Lawyers Journal

For the IRS, the fiscal year ended Sept. 30, 2014, marked the fourth consecutive year of reduced appropriations.¹ Substantially reduced funding has had a serious negative impact on taxpayer services,² and the number of audits dropped 12 percent from the previous fiscal year to its lowest number since 2005.³ Despite these reduced IRS resources, the IRS, along with the Department of Justice and the Financial Crimes Enforcement Network (FinCen) continue to focus strongly on steps to ensure taxpayer disclosure of offshore assets. As of early November 2015, the Treasury Department has signed 78 Intergovernmental Agreements (IGAs) with other countries in furtherance of the enforcement and compliance provisions of the Foreign Account Tax Compliance Act (FATCA).  Moreover, IGAs have been reached in substance but are still pending with 34 other countries.⁴ Under these IGAs, Competent Authority Arrangements (CAAs) continue to be reached between the IRS and foreign taxing authorities to exchange tax information. On September 24, 2015, the IRS announced that it entered into signed CAAs with Australia and the U.K., with the expectation that several other CAAs will be reached in the near future.⁵ Financial institutions and tax authorities in IGA countries will exchange taxpayer and account holder information using the International Data Exchange Service (IDES) in an effort to enforce offshore account disclosure and prevent money laundering and related crimes.⁶ Under the terms of some IGAs, foreign financial institutions (FFIs) must register with the IRS⁷ to disclose information directly to IRS personnel or face a 30 percent withholding tax on U.S.-source payments made to them. Despite doubts from critics about the ability of Treasury to exert such extraterritorial jurisdiction over foreign financial institutions, there are 177,147 FFIs registered with the IRS as of early November 2015⁸ with the total number steadily increasing monthly.

Moreover, the Department of Justice has been very active during 2015, in reaching agreements under its Swiss Bank Program, in which eligible Swiss banks may resolve potential criminal liability through disclosure of information and other steps.  As of early November, the Department of Justice has made 37 announcements that either involve Swiss Bank Program agreements or involve convictions of taxpayers failing to disclose offshore assets or the income from offshore assets.⁹

Accordingly, despite the reduction in IRS resources, the IRS and other agencies continue to press forward with taxpayer compliance with offshore asset disclosure. Such steps include enforcement of the compliance requirements associated with the two most widely applicable disclosure obligations for U.S. taxpayers: the obligation under the Bank Secrecy Act to file FinCen Form 114, Report of Foreign Bank and Financial Accounts and the FATCA requirement to file IRS Form 8938, Statement of Specified Foreign Financial Assets.

While taxpayers willfully hiding offshore assets are most certainly the focal point of these filing obligations and enforcement measures, most taxpayers that run afoul of these filing obligations are not hiding offshore assets at all, but rather, find themselves caught within the very wide net cast by these rules. Inheritances, business transactions, and many other common and innocuous transactions or situations will frequently bring ownership interests or accounts into a taxpayer's circumstances which are reportable under one or both sets of rules.

Given the large number of taxpayers affected by these two sets of rules, and the substantial civil and criminal penalties for failure to adhere to these requirements, attorneys need to develop a working knowledge of the rules associated with each of these two separate filing obligations to properly advise clients about filing obligations. It is also imperative to understand what actions may cause the attorney or law firm to trigger a disclosure obligation, which may occur through the use of trust or escrow accounts or other financial arrangements to facilitate client business. A good overview of the relevant rules will help the attorney "issue spot" and understand what triggers a disclosure requirement.

Both sets of rules involve various complexities and "gray areas" where further guidance would be helpful. It isn't possible to cover all of these complexities within this article. In the absence of such clear guidance, experienced judgments on part of the tax practitioner are frequently required.  In addition, these two sets of rules form only part of a much larger compliance and disclosure environment, which includes other sets of rules that form separate disclosure obligations for other various interests¹⁰ (and one interest in a foreign asset or entity may trigger several different disclosure requirements each year under the various sets of rules that exist beyond those discussed herein). In addition, the IRS has established programs for taxpayers who have not filed many of the required forms to remedy their delinquency and comply.¹¹

However, the Bank Secrecy Act and FATCA disclosure rules are the most widely applicable disclosure rules, and accordingly, some insight into these two sets of rules can greatly assist attorneys in steering themselves and clients clear of the significant penalties associated with noncompliance. The relevant rules associated with Bank Secrecy Act will first be discussed, followed by a discussion of the rules associated with FATCA.

Bank Secrecy Act offshore asset compliance

The obligation to disclose certain types of assets outside the United States using FinCen Form 114 arises under the Bank Secrecy Act (BSA).¹² This BSA compliance area was previously known as the "FBAR" (foreign bank account report) requirement and practitioners still refer to these rules as the FBAR rules.

Generally, under the BSA, a U.S. person with a financial interest in, or signature authority over, foreign financial accounts must disclose all reportable accounts if the aggregate of such accounts is in excess of $10,000 at any time during the year.  The $10,000 filing threshold is measured in U.S. dollars (USD$10,000).

