December 21, 2011
Hedge Funds and
Public Policy and
By Mary Burke Baker and Roger S. Wise
On December 14, 2011, the Internal Revenue Service (“IRS”) issued temporary and proposed regulations relating to the provision in the
Hiring Incentives to Restore Employment Act
(“HIRE Act”) that require individuals to report their interests in many types of foreign financial assets to the IRS.
The new rules stipulate that individuals must attach Form 8938, “Statement of Specified Foreign
Financial Assets,” to their tax returns – starting with 2011 tax returns filed in 2012 – disclosing details about their foreign financial holdings.
The new reporting requirement, found at Internal Revenue Code (“IRC”) Section 6038D, was part of the
Foreign Account Tax Compliance Act
(“FATCA”) title of the HIRE Act. This section has received little attention to date compared to other sections of FATCA, but represents an immediate and significant new reporting obligation in addition to the Report of Foreign Bank and Financial Accounts
(“FBAR”) for U.S. individuals holding foreign financial assets. Form 8938 does not replace the
FBAR, which is filed with the Financial Crimes Enforcement Network (“FinCEN”), and many people will be required to file both forms. Although similar in some respects, the differences between the information requested on the FBAR form and Form 8938 will add complexity to the filing process and may make compliance with both sets of rules more difficult. Failure to comply with the new FATCA reporting rules could result in substantial penalties – up to $50,000 for failure to file Form 8938, plus
40% of any underpayment of tax attributable to undisclosed foreign assets.
In general, Form 8938 must be filed when a “specified person” has an interest in one or more
“specified foreign financial assets” with an
fair market value exceeding either $50,000 on the last day of the taxable year or $75,000 at any time during the taxable year for single filers, and
$100,000 on the last day of the taxable year or $150,000 at any time during the year for joint filers.
For specified persons living outside the United States, these thresholds are $200,000 and $400,000 for single filers, and $300,000 and $600,000 for joint filers. The amount reported on Form 8938 is the
fair market value of the assets during the year.
For 2011, only individuals are required to file Form 8938. This contrasts with the broader ambit of the FBAR filing requirement, that applies to all United States persons, including entities created or organized in the United States. Proposed regulations would extend the Form 8938 filing requirement to certain domestic entities. These entities include domestic corporations and partnerships exceeding the aggregate reporting threshold that are closely held by a specified individual (generally 80% ownership) and that generate significant amounts of passive income or hold a significant amount of assets that generate passive income (generally 50%), and domestic trusts exceeding the aggregate reporting threshold with one or more specified persons as beneficiaries. Although the Treasury
Department and the IRS expect these proposed regulations to be finalized during 2012, they would only apply to taxable years beginning after December 31, 2011.
Under Section 6038D, a person generally is considered to have an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross proceeds or distributions attributable to the holding or disposition of the asset are, or would be, required to be reported, included, or otherwise reflected on the person’s tax return (even if none of these are required to be included in any particular tax year).
The definition of specified foreign financial assets follows the definitions found in IRC Section 1471, the more well-known provision of FATCA that requires foreign financial institutions to identify their
U.S. account holders to the IRS or be subject to a 30% withholding tax on all U.S.-source payments received. Specified foreign financial assets include a) any financial account maintained by a foreign financial institution, including a bank or custodial account and stock or debt issued by the foreign financial institution; b) stock or securities issued by any person other than a U.S. person; c) any financial instrument or contract held for investment whose issuer or counterparty is not a U.S. person; and d) any interest in a foreign entity. Examples of assets other than financial accounts that may be considered specified foreign financial assets include, but are not limited to, swaps or similar agreements with a foreign counterparty, and any option or other derivative instrument involving a foreign party or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer.
Certain foreign financial assets are excluded from the Section 6038D rules. These include foreign assets reported on certain other IRS information reporting forms to avoid duplicative reporting (but this does not include the FBAR form), certain assets held by a bona fide resident of a U.S. territory, and assets subject to mark-to-market reporting.
Information required to be reported on Form 8938 includes a) the name and address of the foreign financial institution and the account number; b) for assets not held in a foreign financial institution, the name and address of the issuer of stock or a security, and information that identifies the class or issue of the asset; c) information that identifies the financial instrument or contract, including the names and addresses of all issuers and counterparties; d) information that identifies an interest in a foreign entity, including the name and address of the entity; e) the maximum value of the asset during the portion of the year that it was held by the specified person; f) whether a depository or custodial account was opened or closed during the year; g) whether other types of foreign financial assets were acquired or sold during the year; h) the amount of any income, gain, loss, deduction, or credit recognized for the taxable year with respect to the foreign asset and the IRS schedule or form on which it was reported; i) the foreign exchange rate used to convert the value of the asset to U.S. dollars; and j) the IRS form the asset was reported on if other than Form 8938.
The temporary regulations, effective December 19, 2011, and applicable to calendar year 2011 tax returns, provide short notice to individuals with foreign financial interests who must comply with the new reporting requirement by the time they file their 2011 personal income taxes. Taxpayers who may be affected by the new rules are encouraged to seek assistance promptly to understand their filing obligations and have sufficient time to gather the information necessary to accurately file Form 8938.
Form 8938, “Statement of Specified Foreign Financial Assets,” and Instructions for Form 8938 are available on the IRS website or by clicking here and here .
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Circular 230 Notice
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or
(ii) promoting, marketing or recommending to another party any transaction or matter addressed within.
Mary Burke Baker
Roger S. Wise