Lead Article

Receiving FATCA Letter from Your Foreign Bank

Since July 1, 2014, the most feared US legislation regarding international tax enforcement – Foreign Account Tax Compliance Act (“FATCA”) – is being implemented by most banks around the world. As part of this compliance, foreign banks are sending out so-called FATCA letter to their customers seeking to verify certain type of information. In this article, I would like to introduce this FATCA letter and what the FATCA letter may mean to a US taxpayer with undisclosed foreign bank and financial accounts.

What is FATCA?

FATCA was signed into law in 2010 and codified in Sections 1471 through 1474 of the Internal Revenue Code. The law was enacted in order to reduce offshore tax evasion by US persons with undisclosed offshore accounts. There are two parts to FATCA – US taxpayer reporting of foreign assets and income on Form 8938 and reporting by a foreign financial institution (FFI) of foreign bank and financial account to the IRS.  Here, I will concentrate on the latter, because it is an FFI that sends out the FATCA letter.

FATCA generally requires a foreign payee (i.e. FFI) to identify certain US accountholders and report their accounts to the IRS. Such reporting is done either through an FFI Agreement directly to the IRS or through a set of local laws that implement FATCA.

If an FFI refuses to do so or otherwise does not satisfy these requirements (and is not otherwise exempt), US-source payments made to the FFI may be subject to withholding under FATCA at a rate of 30%. Note that FATCA information reporting and withholding requirements generally do not apply to FFIs that are treated as “deemed-compliant” because they present a relatively low risk of being used for tax evasion or are otherwise exempt from FATCA withholding.

FATCA Implementation and FATCA Letter

As of July 1, 2014, the FATCA went into full effect, which means that FFIs now have to report the required FATCA information to the IRS. However, it appears that the IRS is not likely to fully enforce the penalties until the end of 2014 just to give FFIs enough time to comply.

Nevertheless, many FFIs are making a full effort to comply with FATCA. As part of this effort, FFIs around the world have been sending out “FATCA letters”. A FATCA letter is basically a letter from your bank or other financial institution which introduces FATCA to their customers and asks them to provide answers to a various set of questions aiming to find out information specific to FATCA compliance. Often, instead of asking all of these questions directly a FATCA letter would simply list out a series of forms that contain these questions (for example, W9, W8BEN, et cetera).

If the customer refuses to answer the questions or provide the necessary forms, the financial institution would often close the account and report it as a “recalcitrant account” to the IRS.

Impact of FATCA Letter on US Taxpayers with Undisclosed Accounts

A FATCA letter may have a very profound impact on a US taxpayer with foreign accounts which were not properly disclosed to the IRS (usually on the FBAR and/or Form 8938). Let’s concentrate on two most important aspects of receiving a FATCA letter. First, a FATCA letter puts the taxpayer on notice that he is required to report his foreign financial accounts and foreign income to the IRS. This may have a big impact on whether the taxpayer can later certify his non-willfulness for the purposes of the Streamline Filing Compliance Procedures.

Second, a FATCA letter starts the clock for the taxpayer to beat the bank’s disclosure of his account to the IRS. If the taxpayer intends to participate in the IRS Offshore Voluntary Disclosure Program (“OVDP”), it is imperative that he files his Pre-Clearance Request before the IRS finds out about his non-compliance with respect to his foreign accounts. If the latter occurs, the taxpayer may not be able to enter the OVDP.

In essence, receiving a FATCA letter forces the taxpayer to quickly choose the path of his voluntary disclosure under significant time pressure.

Contact Sherayzen Law Office if You Received a FATCA Letter

If you received a FATCA letter from your bank or any other financial institution, you should contact Sherayzen Law Office immediately to assess your situation and determine the path of your voluntary disclosure. Our highly experienced team of international tax professionals will thoroughly analyze your case, prepare all of the required documentation (legal documents and tax forms), conduct the voluntary disclosure and defend your interests before the IRS.

Remember, time is of the essence in these matters. So, Call Us Now to Schedule Your Confidential Consultation!

New 2014 OVDP Update: Introduction

On June 18, 2014, the IRS made a major upgrade to its existing Offshore Voluntary Disclosure Program (“OVDP”). While the changes to the OVDP rules are significant, the new rules regarding the Streamlined Procedure maybe even more important.

Here is a summary of the 2014 changes to the 2012 OVDP:

2014 OVDP Update: New Miscellaneous 50% Penalty

The IRS added a new FAQ 7.2 which imposes a 50% offshore penalty on taxpayers who participate in the OVDP if: either a foreign financial institution at which the taxpayer has or had an account or a facilitator who helped the taxpayer establish or maintain an offshore arrangement has been publicly identified as being under investigation or as cooperating with a government investigation.

I believe that this new penalty is a direct consequence of the successful IRS and DOJ efforts to enforce FATCA overseas, particularly the Swiss Program for Banks.  Read this article for more information.

2014 OVDP Update: Elimination of the Reduced Penalty Structure Under FAQ 52 and 53

The reduced 12.5% and 5% penalty structure under former FAQs 52 and 53 has been eliminated due to the expansion of the Streamlined Filing Compliance Procedures. Rather, the new Streamline Offshore Procedure will take over. Special procedures apply to the taxpayer who already entered the OVDP program. I will provide more details in a later article.