For purposes of these rules, a U.S. person is defined as a U.S. citizen, a U.S. resident, or an entity established under either U.S. federal law, the laws of a state (or the District of Columbia) or U.S. territories or possessions.¹³ Determining whether an entity (such as a corporation, LLC, partnership or other entity) has been established under federal or state law¹⁴ or whether an individual is a U.S. citizen is typically straightforward. However, a determination of U.S. residency may be more complicated. Generally, the FBAR rules refer to the U.S. residency rules found in IRC §7701(b). Under IRC §7701(b), a U.S. resident is generally a non-citizen of the United States that is either:¹⁵

• Admitted as a lawful permanent resident of the United States at any time during the year
• Meets the substantial presence test;¹⁶
• Makes the "first-year" election under IRC §7701(b)(4)

For purposes of this rule, the definition of "United States" includes not only the 50 states and the District of Columbia, but also U.S. territories and possessions.¹⁷ FinCen guidance indicates that individuals who "elect to be treated as residents for U.S. tax purposes under section 7701(b) should file FBARs only with respect to foreign accounts held during the period covered by the election."¹⁸ In addition, a U.S. resident who elects to be treated as a nonresident of the U.S. under a tax treaty must still comply with the FBAR rules.¹⁹

Generally, a joint return may not be filed if either spouse is a nonresident alien.²⁰ One common tax election used by spouses is the tax election available under IRC §6013(g). This special tax election, effective for the year in which it is made and for subsequent years until revoked, is a joint election made by U.S. citizen and nonresident alien spouses allowing a joint return to be filed. FinCen guidance indicates that the IRC §6013(g) election itself is not sufficient to make the nonresident alien spouse subject to the FBAR rules.²¹ In addition, under the Foreign Investment in Real Property Tax Act (FIRPTA), a foreign corporation holding a U.S. real property interest (USRPI) that elects under IRC §897(i) to be treated as a U.S. corporation for income tax purposes is not subject to the FBAR disclosure requirements solely because of the §897(i) election.²²

Financial interest or signature authority

The FBAR filing and disclosure requirement covers foreign financial accounts in which the U.S. person has either a "financial interest" or accounts over which the U.S. person has "signature authority."

Financial interest

A financial interest in a foreign financial account exists if the U.S. person is either:

• Holder of legal title of the account
• Constructive owner of the account
• Deemed owner of the account

Holding legal title of the foreign financial account will constitute a financial interest in that account even though the U.S. person is holding or maintaining that account for another party's benefit.²³ For accounts titled jointly among two or more U.S. persons, all U.S. persons named on the account have a financial interest in that account.²⁴

Constructive foreign financial account ownership typically arises if the account owner is acting on behalf of another party. Typical examples are attorney escrow or trust accounts, and accounts in the name of an agent or nominee.

The deemed ownership rules for foreign financial accounts are generally a series of "look-through" rules designed to attribute ownership of an entity-owned foreign financial account to a more-than-half owner of that entity.  Specifically, a U.S. person is deemed to be the owner of a foreign financial account if:

• The account is owned by a corporation in which the U.S. person owns more than half of the voting power or share value in the corporation.
• The account is owned by a partnership in which the U.S. person owns more than half of the profits or capital.
• The account is owned by any entity other than a trust, and the U.S. person owns more than half of the entity's voting power, value of the equity interest or assets, or profits interest.
• The account is owned by a trust and the U.S. person is the grantor and owner of that trust under U.S. federal tax rules.²⁵
• The account is owned by a trust in which the U.S. person has a present beneficial interest in more than half of the assets or receives more than half of the current income of the trust.

With respect to trusts, FinCen guidance indicates that the status of discretionary beneficiary alone does not constitute deemed ownership, and that the term "present beneficial interest" is not intended to include a remainder interest under FBAR rules.²⁶

Further, the FBAR deemed ownership rules do not incorporate the attribution rules found in either IRC §§267 or 318. Accordingly, entity ownership interests of related parties are not aggregated together under the deemed ownership rules.

Signature authority

An individual has signature authority over a foreign financial account if the individual has the ability to control the disposition of money or other account assets through any type of communication with the financial institution or party at which the account is maintained. The existence of a power of attorney over an account that authorizes control over its funds will generally constitute signature authority, even if the power of attorney authority is never exercised.²⁷ For joint accounts, signature authority may exist either jointly with other account owners, or on a joint-and-several basis.²⁸

There are several situations over which FinCen does not believe FBAR filing or disclosure requirements are necessary, even though an individual has signature authority over one or more accounts.  Generally, these situations cover individuals who are employees or officers of banks or publicly-listed U.S. corporations who have authority to control or direct funds in foreign financial accounts in which the employee or officer has no financial interest, because the accounts are owned by the employer (and such accounts are likely disclosed under other regulatory rules).  Accordingly, there are five exceptions for such individuals that have signature authority (but no financial interest) in employer accounts.²⁹

Foreign financial accounts

Generally, under the FBAR rules, a foreign financial account is an account located outside the geographic bounds of the United States. For purposes of this rule, the definition of "United States" includes U.S. territories and possessions.³⁰ Accordingly, an account in Puerto Rico would not be considered reportable.  The types of accounts³¹ subject to disclosure, referred to as "reportable accounts" include the following types of accounts if located outside the geographic bounds of the United States.

