FATCA’s Form 8938 Reporting Obligations

Presented by Attorney David J. LewisOf Krugliak, Wilkins, Griffiths & Dougherty

Co., LPA

All contents herein are protected by U.S. Copyright Laws - Copyright © 2013Krugliak, Wilkins, Griffiths & Dougherty Co., L.P.A. 00621284

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Form 8938

• IRC §6038D, enacted as part of FATCA, requires certain taxpayers with an interest in a “specified foreign financial asset” to attach Form 8938 Statement of Specified Foreign Financial Assets to their Form 1040.– Form 8938 was released in its final form on December 21, 2011.

Accordingly, taxpayers must file Form 8938 starting with their 2011 Form 1040, if applicable. BNA Foreign Income Portfolio: U.S. International Portfolio 947-1st.

• Form 8938 consists of four parts, covering foreign deposit and custodial accounts (Part I), other foreign assets (Part II), a summary ledger of tax items attributable to applicable foreign assets (Part III), and a space to check-the-box for the forms eligible for the exception for duplicative reporting (Part IV).

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Form 8938: Who must file?

• A “specified person” or “specified individual” who is required to file an annual U.S. income tax return or information return, and has an interest in one or more foreign financial assets with an aggregate fair market value exceeding the applicable reporting threshold. I.R.C. §6038D; Treas. Reg. §§1.6038D-1T, -2T.

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Form 8938: Who must file?

A “specified person” is defined in the Regulations as any “specified individual” who is: 1. A U.S. citizen;2. A resident alien for any portion of the taxable year;3. A nonresident alien who has elected to be taxed as a U.S.

resident under §6013(g) or (h); or4. A nonresident alien who is a bona fide resident of Puerto

Rico or a §931 U.S. possession (American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands).

See Treas. Reg. §1.6038D-1T(a)(1)-(5).

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Form 8938: Who must file?

• Reporting by domestic entities with interests in specified foreign financial assets is not currently required as the final regulations have yet to be issued on this provision. Notice 2013-10, 2013-8 I.R.B. 503.

• At this time, the IRS has issued proposed rules that would apply the same reporting regime to domestic entities. Prop. Treas. Reg. §1.6038D-6.

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Form 8938: Specified Foreign Financial Assets

“Specified foreign financial assets” are defined as: 1. Financial accounts (e.g. bank accounts, mutual funds, hedge

funds, private equity funds) that are maintained by a foreign financial institution including financial institutions that are organized under the laws of a U.S. possession; and

2. To the extent not held in an account at a financial institution:i. Stocks or securities issued by foreign persons; ii. Any other financial instrument or contract held for investment that

is issued by foreign person or has a foreign person as a counterparty; and

iii. Any interest in a foreign entity.

IRC §6038D(b); Treas. Reg. §1.6038D-1T(a)(6); Treas. Reg. § 1.6038D–3T(a)(2)

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Form 8938: Specified Foreign Financial Assets

Examples of specified foreign financial assets other than financial accounts include:1. Stock issued by a foreign corporation;2. A capital or profit interest in a foreign partnership; 3. Debt issued by a foreign person, including a note, bond or debenture; 4. An interest in a foreign trust;5. An interest in various financial swaps or similar agreement with a

foreign counterparty (e.g. interest rate, currency, equity, and commodity swaps); and

6. Any derivative instrument, including options, in relation to any of the other examples or with respect to any currency or commodity entered into with a foreign counterparty or issuer.

Treas. Reg. §1.6038D-3T(d).

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Form 8938: Interest in Specified Foreign Financial Asset

• A specified person has 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 specified foreign financial asset would be required to be reported on an annual return.

• A specified person has an “interest” even if no income, gains, losses, deductions, credits, gross proceeds, or distributions are attributable to the holding or disposition of the specified foreign financial asset for the taxable year.

Treas. Reg. §1.6038D-2T(b)(1).

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Form 8938: Reporting Thresholds Domestic Taxpayers

• Unmarried taxpayers or married taxpayers filing separate income tax returns: The total value of specified foreign financial assets exceeds $50,000 on the last day of the taxable year or $75,000 at any time during such year. Treas. Reg. §1.6038D-2T(a)(1).

• Married taxpayers filing a joint return: The total value of specified foreign financial assets exceeds $100,000 on the last day of the taxable year or $150,000 at any time during such year. Treas. Reg. §1.6038D-2T(a)(2).