2014 OVDP Update: Elimination of FAQ 17 and 18; Procedure is Still Available

This change is just the clarification of the already existing rules. While technically both rules are eliminated, the taxpayer can still use both rules.  Read this article with respect to the Delinquent FBAR Submission Procedures (replacing FAQ 17). I will provide the FAQ 18 details in a later article.

2014 OVDP Update: New Streamline Procedure Rules – US Residents are Included

It finally happened – taxpayers residing in the United States now have the option to enter the streamline procedures which were first announced on September 1, 2012. Other major changes include the elimination of the $1,500 tax threshold and elimination of the risk assessment process. I will provide more details in a later article.

2014 OVDP Update: Updated Streamlined Foreign Offshore Procedures

The IRS greatly expanded the eligibility requirements for the U.S. taxpayers who reside overseas.  Read this article on the Streamlined Foreign Offshore Procedures.

2014 OVDP Update: Major Changes to FAQ 31-41

These are the important changes that the 2014 OVDP Update made to the calculation of the asset base to which the offshore penalty will apply.

2014 OVDP Update: New Pre-Clearance Procedural Change under FAQ 23

Now, the IRS wants to know more information about you before granting the pre-clearance to apply for the OVDP. The 2014 OVDP Update greatly expands the information required to be submitted under FAQ 23. I will provide more details in a later article.

2014 OVDP Update: Offshore Penalty Must Be Paid With Submission of the OVDP Package

This is a major 2014 OVDP Update to FAQ 7. Now the Offshore Penalty must be paid with the submission of the OVDP Package. Again, I will provide more details in a later article.

Other 2014 OVDP Updates: Procedural Changes

The rest of the 2014 OVDP Update changes are more procedural in nature, but may have real substantive impact. Among them, the changes in the FAQ 25 (requiring the submission of account statements irrespective of the size of the disclosure), new OVDP Letter, new OVDP Letter Attachment, and other technical changes. Once again, I will provide more details in a later article.

Contact Sherayzen Law Office for a Professional Advice Regarding Your Offshore Voluntary Options

The new 2014 OVDP Update presents new opportunities mixed with new traps. It is important to make sure that you get expert advice regarding your Offshore Voluntary Disclosure. This is why you should contact the experienced tax law firm of Sherayzen Law Office. We have helped clients throughout the world and we can help you.

Contact Us to Schedule Your Confidential Consultation!

Form 8938: Who Must File The Frankenstein Son of FBAR

In an earlier article, I discussed in general that the IRS imposed a new tax reporting requirement on individual taxpayers who hold specified foreign financial assets with an aggregate value exceeding a relevant threshold.   Such taxpayers will need to report those assets on the new IRS Form 8938, which must be attached to the taxpayer’s annual income tax return.

In this article, I would like to address the issue of who (i.e. what type of individuals taxpayers) must generally file Form 8938.  I will not address Form 8938 obligations of the specified domestic entities (see below), but it is anticipated that the IRS will soon issue the applicable regulations.

General Test for Filing Form 8938

In order for the requirement to file Form 8938 to arise, a three-prong test must be satisfied:

1. The taxpayer must be a “specified individual”;
2. The specified individual must own (or hold an interest in) “specified foreign financial assets”; and
3. The value of those assets must exceed the applicable reporting threshold.

If the taxpayer meets all of the above three prongs of the test, then he must file Form 8938 together with his annual income tax return.  Let’s explore each of the prongs in more detail.

A.  Definition of Specified Individual

A taxpayer is considered as “specified individual” if he or she is a:

1). U.S. citizen,
2). Resident alien fo the United States for any part of the tax year (note, however, that special regulations apply to this category with respect to the determination of the holding period),
3). Nonresident alien who makes an election to be treated as a resident alien for purposes of filing a joint income tax return; and
4). Nonresident alien who is a bona fide resident of American Samoa or Puerto Rico.

It is important to emphasize that the “resident alien” category includes not only the “green card” holders, but also those who meet the substantial presence test.  Even more important, the IRS will consider such taxpayers as resident aliens even if they elect to be taxed as a resident of a foreign country pursuant to provisions of a U.S. income tax treaty.

In fact, by implementing Form 8938 provisions, the IRS has tremendously expanded its reach not only with respect to the types of foreign financial assets that need to be reported, but also who must report them.

Specified Domestic Entities

Under the current instructions to Form 8938, only individuals are required to file the Form until the IRS issues new regulations that will required U.S. entities to file the Form as well.  It is expected that the IRS will do it fairly soon.  At this point, however, this article will only address Form 8938 requirement for individuals, NOT specified business entities.

B.    Definition of Specified Foreign Financial Assets

A specified individual is required to report an interest in a foreign specified asset.  Due to its varied nature, this requirement can quickly become very complex.  I will not address all of the issues in depth in this article, but rather offer a general simplification of the main categories of what assets should be disclosed on Form 8938 and what it means (in an over-simplified statement rather than an in-depth explanation) to “have an interest” in such assets.

According to the IRS instructions to Form 8938, the “specified foreign financial assets” include any of the following:

1.  Any financial account maintained by a foreign financial institution

First, the definition of “specified foreign financial assets” includes any financial account maintained by a foreign financial institution  Generally, a financial account is any depository or custodial account maintained by a foreign financial institution.  The definition of the “financial institution” is very broad, and, interestingly enough, includes financial institutions organized under the laws of a U.S. possession (American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands).   The IRS instructions specifically list the following investment vehicles as “foreign financial institutions”: foreign mutual funds, foreign hedge funds, and foreign private equity funds.

