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Beware: New Form 8938 - Statement of Foreign Financial Assets

Effective for tax years starting after March 18,2010, individual U.S. taxpayers (as well as bona fide residents of American Samoa and Puerto Rico) are required to include Form 8938, “ Statement of Specified Foreign Financial Assets”, in their income tax returns if they have " specified foreign financial assets" with an aggregate value exceeding an applicable reporting threshold. In effect, this new form is applicable for calendar year 2011. This form does not replace Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts (FBAR)”, but is in addition to it. 

For 2011, Only Individuals Are Required To File: 

Under Code Sec. 6038D, only specified persons are required to file Form 8938 if their interests in specified foreign financial assets exceed an applicable reporting threshold. Specified persons cover basically individual taxpayers who may file a U.S. tax return --- U.S. citizens, U.S. residents, nonresidents who elect to be treated as residents for filing a joint tax return, and residents of American Samoa or Puerto Rico. Bona fide residents of American Samoa or Puerto Rico are included as specified persons because they may be required to file a U.S. income tax return. 

Proposed regulations (Prop. Reg. 1.6083D -6), issued on Dec. 19, 2011, require specified domestic entities to file Form 8938. These proposed regulations are not effective until finalized. Temp. Reg. 1.6038D-1T(a)(12) reserves the definition of a specified domestic entity. Therefore, the filing requirements for 2011 are only applicable to individual taxpayers. 

The applicable reporting threshold for an individual taxpayer varies based on whether an individual lives in the United States or files a joint income tax return. Once the applicable threshold is met, Form 8938 is required regardless whether or not the interests in the specified foreign financial assets have any income tax effect. However, an individual is not required to file Form 8938 if he / she is not required to file an income tax return for the tax year. 

In short, whether an individual taxpayer is required to file Form 8938 depends on his/her filing status , residency and the total value of interests in specified foreign financial assets held by the individual. The following provides an overview of 1) an interest in a specified foreign financial asset, 2) the reporting thresholds and 3) the value of specified foreign financial assets. 

Interests in Specified Financial Assets: 

Under Temp. Reg. 1.6038D -3T, specified foreign financial assets are broadly defined and include assets that one may not believe to be “foreign assets”. The term generally includes, but is not limited to the following assets: 

1. Any financial account maintained by a foreign financial institution. Besides obvious financial institutions such as foreign banks, a foreign financial institution includes investment vehicles such as foreign mutual funds, foreign hedge funds, and foreign private equity funds. 
2. To the extent held for investment (and not in an account maintained by a financial institution), any stock, securities, financial instrument or contract that is issued by a person (or has a counterparty) that is not a U.S. person. Examples of such financial assets include:  
   • stock of a foreign corporation,  
   • a capital or profits 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, and any notional principal contract with a foreign counterparty, 
   • an option or any derivative instrument with respect to any currency, commodity or other financial asset that has a foreign counterparty, 
   • an interest in a foreign retirement plan or foreign deferred compensation plan, and 
   • any foreign life insurance products. 

In accordance with Temp. Reg. 1.6038 D-3T (a) (3) (ii), a financial account is not a specified foreign financial asset if all of the holdings in the account are marked-to-market under Code Sec. 475 (a), (e) or (f). Similarly, a foreign asset not held in a financial account is also not a specified foreign financial asset if it is marked-to market under Code Sec. 475 (a), (e) or (f). Temp. Reg. 1.6038D-3T (b) (2). 

An asset is held for investment if the asset is not used in, or held for use in, the conduct of a trade or business. Under Temp . Reg. 1.6038D -3T (b) (4), an asset is used in, or held for use in, the conduct of a trade or business if the asset is: 1) held for the principal purpose of promoting the current trade or business, 2) acquired and held in the ordinary course of a trade or business (e.g., account or note receivables arriving from the trade or business), or 3) held in a direct relationship to the trade or business. For the purpose of determining whether an asset is held in a direct relationship to a trade or business, principal consideration is given on whether the asset is needed for the present needs of the trade or business. An asset is not considered needed in the trade or business if , for example, it is held for the purpose of providing for future diversification into a new trade or business, future plant replacement, or future business contingencies. Stock is never considered used or held for use in a trade or business. 

