tax year, or more than $150,000 at any time during the tax year.
Finally, if the taxpayer’s tax home is in a foreign country and he or she meets one of the “presence abroad tests” (discussed below), the reporting threshold is satisfied if he or she is not filing a joint return and the total value of the specified foreign financial assets is more than $200,000 on the last day of the tax year, or more than $300,000 at any time during the tax year. If such taxpayer is married and files a joint income tax return, the reporting threshold is
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satisfied only if the total value of all specified foreign financial assets the taxpayer and/or the taxpayer’s spouse owns is more than $400,000 on the last day of the tax year, or more than $600,000 at any time during the tax year.
A taxpayer satisfies the “presence abroad test” if he or she is either a U.S. citizen who has been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year or a U.S. citizen or resident who is present in a foreign country or countries at least 330 full days during any period of 12 consecutive months that ends in the tax year being reported.
Practice Tip:
Since these reporting requirements are new, taxpayers may not be used to gathering the information required to determine if the reporting thresholds are met, or if so, to comply with the reporting requirements. Practitioners should make sure their tax organizers or other information gathering tools are updated to request the appropriate information about foreign assets.
Determining Value of Specified Foreign Financial Assets
A taxpayer must determine the total value of the specified foreign financial assets in which the taxpayer has an interest to figure whether he or she satisfies the applicable reporting threshold. The valuation approach is divided into six basic rules covering various situations, as described below.
1. The total value of specified foreign financial assets in which he has an interest during the tax year or on the last day of the tax year is defined as the fair market value of those assets, as opposed to cost or some other value. For purposes of determining the total value of specified foreign financial assets denominated in a foreign currency the taxpayer must first determine the exchange rate of the foreign currency and then convert to U.S. dollars.
2. If the taxpayer does not know, or have reason to know based on readily accessible information, the fair market value of the taxpayer’s interest in a foreign trust during the tax year, the value to be included in determining the total value of the specified foreign financial assets during the tax year is the maximum value of his interest in the foreign trust.
3. If the taxpayer does not know, or have reason to know based on readily accessible information, the fair market value of his interest in a foreign estate, foreign pension plan, or foreign deferred compensation plan during the tax year, the value to be included in determining the total value of the specified foreign financial assets during the tax year is the fair market value, determined as of the last day of the tax year, of the currency and other property distributed during the tax year to the specified person as a beneficiary or participant. If the taxpayer received no distribution during the tax year and does not know or have reason to know, based on readily accessible information, the fair market value of the interest, he or she can use a value of zero for the interest.
4. If the maximum value of a specified foreign financial asset is less than zero, the deficit is not subtracted from the total value of other assets. Instead, the taxpayer uses a value of zero for the asset.
5. Some assets are reported on forms other than Form 8938. For example, certain transfers to a foreign corporation are reported on Form 5471 instead, and do not have to appear on Form 8938. In determining whether the taxpayer satisfies the applicable reporting threshold, the value of all specified foreign financial assets, even if they are reported on another form in lieu of reporting on Form 8938, must be included.
6. If the taxpayer jointly owns an asset with someone else, the value used to determine the total value of all specified foreign financial assets depends on whether the other owner is the taxpayer’s spouse and, if so, whether his spouse is a specified individual and whether he files a joint or separate return. Except for certain married specified individuals who jointly own a specified foreign financial asset with a spouse, a specified person that jointly owns a specified foreign financial asset must use the value of the entire asset, and not the value of the specified person’s separate interest, for purposes of determining whether the reporting thresholds are exceeded. A specified person, including a married specified individual, that jointly owns a specified foreign financial asset must report the maximum value of the
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entire asset during the portion of the taxable year that the specified person has an interest in the asset. Married specified individuals that jointly own a specified foreign financial asset and that file a joint annual income return tax are only required to report the asset once on the single Form 8938 filed with their return.
EXCEPTIONS
There are several exceptions to the reporting requirements described above. Those exceptions are as follows:
1. Assets held in domestic financial accounts are not specified foreign financial assets, and thus taxpayers do not have to report these on Form 8938. These excepted financial accounts include a financial account that is maintained by a U.S. payer, such as a domestic financial institution. In general, a U.S. payer also includes a domestic branch of a foreign bank or foreign insurance company and a foreign branch or foreign subsidiary of a U.S. financial institution. Moreover, such excepted financial accounts include a financial account that is maintained by a dealer or trader in securities or commodities if all of the holdings in the account are subject to the mark-to-market accounting rules for dealers in securities, or an election under Code §475(e) or (f) is made for all of the holdings in the account.
2. Taxpayers do not have to report any asset that is not held in a financial account if the asset is subject to the mark-to- market accounting rules for dealers in securities or commodities or an election under Code §475(e) or (f) is made for the asset.