In many ways, this first category is reminiscent of the traditional FBAR requirements, but there are important differences which are outside of the scope of this article.

2. Other foreign financial assets

Second, the definition of “specified foreign financial assets” includes other foreign financial assets, which, in turn, include assets that are held for investment and not held in an account maintained by a financial institution.   Such assets include stocks or securities issue by anyone who is not a U.S. person, any interest in a foreign entity, and any financial instrument or contract that has an issuer or counterparty that is other than a U.S. person.

This is an incredible expansion of reporting requirements far beyond the FBAR and even existing foreign business ownership forms such as 5471, 8865 and 8858.  Under Form 8938, the taxpayers will need to report: stock issued by a foreign corporation; a capital or profit interest in a foreign partnership; a note, bond, debenture, or other form of indebtedness issued by a foreign person; an interest in a foreign trust or foreign estate; 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 currency or commodity that is entered into with a foreign counterparty or issuer; and other assets held for investment (a very broad category with a specific definition).

3. Interest in a Foreign Entity

Finally, the “specified foreign financial assets” include any interest in a foreign entity.  Importantly, this includes interest in any specified financial assets owned by a disregarded entity (which the taxpayer owns).

4. Having/Holding an interest in a specified foreign financial asset

Once it is determined that a taxpayers deals with a specified foreign financial asset, it is important to analyze whether, pursuant to the IRS regulations, the taxpayer “holds an interest” in those assets. For the purposes of Form 8938, “holding an interest in a specified financial asset” is a legal term which is defined with some degree of specificity (and sometimes ambiguity) by the IRS.

Generally, the IRS states that the taxpayer holds an interest in a specified financial asset if “any income, gains, losses, deductions, credits, gross proceeds, or distributions from holding or disposing of the asset are or would be required to be reported, included, or otherwise reflected on the [taxpayer’s] tax return.” (see instructions to Form 8938).

In additional to this general rule, the IRS provides a whole host of specific rules which address the situation where the general rule does not apply but the IRS still considers the taxpayers as “holding an interest” in specified foreign financial assets.  I already addressed the disregarded entities above, and there are rules about reporting jointly-owned assets, assets held in financial accounts, kiddie tax (Form 8814), interests held by business entities, grantor trusts, interests in foreign estates and foreign trusts, and so on.

Moreover, there are at least four additional exceptions from the general rule listed by the IRS.  Pursuant to these exceptions, certain specified foreign financial assets need NOT be reported on Form 8938.  These exceptions may be highly relevant to a taxpayer’s particular situation and will be covered in a later article on our website.

Taxpayers are advised to contact Sherayzen Law Office to discuss their particular fact pattern in order to determine whether they own any specified foreign financial assets and whether any exceptions apply.

C.    Reporting Thresholds for Individuals

Once it is determined that the taxpayer is a specified individual who owns specified foreign financial assets, the last step is to determine whether the value of these assets satisfies the applicable reporting threshold – i.e. whether the aggregate value of the specified foreign financial assets exceeds the reporting threshold for your particular category of taxpayers.

In its instructions to Form 8938, the IRS lists four main categories of taxpayers and assigns distinct reportable threshold to each category.  Let’s explore each category.

1. Unmarried Taxpayers Living in the United States

If the taxpayer is not married and lives in the United States, then the applicable reporting threshold is satisfied if the total value of his 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 that tax year.

2. Married Taxpayers Filing a Joint Income Tax Return and Living in the United States

If the taxpayer is married and files joint income tax return with his spouse, then the reporting threshold is satisfied if the value of his specified foreign financial assets is either more than $100,000 on the last day of the tax year, or more than $150,000 at any time during the tax year.

3. Married Taxpayers Filing Separate Income Tax Returns and Living in the United States

If the taxpayer is married and lives in the United States, but files a separate income tax return from his spouse, then the reporting threshold is satisfied if the total value of his 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.  Therefore, this category is very similar to that of the unmarried taxpayer who resides in the United States.

4. Married Taxpayers Living Abroad and Filing a Joint Income Tax return

If the taxpayer lives abroad (a special test applies to determine whether this is the case) and files a joint tax return with his spouse, then the reporting threshold is satisfied if the value of all specified foreign financial assets that you or your spouse owns is either more than $400,000 on the last day of the tax year, or more than $600,000 at any time during the tax year.

5. Married Taxpayers Living Abroad and Filing Any Return Other Than Joint Tax Return

If the taxpayer lives abroad and does not file a joint income tax return (instead he files a different type of tax return such as married filing separately or unmarried), then the reporting threshold is satisfied if the value of all specified foreign financial assets is either more than $200,000 on the last day of the tax year, or more than $300,000 at any time during the tax year.

6. Determining the Total Value of the Specified Foreign Financial Assets

While this article does not deal with the complex issue of how to determine the total value of the specified foreign financial assets (this topic will be the subject of a later article), I wish to emphasize here that these rules can be fairly detailed and apply to specific situations.

For example, if any specified foreign financial asset is denominated in a foreign currency during the tax year, the value of the asset must be determined in the foreign currency and converted to U.S. dollars using the U.S. Treasury Department’s Financial Management Service foreign currency exchange rates.  However, if no such rate is available, then you must use another publicly available exchange rate for purchasing U.S. dollars and disclose it on Form 8938.