• Bank, savings, and checking accounts and certificates of deposit
• Securities and commodities accounts
• Insurance or annuity policies with cash values
• Accounts with mutual funds or other pooled investments that issue shares to the general public that have regular net asset value determinations and regular redemptions
• Other investment funds³²

Under the FBAR rules, even if the above types of accounts are held at a U.S. bank branch, the account is reportable if that branch is located outside the geographic bounds of the United States.

While accounts maintained with a federal or state government agency or at a U.S. military banking facility are exempt from reporting requirements,³³ a federal district court has held that accounts with foreign poker websites are reportable accounts under the FBAR rules because such websites operate as institutions engaged in the business of banking.³⁴ This case underscores not only the possibility of further judicial refinement and expansion of the FBAR reportable account rules, but also the need for tax practitioners to ask clients about online financial activity in determining whether the client is subject to FBAR disclosure requirements.

Retirement accounts covered under IRC §§401(a), 403(a), or 403(b) that hold foreign accounts as investments are not subject to FBAR disclosure.³⁵ In addition, IRA accounts (covered under IRC §408) holding such foreign accounts are likewise exempt.³⁶ However, there is no further "blanket exemption" for a foreign retirement plan.  If the U.S. person has either a financial interest in or signature authority over a foreign retirement plan, the plan is reportable.  The tax practitioner must determine the nature of the client's what rights and degree of control over their interest in the foreign retirement plan to determine whether the requisite "financial interest in" or "signature authority over" that plan exists in order to trigger a filing requirement. Such a determination is frequently a difficult one to make, and there is currently a distinct lack of guidance in this area under the FBAR rules.

Threshold value and currency conversion

A U.S. person with a financial interest in or signature authority over one or more foreign financial accounts must disclose such accounts if their aggregate value exceeds USD$10,000 at any time during the year. To determine whether the taxpayer's relevant accounts exceed the $10,000 threshold, the maximum annual values of the accounts are added together. Determining the maximum value of some types of investments, such as a certificate of deposit, may prove to be a far easier task than for other market-related investments such as stocks or commodities. FBAR guidance indicates that a reasonable approximation of the maximum value attained by the account during the year will suffice. Periodic statements issued in connection with the account or investment may be relied upon for this purpose as long as those statements are genuine statements issued by the financial institution (or other third party with which the account or investment is held) in its ordinary course of business and the statements fairly reflect account values during the year.³⁷

The maximum values of the taxpayer's accounts are used for both threshold determination and reporting purposes. Accounts that are denominated in a foreign currency must have their maximum values for the year converted to a U.S.-dollar-equivalent in order to determine if the USD$10,000 threshold is reached. FBAR guidance is specific about the particular exchange rate used. The appropriate exchange rate is the December 31 Treasury Department's Financial Management Service rate for the year for which the disclosure is being made.³⁸ The December 31 rate for the year is used regardless of the point during the year that the account attained its maximum value. Each year, the Treasury Department's Financial Management Service website provides December 31 exchange rates for the currencies of approximately 180 countries that are used for the conversion into U.S. dollars.

Moreover, the USD $10,000 threshold is not subject to any annual inflation adjustment. The absence of such an adjustment will tend to obligate more taxpayers with nominal foreign account amounts to trigger a filing requirement under the FBAR rules.

Filing FinCen Form 114

For U.S. persons with reportable accounts with maximum values that have exceeded the USD$10,000 threshold must generally disclose details on those accounts and the amounts on FinCen Form 114. FinCen Form 114 must be filed using the online filing system provided by FinCen.  FinCen Form 114 is not filed with the taxpayer's tax return. Several commercial tax preparation software packages also support the electronic filing of FinCen Form 114 through FinCen's online system.

FinCen Form 114 supersedes former Form TD F 90-22.1, which is now obsolete. The FBAR reporting requirement is met by:³⁹

• Completing the FBAR-related questions on a federal tax return
• Timely filing a FinCen Form 114 using the electronic filing system provided by FinCen

Reflecting the broad definition of U.S. persons covered by the FBAR rules, federal tax return FBAR-related questions now appear Form 1040, Schedule B, Part III (for individuals), under the "Other Information" section of page 2 of Form 1041 (for trusts and estates), Schedule B, box 10 of Form 1065 (for partnerships) and Schedule N, boxes 6a and 6b of Form 1120 (for corporations).

The deadline for filing 2015 FinCen Forms 114 is June 30, 2016. For subsequent years, the deadline is changing to a new deadline of April 15 of the following year (with an extension of the tax return also extending the Form 114 due date to October 15).⁴⁰ Accordingly, the deadline for 2016 Forms 114 will be April 15, 2017.