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Form 8938: Reporting Thresholds Taxpayers Living Abroad

You are a taxpayer living abroad if you are:• a citizen of the U.S. and a bona fide resident of a foreign country or countries

for a continuous period which includes an entire taxable year, or• a citizen or resident of the U.S. and who, during any period of 12 consecutive

months, is present in a foreign country or countries for 330 days.I.R.C. § 911(d)(1).If you are a taxpayer living abroad, you must file if:• You are filing a return other than a joint return and the value of your specified

foreign assets exceeds $200,000 on the last day of the tax year or $300,000 at any time during the year; or

• You are filing a joint return, and the value of your specified foreign asset exceeds $400,000 on the last day of the tax year or $600,000 at any time during the year.

See Treas. Reg. §1.6038D-2T(a)(3)-(4).

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Form 8938: Valuing the AssetThe value of a specified foreign financial asset is equated to fair market value, both for purposes of determining if an interest exceeds a reporting threshold and for reporting the maximum value of an asset on Form 8938. • When reporting the maximum value of an asset, a taxpayer may rely on the annual

account statements of the foreign financial institution. – An asset with attributed negative value is treated as having zero value. – For assets that are denominated in a foreign currency, the value must first be determined

in the foreign currency before conversion into U.S. dollars. • As for valuing assets not held in a financial account, the fair market value as

recorded on the last day of the tax year will suffice. In either case, these valuation approaches are unavailable if, based on readily accessible information, the specified person has actual knowledge or reason to know that the purported maximum value of an asset does not reflect the fair marker value of an asset.

Treas. Reg. §1.6038D-5T.

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Form 8938: Valuing the Asset

• A special, but similar fair market value determination applies for foreign trusts and foreign estates, pension plans, and deferred compensation plans. These values are also subject to the actual knowledge or reason-to-know condition. Treas. Reg. §§1.6038D-5T(f)(2),(3).

• Special rules also apply to those jointly owned assets. Generally, the entire value of the asset, and not the value of each person's interest is used to determine value. – This also applies to married individuals who file a joint return. But,

for married individuals who file separate returns, only one-half of the value of the jointly owned asset is used.

Treas. Reg. §1.6038D-2T(c)(1).

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Form 8938: Notable Exceptions from Filing

Certain financial assets are not considered a specified foreign financial asset and are exempt from reporting. Some of these exceptions include:• Foreign real estate is not reportable on Form 8938. But, if the real estate is held by a

foreign entity, the taxpayer’s interest in the foreign entity is reportable. Further, a mortgage or lease would be reportable. http://www.irs.gov/Businesses/Corporations/Basic-Questions-and-Answers-on-Form-8938#Q3

• Accounts at U.S. branches of foreign banks are not reportable on Form 8938. http://www.irs.gov/Businesses/Corporations/Basic-Questions-and-Answers-on-Form-8938#Q10.

• Likewise, accounts at foreign branches of U.S. banks are not reportable. http://www.irs.gov/Businesses/Corporations/Basic-Questions-and-Answers-on-Form-8938#Q11

• An interest in a foreign trust or estate is not reportable unless the person knows or has reason to know based on readily accessible information of the interest. Receipt of a distribution from the foreign trust or estate constitutes actual knowledge. Treas. Reg. § 1.6038D–3T(c)

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Form 8938: Mechanics of Filing

When?• By due date, including extension, for income

tax return, even if none of the assets affect the tax liability of the person. Specified individuals who are married and file joint returns need only submit a single Form 8938.

26 C.F.R. §1.6038D–2T(a).

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Form 8938: Mechanics of FilingWhat?• Although the reportable information varies depending upon the type of

interest involved, Form 8938 generally requires:– Names and addresses of foreign financial institutions, issuers and

counterparties, and entities;– Information sufficient to identify a financial instrument or contract, including

dates, account type, and numbers;– Amounts of income, gain, loss, deduction, or credit recognized with respect to

the foreign asset;– All corresponding schedules, forms or returns filed with the IRS within which

the asset was reported or included;– The foreign currency exchange rate used to determine the U.S. dollar value of

an asset; and– The maximum value of an asset for the portion of the taxable year during

which the interest is held.

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Form 8938: Penalties

• For a failure to timely file, a $10,000 penalty may be imposed. Ninety days after notice of a failure to file from the IRS, the initial penalty increases by $10,000 for each 30-day period, up to $50,000 for each failure.