Other rules deal with valuation of joint interests (including with someone other than a spouse), valuation of assets with no positive value, figuring out the maximum value of the assets during the tax year (including assets with no positive value), currency conversion date determination, et cetera.

Contact Sherayzen Law Office For Help With IRS Form 8938

The reporting requirements under Form 8938 can be incredibly complex.  Obviously, this article provides only some general information with respect to Form 8938, and my hope is that it will provide sufficient background to the readers to raise the awareness that Form 8938 requirements may apply to them.  However, the article cannot be relied upon to determine the tax obligations for your particular fact pattern since it does NOT offer legal advice.

For legal advice with respect to Form 8938, determination whether its requirements apply to you, and help with drafting the form properly, you should contact Sherayzen Law Office.  Our experienced tax compliance firm will help you resolve any issues related to Form 8938 and guide you toward proper compliance with its requirements.

Preventing the Disaster: Understanding When to File the Report on Foreign Bank and Financial Accounts (FBAR)

Despite the potentially grave consequences, many U.S. taxpayers are completely unaware of the extensive reporting requirements under the Bank Secrecy Act, particularly of the disclosure of ownership or other interest in or authority over financial accounts in a foreign country by filing the Report of Foreign Bank and Financial Accounts (the “FBAR”). While one can often fault the desire for secrecy on the part of the taxpayers or insufficient diligence of their tax advisors, it seems that the greater part of the blame for this failure should be ascribed to the ever-increasing scope of the reporting requirements (for example, see increasing disclosure requirements and new penalties imposed under Title V of the Hiring Incentives to Restore Employment Act). A person with a foreign account of only $10,500 is unlikely to imagine that he needs to file every year unfamiliar additional paperwork by a date which usually does not coincide with the rest of his tax filings. Nor is this person likely to forward to his tax advisors any information about the account. Given the severe penalties for non-compliance, however, the tax practitioners must be able to alert their clients to the FBAR requirements. This is precisely the purpose of this essay – to clarify for tax attorneys and other tax advisors the situations in which their clients need to file the FBAR. First, I will discuss the definition of “U.S. persons” who may need to file FBARs. Second, I will explain the crucial term “financial accounts.” Then, I will review the procedures for determining the aggregate maximum value of these accounts. I will turn next to the confusing issues of what constitutes a financial interest in or signature and comparable authority over a “financial account.” Finally, I will examine the consequences of failing to file the FBARs.

General Requirements of the FBAR

Pursuant to the Bank Secrecy Act, 31 U.S.C. §5311 et seq., the Department of Treasury (the “DOT”) has established certain recordkeeping and filing requirements for the United States persons with financial interests in or signature authority (and other comparable authority) over financial accounts maintained with financial institutions in foreign countries. If the aggregate balances of such foreign accounts exceed $10,000 at any time during the relevant year, FinCEN Form 114 formerly Form TD F 90-22.1 (the FBAR) must be filed with the DOT. Thus, the FBAR filing is required if four conditions are present:
1). The filer is a U.S. person;
2). There is one or more financial accounts in a foreign country;
3). The aggregate balances of these foreign financial accounts exceed $10,000; and
4). This U.S. person has either a financial interest in or signature authority (or other comparable authority) over these foreign financial accounts.

Definition of “U.S. Person”

Since October of 2008, the definition of a “U.S. person” has been going through a turbulent phase of uncertainty with periodic expansions and retractions. The pre-2008 FBAR instructions (dating back to July of 2000 version) defined the “U.S. person” broadly as: “(1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust.”

Two important features of this definition stand out. First, the term “person” is defined to include not only individuals, but also virtually any type of business entity, estate or trust. Even a single-member LLC, which is generally disregarded for tax purposes, may be classified as a U.S. person because it has a separate juridical existence from its owner. A partnership or a corporation created or organized in the United States is considered “domestic” under 26 U.S.C. §7701(a)(4).

Second, the definition of who should be considered as a U.S. resident is interpreted under 26 U.S.C. §7701. Under 26 U.S.C. §7701(b), an individual is a U.S. resident if he meets any of the three bright-line tests: (1) lawful admission for permanent residence to the United States (“green card”); (2) substantial presence in the U.S.: the sum of the number of days on which such individual was present in the United States during the current year and the 2 preceding calendar years (when multiplied by the applicable multiplier determined under the relevant IRS table) equals or exceeds 183 days; and (3) first-year election to be treated as a resident under 26 U.S.C. §7701(b)(4). Thus, the definition of a U.S. resident under the tax rules is much broader than the one used in immigration law.

In October of 2008, the IRS revised the FBAR instructions and further expanded the definition of a “U.S. person” by including the persons “in and doing business in the United States.” This revision caused a widespread confusion among tax professionals. The outburst of comments and questions prompted the IRS to issue Announcements 2009-51 and 2010-16, suspending FBAR filing requirement through June of 2010 (i.e. for calendar years 2008 and 2009) for persons who are not U.S. citizens, U.S. residents, and domestic entities. Instead, the tax professionals were referred back to July of 2000 FBAR definition of a “U.S. person.”