Practitioners must register with the FinCen online system to file returns for clients.⁴¹ Special rules exist for the filing of a joint Form 114 for spouses.⁴² Special simplified filing requirements exist for taxpayers who have either a financial interest in 25 or more accounts or who have signature authority over (but no financial interest in) 25 or more accounts.⁴³

Penalties

Under the relevant statutes, both civil and criminal penalties for failure to file Form 114 may be imposed. In addition, current IRS guidance indicates that under certain circumstances, relief may be available for a taxpayer delinquent in filing FinCen Forms 114 for prior years in which a filing requirement existed.

Failure to file a Form 114 may result in a civil penalty of $10,000 per violation.⁴⁴ However, the penalty may waived if reasonable cause exists for the failure to file and the amount was properly reported.⁴⁵ Willful failure to file may result in a penalty as high as the greater of $100,000 or 50 percent of the total balance for the foreign accounts not disclosed.⁴⁶

A maximum criminal fine of $250,000 or up to five years imprisonment may be imposed.  However, if the failure to file Form 114 is part of an overall pattern of illegal activity, the fine and term of imprisonment may be increased to $500,000 and 10 years, respectively.⁴⁷ Both the criminal fine and imprisonment may be imposed.⁴⁸

The most recent guidance from the IRS indicates that taxpayers who are not using other special IRS offshore disclosure programs⁴⁹ and who are not under an IRS examination or criminal investigation should file any delinquent Forms 114.⁵⁰ The FinCen electronic filing system will accommodate the filing of delinquent returns.

In addition, the IRS currently takes the position that a penalty will not be imposed for failure to file a delinquent FBAR if the income from the undisclosed accounts was properly reported on tax returns and the tax on that income has been paid (and the IRS has not previously contacted the taxpayer about delinquent FinCen Forms 114 for the years involved).⁵¹

Foreign Account Tax Compliance Act

The foreign account disclosure rules under FATCA comprise an entirely separate potential foreign asset disclosure requirement from the FBAR rules. Taxpayers may trigger either or both sets of rules. The FATCA rules, definitions and thresholds are very different than those found under the FBAR requirement, which can make compliance with both sets of rules difficult.

Under FATCA, there are disclosure requirements that apply to specified persons having an interest in specified foreign financial assets (SFFAs) that exceed the applicable threshold.  The FATCA filing requirement exists for all tax years ending after December 19, 2011.⁵²

Specified persons

While the FBAR rules discussed earlier reaches those individuals and entities included in the definition of "U.S. person" as explained earlier, FATCA affects "specified persons."  A specified person is generally an individual who is required to file an annual tax return, and includes:⁵³

• A U.S. citizen or resident alien (including those who are resident aliens for any part of a tax year)
• A nonresident alien married to a U.S. citizen who elects to be treated as a U.S. resident for tax purposes (such as those nonresident aliens making the joint election under IRC §§6013(g) or (h) with their U.S. citizen spouse)⁵⁴
• A nonresident alien who is a bona fide resident of Puerto Rico or a U.S. possession⁵⁵ who is required  to file an annual U.S. federal income tax return

While proposed regulations⁵⁶ have been drafted to include certain entities, these regulations have not yet been finalized and are not presently effective. Accordingly, no entities currently have compliance issues under the FATCA rules discussed herein. Only individuals falling under the definition of "specified person" have compliance obligations under this asset disclosure aspect of FATCA, which is mandated by IRC §6038D.

Interest in the SFFA

To be subject to the FATCA disclosure rules, the specified person must have the type of interest in an SFFA that FATCA encompasses. FATCA applies if the interest is such that the specified person is, or would be, required to report any income, gains, losses, deductions, or credits generated by the asset (even if there are no such items generated by the asset to actually report in the tax year).⁵⁷

For a parent making an election to report a child's unearned income on the parent's return, the parent is considered to be the specified person having an interest in an SFFA held by the child.

Generally, if an entity (such as a trust, partnership or corporation) holds SFFAs, the specified person is not considered to have an interest in those SFFAs solely because of their status as a beneficiary, partner or shareholder of the entity.⁵⁸ However, a specified person who owns a foreign disregarded entity is treated as directly owning the SFFAs within that entity. If a specified person is considered the owner of a trust under the Code, they are treated as having an interest in the SFFAs held in the trust.⁵⁹ The grantor trust rules found in Code sections 671 through 679 are referred to in order to determine trust ownership.

Note that these rules regarding interest in an SFFA are quite different than the legal ownership, constructive ownership and deemed ownership rules associated with the FBAR rules discussed previously.

