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Specified Domestic Entity: Passive Test | FATCA Form 8938 Lawyer & Attorney

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This article is published as part of a long series of articles on the Specified Domestic Entity (“SDE”) Definition. In a previous article, I stated that the term “formed or availed of” consists of two legal tests: the Closely-Held Test and the Passive Test. Since I already explained the general requirements of the Closely-Held Test in another article, I would like to focus today on the Passive Test.

The Passive Test: Background Information

Starting tax year 2016, business entities classified as SDEs may be required to attach Form 8938 to their US tax returns. What entity is considered to be SDE? The answer is found in Treas. Reg. §1.6038D-6(a): “a specified domestic entity is a domestic corporation, a domestic partnership, or a trust described in IRC Section 7701(a)(30)(E), if such corporation, partnership, or trust is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets.”

I already explained in a previous article that “formed or availed of” is a term of art and a requirement that an entity meets two legal tests: the Closely-Held Test and the Passive Test.

The Passive Test: General Requirements

The Passive Test consists of two threshold requirements: the Passive Income Threshold and the Passive Assets Threshold. If one of these Thresholds is satisfied, the Passive Test is met and a business entity would be considered as formed or availed of for the purposes of holding specified foreign financial assets. Let’s explore these two requirements in more detail.

The Passive Test: the Passive Income Threshold

The Passive Income Threshold is satisfied if “at least 50 percent of a corporation’s or a partnership’s gross income for the taxable year is passive income.” Treas. Reg. §1.6038D-6(b)(1)(ii). The definition of passive income includes:

“(A) Dividends,

(B) Interest;

(C) Income equivalent to interest, including substitute interest;

(D) Rents and royalties, other than rents and royalties derived in the active conduct of a trade or business conducted, at least in part, by employees of the corporation or partnership;

(E) Annuities;

(F) The excess of gains over losses from the sale or exchange of property that gives rise to passive income described in paragraphs (b)(3)(i)(A) through (b)(3)(i)(E) of this section;

(G) The excess of gains over losses from transactions (including futures, forwards, and similar transactions) in any commodity, but not including –

(1) Any commodity hedging transaction described in section 954(c)(5)(A), determined by treating the corporation or partnership as a controlled foreign corporation; or

(2) Active business gains or losses from the sale of commodities, but only if substantially all the corporation or partnership’s commodities are property described in paragraph (1), (2), or (8) of section 1221(a);

(H) The excess of foreign currency gains over foreign currency losses (as defined in section 988(b)) attributable to any section 988 transaction; and

(I) Net income from notional principal contracts as defined in § 1.446-3(c)(1).” Treas. Reg. §1.6038D-6(b)(3).

The Treasury Regulations also contain certain exceptions to the definition of passive income (for example, for dealers).

The Passive Test: the Passive Assets Threshold

The Passive Assets Threshold is satisfied if at least 50 percent of the assets held by a corporation or a partnership for the taxable year “are assets that produce or are held for the production of passive income.” Treas. Reg. §1.6038D-6(b)(1)(ii). Such assets are called “passive assets”. Id.

The percentage of passive assets held by a corporation or a partnership during a taxable year is determined based on “the weighted average percentage of passive assets (weighted by total assets and measured quarterly).” Id. This is very similar to the PFIC test.

The regulations allow for two different methods of valuation of the assets for the purpose of the Passive Asset Threshold. The first method is Fair Market Value of the assets. The second method is valuation of assets based on the “book value of the assets that is reflected on the corporation’s or partnership’s balance sheet.” Id. Surprisingly, both US and an international financial accounting standard are permitted for the purpose of the valuation of assets (usually, only US GAAP is allowed).

Contact Sherayzen Law Office for Professional Help with FATCA Form 8938 Compliance

If you are concerned about whether your entity is required to file Form 8938 or you have any other FATCA-related questions, please contact Sherayzen Law Office for professional help. Sherayzen Law Office is an international tax law firm that specializes in the US international tax compliance, including FATCA Form 8938 compliance. We have helped hundreds of US taxpayers with their FATCA requirements and We can help You!

Contact Us Today to Schedule Your Confidential Consultation!

Specified Domestic Entity: Domestic Entity | FATCA Lawyer & Attorney

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This is the second article from the series of articles concerning the definition of a Specified Domestic Entity. Today, I will explore what business entities are considered to be “Domestic”.

Specified Domestic Entity Background Information

Specified Domestic Entity is a new category of FATCA Form 8938 filers. Under FATCA, Form 8938 has to be filed with a US taxpayer’s tax return in order to report his Specified Foreign Financial Assets (“SFFA”). Prior to tax year 2016, Form 8938 was applicable only to individual US taxpayers. Starting tax year 2016, however, Specified Domestic Entities are required to file Form 8938 as long as the total value of their SFFA meets the filing threshold.

Definition of a Domestic Entity for the Purposes of FATCA Form 8938

For the purposes of FATCA Form 8938, whether a corporation or a partnership is considered “domestic” is determined under the general definition found in 26 U.S.C. §7701(a)(4): “the term ‘domestic’ when applied to a corporation or partnership means created or organized in the United States or under the law of the United States or of any State unless, in the case of a partnership, the Secretary provides otherwise by regulations.” Thus, while the definition of a domestic corporation is fairly straightforward, it is not always the case with respect to domestic partnerships.

It should also be remembered that an LLC is never taxed as an LLC under the US tax law. Rather, LLC can be taxed either as a partnership or a corporation; it can also be treated as a disregarded entity if there is only one owner of the LLC and the LLC never elected to be taxed as a corporation.

