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

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!

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Specified Domestic Entity Form 8938 Filing Threshold | FATCA Lawyer

The Specified Domestic Entity Form 8938 filing threshold is likely to be very easily satisfied by the majority of Specified Domestic Entities. With the major tax return filing deadlines just two or three months away (depending on whether an entity is a corporation, a partnership or a trust), every Specified Domestic Entity must assess whether it is required to file FATCA Form 8938. Failure to do so may result in imposition of Form 8938 penalties by the IRS.

Specified Domestic Entity Form 8938 Filing Threshold

For tax years beginning after December 31, 2015, a Specified Domestic Entity must file Form 8938 if the total value of its Specified Foreign Financial Assets exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year. This is an incredibly low Specified Domestic Entity Form 8938 filing threshold that pretty much means that virtually all Specified Domestic Entities will have to file a Form 8938.

Transition Years Are Most Dangerous

Transition tax years 2016, 2017 and 2018 are likely to be the most dangerous for Specified Domestic Entities. Since the Specified Domestic Entity Form 8938 filing threshold is very low and the awareness of the Specified Domestic Entity Form 8938 filing obligation is limited to a small number of specialized tax professionals, there can be no doubt that many Specified Domestic Entities will fail to comply with their Form 8938 filing obligations and may face steep Form 8938 penalties.

Contact Sherayzen Law Office for Help with the Specified Domestic Entity Form 8938 Filing Obligations

If your business or a trust is classified as a Specified Domestic Entity and your entity failed to file FATCA Form 8938,  contact Sherayzen Law Office for professional help. Our international tax law firm specializes in helping business and individuals with their US international tax compliance requirements, including Form 8938, and with their offshore voluntary disclosures involving a Form 8938.

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FATCA PFIC Reporting | International Tax Attorney

FATCA PFIC Reporting is an important feature in today’s U.S. tax compliance. In this article, I will focus on the explanation of the FATCA PFIC Reporting requirement for U.S. shareholders of a PFIC.

FATCA PFIC Reporting: FATCA Background

The Foreign Account Tax Compliance Act (“FATCA”) is contained in Chapters 1471–1474 of the Internal Revenue Code (“IRC”) as enacted into law by section 501(a) of the Hiring Incentives to Restore Employments (HIRE) Act 2010. FATCA was enacted specifically to combat offshore tax evasion by US persons with secret foreign accounts.

There are two large parts of FATCA. The first part concerns only foreign financial institutions (FFIs). Under FATCA, the FFIs are now required to identify US accountholders and report their accounts to the IRS. The second part of FATCA requires US taxpayers to report their foreign assets and foreign income on Form 8938, which is filed with the taxpayers’ US tax return.

This article is mostly concerned with the FATCA PFIC reporting on Form 8938.

FATCA PFIC Reporting: PFIC Background

A Passive Foreign Investment Company, commonly known as PFIC, is one of the most complex tax designations in the United States. The annual tax compliance for PFICs (especially default Section 1291 PFICs) can be tremendously burdensome. Furthermore, distributions and capital gains from PFICs may be subject to a much higher PFIC income tax (and PFIC interest on the PFIC tax).

A PFIC is any foreign corporation that falls within the definition of IRC Section 1297(a), which states that a foreign corporation is a PFIC if: “(1) 75 percent or more of the gross income of such corporation for the taxable year is passive income, or (2) the average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.” Foreign mutual funds is one of the most common examples of PFICs; however, other companies may also fall within the scope of the IRC Section 1297(a).

If a U.S. taxpayer has PFICs, he is required to file Form 8621 “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund”. A separate form 8621 should be filed for each PFIC (often, it is more convenient to file a separate Form 8621 for various blocks of the same PFIC; however, one needs to make sure that the same identification number is provided on each Form 8621 filed for the same PFIC).

FATCA PFIC Reporting: Relationship Between Form 8938 and Form 8621

In general, the FATCA foreign financial asset reporting on Form 8938 overlaps with the PFIC reporting obligation on Form 8621, but the relationship between the two forms is fairly clear. If forms 8621 must be filed (and, since 2013, this is pretty much always the case for PFICs), then the PFICs do not need to be reported on Form 8938. The number of forms 8621 must still be specified on Form 8938.

It is also important to remember that PFICs must still be disclosed on FBARs even if they are reported on Forms 8621 and 8938.

Contact Sherayzen Law Office for Help with FATCA PFIC Reporting

PFIC calculations themselves are some of the most complex requirements in the IRC. FATCA PFIC reporting further complicates the already difficult issues surrounding PFICs. It is very easy to make mistakes which result in the imposition of high IRS penalties. The correction of these mistakes will also likely result in additional legal fees.

This is why you need to secure the help of an experienced international tax law firm as early as possible and Sherayzen Law Office is the perfect fit. We have helped numerous US taxpayers around the world with their FATCA PFIC matters and we can help you.

Contact Us Today to Schedule Your Confidential Consultation!