A new tax reporting obligation is being imposed on U.S. individuals that have an interest in specified foreign financial assets when the total aggregate value of those assets exceeds an applicable reporting threshold. This reporting obligation is effective starting for tax year 2011 and is satisfied by attaching Form 8938, Statement of Foreign Financial Assets, to the individual taxpayer’s 2011 Form 1040. The penalties for failing to file a required Form 8938 are severe. Thus, U.S. individuals with interests in foreign assets must carefully analyze their potential obligation to report such interest on a Form 8938 attached to their 2011 Form 1040.
Only Individuals … For Now
The IRS anticipates issuing regulations that will require certain domestic entities to file Form 8938 if such entity were formed or availed of to hold specified foreign financial assets. Until the IRS issues such regulations, only individuals must file Form 8938. The IRS has stated that they intend to issue regulations applicable to domestic entities during 2012. Thus, some domestic entities may have this filing obligation starting with their 2012 tax returns. However, the obligation will only be imposed on individuals with respect to 2011 tax returns.
Specified Foreign Financial Assets
Individuals must identify whether they have an interest in any specified foreign financial assets. For this purpose, a specified foreign financial asset is defined as:
- Any financial account maintained by a foreign financial institution; and
- The following assets to the extent that they’re held for investment and not held in a financial account:
- Any interest in a foreign entity;
- Any stock or securities issued by someone that is not a U.S. person; and
- Any financial instrument or contract with an issuer or counterparty that is not a U.S. person.
The term “held for investment” encompasses all assets that are not used in, or held for use in, the conduct of any trade or business. Stock is never considered used or held for use in the conduct of a trade or business.
There are exceptions to the definition of “specified foreign financial asset” for assets that are subject to the mark-to-market accounting rules and for assets held in a domestic bankruptcy trust.
Applicable Reporting Threshold
Individuals that own an interest in specified foreign financial assets must then value each interest based on the highest fair market value of each asset during the tax year as well as the value of each asset as of the last day of the tax year. The Form 8938 is required if the aggregate fair market value of all the individual’s specified foreign financial assets exceeds certain thresholds. Married individuals that file a joint income tax return file a single Form 8938 that reports all the specified foreign financial assets of both spouses. The filing thresholds vary based on the individual’s filing status and whether or not the individual lives within the U.S. The following table summarizes the filing thresholds:
|Filing Status||Living In||Value on Last Day of Year||Value on Any Day of Year|
|Unmarried or Married Filing Separately||U.S.||$50,000||$75,000|
|Married Filing Jointly||U.S.||$100,000||$150,000|
|Unmarried or Married Filing Separately||Foreign Country||$200,000||$300,000|
|Married Filing Jointly||Foreign Country||$400,000||$600,000|
The failure to comply with the Form 8938 reporting obligation can result in significant penalties. The penalties can be waived by the IRS if the failure to file was due to reasonable cause and was not willful. However, there can be no guarantees that the failure to file penalties will be waived. There are at least seven different penalties that can be imposed with respect to Form 8938. The general failure to file penalty is $10,000 per failure. The IRS can impose an additional $10,000-per-month penalty if the failure continues after the taxpayer is notified by the IRS. If unreported income is associated with the undisclosed specified foreign financial assets, there is a 40% accuracy related penalty. The statute of limitations remains open for all or part of the tax return until three years after the date on which the required Form 8938 is filed. Furthermore, there is a special six-year statute of limitations for unreported income associated with disclosed specified foreign financial assets. Finally, fraud and criminal penalties can be imposed when there is a willful failure to file that is part of a tax evasion scheme.
The above client alert provides a brief summary of this new reporting obligation. There are significant nuance and details that are beyond the scope of this alert. Please contact your Katz, Sapper & Miller advisor to discuss specific questions that may be applicable to you.