• The failure to comply with the reporting requirements or any underpayment related to such failure may result in criminal penalties.

I.R.C. §6038D(d); Treas. Reg. §1.6038D-8T(a),(c), (f)(2).

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Form 8938: Penalties

• Where a specified person has failed, upon request by the IRS, to provide sufficient information to determine the aggregate value of the foreign financial asset, the IRS will apply a presumptive value in excess of the reporting threshold for the purpose of assessing penalties.

I.R.C. §6038D(e); Treas. Reg. §1.6038D-8T(d).

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Form 8938: Penalties

There is a “reasonable cause” exception to the enforcement of a penalty for the failure to file. • The specified person must show that the failure is due

to reasonable cause, and not willful neglect. This determination is made on a case-by-case basis.

• Notably, the regulations specifically provide that the fact that a foreign jurisdiction would impose civil or criminal penalties for disclosing the required information is not reasonable cause.

I.R.C. §6038D(g); Treas. Reg. §1.6038D-8T(e).

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Form 8938: Penalties

With the implementation of FATCA and its regulations: • IRC §6662 was amended to impose a 40% penalty on any

understatement related to an undisclosed foreign financial asset that is subject to reporting under I.R.C. §6038D.

• Additionally, §6501 was amended to create a six-year statute of limitations for assessment of tax on understatements of income related to foreign financial assets.

BNA Foreign Income Portfolio: U.S. International Portfolio 947-1st.

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Form 8938 and the FBAR

• The information required to be reported on Form 8938 and the FBAR Form TD F 90-22.1 is similar, but not identical.

• These two forms constitute separate reporting obligations based on different policy considerations– Form 8938 concerns tax administration and Form TD 90-22.1 pertains to law enforcement. BNA Foreign Income Portfolio: U.S. International Portfolio 947-1st.

• For further explanation as to the differences between these forms see Comparison of Form 8938 and FBAR Requirements, available at http://www.irs.gov/Businesses/Comparison-of-Form-8938-and-FBAR-Requirements

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Form 8938 and the FBARForm 8938 FBAR

Must domestic entities file?

No. Yes.

Reporting Thresholds $50,000 on the last day of the tax year or $75,000 at any time during the tax year. Higher threshold amounts apply to married individuals filing jointly and individuals living abroad. (See slides “Form 8938: Reporting Thresholds”)

$10,000 at any time during the calendar year.

Does the United States include U.S. territories?

No. Yes, resident aliens of U.S territories and U.S. territory entities are subject to FBAR reporting.

Financial account held at a foreign branch of a U.S. financial institution

Not reportable. Reportable.

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Duplicative ReportingA specified person is not required to report a specified foreign financial asset on Form 8938 if the specified person reports the asset on at least one of the following forms : • Form 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of

Certain Foreign Gifts”;• Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign

Corporations”;• Form 8621, “Return by a Shareholder of a Passive Foreign Investment Company or Qualified

Electing Fund”;• Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships”; Form

8891, “U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans”; or

• Any other form under Title 26 of the U.S. Code that is identified by the Secretary in as being for this same purpose.

The specified person is obligated, however, to report on Form 8938 the filing of the form on which the asset is reported.

Treas. Reg. §1.6038D-7T(a).

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Duplicative Reporting

• This exception also applies to foreign grantor trusts, provided that the specified person, who is treated as the owner of the trust or any portion thereof under §§671–679, and the trust timely file Forms 3520 and 3520-A and the person indicates this on Form 8938. Treas. Reg. §1.6038D-7T(a)(2).

• Additionally, this applies to a specified person who is treated as an owner of certain other domestic trusts under §§671–679, if the trust is either (1) a widely-held fixed investment trust under Treas. Reg. §1.671-5, or (2) a liquidating trust created pursuant to a court order issued in a bankruptcy proceeding under Chapter 7 or a confirmed plan under Chapter 11 of the Bankruptcy Code. (See Treas. Reg. §1.6038D-7T(b)).

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Duplicative ReportingFinally, a specified individual who is a bona fide resident of a U.S. possession and who is required to file Form 8938 is not required to report the following specified foreign financial assets:• A financial account with a financial institution organized under the laws of the U.S.

possession;• A financial account with a branch of a financial institution not organized under the laws

of the U.S. possession, if the branch is subject to the same reporting requirements that apply to a financial institution organized under the laws of the U.S. possession;

• Stock or securities issued by an entity organized under the laws of the U.S. possession;• An interest in an entity organized under the laws of the U.S. possession; and• A financial instrument or contract held for investment, provided foreign issuer or

counterparty is (1) an entity organized under the laws of the U.S. possession, or (2) a bona fide resident of the U.S. possession of which the specified individual is a bona fide resident.

