Foreign Account Tax Compliance Act

Accountants Beware: Offshore Disclosure with Form 8938 is a Legal Issue

In an earlier article, I already explained why the FBAR disclosure is a legal issue. In terms of their lineage, Forms 8938 are very similar to the FBARs. While the FBARs are the creation of Bank Secrecy Act, Form 8938 is a creation of a legislation of a similar nature – FATCA (Foreign Account Tax Compliance Act).

The intent of both laws is similar – to produce legal disclosure of foreign assets by U.S. taxpayers. Notice that I am talking about legal disclosure, not an accounting calculation.

While the penalties associated with failure to file Form 8938 are not as severe as those of the FBAR, they are still substantial and have legal and tax repercussions. Where non-compliance is such that it requires voluntary disclosure, the issues associated with Form 8938 take on a new importance that requires the full protection of the attorney-client privilege and complex legal advocacy.

This is why it is so important for the accountants to avoid committing malpractice and recognize that an offshore disclosure that involves filing delinquent Forms 8938 is a legal issue that should be left to international tax attorneys who are trained and experienced in this area of law.

Contact Sherayzen Law Office for Legal Help with Your Voluntary Disclosure of Offshore Assets

If you have undisclosed offshore assets, contact Sherayzen Law Office NOW. Our experienced international tax law firm will thoroughly analyze your case, estimate your potential FBAR penalties, identify all non-compliance issues, and develop a comprehensive approach to your offshore voluntary disclosure.

Application of Offshore Penalty to Business Ownership Interests

In another essay, I previously discussed the possible inclusion of the business ownership interests in the calculation of the OVDP (2012 Offshore Voluntary Disclosure Program) Offshore Penalty.  In this article, I would like to explore in more depth the application of the Offshore Penalty to ownership of business interests.

OVDP Offshore Penalty

It is a requirement of the OVDP that the taxpayers who enter the program pay the Offshore Penalty. This penalty is imposed in lieu of all other penalties that may apply to the taxpayer’s undisclosed foreign assets and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period. The default penalty rate is 27.5% (in limited cases, the penalty is reduced to 12.5% or 5%) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure.

The Offshore Penalty calculation includes business ownership interests related to tax noncompliance. Tax noncompliance includes failure to report income from the assets, as well as failure to pay U.S. tax that was due with respect to the funds used to acquire the asset.

Business Ownership Interests Are Included in the Offshore Penalty; Limited Exceptions

As I previously discussed, the Offshore Penalty is much broader than simply the FBAR penalty. Among other items, the Offshore Penalty encompasses ownership interest in businesses related to income tax non-compliance or acquired by tainted funds (i.e. funds that were subject to U.S. tax but on which no such tax was paid; the definition also includes funds derived from illegal sources such as criminal and terrorist activities).

There are exceptions to this rule, however. Two most prominent exceptions deserve to be emphasized here. First, where a business interest was not obtained by tainted funds and there are no under-reported U.S. tax liabilities, the taxpayer is likely to be able to exclude the business interest from the Offshore Penalty.

Second, the OVDP rules carve out a limited exception for U.S. taxpayers who are foreign residents and quality for the third category of 5% penalty rate. For these taxpayers only, the IRS stated that the offshore penalty will not apply to non-financial assets, such as real property, business interests, or artworks, purchased with funds for which the taxpayer can establish that all applicable taxes have been paid, either in the U.S. or in the country of residence. This exception only applies if the income tax returns filed with the foreign tax authority included the offshore-related taxable income that was not reported on the U.S. tax return.

Obviously, the determination of whether either of these two exceptions (or any other exception) applies in your individual case should only be determined by an international tax attorney experienced in the area of offshore voluntary disclosures.

Major Types of Business Ownership Interests Covered by the Offshore Penalty

The biggest category of business ownership interests covered by the Offshore Penalty includes ownership of foreign entities for which information returns, such as Forms 5471, 8865, 8858, 926 and so on, should have been filed by the non-compliant taxpayer. Most often, this category includes ownership of closely-held foreign corporation, interest in the controlled foreign partnership and contribution of property to a foreign corporation.

Notice that, even if the business entity controlled by the taxpayer is not itself tax non-compliant, but it holds the assets which are non-compliant (usually because they were purchased by using tainted funds), the entire ownership interest in the business entity may be exposed to the Offshore Penalty.

Another type of business interest that is often subject to Offshore Penalty involves business entities that are virtually indistinguishable from its owners. In situations where a business entity is an alter ego or nominee of the taxpayer, the IRS may determine that the Offshore Penalty should be applied to the underlying assets of the entity.

The most spectacular reach of the OVDP, however, is the possibility of involving domestic entities. In spite of having “Offshore” in its name, the Offshore Penalty can actually apply to ownership of U.S. businesses acquired with tainted funds. This is a critically-important consideration for non-compliant U.S. taxpayers who repatriated tainted funds back to the United States and invested them into U.S. businesses.

