It is not illegal for U.S. taxpayers to maintain accounts at foreign financial institutions, invest in foreign assets, or own foreign-controlled corporations. However, U.S. taxpayers with foreign assets must fulfill various reporting requirements under the Bank Secrecy Act and the Internal Revenue Code.
Below is a list of commonly-missed forms that relate to foreign assets:
- FinCEN Form 114, Report of Foreign Bank and Financial Accounts: Commonly referred to as an FBAR, this information-reporting form has caused quite the upheaval for U.S. taxpayers with foreign financial accounts in recent years. Though an FBAR filing requirement has existed since the Bank Secrecy Act of 1970 was implemented, the IRS began actively exercising its enforcement authority over the filing requirement in 2009. Civil penalties for failure to file the FBAR form can range anywhere from a simple warning letter with no penalties to 50% of the unreported account value.
- Form 8938, Statement of Specified Foreign Financial Assets: This form is required to be filed each year along with the income tax return, Form 1040. The first year in which it was required was the tax year 2011 filing. Failure to file Form 8938 can result in a $10,000 civil penalty for every year in which the form was not filed, with additional penalties for a continued failure to file.
- Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts: This form is often over-looked because taxpayers mistakenly believe that, if assets are held in a foreign trust, there is no related individual filing requirement. Additionally, certain large gifts and bequests from certain foreign persons, though not taxable to the recipient, must be reported to the IRS on Form 3520. Civil penalties for failure to file Form 3520 are the greater of $10,000 or varying percentages of the amount of the distribution from a foreign trust or the amount of the gift or bequest from a foreign person.
- Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations: Because of the complex and lengthy tax law definitions involved with this form, many taxpayers do not know when their foreign investments have triggered the Form 5471 filing requirement. Failure to file Form 5471 can result in a $10,000 penalty for each annual accounting period of each foreign corporation. Ninety days after the filing deadline, a continued failure to file results in an additional $10,000 penalty for each thirty day period, or fraction thereof, after the ninety day period has expired.
While the failure to file any of the above-listed forms can result in criminal prosecution and severe civil penalties, amnesty is available through the IRS 2012 Offshore Voluntary Disclosure Program. Additionally, a reduction or waiver of any potential penalties for failure to file may be available, depending on the particular facts and circumstances of your case.
The Report of Foreign Bank and Financial Accounts, more commonly referred to as the “FBAR” form, is used to report a taxpayer’s financial interest in or signature authority over a foreign financial account.
Filed separately from the annual tax return, Form 1040, the annual filing deadline for the FBAR form is June 30th of the year immediately following the calendar year being reported. No extension of time to file is available. Unlike Form 1040, which must be postmarked by the filing deadline, an FBAR must be received by the filing deadline every year. However, as of June 30, 2013, all FBAR forms, including delinquent forms, must be filed electronically using FinCEN’s online BSA filing system, available here: http://bsaefiling.fincen.treas.gov/main.html.
It is important to understand that some FBAR and Form 8938 reporting requirements may overlap. However, the filing of one form does not excuse the taxpayer from filing the other form, as the purposes of the forms differ. A comparison of the requirements for the two forms can be found here: http://www.irs.gov/Businesses/Comparison-of-Form-8938-and-FBAR-Requirements.
Do You Have an FBAR Filing Requirement?
All United States persons that have a financial interest or signature authority over a foreign financial account must file an FBAR if the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year. This means that if you have two different foreign accounts and one has $5,000 in it and the other has $5,001 in it, both of those accounts must be reported on the FBAR form, because the total value of both of those accounts is $10,001. This can be tricky if you have a brokerage or mutual fund account that changes value throughout the year, depending on the market.
If you are not sure whether your account value triggers an FBAR filing requirement, contact at tax law professional at Brown, PC to discuss the facts of your case. We can be reached at 817-870-0025 or toll free at 888-870-0025. We represent U.S. taxpayers with foreign financial account reporting issues throughout the world.
Additional definitions that may help you determine whether you have an FBAR filing requirement include:
- United States Person: For the purposes of the FBAR, a United States person includes U.S. citizens, residents, corporations, partnerships, limited liability companies, trusts and estates. Only those entities created or organized in the U.S. or under U.S. law are considered U.S. persons for FBAR filing purposes.
- United States Resident: A United States resident is an alien residing in the United States. Residency is defined in Section 7701(b) of the Internal Revenue Code, based on, among other things, the number of days a taxpayer was present in the United States.
- Financial Interest: A United States person has financial interest in a foreign financial account for which:
- the U.S. person is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the United States person or for the benefit of another person; or
- the owner of record or holder of legal title is one of the following:
- An agent, nominee, attorney, or a person acting in some other capacity on behalf of the U.S. person with respect to the account;
- A corporation in which the U.S. person owns directly or indirectly: i) more than 50% of the total value of shares of stock or ii) more than 50 percent of the voting power of all shares of stock;
- A partnership in which the U.S. person owns directly or indirectly: i) an interest in more than 50% of the partnership’s profits, taking into account any special allocation agreements, or ii) an interest in more than 50% of the partnership capital;
- A trust of which the U.S. person: i) is the trust grantor and ii) has an ownership interest in the trust for U.S. federal tax purposes.