In the meantime, in February of 2010, the IRS published new Proposed FBAR regulations under 31 C.F.R. §103. The proposed rules modify the definition of a “U.S. person” as follows: “a citizen or resident of the United States, or an entity, including but not limited to a corporation, partnership, trust or limited liability company, created, organized, or formed under the laws of the United States, any state, the District of Columbia, the Territories, and Insular Possessions of the United States or the Indian Tribes.” This definition applies even if an entity elected to be disregarded for tax purposes. The determination of a U.S. resident status is to be done according to 26 U.S.C. §7701(b) and regulations thereunder, except the meaning of the “United States”(which is to be defined by 31 U.S.C. 103.11(nn)).

Thus, if the proposed regulations will ultimately be codified in their current form, the definition of the “U.S. person” will be slightly broader than that of the July of 2000, but will represent a major regression from October 2008 definition. Nevertheless, based on even contemporary definition of the “U.S. person,” the IRS has been able to cast a wide net over U.S. taxpayers, trying to force disclosure of as many foreign financial accounts as possible. This trend toward maximizing the scope of disclosure also dominates the definition of what constitutes a foreign financial account – the issue to which I now turn.

Definition of “Foreign Financial Account”

The term “foreign financial accounts” is described expansively and includes any bank, brokerage, securities, securities derivatives and other financial instruments accounts located outside of the United States and its territories. In the instructions to the Form 114, the IRS also includes in this definition savings, demand, deposit, time deposit, debit card, prepaid credit card and any other account maintained with a financial institution or other person engaged in the business of a financial institution. Since October 2008, accounts, such as mutual funds, where the assets are held in a commingled fund and the account owner holds an equity interest in the fund are also considered “financial accounts.” It should be noted that the IRS granted the extension for reporting mutual fund accounts (and certain other filers) for the tax year 2008 and earlier years until June 30, 2010. Individual bonds, notes and stock certificates are not considered as “financial accounts.”

The Proposed Regulations further elaborate the definition of “foreign accounts.” The term includes all “bank, securities, and other financial accounts,” but the understanding of what these terms mean is expanded. The IRS expressly states that, in defining types of the accounts that must be reported on the FBAR, it will focus on the kinds of financial services for which a person maintains an account with a foreign financial institution, irrespective of how long this account is being maintained. The IRS, however, limits itself by stating that “an account is not established simply by conducting transactions such as wiring money or purchasing a money order where no relationship has otherwise been established.”

Outside of this limitation, the Proposed Regulations tend to add the types of accounts that need to be reported on the FBAR. The definition of the “bank account” expressly includes time deposits, such as certificates of deposit accounts that allow an account owner to “deposit funds with a banking institution and redeem the initial amount, along with interest earned after a prescribed period of time.” A “securities account” is defined as “an account maintained with a person in the business of buying, selling, holding, or trading stock or other securities.”

The term “other financial accounts” receives most attention under the Proposed Regulations. The IRS states that, due to the fact that this term covers a broad range of relationships with foreign financial institutions, the new regulations strive to delineate clearly what accounts should be included in the definition. Hence, the Proposed Regulations include in “other financial accounts” the following types of accounts:
“an account with a person that is in the business of accepting deposits as a financial agency; an account that is an insurance policy with a cash value or an annuity policy; an account with a person that acts as a broker or dealer for futures or options transactions in any commodity on or subject to the rules of a commodity exchange or association; or an account with a mutual fund or similar pooled fund which issues shares available to the general public that have a regular net asset value determination and regular redemptions.”

Foreign retirement accounts present an interesting classification problem. The Proposed Regulations state that “participants and beneficiaries in retirement plans under sections 401(a), 403(a) or 403(b) of the Internal Revenue Code as well as owners and beneficiaries of individual
retirement accounts under section 408 of the Internal Revenue Code or Roth IRAs under section 408A of the Internal Revenue Code are not required to file an FBAR with respect to a foreign financial account held by or on behalf of the retirement plan or IRA.” This exception, however, is not extended to the foreign financial accounts. Therefore, it appears that a foreign retirement account that is similar in design to an IRA needs to be disclosed in the FBAR.

The readers must also be aware that other reporting requirements may apply to a foreign retirement account. For example, Canadian Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) should be reported by U.S. residents on Form 8891. In other cases, a foreign retirement plan may be considered as “foreign trust” by the IRS and should be reported on Form 3520.

There are three narrow categories of foreign financial accounts for which the U.S. persons do not have to file the FBAR. First, accounts held in a military banking facility designated by the U.S. government to serve U.S. Government installations located abroad. Second, officers or employees of most banks regulated by the federal government are exempt from filing the FBARs (unless an officer or an employee has personal financial interest in the account). Finally, officers or employees of publicly-traded domestic corporations or privately-owned corporations with assets exceeding $10 million and 500 or more shareholders of record, need not file an FBAR concerning the signature authority (usually acquired by virtue of the officer’s or employee’s position) over a foreign financial account of the corporation (as long as an officer or an employee has no personal financial interest in the account, and he is advised in writing by the chief financial officer of the corporation that the corporation has filed a current report which includes that account).

Aggregate Balance Exceeds $10,000

Despite appearances, the requirement that the aggregate value of all of the foreign financial accounts exceeds $10,000 at any time during a calendar year is not without complications. In order to figure out the account value in a calendar year, one needs to look first at the largest amount of currency and/or monetary instruments that appear on any quarterly or more frequently issued account statement for the relevant year. If the financial institution which manages the account does not issue any periodic account statements, then the maximum account value is the largest amount of currency and/or monetary instruments in the account at any time during the applicable year. If the account consists of stocks or other non-monetary assets, then one only needs to consider fair market value at the end of the relevant year. If, however, the non-monetary assets were withdrawn before the end of the calendar year, then the account value is determined to be the fair market value of the withdrawn assets at the time of the withdrawal.