Specified foreign financial asset

Generally, a specified foreign financial asset (SFFA) is a financial account⁶⁰ maintained with a foreign financial institution (FFI).⁶¹ Some accounts are specifically excluded such as accounts maintained by a U.S. payor, and accounts that are subject to the "mark to market" rules of IRC §475.⁶² A U.S. payor is generally:⁶³

• Any U.S. person⁶⁴
• The U.S. or a state government or any agency thereof
• A foreign corporation in which more than half of the stock (measured by either voting power or value) is owned by U.S. shareholders on any day of the foreign corporation's tax year
• A foreign partnership in which one or more partners are U.S. persons owning (in aggregate) more than half of the capital or income interest at any time during the partnership's tax year
• A foreign partnership engaged in the conduct of a trade or business within the U.S. at any time during the tax year, or
• A foreign person who has more than half their gross income effectively connected with a U.S. trade or business for the previous three years

Furthermore, the following assets are SFFAs even if they are not held within an account at an FFI but are held for investment purposes.⁶⁵

• A stock or security issued by a non-U.S. person
• A financial instrument or contract having an issuer or counterparty who is non-U.S. person⁶⁶
• An interest in a foreign entity

The definition of "U.S. person" under this rule is found in IRC §7701(a)(30). Under this definition, a U.S. person includes a U.S. citizen or resident, as well as a U.S. domestic corporation, partnership or estate⁶⁷ and certain trusts.⁶⁸

While the FBAR rules mentioned earlier require an asset to be located outside the geographic bounds of the U.S., it should be noted that under FATCA, the physical location of the asset is irrelevant: it is quite possible for the taxpayer to have the requisite interest in an SFFA that is physically located within the United States.

Trade or business exception

The concept of "held for investment purposes" under this rule is juxtaposed with the concept of use of the asset in a trade or business. A trade or business exception exists for assets so used, and such assets need not be disclosed. An asset is considered used in a trade or business if the asset is:

• Held for the principal purpose of promoting the present conduct⁶⁹ of the business
• Acquired and held in the ordinary course of business
• Otherwise held in direct relationship to the business

Regulatory guidance indicates that there is a presumption that an asset is held in direct relationship to the business if the asset's use is in connection with a present, (not future), need of the business and the following three factors exist:⁷⁰

• The asset was acquired with funds generated by the trade or business
• Income from the asset is retained or reinvested in the business, and
• Persons actively managing the business exercise significant management and control over the asset's investment

Unless the asset meets the requirements of this trade or business exception, the asset is considered to be held for investment purposes (and will constitute a SFFA subject to disclosure if the taxpayer meets the other requirements that will trigger a reporting requirement). Under these rules, shares of stock are never considered to be held for use in a trade or business (and are therefore always considered to be held for investment).⁷¹

Special rule for interests in trusts or estates

Frequently in estate and trust planning situations, beneficial interests are created without the beneficiary having knowledge of that interest at the time the interest is created. Beneficiaries frequently are unaware of an interest until a contingent event or death occurs. Because an interest in any foreign entity, including a trust or estate, may constitute an SFFA, FATCA compliance may prove problematic for a beneficiary with an interest in a trust or estate of which they are unaware.  The FATCA compliance rules take this situation into account by providing a "knowledge rule" for interests in foreign trusts and estates.⁷² Under this rule, an interest in a foreign trust or estate does not constitute an SFFA unless the interest holder knows of their interest, or has reason to know of that interest based on readily accessible information.  Under this rule, if the interest holder receives a distribution from the trust or estate, such distribution will impute the requisite knowledge necessary to make their interest an SFFA, which may need to be disclosed if other requirements are met that make disclosure necessary.

Applicable thresholds

While the FBAR rules provide a straightforward USD$10,000 filing threshold, a taxpayer's applicable threshold under FATCA varies according to their filing status, residency, and the aggregate value of their SFFAs (measured both during the year and at the end of the year). The taxpayer exceeds their applicable filing threshold, and may have a disclosure obligation if other requirements are met, if either the "during the year" or "end of year" threshold is exceeded.  It is not necessary to exceed both thresholds. The "during the year" threshold is exceeded if the taxpayer has an aggregate SFFA value that exceeds their applicable "during the year" threshold at any time during the tax year.  The "end of year" threshold is exceeded if that aggregate value exceeds the taxpayer's applicable "end of year" threshold on the last day of the tax year.  The following table summarizes these applicable threshold amounts for taxpayers based on their filing status and residency.

	Taxpayers Living in the U.S.		Taxpayers Living Outside the U.S.
Filing Status	SFFA Value at Year-End	SFFA Value During the Year	SFFA Value at Year-End	SFFA Value During the Year
Single, Head of Household or Qualified Widow(er)	$ 50,000	$ 75,000	$200,000	$300,000
Married Filing Jointly	$100,000	$150,000	$400,000	$600,000
Married Filing Separately	$ 50,000	$ 75,000	$200,000	$300,000

 

Generally, the maximum fair market value (MFMV) of an SFFA is used for both threshold determination and reporting purposes.⁷³ However, a reasonable estimate of an asset's MFMV may be used for these purposes. ⁷⁴

Generally, assets denominated in foreign currencies must be converted to U.S. dollars for threshold determination and reporting purposes.  Under relevant guidance, the correct exchange rate used is the rate used to purchase U.S. dollars on the last day of the specified person's tax year, even if the SFFA was disposed of earlier within the year.⁷⁵ Generally, for a calendar year taxpayer, the same December 31 Treasury Department Financial Management Service exchange rates are used as required under the FBAR rules.⁷⁶

The IRS has provided regulatory valuation guidance for both SFFAs that are financial accounts and for SFFAs that are not financial accounts.

