New reporting form for beneficiaries of a foreign trust & the December 15th, 2011 deadline is looming for Americans living and working overseas

PART I.

The final extension of time to file your 2010 Individual Income Tax Return is fast approaching, December 15, 2011. This extension is given only for U.S. Taxpayers who live and work overseas.  It also includes dual citizens of the United States, such as a foreign national living and working in their home land but had a parent who was a U.S. Citizen, and U.S. citizens who are long-term residents of a foreign country have a filing requirement to file U.S. tax returns.  However, the deadline for filing the Reports of Foreign Bank and Financial Accounts (FBARs) has passed as of June 30, 201.  Now, there is an even more worrisome report, Form 8938 (see part II for a discussion).  According to the latest IRS statistics there is a very large part of the world population that has yet to come forward and become current with IRS filings.  The IRS is aware that many of these individuals are only recently aware of these requirements for being in compliance with the U.S. laws.

IRS OPENS A HOTLINE FOR THE PUBLIC TO CALL IN

Again, the IRS is making public concessions if these individuals begin the process of becoming compliant.  Last month the IRS announced a toll-free hotline for members of the public to call in and ask the IRS the filing requirements and possible penalties that may be imposed upon them.  With only a month passing since setting up this hotline, I am not sure how successful this method of attracting individuals into being compliant nor am I sure of how they treated the phone calls.  It is possible to gather evidence of the caller’s phone I.D. and during the conversation with a highly trained IRS Agent; a lot of innocent statements can become your own worst enemy.  These heavily trained Agents are experts at soliciting and gathering information from unsuspecting individuals.  Below is the IRS announcement:

Helpline connects practitioners and filers, both domestic and abroad, with a team of specially trained technicians, examiners and specialists to answer technical Title 31 questions.

To reach the FBAR and Title 31 Helpline, dial:
• 866-270-0733 for callers within the U.S. (toll-free)
• 313-234-6146 for callers outside the U.S. (not toll-free)

Hours of operation for the FBAR and Title 31 Helpline are Monday - Friday, 8 a.m. to 4:30 p.m., Eastern time. An IRS employee will respond to messages left after-hours.

The announcement openly states that the individuals behind the IRS phones are specially trained… examiners and if you call after hours and leave them your phone number, they are happy to return your call on the next business day, An IRS employee will respond to messages left after-hours.  As a trained attorney, I would not be calling in and I would seriously doubt that an individual with no legal training in tax laws would risk making such a call. However, the IRS must have felt strongly enough that people would be calling in to establish two telephone number, one is toll-free.


I hope you are following my series of articles on this compliance matter.  The penalties are shocking!  The exposure to criminal recourse is extremely high!   Although I agree that for members of the taxpaying public there is a compelling need to get yourself right with the U.S. Treasury, you should not just enter the arena of the IRS without knowing your rights and protections. 

As an example, the IRS states that not all penalties will be imposed in all cases.  The U.S. Treasury cites examples such as taxpayers who owe no U.S. tax because of the possible application of the foreign earned income exclusion or foreign tax credits will zero out any penalty for failure to file or failure to pay. I disagree, since the foreign sourced earned income exclusion limit may not cover all of your earnings or days worked in the U.S. will not fall under this exclusion.  Also, even though your particular country of residence has a Double Tax Relief Treaty with the U.S., the tax credit may not apply in full under the always lurking and menacing Alternative Minimum Tax calculation.  Also, there are more than 14 penalties that may apply to you and these penalties increase over time (usually calculated per month) and also carry heavy interest charges that compound daily!  Most IRS interest rates, currently, are around 4% compounding daily.  You will never get these rates on your savings accounts.

