In our May 2011 edition of the Focus, we discussed the Internal Revenue Service (IRS) initiative focused on information reporting requirements for taxpayers who maintained foreign financial accounts that, in the aggregate, exceeded $10,000 at any time during the tax year.  If a taxpayer has one or more of these accounts, they are required to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts each year.

The IRS is no longer just focusing on your foreign financial accounts.  Now they want to know about your foreign financial assets too!  For tax years ending after December 19, 2011, a “specified person” must File Form 8938, Statement of Specified Foreign Financial Assets, with their Form 1040 if the person has an interest in one or more “specified foreign financial assets”.  Form 8938 is required if the aggregate fair market value exceeds either $50,000 on the last day of the tax year or $75,000 at any time during the tax year.  These thresholds are increased to $100,000 and $150,000, respectively, for married couples filing a joint return.  Generally, for individuals living abroad and who have established their tax home in a foreign country, the thresholds further increase to $200,000 ($400,000 for joint return) and $300,000 ($600,000 for joint return), respectively.

Who is a “specified person”?

A specified person includes any U.S. citizen, resident alien of the U.S. for any part of the year, a nonresident alien that elects to be treated as a resident alien for purposes of filing a joint income tax return, or a nonresident alien who is a bona fide resident of Puerto Rico, the U.S. Virgin Islands and certain other U.S. possessions.   A domestic entity will also qualify as a specified person if the entity was formed to hold or otherwise avail itself of specified foreign financial assets.

What is a “specified foreign financial asset”?

Specified foreign financial assets include the following:

• Any depository or custodial account maintained at foreign financial institutions,
• To the extent not held in an account at a financial institution
  - Any stocks or securities issued by foreign corporations,
  - Any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and
  - Any interest in a foreign entity.

The classification of an asset as a foreign financial asset is generally determined by whether the asset is held directly by the taxpayer, in a financial account at a U.S. financial institution, or in a financial account at a foreign financial institution.  A financial account that is held in a U.S. financial institution (such as Chase Bank), including a foreign branch of that U.S. financial institution does not qualify as a specified foreign financial asset.  However, if the financial account is held in a foreign financial institution, the entire account is a specified foreign financial asset even if the account includes U.S. investment assets.

A taxpayer is deemed to have an “interest” in a specified foreign financial assets if any item of income, gain, deduction, loss, credit, gross proceeds or distribution attributable to the holding or disposition of the asset are required to be reported, included or otherwise disclosed by the taxpayer on an annual return.  A taxpayer will be deemed to have an interest in the specified foreign financial asset even if there is no income, gain, deduction, loss, proceeds or distributions actually required to be reported on an annual return for the tax year.

What Value to Report?

The “value” of the specified foreign financial asset is determined by reference to its “fair market value”.  Fortunately the IRS is not requiring appraisals to be obtained in order to establish fair market value.  For those assets whose fair market value is not readily obtainable (such as real estate, partnership interests, etc.).  The IRS will generally allow any reasonable method of determining an asset’s fair market value.

If the fair market value reporting thresholds are met, the specified foreign financial asset must be reported on Form 8938.  Each owner of a joint interest in a specified foreign financial asset generally includes the asset’s full fair market value.  Married couples filing a joint tax return file a single form that reports all of the specified foreign financial assets and their respective fair market values.   Married individuals filing separate tax returns generally report only half of the fair market value of jointly owned assets.

Penalties for Failure to File

If a taxpayer fails to file Form 8938 and/or fails to provide all required information, is subject to a penalty of up to $10,000.  If the IRS notifies the taxpayer of its failure, additional penalties of $10,000 for each 30-day period (or fraction thereof) up to a maximum penalty of $50,000 can be assessed.  If the taxpayer establishes that the failure to file or provide all required information was due to reasonable cause and not willful neglect, the IRS will generally waive the penalties.

“Big Brother” continues to watch over us and now the “surveillance” has taken on more of an international flavor!  To discuss the potential need to report specified foreign financial assets on your next tax return, please contact your DB&B tax advisor.

The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.