3. Taxpayers do not have to report a specified foreign financial asset on Form 8938 if they report it on one or more other specified forms that are timely filed with the IRS for the same tax year. These forms include Form 3520, 5471, 8621, 8865 and 8891. As noted above, however, the amounts reported on these other forms are still included in the calculation determining whether the Form 8938 reporting threshold has been met.
4. If the taxpayer is considered the owner, under the grantor trust rules, of any part of a foreign trust, he or she does not have to report any of the specified foreign financial assets held by the part of the trust he or she is considered to own, provided two conditions are satisfied. First, the taxpayer must report the trust on a Form 3520 that they timely file with the IRS for the same tax year. Second, the trust must timely file Form 3520-A with the IRS for the same tax year.
5. If a taxpayer is considered the owner, under the grantor trust rules, of any part of a domestic widely-held fixed investment trust under Treasury Regulations §1.671-5, he or she does not have to report any specified foreign financial asset held by the part of the trust he or she is considered to own.
6. If a taxpayer is considered the owner, under the grantor trust rules, of any part of a domestic liquidating trust under Treasury Regulations §301.7701-4(d) that is created under chapter 7 or chapter 11 of the Bankruptcy Code, the taxpayer does not have to report any specified foreign financial asset held by the part of the trust that the taxpayer is considered to own.
7. If a taxpayer is a bona fide resident of a U.S. possession (American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, or the U.S. Virgin Islands) who is required to file Form 8938, he or she does not have to report the following specified foreign financial assets on Form 8938:
A financial account maintained by a financial institution organized under the laws of the U.S. possession of which he or she is a bona fide resident;
A financial account maintained by a branch of a financial institution not organized under the laws of the U.S. possession of which he or she is a bona fide resident, if the branch is subject to the same tax and information reporting requirements that apply to a financial institution organized under the laws of the U.S. possession;
Stock or securities issued by an entity organized under the law so the U.S. possession of which he or she is a bona fide resident;
An interest in an entity organized under the laws of the U.S. possession of which he or she is a bona fide resident; and
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5. A financial instrument or contract held for investment, provided each issuer or counterparty that is not a U.S. person is an entity organized under the laws of the U.S. possession of which he or she is a bona fide resident.
PENALTIES
Several different types of penalties may apply to taxpayers who fail to file a correct Form 8938 in a timely manner (i.e., with a timely filed federal income tax return). Penalties also apply if there is an understatement of tax or omission of income relating to a specified foreign financial asset.
If a taxpayer is required to file Form 8938 but does not file a complete and correct Form 8938 by the due date (including extensions) of that taxpayer’s federal income tax return, the taxpayer will be subject to a penalty $10,000. If the taxpayer does not file the complete and correct form within 90 days after the IRS mails them a notice of the failure to file, the taxpayer is subject to an additional penalty of $10,000 for each 30-day period (or part of thereof) during which the failure to file continues after the 90-day period has expired.
The maximum additional penalty for a continuing failure to file Form 8938 is $50,000. If taxpayers file a joint income tax return, the failure to file penalties apply only once. Of course, the liabilities for any such penalties related to a joint return are jointly and severally imposed on each joint filer.
In addition, under certain circumstances a presumption regarding the filing requirement arises. Specifically, if the IRS asks taxpayer for information about the value of any asset, but taxpayer does not provide enough information for the IRS to determine the value of that asset, the taxpayer is presumed to own specified foreign financial assets with a value of more than the applicable reporting threshold.
If a taxpayer underpays his or her tax as a result of a transaction involving an undisclosed specified foreign financial asset, they are subject to a penalty equal to 40 percent of the underpayment. This would occur, for example, if the taxpayer did not report ownership of shares in a foreign corporation on Form 8938 and they received taxable distributions from the company that was not reported on their income tax return. Likewise, the penalty would apply if the taxpayer did not report ownership of shares in a foreign company on Form 8938 and they sold the shares in the company for a gain, failing to report the gain on their income tax return. A third example would be a taxpayer who did not report a foreign pension on Form 8938 and received a taxable distribution from the pension plan that was not reported on their income tax return.
When a taxpayer under pays his or her tax due to fraud, a penalty of 75 percent of the underpayment due to fraud is imposed. Finally, failure to file Form 8938, fail to report an asset, or an underpayment of tax may expose the taxpayer to criminal penalties as well.
FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA)
As a response to IRS and congressional concerns that U.S. taxpayers were not fully disclosing the extent of financial assets held abroad, Congress passed the Foreign Account Tax Compliance Act (“FATCA”) in 2010. Many U.S taxpayers, particularly those living abroad, have incurred increased compliance burdens and costs as a result of FATCA's expanded reporting obligations, most of which repeat existing FBAR filing requirements. These hardships include additional tax preparation fees and the unwillingness of some foreign financial institutions to do business with U.S. expatriates.