An individual is generally considered to have an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross receipts, or distributions attributable to the specified foreign financial asset would be reported or otherwise reflected on an annual income tax return of such individual. The individual is considered to have an interest in the specified foreign financial asset even if there were no income, gains, losses, deductions, credits, gross receipts, or distributions for the tax year. Temp. Reg. 1.6038D -2T (b)(1) 

An individual is generally not treated as having an interest in any specified foreign financial assets held by a partnership, corporation , trust, or estate solely as a result of his/her status as a partner, shareholder, or beneficiary. However, an individual is considered to have an interest in specified foreign financial assets if he/ she is the owner of a disregarded entity (e.g., single member LLC) which owns such assets. Unless an exception specified in Temp. Reg. 1.6038D-2T(b)(3) applies ,a grantor of a grantor trust is also treated as owning interests in specified foreign financial assets held by such trust. A parent that makes an election under Code Sec. 1(g)(7) to include unearned income of a child is considered to have an interest in the specified foreign financial assets held by the child. Temp. Reg. 1.6038D-2T (b) (2) 

Reporting Thresholds: 

The reporting threshold varies depending on an individual taxpayer's filing status and residency. Following is a table showing that an individual taxpayer must file Form 8938 when the total fair market value (FMV) of specified foreign financial assets exceeds one of two thresholds (i.e., amount at year end or maximum amount anytime during the year) in accordance with his/ her filing status and residency. 

Under Temp. Reg. 1.6038D-2T (3) and (4), an individual is considered living abroad if he/she is a qualified individual under Code Sec. 911(d)(1) for the foreign earned income exclusion. 

Value of Foreign Financial Assets: 

Generally, FMV is used for the purpose of determining if the specified foreign financial assets exceed an applicable reporting threshold. Specific rules are set forth in Temp. Reg.1.6038D-5T for the purpose of determining the FMV of certain assets. For example, if the value of a specified foreign financial asset is less than zero, the value is treated as zero. 

If the foreign asset is denominated in foreign currency, the value is first determined in the foreign currency and then converted to U.S. dollars using the foreign currency exchange rate on the last day of the taxable year. In most cases, the U.S. Treasury Department’s Financial Management Service foreign currency exchange rate for purchasing the U.S. dollars must be used (find rate at www.fms.treas.gov/intn.html). If a U.S. Treasury Financial Management Service foreign currency exchange rate is not available, another publicly available foreign currency exchange rate may be used as long as it is disclosed on Form 8938. 

If an asset is jointly owned, the value that an individual uses to determine the total value of all specified foreign financial assets depends on whether the other owner is a spouse, and if so, whether the spouse is a specified individual and whether a joint or separate return is filed. See Temp. Reg. 1.6038D-2T(c). 

• Joint ownership with spouse filing joint return 
  • File one combine Form 8938 for the tax year, if required. 
  • Include the value of the assets jointly owned with the spouse only once to determine the total value of all specified foreign financial assets. 
• Joint ownership with spouse filing separate return 
  • Each spouse files a separate Form 8938, if required. 
  • Include one-half of the value of the assets jointly owned with the spouse to determine the total value of all specified foreign financial assets. 
• Joint ownership with others, or with a spouse who is not a specified individual 
  • Each owner files a separate Form 8938, if required. 
  • Include the entire value of the jointly owned assets to determine the total value of all specified foreign financial assets. 

Penalties 

Failure to file a complete Form 8938 will result in a $10,000 penalty. Although the penalty may be waived when there is reasonable cause, a taxpayer must make an affirmative showing of all the facts alleged as reasonable cause. 

Other penalties, including accuracy-related penalty, fraud, and criminal penalties, may also apply. 

For further information, please contact Paul C. Lau at plau@BlackmanKallick.com or 312-980-2935, Amanda Zhong at azhong@BlackmanKallick.com or 312-980-3324, or your Blackman Kallick representative. This alert was originally published on icpas.org. 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.