IRS Issues Draft Form 8938 Instructions

The Hiring Incentives to Restore Employment Act included a number of information reporting requirements intended to increase worldwide compliance with U.S. tax laws. One of those provisions is Section 6038D, which requires that Form 8938 be filed by every specified person who owns specified foreign financial assets (SFFA) with an aggregate value in excess of the applicable threshold amount. On Sept. 28, 2011, the Internal Revenue Service issued the much anticipated draft instructions for Form 8938, and they contain a number of taxpayer friendly provisions. Here’s a summary of key portions of the draft instructions.
Specified Person A specified person includes (1) a U.S. citizen, (2) a resident alien, (3) a nonresident alien who elects to be treated as a resident alien for purposes of filing a joint income tax return, and 4) a nonresident alien who’s a bona fide resident of American Samoa or Puerto Rico. The draft instructions state that entities are likely to be classified as specified persons as well, but “Until such regulations or other guidance is issued, only individuals must file Form 8938.”
SFFA An SFFA includes (1) any financial account maintained by a foreign financial institution, and (2) other foreign financial assets held for investment. SFFAs include 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 issue or counterparty that’s other than a U.S. person. The definition of SFFA includes foreign mutual funds, foreign hedge funds, foreign private equity funds, interests in privately held foreign entities, swaps, options and derivatives.
Applicable Threshold Amount Unmarried taxpayers and married taxpayers filing separately who live in the United States exceed the applicable threshold if the value of all SFFAs exceeds $50,000 at the end of the year or $100,000 at any time during the year. For married taxpayers who file jointly and live in the United States, those thresholds are $100,000 and $200,000. The thresholds are most generous for taxpayers living abroad: $200,000 at the end of the year or $400,000 at any time for persons who don’t file joint returns; $400,000 and $600,000 for joint filers. The draft instructions contain fairly detailed guidance on how to value an SFFA. An asset can’t be assigned a negative value. All assets must be valued in dollars and there are specific rules on currency conversion. For financial assets, periodic statements can generally be relied upon. For other assets, the last day of the year is the date for valuation. When determining if the value of all SFFAs exceeds the threshold amount. jointly owned property is reported based on the value of the whole asset, except for married persons filing separately who will each include only one-half the value of the jointly owned SFFA. If Form 8938 is required, you must report the full value of jointly owned assets in all instances. Estates, pension plans and deferred compensation plans are also valued at the end of the tax year. Such assets are often difficult to value and the draft instructions generally provide that if you don’t know the fair market value of your interest, you can report any cash and other property distributed to you during the tax year as the value. Similarly, non-grantor discretionary trusts are valued based on the value “of all of the cash or other property distributed during the tax year from the trust to you . . .” Mandatory trust distributions are valued using the Section 7520 tables.
Entity Versus Aggregate If the value of SFFAs exceeds the applicable threshold amount, you must disclose all SFFAs, regardless of value. Only entity level reporting is required for financial accounts, partnerships, corporations, non-grantor trusts and estates. You must disclose underlying investments if you have an interest in a disregarded entity or are the grantor of a grantor trust. The draft instructions further state “an interest in a foreign trust or foreign estate is not a SFFA unless you know or should have known of the interest.”
Avoiding Duplicative Reporting You don’t need to report an SFFA on Form 8938 if you’ve reported it on Form 3520, 5471, 8621, 8865 or 8891. You must, however, identify on Form 8938 which of those forms were filed that reported what would otherwise be a reportable SFFA.
Penalties The civil penalties for failing to file Form 8938 aren’t nearly as extreme as for failing to file a Report of Foreign Bank and Financial Account. The penalty is $10,000 per year, which can increase to $50,000 per year if you still don’t file the form after the IRS mails a notice. A 40 percent accuracy-related penalty and a 75 percent fraud penalty can apply if there’s an underpayment of tax related to an undisclosed SFFA. Criminal penalties are also possible.
Statute of Limitations The statute of limitations for assessing tax generally doesn’t begin to run if Form 8938 isn’t filed. Even if Form 8938 is filed (or if the Form isn’t required), if $5,000 of income related to an SFFA is omitted, the statute of limitations is extended to six years instead of three.