- A trust in which the U.S. person has a greater than 50% present beneficial interest in the assets or income of the trust for the calendar year;
- Any other entity, including foreign entities, in which the U.S. person owns directly or indirectly more than 50% of the voting power, total value of equity interest or assets, or interest in profits.
- Signature Authority: Signature authority is the authority of an individual (alone or in conjunction with other individuals) to control the disposition of assets held in a foreign financial account by direct communication to the foreign financial institution that maintains the account.
- Foreign Financial Account: A foreign financial account is a financial account located outside of the U.S. and maintained with a branch located outside of the U.S. Financial accounts including traditional bank accounts, securities accounts, and brokerage accounts.
Penalties for Failure to File
Civil penalties for a non-willful failure to file an FBAR are not to exceed $10,000 per violation. However, each unreported account is considered one violation. Therefore, a taxpayer who has four financial accounts could be penalized $40,000 for each year in which an FBAR form was not filed.
A taxpayer that willfully fails to file an FBAR can be assessed a civil penalty equal to the greater of $100,000 or 50% of the unreported account balance at the time of the violation. Additionally, a willful failure to file may be subject criminal penalties, including monetary fines, restitution, and incarceration.
Form 8938, Statement of Specified Foreign Financial Assets
Beginning with tax year 2011, Form 8938 must be filed by certain U.S. taxpayers if they hold specified foreign financial assets with an aggregate value exceeding $50,000 on the last day of the tax year, or $100,000 for married taxpayers filing a joint return. The Form 8939 filing requirement is also triggered if the aggregate value of specified foreign financial assets exceeded $75,000 at any time during the tax year, or $150,000 for married taxpayers filing a joint return. For U.S. taxpayers that do not live in the U.S., the values that trigger the Form 8938 requirement increase to $200,000 at the end of the tax year or $300,000 at any time during the tax year for individuals and for $400,000 at the end of the year or $600,000 at any time during the tax year for married taxpayers filing a joint return.
Form 8938 is filed with Form 1040 and is due on either April 15th of the year immediately following the year being reporting, or on October 15th if a valid request for an extension of time to file is timely filed. A request to extend the time to file Form 1040 automatically extends the time to file Form 8938. Taxpayers who do not have a Form 1040 filing requirement do not have to file Form 8938.
It is important to understand that some Form 8938 and FBAR reporting requirements may overlap. However, the filing of one form does not excuse the taxpayer from filing the other form, as the purposes of the forms differ. A comparison of the requirements for the two forms can be found here: http://www.irs.gov/Businesses/Comparison-of-Form-8938-and-FBAR-Requirements.
Definitions that may help you determine whether you are required to file Form 8938 with your annual tax return, Form 1040, include:
- United States Person: For the purposes of Form 8938, United States persons include U.S. citizens, resident aliens, non-resident aliens who make an election to be treated as a resident alien for the purposes of filing a joint income tax return, and non-resident aliens who are bona fide residents of American Samoa or Puerto Rico.
- Specified Foreign Financial Assets: Any financial account maintained by a foreign financial institution, unless the account is maintained the foreign branch of a U.S. financial institution or the U.S. branch of a foreign financial institution; and other foreign financial assets held for investment that are not in an account maintained by a U.S. or foreign financial institution, including stock or securities issued by someone other than 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.
A civil penalty of $10,000 may be assessed for failure to timely file a complete and correct Form 8938. There is also a continued failure to file penalty of $10,000 for each thirty day period or fraction thereof until Form 8938 is filed. The continued failure to file penalty commences 90 days from the form’s original due date. The maximum penalty for failure to file Form 8938 is $50,000 per year.
Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Foreign Gifts
Because the filing requirements associated with Form 3520 are relatively in-depth and complicated, we recommend that you consult with a tax professional if you think you may have an obligation to report transactions on this form.
Form 3520 was created for U.S. persons and executors of estates of U.S. decedents to report certain transactions with foreign trusts, ownership of foreign trusts under certain Internal Revenue Code sections, and receipt of certain large gifts or bequests from certain foreign persons. It is one of the most confusing and commonly missed forms because the tax laws that define who are required to file are complex, and oftentimes, individual taxpayers do not realize that foreign trusts have a filing requirement that is related to their individual return. Furthermore, taxpayers who must file Form 3520 because of a large foreign gift or bequest received often do not think to tell their tax preparer that they received such a gift or bequest since it is not classified as taxable income.
Form 3520 is filed with a taxpayer’s annual income tax return, Form 1040, and is due on the date that Form 1040 is due, including valid extensions. When Form 3520 is filed with respect to a U.S. decedent, the due date matches that of Form 706, U.S. Estate Tax Return. In some cases, Form 3520 may need to be filed even if Form 706 is not required.
You are required to file Form 3520 with your annual Form 1040 if:
- You are the responsible party for reporting a reportable event that occurred during the current tax year, or you held an outstanding obligation of a related foreign trust (or an obligation of a person related to the trust) that you treated as a qualified obligation during the current tax year.