For financial accounts, if the foreign financial institution provides periodic statements indicating an account value, and such statements are produced at least annually, those statements may be relied upon to determine the financial account's MFMV for threshold and reporting purposes unless there is reason to know, based on readily accessible information, that such statements do not reflect a reasonable estimate of the MFMV of the account during the year. Where accurate statements are used and relied upon, a currency conversion to U.S. dollars indicated on the statement may also be relied upon.

For an SFFA that is not a financial account maintained at a financial institution, the value of the asset on the last day of the tax year may serve as the MFMV for threshold determination and reporting purposes. This last-day-of-year value may be used unless the taxpayer has reason to know that this value is not a reasonable estimate of the asset's MFMV. If readily accessible information exists to indicate that the last-day-of-year value is not reflective of a reasonable estimate of the SFFA's MFMV, either an actual maximum value or another more reasonable estimate should be used.

Special valuation rules for estates, pension plans and deferred compensation plans

Arriving at an appropriate value for interests in estates, pension plans and deferred compensation plans is a frequently challenging process. Generally, for these assets, IRS guidance indicates that the FMV of the total beneficial interest in the asset on the final day of the tax year must be used. However, where this value proves difficult or impossible to determine, the FMV of any currency or other property actually distributed to the specified person may be used. If no distributions are received during the tax year and there is no reason to know what the FMV of the interest is on the last day of the tax year, a zero value may be used.⁷⁷

Special valuation rules for trusts

The rules regarding valuation of SFFAs also recognize the difficulties frequently inherent in valuing an interest in a trust. Under the rules, the appropriate value for a foreign trust interest is generally the value of distributions to the specified person, plus the value of their right to receive mandatory distributions from the trust.⁷⁸

Special rule for joint interests.⁷⁹

Generally, each specified person who is a joint SFFA owner must include the full value of the SFFA for both threshold determination and reporting purposes. However, special rules apply to married taxpayers who file jointly (MFJ) and to those filing separately (MFS). For MFS taxpayers, when both spouses are specified individuals, the SFFA value to include for threshold determination purposes is different than the value actually reported. The following table summarizes the threshold determination and reporting rules for joint interests for MFJ and MFS taxpayers.

Filing Status	Threshold Determination Rule for Jointly Held SFFAs	Amount of Jointly Held SFFAs to Report
MFJ	Include the value of jointly owned SFFAs only once.	Report all assets in which there is a joint interest only once.
MFS (when both spouses are specified persons)	Each spouse includes only half of any jointly owned SFFAs.	Each spouse reports the entire value of jointly held SFFAs.
MFS (where one spouse is a specified person)	The specified person includes the entire value of jointly owned SFFAs.	The specified person reports the entire value of a jointly owned SFFAs.

 

Reporting specified foreign financial assets

To meet the disclosure requirements for a specified person with SFFAs having aggregate values in excess of the specified person's applicable threshold amount, IRS Form 8938 is used. Form 8938 is attached to the taxpayer's annual tax return and is due on the same date as the tax return (including extensions).

SFFAs do not need to be reported on Form 8938 if the same SFFAs are reported on Forms 3520, 3520-A, 5471, 8621, or 8865.⁸⁰ However, Form 8938 must still be filed, and part IV must be completed to indicate which other of these international information returns were used to report the SFFAs that do not appear on Form 8938.

Penalties

Under the terms of IRC §6038D, the penalty associated with failure to file Form 8938 is $10,000, plus an additional $10,000 for each subsequent month of noncompliance after 90 days of a notification from the IRS of the failure to file. This penalty may continue to accrue up to a maximum of $50,000 per delinquent Form 8938.⁸¹ This penalty may be waived if the failure to file is due to reasonable cause and there was no willful neglect on part of the non-filing taxpayer.

Conclusion

The disclosure rules mandated by the Bank Secrecy Act and FATCA that may respectively require the filing of FinCen Form 114 or IRS Form 8938 involve very different definitions, thresholds and cover different types of accounts and assets. While substantial penalties may result for willful failure to disclose assets outside the U.S., the Bank Secrecy Act and FATCA disclosure requirements are routinely triggered by clients who have no intention of hiding offshore assets.  Increasingly, unwary clients with no intention of hiding offshore assets are caught in the widespread net of these rules that require the tax practitioner to exercise the requisite due diligence⁸² in asking relevant and probing questions about seemingly innocuous situations (such as inheritances, foreign business interests, or children obtaining an education in a foreign country) that may lead to the creation or acquisition of the types of accounts or other assets implicated by these rules. Since specified foreign financial assets do not necessarily need to be physically located outside the geographic bounds of the U.S., clients may not even think of various assets encompassed by those rules as being "offshore" or "foreign." In addition, the absence of any annual inflation indexing provision for either the $10,000 FBAR threshold or the various applicable FATCA thresholds means that these rules affect an increasing number of taxpayers each year who might otherwise be unaffected.