Treas. Reg. §1.6038D-7T(c)(1)-(5).

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Form 8938 and Offshore Voluntary Disclosure Program

• FATCA’s efforts are aimed at foreign financial institutions, requesting cooperation to prevent tax evasion by U.S. taxpayers.

• Alternatively, the Offshore Voluntary Disclosure Program (OVDP) focuses its efforts on taxpayers, allowing them to come forward and report undeclared foreign income and assets.

• Participation in the OVDP requires taxpayers to produce relevant foreign financial documentation and forms, including Form 8938. OVDP FAQ 7, 25.

• As FATCA becomes more of a reality, foreign financial information will be disclosed to the IRS, with or without taxpayer cooperation. Thus, taxpayers may be encouraged to participate in the OVDP, in an effort to avoid foreign reporting penalties.

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Form 8938 and Treasury Circular 230

Treasury Circular 230• Going forward, tax preparers need to be aware of the possible preparer liability in connection to

foreign financial reporting. • Under Treasury Circular 230 the following rules apply:

– §10.21: A practitioner who knows of a client’s noncompliance, omission, or error on tax returns, must advise the client of the noncompliance, omission, or error and let them know of the potential consequences of such.

– § 10.22: A practitioner must exercise due diligence, accurately prepare and file returns, and determine the accuracy of representations made by the practitioner to the Department of the Treasury.

– § 10.33: A practitioner must provide clients with the highest quality representation by establishing the facts, determining the reasonableness of any assumptions or representations, relating the applicable law to the relevant facts, and arriving at a conclusion supported by the law and facts.

– § 10.34: A practitioner may not submit documents to the IRS to limit tax in frivolous or intentional disregard of tax rules and they must advise clients of potential penalties that are reasonably likely to result from the position taken on the tax return.

• Before the implementation of Form 8938, the preparer only needed the taxpayer’s foreign bank account information to complete Schedule B on Form 1040. Additionally, the preparer need to advise the client of the FBAR filing and the consequences of failing to file the FBAR (which is not attached to a return and does not need to be signed by a return preparer). However, because Form 8938 is part of Form 1040, the preparer who signs the return is now responsible for the foreign financial asset information reporting, and Circular 230 rules apply.

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Title 31 Subpoena

• The IRS has used Title 31 subpoenas (31 USC § 3804) to compel U.S. taxpayers suspected of holding foreign financial assets to provide bank account records and documents for purposes of an investigation.

• When subpoenaed, the taxpayer must decide whether to disclose potentially self-incriminating evidence or be subject to civil or criminal penalties. It would therefore seem that the taxpayer could invoke the Fifth Amendment right against self-incrimination and refuse to comply. However, the case law does not support this rationale.

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Title 31 Subpoena

Required Records Exception• In Shapiro v. United States (1948), 335 U.S. 1, 68 S.Ct. 1375, 92 L.Ed.

1787 , the government requested a fruit wholesaler’s records of prices. The U.S. Supreme Court ultimately held that the government can require the production of “essentially regulatory” records where the conduct was not “inherently criminal” and the records have “public aspects” rather than being purely personal.

• From this holding, the “Required Records Exception” or the “Required Records Doctrine” was born. Thus, when the government is authorized to regulate an activity, an individual's Fifth Amendment privilege does not prevent the government from imposing recordkeeping, inspection, and reporting requirements as part of a valid regulatory scheme.

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Title 31 Subpoena

Building on Shapiro, the Supreme Court articulated three elements of the Required Records Exception in Grosso v. United States (1968), 390 U.S. 62, 88 S.Ct. 709, 19 L.Ed.2d 906, and Marchetti v. United States(1968), 390 U.S. 39, 88 S. Ct. 697, 19 L. Ed. 2d 889—both cases dealt with whether the Exception applied to the payment of an excise tax on illegal gambling wagers. The Supreme Court described the three “premises” as follows: 1. the purposes of the inquiry must be essentially regulatory; 2. the information must be obtained by requiring the

preservation of records that are customarily kept; and 3. the records must have assumed “public aspects” which render

them analogous to public documents.

