The IRS has released new Form 8938, Statement of Specified Foreign Financial Assets, for reporting foreign financial assets for the 2011 tax year. This form requires individual taxpayers to report their interests in a wide variety of foreign assets. Failure to file Form 8938 can result in substantial penalties as well as further government inquiry into a taxpayer’s financial affairs.

The IRS also issued proposed 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 proposed regulations are final, only individuals must file Form 8938.

Required foreign asset reporting
The filing requirement is part of the Foreign Asset Tax Compliance Act (FATCA), which was enacted in 2010. It is intended to improve tax compliance by US taxpayers who hold offshore financial accounts.

FATCA also requires foreign financial institutions to report to the IRS certain information about the financial accounts held by US taxpayers or foreign entities in which US taxpayers hold a substantial ownership interest. Taxpayers themselves are required to report corresponding information on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). In its newly released guidance, the IRS emphasized that the Form 8938 filing requirement does not preempt the FBAR filing requirement.

Who is covered?
The filing requirement generally applies to taxpayers who have an interest in “specified foreign financial assets.“ This includes US citizens and residents, nonresident aliens who make an election to be treated as resident aliens for purposes of filing joint income tax returns, and certain nonresidents who live in US commonwealths and territories such as Puerto Rico and American Samoa. However, these taxpayers are required to file only if the aggregate value of their specified foreign financial assets exceeds certain thresholds.

The penalty for failing to file Form 8938 is $10,000, with an additional penalty of up to $50,000 for continued failure to file after receiving IRS notification to file. A 40 percent penalty on any understatement of tax attributable to undisclosed assets can also be imposed.

What is a specified foreign financial asset?
A specified foreign asset generally includes 1) financial accounts maintained by a foreign financial institution, and 2) other foreign financial assets held for investment that are not in an account in a US or foreign financial institution, such as an interest in a foreign entity. The IRS does recognize some exceptions, though. The following are not considered reportable:

• A financial account that is maintained by a US payer, such as a domestic financial institution. In general, a US payer also includes a domestic branch of a foreign bank or foreign insurance company and a foreign branch or foreign subsidiary of a US financial institution.
• 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 section 475(e) or (f) is made for all of the holdings in the account.
• Assets reported on certain other tax forms related to foreign assets or investments (the value of specified foreign financial assets reported on those forms is included in determining the total value of assets for Form 8938 purposes, but the assets do not need to be reported on Form 8938).

An interest in a foreign trust or a foreign estate is not a specified foreign financial asset unless you know or have reason to know, based on readily accessible information, of the interest. If you receive a distribution from the foreign trust or foreign estate, you are considered to know of the interest.

If you are considered the owner under the grantor trust rules of any part of a foreign trust, you do not have to report any of the specified foreign financial assets held by the part of the trust you are considered to own if you satisfy the following conditions.

• You report the trust on a Form 3520 that you timely file with the IRS for the same tax year,
• The trust timely files Form 3520-A, Annual Information Return of Foreign Trust With a US Owner, with the IRS for the same tax year,
• Interests in a social security, social insurance or other similar program of a foreign government, and
• Specified foreign financial assets held in a bankruptcy trust or a domestic widely held fixed investment trust in which the taxpayer is a beneficiary.

Additional exceptions apply.

What are the filing thresholds?
The IRS has set different thresholds depending on a taxpayer’s circumstances. For example, it acknowledges that individuals living abroad will likely have more foreign assets that are not of the type targeted by FATCA by giving those taxpayers higher thresholds.

Here are the specific thresholds for filing Form 8938:

Single, head of household, and married filing separately taxpayers living in the US. The total value of specified foreign financial assets exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year.

Married taxpayers filing a joint income tax return living in the US. The total value of specified foreign financial assets exceeds $100,000 on the last day of the tax year or $150,000 at any time during the tax year.

Single, head of household, and married filing separately taxpayers living abroad. The total value of specified foreign financial assets exceeds $200,000 on the last day of the tax year or $300,000 at any time during the year.

Married taxpayers filing a joint income tax return living abroad. The total value of specified foreign financial assets exceeds $400,000 on the last day of the tax year or $600,000 at any time during the year. These thresholds apply even if only one spouse resides abroad.

Filing from afar
The IRS also recently released a fact sheet (FS-2011-13) to help clarify the obligations of taxpayers who are US citizens or dual citizens living abroad to file federal income tax returns and FBARs.

US citizens, whether living abroad or in the US, must file a federal income tax return for any tax year in which gross income is equal to or greater than the applicable exemption amount and standard deduction. Generally, taxpayers must report their worldwide income on their returns, rather than just US income.

The failure to file an income tax return and all required forms such as Form 8938 or pay the amount of tax due subjects taxpayers to penalties, unless they can show that the failure was due to “reasonable cause“ and not willful neglect.

The IRS has outlined several factors that weigh in favor of or against the determination that a failure was due to reasonable cause. Examples include the taxpayer’s education and the level of complexity of the tax or compliance issue.

Individuals only — for now
The Form 8938 requirement applies only to individual taxpayers at this time. But the IRS has issued proposed regulations setting forth requirements for certain domestic entities to report foreign financial assets in the same manner as an individual. They are expected to kick in for the 2012 tax year.

If you hold foreign assets, it is important to determine whether you are subject to the Form 8938 requirements — as well as to FBAR reporting rules. Please contact us for assistance.

Contact our international services team >