While these Bank Secrecy Act and FATCA rules associated with FinCen Form 114 and IRS Form 8938 are only part of a much larger foreign asset disclosure regime, their widespread applicability makes them among the most important rules for attorneys to bear in mind when advising clients.

---

¹Internal Revenue Service Data Book, 2014, Letter from the Commissioner.  It is anticipated that the release date for the 2015 IRS Data Book will be March, 2016.  Actual appropriation amounts and other sources and amounts of IRS operating funds, such as those from special programs and user fees, may be found in Budget in Brief, Internal Revenue Service. This is a publication of the Department of the Treasury.  The 2015 Budget in Brief may be found at www.irs.gov/PUP/newsroom/IRS%20FY%202015%20Budget%20in%20Brief.pdf

² National Taxpayer Advocate, Annual Report to Congress, 2014. The 2015 Annual Report to Congress is expected in January, 2016.

³ Internal Revenue Service Data Book, 2014, Letter from the Commissioner.

⁴ Resource Center, FATCA Archive, U.S. Department of the Treasury, Nov. 5, 2015. [http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx]. Accessed on Nov. 10, 2015.

⁵ See IRS Information Release IR-2015-108, Sep. 24, 2015 at https://www.irs.gov/uac/Newsroom/US-Signs-Competent-Authority-Arrangements-with-Australia-and-the-United-Kingdom-in-Accordance-with-the-Intergovernmental-Agreements

⁶ For further information and resources on IDES, see https://www.irs.gov/Businesses/Corporations/International-Data-Exchange-Service

⁷Rev. Proc. 2014-38, 2014-29 IRB 131 (Jul. 14, 2014).

⁸ The list of FFIs registered with the IRS may be downloaded from https://apps.irs.gov/app/fatcaFfiList/flu.jsf

 

⁹Offshore Compliance Initiative, United States Department of Justice. Nov. 5, 2015. [www.justice.gov/tax/offshore-compliance-initiative] Accessed on Nov. 10, 2015.

¹⁰ For example, there are several "international information returns" that may need to be filed by various types of taxpayers with interests in foreign corporations, trusts, estates, or partnerships.  Many of

¹¹ Such programs include the Streamlined Compliance Procedures (for taxpayers who have not willfully failed to disclose assets) and the Offshore Voluntary Disclosure Program (OVDP) for taxpayers who have willfully failed to comply). More information on these programs, respectively, may be found at https://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures and https://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program

¹² 31 CFR §1010.350.

¹³ 31 CFR §1010.350(b).

¹⁴ An entity is subject to the FBAR rules even if it is treated as a disregarded entity under federal income tax rules.  FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234.

¹⁵ IRC §7701(b).

¹⁶ See IRC §7701(b)(3)(A) and Treas. Reg. §301.7701(b)-(4)(a) for further details on the substantial presence test.

¹⁷ FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10238; 31 CFR 103.11(nn).

¹⁸ FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10238.

¹⁹Ibid.

²⁰ IRC §6013(a)(1); S.R. Nico, Jr. v. Comm'r, 67 TC 647 (Jan. 10, 1977), aff'd in part, rev'd in part, and remanded, 565 F.2d 1234 (2^nd Cir. 1977).

²¹ FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10238. For further details on this election, see IRC §6013(g) and Treas. Reg. §1.6013-6.

²² FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10238. Generally, FIRPTA imposes special rules, including tax withholding rules, upon the sale of foreign-held U.S. real property interests. For an overview of FIRPTA, see IRM 4.61.12, Foreign Investment in Real Property Tax Act as well as IRC §897, 1445, 6039C and underlying regulations.

²³ FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10240.

²⁴ Ibid.

²⁵ These grantor trust rules are found at IRC §§671-679.

²⁶ FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10240.

²⁷ IRS FBAR Reference Guide, found at https://www.irs.gov/pub/irs-utl/IRS_FBAR_Reference_Guide.pdf

²⁸ Ibid.

²⁹ These five exceptions are found at 31 CFR §1010.350(f)(2). Further guidance on these exceptions is also found in the FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, at 10241.

³⁰ FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10240, referencing 31 CFR 103.11(nn).

³¹ 31 CFR §1010.350(c).

³² While 31 CFR §1010.350(c)(3)(iv)(B) specifically includes "other investment fund", further explanation or guidance has been reserved regarding what constitutes such an investment.

³³ While 31 CFR §1010.350(c)(4)(iii).

³⁴ U.S. v. Hom, 2014 U.S. Dist. LEXIS 77489 (N.D. CA 2014).

³⁵ 31 CFR §1010.350(g)(4).

³⁶ Ibid.

