Tax Planning

Form 8938: Not a Prelude to a Wealth Tax…This Time [Part I]

Back in 2010, President Obama signed the infamous Foreign Account Tax Compliance Act (“FATCA”). Among other provisions, FATCA provides that if you hold a “specified foreign financial asset” (SFFA), you must attach a disclosure statement to your income tax return for each year in which the aggregate value of all such assets exceeds $50,000, or a larger sum as directed by the IRS. You make this disclosure on a yet-to-be-officially released form (Form 8938) and submit this form with your annual tax return. (FATCA is part of the larger HIRE Act, which I wrote about here.

This requirement covers tax years from 2010 forward. However, the IRS has suspended the 2010 reporting obligation until after Form 8938 is released in its final form. When it is, you’ll have to attach Form 8938 for any years in which reporting was suspended (currently, just 2010) to your first tax return in which the final version of Form 8938 is available (presumably, your 2011 return).

In June 2011, the IRS issued a draft version of Form 8938.  When it was released, I thought the draft version of Form 8938 implied that you’d have to list details of virtually all property you hold outside the United States. I also believed that its disclosure requirements might signify early preparations for an eventual wealth tax on offshore assets. But the June version also came without any instructions, so there was no way to know for sure.

Now, the IRS has issued a more comprehensive draft version of Form 8938 along with detailed instructions on how to complete it. A wealth tax imposed by separate legislation remains a distinct possibility, but the instructions for Form 8938 now focus on financial assets, not non-financial assets. Numerous types of non-financial assets held offshore remain non-reportable, as I’ll describe in Part II of this article.

What’s a “Specified Foreign Financial Asset?”

The draft instructions follow the original language in FATCA fairly closely in defining these items:

SFFAs include the following assets:

1. Any financial account maintained by a foreign financial institution.

2. Other foreign financial assets, which include any of the following assets that are held for investment and not held in an account maintained by a financial institution.

(a) stock or securities issued by someone other than a U.S. person,

(b) Any interest in a foreign entity, and

(c) Any financial instrument or contract that has an issuer or counterparty that is other than a U.S. person.

I don’t have the space to describe all the criteria the IRS applies to define “financial account” and “foreign financial institution,” and “other SFFAs.” But, there are a few rules and definitions that you should know about:

* A financial account includes accounts maintained in U.S. possessions (e.g., the U.S. Virgin Islands, Guam, Puerto Rico, etc.). Even though these accounts aren’t technically outside the United States, you must report them on Form 8938 if you meet the reporting threshold.

* SFFAs held by a foreign corporate entity that you elect to have taxed as a “disregarded entity” (e.g., an offshore LLC) must be reported on Form 8938. That’s beside the fact that you must also file an annual disclosure form for the LLC, and quite possibly, a separate disclosure form for both the LLC and for you personally: Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR).

* You must report any interest in any foreign entity (e.g., foreign corporation, partnership, etc.) on Form 8938. However, if that entity isn’t taxed as a disregarded entity, you need only report your interest in that entity itself, and not the entity’s ownership of any SFFAs.

* Interests in jointly owned assets. A joint owner has an interest in the entire asset, which must be reported at its entire value. There is an exception if you jointly own reportable assets with your spouse who files a separate tax return, in which case you only report 50% of the value.

* Interests in assets held in financial accounts. You don’t need to report an interest in the assets held in a financial account if you report your interest in that account itself.

* A foreign financial institution includes investment vehicles such as foreign mutual funds, foreign hedge funds, and foreign private equity funds.

* If your income is below the filing threshold for a particular year, you don’t need to file Form 8938, even if the value of your SFFAs exceeds the reporting threshold.

Other SFFAs include the following, if held for investment:

* Stock issued by 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 estate

* An option or other derivative investment entered into with a foreign counterparty or issuer.

You need not report any of these SFFAs if you hold them for use in the conduct of any trade or business. For instance, let’s say you’re an exporter. Your foreign counterparty insists that you enter into an option arrangement to protect it from foreign currency fluctuations. When you do so, that arrangement apparently wouldn’t be reportable on Form 8938.

If all this sounds unbelievably complex, it is. If you meet the thresholds established for filing Form 8938, you’ll almost certainly need professional assistance to complete it.

Incidentally, Form 8938 in many respects duplicates reporting obligations that are already in place with respect to all U.S. citizens or permanent residents, no matter where they live. However, the IRS emphasizes that filing Form 8938 in no way relieves you of these your obligations to make these additional disclosures. The most important of these, but by no means the only one that may apply, is your annual obligation to file the FBAR.

Increased Filing Thresholds

One bright spot is that the filing thresholds are in many circumstances higher than the $50,000 figure FATCA suggested.

The Instructions provide that individuals satisfy the reporting thresholds if they have SFFAs of more than $100,000 at any time during the year

Unmarried persons living in the United States you must file Form 8938 if the total value of their SFFAs on the last day of the year exceeds $50,000, or if that value exceeded $100,000 at any time during the year. The same rules apply to married taxpayers filing separate returns and living in the United States. That threshold doubles to $100,000 for U.S.-resident married taxpayers filing a joint return

Bona-fide residents of foreign countries who must file U.S. tax returns by virtue of their status as a U.S. citizen or permanent resident have higher thresholds. For foreign residents not filing a joint tax return, Form 8938 is required only if the total value of their SFFAs is more than $200,000 on the last day of the tax year or more than $400,000 at any time during the tax year.  For foreign residents that abroad and file a joint tax return, the threshold rises to $400,000 and $600,000, respectively.

So…What’s Non-Reportable?

That’s a great question, and that I’ll report on in my next blog entry. Until then, if you’d like to review the draft instructions for Form 8938 for yourself, click here.

(An earlier version of this post was published by The Sovereign Society, https://banyanhill.com/)

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