The maximum value of a foreign financial account must be reported in U.S. dollars on the FBAR. Therefore, a taxpayer needs to convert foreign currency into the corresponding amount of U.S. dollars using the official exchange rate at the end of the relevant calendar year.

A final word of caution on the topic of the account balance. Notice the word “aggregate” – it means that the balances of all of the filer’s foreign financial accounts should be tallied to determine whether the $10,000 threshold is exceeded. For example, if the filer has one foreign bank account of $6,000 and another of $5,000, then he still needs to file the FBAR with the DOT, because the aggregate value of both accounts exceeds the required $10,000.

Financial Interest, Signature Authority, and Other Comparable Authority

The final condition that must be met before the requirement to file the FBAR arises is that the U.S. person has either a financial interest in, or a signature authority or other comparable authority over the relevant foreign financial accounts. In deciding whether the FBAR is required, it is useful to go through all three of these requirements in order.

First, the filer needs to determine whether he has a financial interest in the account. If the account is owned by an individual, the financial interest exists if the filer is the owner of record or has legal title in the financial account, whether the account is maintained for his own benefit or for the benefit of others, including non-U.S. persons. Hence, if the owner of record or holder of legal title is a U.S. person acting as an agent, nominee, or in some other capacity on behalf of another U.S. person, the financial interest in the account exists and this agent or nominee needs to file the FBAR. If a corporation is the owner of record or the holder of legal title in the financial account, a shareholder of a corporation has a financial interest in the account if he owns, directly or indirectly, more than 50 percent of the total value of the shares of stock or has more than 50 percent of the voting power. Where a partnership is the owner of record or the holder of legal title in the financial account, a partner has a financial interest in the financial account if he owns, directly or indirectly, more than 50 percent of the interest in profits or capital. Similar rule applies to any other entity (other than a trust) where a U.S. person owns, directly or indirectly, more than 50 percent of the voting power, total value of the equity interest or assets, or interest in profits. Special rules apply to trust and can be found in the Proposed Regulations. Finally, a U.S. person who “causes an entity to be created for a purpose of evading the reporting requirement shall have a financial interest in any bank, securities, or other financial account in a foreign country for which the entity is the owner of record or holder of legal title.”

If there is no financial interest in the foreign financial account, the filer should determine whether he has signature authority over the account. A U.S. person has account signature authority if that person can control the disposition of money or other property in the account by delivery of a document containing his signature to the bank or other person with whom the account is maintained. Notice, once again, that control over the disposition of assets in the account is one of the main factors in deciding whether the FBAR needs to be filed.

It is important to mention that, pursuant to the IRS Announcement 2010-23, persons with signature authority over, but no financial interest in, a foreign financial accounts for which an FBAR would otherwise have been due on June 30, 2010, will now have until June 30, 2011, to report those foreign financial accounts. Combined with IRS Announcement 2009-62, this means that the deadline has been extended for the calendar year 2009 and all prior years.

Finally, even if no financial interest or signature authority exists, the filer has to continue his analysis and determine whether he has “other comparable authority” over the account. This catch-all, ambiguous term is not defined by the IRS. Nevertheless, the instructions to Form 114 generally state that the other comparable authority exists when the filer can exercise power comparable to the signature authority over the account by communication with the bank or other person with whom the account is maintained, either directly or through an agent, or in some other capacity on behalf of the U.S. person.

Penalties

Now that the reader has received an extensive background on the FBAR filing requirements, I would like to discuss some of the penalties that may be imposed as a result of the failure to file the FBAR even though your client was required to do so. In particular, I will focus on three general scenarios describing specific penalties commonly attributed to each of them. The first scenario is where your client willfully failed to file the FBAR, or destroyed or otherwise failed to maintain proper records of account, and the IRS learned about it when it launched an investigation of your client. This is the worst type of scenario which carries substantial penalties. The IRS may impose civil penalties of up to the greater of $100,000, or 50 percent of the value of the account at the time of the violation, as well as criminal penalties of up to $500,000, or 10 years of imprisonment, or both. It should be noted these penalties apply separately to each undisclosed account. Hence, if your client fails to disclose two or more accounts, the penalties are likely to be significantly higher.

Another scenario is where your client negligently and non-willfully failed to file the FBAR, and the IRS learned about it during an investigation of your client. Unlike the first scenario, there are no criminal penalties for non-willful failure to file the FBAR; only civil penalties of up to $10,000 per each violation (unless there is a pattern of negligence which carries additional civil penalties of no more than $50,000 per any violation). Each undisclosed account constitutes a separate violation, and, therefore, the penalties may be significantly higher where your client fails to disclose two or more accounts . In this scenario, your client fares much better, and you may be able to obtain lower penalties by showing of reasonable cause for the failure to file.

The third scenario is where your client non-willfully fails to file the FBAR, accidentally discovers his mistake, and comes to you before the IRS commences its investigation of your client’s finances. This is the most favorable of all scenarios due to the fact that your client may qualify for the benefits of a voluntary disclosure program, despite the fact that the position of the IRS regarding civil penalties for voluntarily filed but delinquent FBARs is uncertain following the October 15, 2009 voluntary disclosure deadline. The best strategy for addressing delinquent FBARs, however, varies depending on the facts and circumstances of the particular case.