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Title 31 SubpoenaFour Circuit Courts have addressed the Fifth Amendment challenge to the Required Records Exception. In all four cases, the Required Records Exception has been applied to render the Fifth Amendment privilege against self-incrimination inapplicable and require an individual to produce records regarding foreign bank accounts. The cases are as follows:• In re M.H., 648 F.3d 1067 (9th Cir. 2011) cert. denied, 133 S. Ct. 26, 183 L. Ed. 2d 676 (U.S.

2012) : The Ninth Circuit Court held that requiring taxpayers with offshore bank accounts to keep and maintain banking information for government inspection was essentially regulatory in nature. The Court reasoned that having a foreign bank account was not an illegal activity, and the information that taxpayers were required produce was not inherently criminal. Thus, the required records doctrine applied to bring records requested outside the scope of the Fifth Amendment privilege.

• In re Special February 2011-1 Grand Jury Subpoena Dated September 12, 2011, 691 F.3d 903 (7th Cir. 2012) cert. denied, 133 S. Ct. 2338, 185 L. Ed. 2d 1064 (U.S. 2013):The Seventh Circuit held that the Fifth Amendment did not protect the taxpayer from producing foreign financial records in response to a grand jury subpoena. The Court reasoned: “The voluntary choice to engage in an activity that imposes record-keeping requirements under a valid civil regulatory scheme carries consequences, perhaps the most significant of which, is the possibility that those records might have to be turned over upon demand, notwithstanding any Fifth Amendment privilege.”

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Title 31 Subpoena• In re Grand Jury Subpoena, 696 F.3d 428 (5th Cir. 2012): The Fifth Circuit held

that taxpayers using offshore bank accounts to keep and maintain banking information for government inspection was essentially regulatory in nature. Accordingly, the Required Records Exception precluded Fifth Amendment protection and taxpayer was required to bring records of foreign bank accounts, which were requested pursuant to a grand jury proceeding.

• In re Grand Jury Proceedings, No. 4-10, 707 F.3d 1262 (11th Cir. 2013): The Eleventh Circuit held that the taxpayer's and his wife's foreign financial account records had “public aspects,” thus weighing in favor of finding that those records fell within Required Records Exception to Fifth Amendment privilege for purposes of the grand jury subpoena. The Court noted that the taxpayer and his wife were required to keep these records by valid regulatory scheme—regardless of fact that they were only required to submit an FBAR—and, further, Treasury Department shared information it collected regarding those records with other agencies.

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Recent FACTA News• In early July 2013, the Swiss government revealed a program that permits about a dozen

Swiss banks being investigated by the U.S. DOJ to hand over "leaver lists“, that is, information on U.S. clients' accounts that were transferred to other Swiss banking institutions when the U.S. began targeting overseas tax evasion. Credit Suisse and the Zurich Cantonal Bank (Zürcher Kantonalbank) are the first banks in Switzerland that will provide to the IRS a “leaver list.”

• The Swiss Broadcasting Corporation has reported that although names and account details will not be handed over to the U.S. authorities, the disclosure will include the number of “leavers”, the amount of assets transferred, and the names of the destination financial entities.

• Furthermore, U.S. cannot go on a “fishing expedition” by making a broad request to Switzerland in hopes finding U.S. account holders who have committed tax fraud. The requests must be well defined and indicate that the targeted individual has committed tax fraud.

See Zsuzsanna Kadar, Credit Suisse to provide “leaver list” to the U.S., International Taxes Weekly Newsletter Volume 5, No. 33 (Preview Documents for the week of 08/06/2013); and WSJ: Swiss banks near deal on U.S. tax information, RIA International Taxes Weekly Newsletter (07/16/2013)

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Recent FATCA News• In light of the growing awareness foreign financial institutions have

in regard to FATCA compliance, several other major developments have recently occurred (BNA Daily Tax Report, July 9, 2013): – Israeli banking officials have reported that Americans have withdrawn

billions from Israeli banks due to FATCA. BNA Daily Tax Report, July 8, 2013.

– Russia has enacted legislation to comply with FATCA. BNA Daily Tax Report, July 8, 2013.

– Germany's upper house approved a bill to implement FATCA. BNA Daily Tax Report, July 8, 2013.

– Chile reports that the U.S. has begun the process for an intergovernmental agreement. BNA Daily Tax Report, July 10, 2013.

– The EU anticipates reciprocity with respect to investor information disclosure from the U.S. BNA Daily Tax Report, July 8, 2013.

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