A trust is considered to be a “domestic trust” if it meets the 26 U.S.C. §7701(a)(30)(E). The tests under this section of the Internal Revenue Code (IRC) can be fairly complex and may require additional analysis (see this article for further analysis).

Contact Sherayzen Law Office for Professional Help With FATCA Form 8938

If you need help with the FATCA Form 8938 compliance (including the definition of a Specified Domestic Entity), contact Sherayzen Law Office for professional help. Our experienced international tax team, headed by international tax attorney Eugene Sherayzen, Esq., will thoroughly analyze your case, determine whether you need to file Form 8938 and any other US international information returns, and prepare these forms for you. We can also help you with the voluntary disclosure of any of your offshore assets if you did not timely comply with your US tax obligations with respect to these assets.

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Foreign Inheritance Form 8938 Reporting | Form 8938 Lawyers

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Foreign Inheritance Form 8938 reporting has quickly turned into one of the most important tax reporting requirements despite being one of the newest tax forms that debuted barely four years ago in 2012 (for the tax year 2011). In this article, I will discuss when Form 8938 needs to be filed with respect to inherited assets. For the purposes of this article, I will only discuss Form 8938 with respect to the assets actually received, not the assets which are still in the estate. I will also avoid the discussion of Form 3520; it is important to note, though, that Form 3520 is likely to be one of the most relevant reporting requirements with respect to foreign inheritance.

Foreign Inheritance Form 8938 Reporting: Form 8938 Basics

IRS Form 8938 was created by the infamous Foreign Account Tax Compliance Act (FATCA) and, generally, it requires individual U.S. taxpayers to report what are known as “specified foreign financial assets” if the value of those assets exceeds the applicable reporting threshold.

It is beyond the scope of this article to explore Form 8938 filing requirements in detail, but, in essence, IRS Form 8938 requires the reporting of three types of assets. The first category consists of financial accounts maintained at foreign financial institutions. This category closely follows the FBAR reporting requirements (with important exceptions, such as signatory authority accounts) but requires U.S. taxpayers to disclose more information with respect to these accounts.

The second category is the requirement to disclose the ownership of a whole new set of classes of assets grouped together under the vague definition of “other foreign financial assets”. Basically, other foreign financial assets include classes of assets which are held for investment but not held in an account maintained by a financial institution. Such assets include stocks or securities issued 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.

Finally, Form 8938 requires the taxpayer to report whether he disclosed any assets on Forms 5471, 8865, 8621, 3520 and 3520-A.

It should be remembered that Form 8938 has its own set of independent penalties associated with Form 8938 noncompliance. These penalties are imposed in addition to penalties associated with FBARs, Form 3520 and other U.S. information returns.

Foreign Inheritance Form 8938 Reporting: Foreign Financial Accounts

If you received foreign bank and financial accounts as part of your foreign inheritance, you will need to disclose these accounts on Forms 8938 if the relevant filing threshold requirement is satisfied. In a foreign inheritance context, an issue often arises if you are an executor of a foreign estate and have signatory authority over the estate’s financial accounts. Whether Form 8938 would need to be filed for the accounts in this situation is a fact-dependent question and needs to be explored by an international tax attorney (though, in the great majority of cases, an FBAR would need to be filed in this context as long as the relevant reporting threshold is satisfied).

Foreign Inheritance Form 8938 Reporting: Other Investment Instruments

If you received other investment instructions as part of your foreign inheritance, your international tax attorney should explore whether these instruments satisfy the second category of reportable Form 8938 assets. Examples of other foreign financial assets include: a note, bond, debenture, or other form of indebtedness issued by a foreign person; 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.

Foreign Inheritance Form 8938 Reporting: Foreign Business Ownership

The detailed exploration of the reporting of an ownership interest in a foreign business is beyond the scope of this article. Therefore, I want to briefly mention that, if you inherited an ownership interest in a foreign corporation, partnership or a disregarded entity, this interest may need to be reported on Form 8938. However, it is possible that this interest may also have to be reported on Forms 5471, 8865, 8858 and other U.S. information reports related to business entities. In this case, it is possible that you will only need to report on Form 8938 that the information regarding an ownership interest in a foreign entity was reported on Form 5471, 8865 and/or 8621.

The final decision on how a foreign business ownership needs to be reported to the IRS should rest with your international tax lawyer.

Foreign Inheritance Form 8938 Reporting: Foreign Trust Beneficiary Interest

The detailed exploration of the reporting of a beneficiary interest in a foreign trust is beyond the scope of this article. For the purposes of this article, let me just provide this brief and over-simplified summary – if you inherited a beneficiary interest in a foreign trust, you should report it on Form 8938 unless it is already reported on Forms 3520 and/or 3520-A (if the latter is the case, you just need to check the box on Form 8938 for the appropriate form on which the beneficiary interest was reported). Again, the decision on how to report your foreign trust beneficiary interest should rest with your international tax lawyer.

Contact Sherayzen Law Office for Professional Help with Your Foreign Inheritance Form 8938 Reporting

The U.S. tax requirements related to reporting of your foreign inheritance may be highly complex and it is very easy to run into trouble. Contact Sherayzen Law Office for professional help. Our legal team is highly experienced in foreign inheritance reporting, including Forms 8938, 3520 (all parts of Form 3520: foreign trusts, foreign gifts and foreign inheritance), 3520-A, 5471, 8621, 8865 and other relevant forms. We have also helped U.S. taxpayers around the globe with their offshore voluntary disclosures with respect to late reporting of their foreign inheritance.

Contact Us Today to Schedule Your Confidential Consultation!