A word of caution: this discussion focuses solely on the penalties associated with the failure to file the FBAR. This article does not address the various strategies that may be employed in dealing with the delinquent FBAR filings in the post-October 15, 2009 world, including qualification for the voluntary disclosure program. In certain situations, there may also be other relevant significant tax issues outside of the FBAR realm – the most important of which is non-payment of taxes on undisclosed income by the U.S. taxpayers – which may significantly alter the amount of penalties, interest, and taxes due to the IRS.

Conclusion

Based on the analysis above, it is easy to see now why so many of the U.S. taxpayers fail to file an FBAR when it is required. While the seemingly simple instructions of the FBAR can readily become complex and unpredictable when applied to specific individual circumstances, the main cause of non-filing seems to be simply a failure to recognize that the FBAR report needs to be filed. This problem is exactly what this article is designed to address, and I hope that I have provided the readers with the necessary legal knowledge to conduct a proper legal analysis of relevant circumstances and recognize when the FBAR needs to be filed. This is the crucial first step in preventing regulatory non-compliance and its potentially disastrous consequences for you and your clients.

Minnesota Unemployment Insurance: Independent Contractors in the Trucking Industry ~ By: Eugene Sherayzen, Sherayzen Law Office

Standing at the crossroads of tax and employment law, the perennial problem of whether a worker is an employee or an independent contractor has been among the most important and common unemployment insurance tax issues. This problem is particularly complex in the trucking industry, due to the special conditions present in that industry’s working environment. In fact, it became so complicated that Minnesota legislators found it necessary to deal with it specifically in Minnesota Statute 268.035. In this article, I will rely on my own experience to explain the requirements of this legislation as it pertains to independent contractors in the trucking industry, and offer practical guidelines in certain common situations in that industry.

I will start by providing some background on the Minnesota Unemployment Insurance Program (hereinafter “UI”). Under Minnesota law, an individual or an organization that pays “covered wages” in the state of Minnesota is required to register with the UI, submit quarterly wage reports, and pay the appropriate unemployment insurance taxes as computed by the UI. Generally, “covered wages” are the compensation that a Minnesota employer pays to his employees for the work done mostly in Minnesota (there are some important exceptions regarding covered wages, especially with regard to the officers of business entities, religious services, and work performed out-of-state). Because covered wages are those paid to employees, we can deduce that if the compensation is paid to an independent contractor, then the business owner does not need to pay any UI taxes. This clarifies the reason why one of the most frequent battles fought between employers and the UI is the issue of proper classification of a worker as an employee or independent contractor.

To provide context for this classification, this article will examine who is considered an independent contractor in the trucking industry by the UI. Traditionally, under common law, five factors (still closely followed by the UI for the classification of many other categories of workers outside of the trucking industry) were used to determine whether a worker is an independent contractor: (1) the right to control the means and manner of performance; (2) the mode of payment; (3) furnishing of materials and tools; (4) control of premises where work is performed; and (5) the right of employer to hire and discharge. Wise v. Denesen Insulation Co., 387 N.W.2d 477, 479 (Minn. Ct. App. 1986). The presence of one factor is insufficient to find an employment relationship if such factor is countered by other factors. Stenvik v. Constant, 502 N.W.2d 416, 420-421 (Minn. Ct. App. 1993). While the common-law test is no longer the current law for trucking industry purposes, it is useful to mention these factors because they still form the basis for the current statutory requirements as spelled out in Minn. Stat. § 268.035.
Minn. Stat. § 268.035 subd. 25b regulates the issue of whether a worker in the trucking industry qualifies as an independent contractor. Minn. Stat. § 268.035 subd. 25b states:
“In the trucking industry, an owner operator of a vehicle that is licensed and registered as a truck, tractor, or truck tractor by a governmental motor vehicle regulatory agency is an independent contractor, and is not considered an employee, while performing services in the operation of the truck only if each of the following factors is present:

(1) the individual owns the equipment or holds it under a bona fide lease arrangement;
(2) the individual is responsible for the maintenance of the equipment;
(3) the individual bears the principal burdens of the operating costs, including fuel, repairs, supplies, vehicle insurance, and personal expenses while on the road;
(4) the individual is responsible for supplying the necessary personal services to operate the equipment;
(5) the individual’s compensation is based on factors related to the work performed, such as a percentage of any schedule of rates, and not on the basis of the hours or time expended; and
(6) the individual enters into a written contract that specifies the relationship to be that of an independent contractor and not that of an employee.”
Each of these six requirements must be met in order for a worker to be considered as an independent contractor. An analysis of the specific requirements follows below.
1) The individual owns the equipment or holds it under a bona fide lease arrangement.
This first requirement means that the employer has to show one of the following: a) the worker supplies his own equipment, or b) the worker entered into a bona fide lease with the employer or a third party. Usually, it is the second option that causes problems for the employer (especially if the employer is also a lessor), because the issue of whether a lease is bona fide depends mainly on the facts. There are two common scenarios, though, that I wish to share with the reader.