Contact Sherayzen Law Office for Help With Your Voluntary Disclosure of Offshore and Domestic Business Ownership Interests

Sherayzen Law Office can help you with the disclosure of any of your foreign assets, including Offshore and Domestic business ownership interests. Our international tax law firm is highly experienced in conducting offshore voluntary disclosures of business interests. We will thoroughly analyze your case, assess your tax liability as well as the liability that you would face under the OVDP, determine the available disclosure options and implement the disclosure strategy (including preparation of all legal and tax documents as well as IRS representation).

Contact Sherayzen Law Office NOW to schedule your consultation!

Form 8938 Penalties

As discussed in an earlier article, Form 8938 is used by specified individuals to report the ownership of specified foreign financial assets if the total value of those assets exceeds an applicable threshold amount.

Similarly to most international tax forms issued by the IRS, Form 8938 has its own system of penalties. What makes Form 8938 penalties stand out are the scope of coverage, the severity of penalties, and the effect on the IRS statute of limitations.

A. Scope of Form 8938

Form 8938 is much more intrusive than the now-famous FBARs. While the threshold amount for filing the FBAR is much lower (only $10,000), the type of information requested by Form 8938 is much broader. The FBARs only require disclosure of foreign bank and financial accounts.

Form 8938, however, requires the disclosure not only of the interest held in foreign bank and financial accounts (which may also be somewhat different from the FBAR definition), but also of the interest held in foreign entities and “other foreign financial assets” – the definition of which includes an array of varies types of swaps, contracts, and stocks.

Moreover, Form 8938 directly ties assets disclosed on Forms 3520, 3520-A, 5471, 8621, 8865 and 8891 to the assets that need to be reported on Form 8938 (pursuant to the “duplication” rule, the taxpayers do not need to report on Form 8938 the assets already reported the five aforementioned forms). Therefore, Form 8938 makes it much easier for the IRS to to uncover potential issues with the other six forms (all of which have their own applicable penalty standards).

A word of caution: even if a specified foreign financial asset is reported on any of the six forms listed above, the taxpayer must still include the value of the asset in determining whether the aggregate value of the taxpayer’s specified foreign financial assets is more then the reporting threshold that applies to the taxpayer.

Finally, the IRS can use Form 8938 to analyze if the taxpayer was supposed to file the FBAR and failed to do so (or failed to do so correctly).

Thus, it becomes obvious that Form 8938, which popularly known as a “Son of FBAR”, far excels its father-FBAR in enhancing the IRS capacity to gather additional taxpayer data, use this data for deeper analysis of the taxpayer non-compliance, and imposing civil and criminal penalties on non-compliant taxpayers.

B. Form 8938 Penalties

Form 8938 has a severe penalty system.

1. Failure-to-File Penalty

If the taxpayer is required to file Form 8938, but fails to file a complete and correct Form 8938 by the due date (including extensions), he may be subject to a penalty of $10,000.

If the IRS discovers non-compliance and mails the corresponding notice to the taxpayer, but the taxpayer still does not file Form 8938 within 90 days after the mailing of the notice, additional penalties of $10,000 may be imposed for each 30-day period (or part of a period) of non-compliance after the expiration of the 90-day period. This additional penalty is currently capped at $50,000.

What about the situations where the taxpayer believes that the assets in question are below the threshold amount but the IRS asks the information about the assets in any case? In this case, if the taxpayer fails to respond to the IRS inquiry, the IRS has the power to presume that the taxpayer owns specified foreign financial assets with a value of more than the reporting threshold (even if it is not so in reality). Hence, the IRS can impose failure to file penalties if Form 8938 is not filed.

Common to other forms, From 8938 instructions provide for the reasonable cause exception. However, to avoid the penalties, the taxpayer must affirmatively show the facts that support a reasonable cause claim. The IRS does not consider the potential imposition of civil and criminal penalties by a foreign jurisdiction as a reasonable cause.

Keep in mind that the married taxpayers who file a joint income tax return have a joint and several liability for all IRS penalties.

2. Accuracy-Related Penalty

While Form 8938 is a purely reporting requirement, it contains a provision related to enhancing the accuracy-related penalties. If the taxpayer underpays his tax as a result of a transaction involving an undisclosed specified foreign financial asset, the IRS may impose a penalty of 40% of the underpayment.

For example, if the taxpayer does not report a foreign pension on Form 8938 and he receives a taxable distribution from the pension plan that he did not report on his income tax return, the taxpayer will be subject to the 40% penalty on the underpayment.

The same would be true with respect to any specified foreign financial asset, including ownership of shares in a foreign corporation or an interest in a foreign partnership.

3. Civil Fraud Penalty

If the taxpayer commits civil fraud which results in non-payment of penalties and involves Form 8938, the taxpayer will be subject to the civil fraud penalty of 75% of the underpayment due to fraud.

4. Criminal Penalties

In addition to civil penalties, the IRS may initiate a criminal prosecution of (and impose criminal penalties on) the taxpayers who fail to file Form 8938, fail to report an asset on Form 8938 or have an underpayment of tax.