³⁷ FinCen Final Rule RIN 1506-AB08, 76 Fed. Reg. 10,234, 10237; IRS FBAR Reference Guide.

³⁸ These rates are found at https://www.fiscal.treasury.gov/fsreports/rpt/treasRptRateExch/treasRptRateExch_home.htm

³⁹ IRS FBAR Reference Guide.

⁴⁰ 2015 Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Section 2006(b)(11).

⁴¹ To file FinCen Forms 114 on behalf of clients, the practitioner must enroll as an "institution" at http://bsaefiling.fincen.treas.gov/Enroll.html

⁴² See the IRS FBAR Reference Guide, found at https://www.irs.gov/pub/irs-utl/IRS_FBAR_Reference_Guide.pdf

⁴³ 31 CFR 103.24; IRS FBAR Reference Guide.

⁴⁴ 31 USC §5321(a)(5)(B).

⁴⁵ Ibid.

⁴⁶ 31 USC §5321(a)(5)(C).

⁴⁷ 31 USC §5322(b).

⁴⁸ 31 USC §5322(a), (b).

⁴⁹ Specifically, the Offshore Voluntary Disclosure Program (OVDP) or either Streamlined Filing Compliance Procedure (SFCPs). For further information on the OVDP, see https://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program and for further details on the SFCPs, see https://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures

⁵⁰ See https://www.irs.gov/Individuals/International-Taxpayers/Delinquent-FBAR-Submission-Procedures

⁵¹ Ibid.

⁵² Treas. Reg. §1.6038D-2(g).

⁵³ Treas. Reg. §1.6038D-1(a)(1).

⁵⁴ A dual resident taxpayer who files a U.S. Form 1040NR with a Form 8833 to be taxed as a resident of a foreign country under terms of a tax treaty is exempt from the FATCA filing requirement. See Treas. Reg. §1.6038D-2(e) for special rules regarding dual resident taxpayers.

⁵⁵ Other relevant U.S. possessions covered for purposes of these FATCA rules are covered by IRC §931.

⁵⁶ See Prop. Treas. Reg. §1.6038D-6 and IRS Notice 2013-10.

⁵⁷ Treas. Reg. §1.6038D-2(b)(1).

⁵⁸ Treas. Reg. §1.6038D-2(b)(4)(i).

⁵⁹ Treas. Reg. §1.6038D-2(b)(4)(ii).

⁶⁰ "Financial account" is defined at IRC §1471(d)(2), which defines a financial account as any depository or custodial account at the FFI or any debt or equity interest in the FFI itself.

⁶¹ "Foreign financial institution" is defined by IRC §1471(d)(4), which defines an FFI as a foreign entity that: accepts deposits in the ordinary course of business, holds financial assets for others as a substantial portion of its business, or that is engaged primarily in the securities or commodities business.

⁶² Treas. Reg. §1.6038D-3(a)(3).

⁶³ Treas. Reg. §1.6038D-3(a)(3), referencing Treas. Reg. §1.6049-5(c)(5).

⁶⁴ The IRC §7701(a)(30) definition of "U.S. person" is referenced, and includes a foreign branch or office of such person.

⁶⁵ Instructions for Form 8938.

⁶⁶ "U.S. person" for purposes of this rule is defined by IRC §7701(a)(30).

⁶⁷ An estate is not a "U.S. person" if it does not have income reportable under U.S. federal tax law. See IRC §7701(a)(31)(A).

⁶⁸ A trust is a "U.S. person" if a U.S. court has jurisdiction to supervise its administration and U.S. persons have authority to control substantial trust decisions.  See IRC §7701(a)(30)(E).

⁶⁹ "Present conduct Assets held for future business conduct, such as for future acquisitions or diversification of product line, do not qualify.

⁷⁰ Treas. Reg. §1.6038D-3(b)(5).

⁷¹ Treas. Reg. §1.6038D-3(b)(5).

⁷² Treas. Reg. §1.6038D-3(c).

⁷³ Treas. Reg. §1.6038D-5(b)(1).

⁷⁴ Treas. Reg. §1.6038D-5(b)(2).

⁷⁵ Treas. Reg. §1.6038D-5(c)(4).

⁷⁶ Ibid.

⁷⁷ See Treas. Reg. §1.6038D-5(f)(3) and the Instructions for Form 8938.

⁷⁸ The valuation of these mandatory distribution rights involves the use of valuation tables under IRC §7520. See Treas. Reg. §1.6038D-5(f)(2) and IRC §7520 for further details.

⁷⁹ Treas. Reg. §1.6038D-2(c).

⁸⁰ Instructions for Form 8938.

⁸¹ IRC §6038D(d).

⁸² For the most recent IRS statement regarding Circular 230 due diligence relating to the FBAR requirement, see https://www.irs.gov/pub/irs-utl/Professional%20Responsibility%20and%20the%20Report%20of%20Foreign%20Bank%20and%20Financial%20Accounts%20web%20write-up%206-7-2013.pdf

---