Scenario one: A worker rents all of his equipment from the employer, and pays the employer a nominal rental price of one dollar per month. When this case comes to a UI auditor, he will raise two issues immediately. First, the fact that the employer is also the lessor immediately invites greater scrutiny on whether this is a bona fide lease. The second, and much more significant, problem is the one-dollar rent. The UI is usually unwilling to consider a lease as bona fide if the rent is nominal.
Scenario two: A worker rents all of his equipment from the employer, and the corresponding rental payment results in a worker’s pay reduction (i.e. the employer deducts the rent payment from the worker’s paycheck). In general, the pay reduction as a rent payment is sufficient to satisfy the bona fide lease requirement, but the outcome again depends on the details. The employer must be prepared to show (i.e. his assertion must be supported by business records) that the deduction is real, consistent, and equivalent to the actual rent payment. When such a scenario arises, the business owner’s attorney should insist that the independent contractor sign the necessary documents to support his client’s assertion.

2) The individual is responsible for the maintenance of the equipment.
This requirement is fairly straightforward. Whether he owns or rents the equipment, the worker must be responsible for the maintenance of all trucking equipment (trucks, trailers, cargo chains, etc.). This requirement should be included in the “independent contractor” agreement between the worker and the employer. I have also found that often the best evidence of the worker’s responsibility for the maintenance of the equipment is a lawsuit initiated by the employer against any current or previous workers for damaging the equipment.

3) The individual bears the principal burdens of the operating costs, including fuel, repairs, supplies, vehicle insurance, and personal expenses while on the road.
This “principal burden” requirement can become very complicated on account of even the most minute of details. This is mainly because the real issue here (as in requirement two) is the first factor of the common law test – control over the means and manner of performance. To satisfy this standard, the worker should be required pay for the operating costs of the business such as fuel, repairs, and supplies.
The less obvious issues are exemplified by the following scenario: a worker bears the burden of the operating costs through a pay reduction. In general, this scenario could satisfy the “principal burden” requirement, but once again it is highly fact-dependent. Unlike the rent, the operating costs are not so easily calculated especially given the wild fluctuations in the price of oil and diesel that the reader has had an opportunity (or misfortune) to observe recently. It is tremendously difficult to properly reflect this calculation in the records. Yet, such failure to correlate the operating costs with the pay reduction is likely to result in the UI finding that the pay reduction is not related to the operating costs, and, therefore, the employer bears the principal burden of the operating costs. Another important factor is whether the worker is given a choice to pay the operating costs directly or through a pay reduction. Where such choice exists, the UI is more likely to consider the worker as an independent contractor since the worker seems to have more control over the manner of his performance.

4) The individual is responsible for supplying the necessary personal services to operate the equipment.
The usual problems associated with this requirement are the ones that are related to the control of the actual performance. The most common issues involve route and schedule control. The employer’s control over the manner of performance can be strong evidence in favor of finding an employment relationship. Note, however, that the employer’s control might be mitigated and even entirely disregarded if it corresponds to governmental regulations or common industry practices. I will deal with this issue again in more detail in connection with the next statutory requirement.

5) The individual’s compensation is based on factors related to the work performed, such as a percentage of any schedule of rates, and not on the basis of the hours or time expended.
Usually, this requirement is satisfied if the workers are paid per job, and not on an hourly basis. A business owner’s attorney should try to make sure that the workers are paid on a percentage basis if possible. The other common alternative, which is payment on a “per mile” basis, is fraught with danger. The most significant concern with this alternative is the “control over manner of performance” issue discussed in connection with requirement four. This is because the UI auditors might consider per mile payment as a disguised hourly payment.

The best remedy to this problem is to explain per mile payment basis as compliance with government regulations and common industry practices. For example, per mile payment might be based on the federal government’s calculation of mileage for interstate highways. This way, the payment is related to the job performed, but there is no control by the employer because the number of miles traveled is based on an objective (i.e. divorced from the actual number of miles traveled) government calculation which is a common practice in the trucking industry.

6) The individual enters into a written contract that specifies the relationship to be that of an independent contractor and not that of an employee.

This requirement must be strictly complied with. If there is no written contract between the worker and the business owner, the UI will consider the worker to be an employee. The contract should include at least the following two clauses: a) this is a relationship between an independent contractor and the business owner, and b) this is not an employee-employer relationship. If possible, an owner-operator addendum should be considered by the attorney, because it provides additional evidence of the existence of an independent contractor relationship.

An ambiguous or reckless choice of words in the contract can jeopardize the outcome of the case. The business owner’s attorney should be very careful about what he includes in the contract. Statements that are interpretative of control or of an employment relationship should be avoided. Clauses that include careless inaccuracies, such as “the contractor must obey” or “follow instructions”, need to be redrafted. If some control by the employer is required by state or federal regulations, the contract should so indicate.
Finally, the business owner’s attorney should advise his client that the contract is only as good as the parties’ compliance with it. The UI does not automatically accept that the contract accurately describes the parties’ performance, and, if necessary, it may choose to investigate whether the parties actually conform to the terms of their agreement. Even the best contract will not protect the employer where the parties’ conduct does not correspond to it.

These are, in essence, the current statutory requirements which may result in a finding an independent contractor relationship in the trucking industry. While I provided a number of practical comments on this issue, there are many more issues to consider with respect to Minn. Stat. § 268.035 subd. 25b. I hope that this article provides sufficient background for practicing attorneys to understand the basics of this area of law and to avoid the most common traps.