FATCA places substantial day-to-day compliance burdens and costs of implementation on financial institutions. For example, a broad range of U.S.-source payments to a foreign financial institution (“FFI”) are subject to a 30 percent withholding tax, unless the FFI agrees to provide comprehensive information regarding accounts of U.S. taxpayers.5 FATCA further charges withholding agents with the responsibility of determining whether they are obliged to undertake FATCA withholding and implementing it when required.6
In turn, FFIs who have reached agreements with the IRS to avoid being subject to systematic withholding must impose withholding on any of their own customers defined as "recalcitrant account holders." Although FFIs have some latitude
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in identifying recalcitrant account holders, customers are in jeopardy of facing withholding if they do not provide the FFI with either a Form W-9 to certify they are U.S. persons, or a Form W-8BEN to certify they are foreign persons.
When completing a Form W-9, individuals are generally obligated to provide a Social Security number (SSN). According to the National taxpayer Advocate’s Fiscal 2016 Report to Congress, that office has received reports that these SSNs are becoming increasingly difficult to obtain for U.S. persons residing abroad who do not already have them. This difficulty, caused in part by a limited number of locations where required interviews for obtaining an SSN can occur, only enhances the burden of FATCA withholding and increases the challenges to obtaining a credit or refund of the withholding in the future.
As part of the 2013 Annual Report to Congress, the National Taxpayer Advocate expressed concerns over the broad sweep of FATCA and the compliance burdens it imposed on individuals and financial institutions. In identifying this issue as a Most Serious Problem, the National Taxpayer Advocate urged the IRS to:
Gather only the information it would actually use;
Learn from its experiences with the Offshore Voluntary Disclosure (OVD) programs to more effectively preserve the due process rights of taxpayers; and
Burden impacted parties as little as possible, consistent with the congressional mandate of FATCA.
In her 2013 report, the National Taxpayer Advocate also observed that based on analysis of the data then available ". . . to this point, the IRS is imposing additional reporting burdens and increased potential penalties primarily on a category of taxpayers that, under principles of quality tax administration, should be encouraged, rather than penalized." The Fiscal 2016 Report notes that further review of updated and expanded data from FY 2010 through the present continues to demonstrate the weight of FATCA is being felt not by tax evaders, but by U.S. taxpayers who likely would be compliant regardless. U.S. taxpayers under the FATCA umbrella who must file Form 8938, Statement of Foreign Financial Assets, are generally at least as compliant as the overall U.S. taxpayer population.
The IRS is developing policies and procedures governing the credit or refund to taxpayers of amounts withheld under FATCA on payments to FFIs or similar institutions. These policies and procedures likewise will apply to amounts withheld on payments of U.S.-source income made directly to non-resident U.S. taxpayers. As proposed, taxpayers would be entitled to a credit or refund only if they can document that the withholding agent actually deposited the amount withheld with the IRS. Some exceptions to this rule may be available if the amount of the under-deposit of tax is de minimis, or if the withholding agent is classified by the IRS as having a demonstrated history of compliance with its deposit requirements. By contrast, the IRS currently accepts creditor-risk in the case of domestic withholding, such as on employment taxes, and taxpayers need only show that the withholding actually occurred to be entitled to a credit or refund from the IRS.
Glossary 27
GLOSSARY
GLOSSARY
alien A resident born in or belonging to another country who has not acquired citizenship by naturalization.
bona fide residence test
A test that determines if a clearly-defined permanent residence has been established in a foreign country. Typically consists of a determination that the taxpayer lives in a foreign country for the entire tax year.
FBAR Foreign Bank Account Reporting is a requirement used to require records and reports that can assist various government agencies in criminal, tax or regulatory investigations or proceedings and in the conduct of intelligence or counterintelligence activities, including anti-terrorist activities.
foreign housing deduction
Amounts paid for housing with self-employment earnings can be used as a deduction from gross income for housing expenses.
foreign housing exclusions
Amounts paid for housing with employer-provided income can be excluded from gross income.
foreign income Income a taxpayer receives for working in a foreign country.
indefinite A period of time without defined limits.
nonresident alien
A non-U.S. citizen who doesn't pass the green card test or the substantial presence test.
physical presence test
To meet this test, the taxpayer must be physically present in a foreign country or countries for at least 330 full days during the 12-month period.
tax home The general locality of an individual's primary place of work. A person's tax home is the city or general vicinity where his or her primary place of business or work is located, regardless of the location of the individual's residence, and has an effect on his/her tax deductions for business travel.
tax treaty A bilateral agreement made by two countries to resolve issues involving double taxation of passive and active income. Tax treaties generally determine the amount of tax that a country can apply to a taxpayer's income and wealth.
Course Overview
Course Description
Learning Objectives
Introduction: Preparers Beware
Streamlined Filing Compliance Procedures
Glossary
Glossary

Documents

REPORTING FOREIGN INCOME AND ASSETS