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 of 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.
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, 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.