C. Form 8938 Effect on the Statute of Limitations

Similar to other FATCA provisions (with respect to Forms 5471, 8621, 8865, et cetera), the IRS greatly extended the statute of limitations for the purposes of Form 8938. Unlike the other forms, however, Form 8938 contains a singular provision without a precedent.

The IRS sets forth this general rule in its instructions: the failure to file Form 8938 or the failure to report a required specified foreign financial asset keeps the statute of limitations open for all or a portion of the taxpayer’s income tax return. Once the correct Form 8938 is filed, the statute of limitations is subject to the common three-year rule (i.e. the IRS has three years to audit the taxpayer’s tax return and assess additional tax and penalties), subject to the aforementioned singular provision.

This provision states that, if the taxpayer does not include in his gross income an amount relating to one or more specified foreign financial assets and this amount is more than $5,000, then the statute of limitations is extend to six years after the taxpayer files a complete tax return that contains Form 8938.

Furthermore, for the purpose of the six-year extended statute of limitations provision, “specified foreign financial assets” include any such asset regardless of: (i) the reporting threshold that applies to the taxpayer, or (ii) whether this asset is excepted from reporting because it was reported on certain other forms (such as Form 5471, 8621, 8865, et cetera).

These provisions constitute an incredible increase in the IRS power to extend the statute of limitations and assess additional tax and penalties on the taxpayers.

Contact Sherayzen Law Office For Legal Help With Form 8938

Given the severe penalties that accompany Form 8938, it is very important that you properly comply with the Form’s requirements. Therefore, if you need to file Form 8938, contact Sherayzen Law Office for legal help. Our experienced international tax compliance firm will guide you through the complex web of the U.S. international tax reporting requirements and assist you in bringing your tax affairs in full compliance with the U.S. tax system.

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.

IRS Form 8938 and Revised Form 8621 Filing Requirements Under Notice 2011-55

The IRS recently released Notice 2011-55, partially suspending certain Foreign Account Tax Compliance Act (“FATCA”) information reporting requirements until Form 8938, (Statement of Specified Foreign Financial Assets), and a revised Form 8621, (Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund) are released.

It is important to note that while the reporting requirements of Forms 8938 and revised Form 8621 have been partially suspended, they have not been excused for taxpayers. Thus, taxpayers should be aware that until the new forms are issued, tax preparation may be necessary in order to be in compliance and avoid severe penalties.

FATCA Reporting Requirements

Congress enacted the FATCA as part of the Hiring Incentives to Restore Employment Act (“HIRE” Act). Included in FATCA is the additional information reporting requirements of IRC Sections 6038(D) and 1298(f).

Under 6038(D), taxpayers who hold more than $50,000 in the aggregate in any financial account maintained by a foreign financial institution, or in any foreign stock, interest in a foreign entity (including a foreign trust, or financial instrument with a foreign counterpart that is not held in a custodial account of a financial institution) are subject to file a Form 8938 with their annual return.

IRC Code Section 1298(f) requires a U.S. person who is a shareholder in a passive foreign investment company (“PFIC”) to file an annual report, Form 8621. Notice 2011-55 states that the IRS will be issuing a revised Form 8621. Once the revised form is issued, individuals must retroactively file the revised Form 8621 for tax years beginning after the date of the HIRE Act (March 18, 2010).

The IRS is planning on also issuing further regulations regarding these reporting requirements.

Notice 2011-55

IRS Notice 2011-55 provides that the IRC 6038D Form 8938 reporting requirements are suspended until the form is released. Additionally, as noted above, for U.S. shareholders of PFIC’s who were not previously required to file Form 8621 under the current requirements before the enactment of Section 1298(f), reporting requirements are suspended (but not excused) until the revised Form 8621 is released. Taxpayers who are already required to file Form 8621 under the current instructions must continue to file the form.

When the IRS issues the revised forms, taxpayers who must file will be required to attach the appropriate forms to their next information return or tax return, completed for the suspended tax year. Failure to file (or to properly file) Form 8938 and/or Form 8621 for the suspended tax year may result in the extension of the statute of limitations under section 6501(c)(8), and penalties may also be applied.

A Form 8938 or revised Form 8621 filed for a suspended tax year with a timely filed information or tax return will generally be treated as having been filed in the date that the income tax or information return for the suspended tax year was filed.

Subject to certain exceptions, the statute of limitations for assessment of tax will not expire until three years after Form 8938 and/or revised Form 8621 is received by the IRS.

FBAR Requirements Not Affected

The IRS stated in Notice 2011-55 that the filing requirements of FinCEN Form 114 formerly Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts; “FBAR”) are not suspended under the notice.

Contact Sherayzen Law Office NOW For Experienced Legal Help

This article is intended to give a brief summary of these issues, and should not be construed as legal or tax advice. Tax planning and reporting often necessitates an experienced understanding of complex regulations, statutes, and case law, and penalties for failure to comply can be substantial. If you have further questions regarding your own tax circumstances, Sherayzen Law Office offers professional advice for all of your Federal, international, cross-border, and state tax needs. Call now at (612) 790-7024 for a consultation today.