- You are a U.S. person who, during the current tax year, is treated as the owner of any part of the assets of a foreign trust under the rules of sections 671 through 679 of the Internal Revenue Code.
- You are a U.S. person who received (directly or indirectly) a distribution from a foreign trust (including the uncompensated use of trust property) during the current tax year, or a related foreign trust held an outstanding obligation issued by you (or an obligation of a person related to you) that you treated as a qualified obligation during the current tax year.
- You are a U.S. person who, during the current tax year, received either: i) More than $100,000 from a nonresident alien individual or foreign estate (including foreign persons related to that nonresident alien individual or foreign estate) that you treated as gifts or bequests; or ii) More than $15,102 (for tax year 2013, this amount may change) from foreign corporations or foreign partnerships (including foreign persons related to such foreign corporations or foreign partnerships) that you treated as gifts.
Civil penalties for failure to file Form 3520 are the greater of $10,000 or varying percentages of the amount of the distribution from a foreign trust or the amount of the gift or bequest from a foreign person.
Form 5471, Information Returns of U.S. Persons with Respect to Certain Foreign Corporations
United States citizens and residents who are officers, directors, or shareholders in certain foreign corporations are responsible for filing Form 5471, Information Returns of U.S. Persons with Respect to Certain Foreign Corporations, if they possess a certain level of ownership or control in a foreign corporation. U.S. domestic corporations, partnerships, and trusts must also file Form 5471.
Form 5471 is filed as an attachment to the annual federal income tax return – Form 1040 for individuals, Form 1120 for corporations, Form 1065 for partnerships, and Form 1041 for trusts. The due date for Form 5471 is the same as the due date of the income tax return, including valid extensions.
Following is a list of definitions associated with Form 5471:
- Category One Filer: The related filing requirement was repealed by Section 413(c)(26) of the American Jobs Creation Act of 2004.
- Category Two Filer: This includes a U.S. citizen or resident who is an officer or director of a foreign corporation in which a U.S. person has acquired (in one or more transactions): i) Stock which meets the 10% stock ownership requirement with respect to the foreign corporation; or ii) An additional 10% or more (in value or voting power) of the outstanding stock of the foreign corporation. Importantly, a U.S. person is considered to have “acquired” stock when that person has an unqualified right to receive the stock, even if the stock is not actually issued.
- Category Three Filer: This category includes: i) A U.S. person who acquires stock in a foreign corporation which, when added to any stock owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation; ii) A U.S. person who acquires stock which, without regard to stock already owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation; iii) A person who is treated as a U.S. shareholder under Section 953(c) of the Internal Revenue Code with respect to the foreign corporation; iv) A person who becomes a U.S. person while meeting the 10% stock ownership requirement with respect to the foreign corporation; or iv) A U.S. person who disposes of sufficient stock in the foreign corporation to reduce his or her interest to less than the stock ownership requirement.
- Category Four Filer: This includes a U.S. person who had control of a foreign corporation for an uninterrupted period of at least thirty days during the annual accounting period of the foreign corporation.
- Category Five Filer: This includes a U.S. shareholder who owns stock in a foreign corporation that is a controlled foreign corporation for an uninterrupted period of thirty days or more during any tax year of the foreign corporation, and who owned that stock on the last day of that year.
- Stock Ownership Requirement: For the purposes of Category 2 and 3, the stock ownership threshold is met if a U.S. person owns: i) 10% or more of the total value of the foreign corporation’s stock; or ii) 10% or more of the total combined voting power of all classes of stock with voting rights.
- Control: A U.S. person has control of a foreign corporation if, at any time during that person’s tax year, it owns stock possessing: i) More than 50% of the total combined voting power of all classes of stock of the foreign corporation entitled to vote; or ii) More than 50% of the total value of shares of all classes of stock of the foreign corporation.
- U.S. Shareholder: For the purposes of Category 5, a U.S. shareholder is a U.S. person who: i) Owns, directly, indirectly, or constructively, 10% or more of the total combined voting power of all classes of voting stock of a controlled foreign corporation; or ii) Owns, directly or indirectly, stock of a controlled foreign corporation that is also a captive insurance company.
- Controlled Foreign Corporation: A foreign corporation that has U.S. shareholders that own, directly, indirectly, or constructively, on any day of the ax year of the foreign corporation, more than 50% of: i) The total combined voting power of all classes of its voting stock; or ii) The total value of the stock of the corporation.
Civil penalties that range from $10,000 to $50,000 per violation may apply for failure to file Form 5471. Additional, criminal penalties including fines and incarceration may apply if willfulness and intent can be shown.
At Brown, PC, our knowledgeable team of tax professionals can help you figure out how to best minimize your risk. If you have unreported foreign income or non-compliant offshore accounts and have not yet entered the OVDP, or if you have already entered the OVDP and want to know whether you might be a good opt-out candidate, contact us at 817-870-0025 or toll free at 888-870-0025 to discuss your case and to schedule a consultation.