The IRS provides an all too simplistic example

Example 1:  Taxpayer is a United States citizen who lived abroad in Country A for all of 2010, during which time Taxpayer worked as an English instructor.  He maintained a checking account with a bank in Country A, and the highest balance in the account did not exceed $10,000 in 2010.  Taxpayer complied with Country A’s tax laws and properly reported all his income on Country A tax returns.  Although Taxpayer earned income in excess of the applicable exemption amount and standard deduction, he did not timely file a federal income tax return for tax year 2010.  After learning of his U.S. filing obligations, Taxpayer filed an accurate, though late, federal income tax return showing no tax liability. 

In this example the IRS determines that there is no tax liability, but as I noted above, this is rarely the case.  The Penalty for failure to file will be applied automatically and the burden of rebutting this penalty is on you.  The IRS further notes:

…this penalty is applicable only in cases in which there is willful intent to avoid filing.  Non-willful violations that the IRS determines are not due to reasonable cause are subject to a penalty of up to $10,000 per violation.  There is no penalty in the case of a violation that IRS determines was due to reasonable cause. 

Although the IRS has penalty mitigation guidelines, the individual examiners are not bound by that guideline.  The examiner may solely determine that the penalty is proper and that the penalty should be increased over and above the guidelines. 

This next example is an all too familiar example for me.  I have many clients who fit this hypothetical:

Taxpayer is a United States citizen who lives and works in Country B as a computer programmer.  Taxpayer has checking and savings accounts with a bank that is located in the city where he lives.  The aggregate balance of the checking and savings accounts is $50,000 during the tax year.  Taxpayer complied with Country B’s tax laws and properly reported all his income on Country B tax returns.  Taxpayer failed to file federal income tax returns and failed to file FBARs to report his financial interest in the checking and savings accounts.  After reading recent press and thus learning of his federal income tax return and FBAR reporting obligations, Taxpayer filed delinquent FBARs, reporting both foreign accounts, and attached statements to the FBARs explaining that he was previously unaware of his obligation to report the accounts on an FBAR.  Taxpayer also filed federal income tax returns properly reporting all income and no tax was due.  The IRS will determine whether the FBAR violation was due to reasonable cause based on all the facts and circumstances.  Taxpayer had a legitimate purpose for maintaining the foreign accounts, there were no indications of efforts taken to intentionally conceal the reporting of income or assets, and no tax was due.  Taxpayer’s explanation for why he failed to timely file an FBAR appears reasonable in view of the facts and circumstances of the case.  Since the IRS determined that the FBAR violation was due to reasonable cause, no FBAR penalty will be asserted.

Once you collect the proper information from your client and perform an initial calculation of the tax liability, there are two bright-line factors:

First, the computer person is on the Internet constantly and is, therefore, imputed to have immediate and in-depth knowledge of the tax filing laws.  Second, the computer person earns more than the foreign sourced earned income exclusion and/or has worked in the U.S. during part of the tax year, which causes the income to fall outside of the exclusion.  Therefore, there is, as in my experience, always a tax owing.  These two bright-line factors will cause my clients to not fit the IRS example above and subject them to tax, penalties, interest and potential criminal prosecution.  Please see my earlier articles where I discuss this in-depth.

PART II.

Form 8938

Now On the Horizon - New Reporting Requirement For Foreign Financial Assets

By now you are familiar with the FBAR, Foreign Bank Account Report, which is incredibly detailed as to your bank accounts held overseas.  If this was not invasive enough, wait until you see Form 8938!  This makes Form 90-22.1 look harmless.   This Form is required by U.S. taxpayers who have an interest in certain specified foreign financial assets with an aggregate value exceeding $50,000 to report everything possible about those assets to the IRS.  Below is a listing of the possible assets and, as of this writing, I believe this form will apply to this tax year, 2011, which leaves you little room to make adjustments to your asset holding overseas:

Specified Foreign Financial Assets

Specified foreign financial assets 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.

Financial account.   

A financial account is any depository or custodial account maintained by a foreign financial institution as well as any equity or debt interest in the foreign financial institution. A specified foreign financial asset includes a financial account maintained by a financial institution that is organized under the laws of a U.S. possession (American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, or the U.S. Virgin Islands).

• It accepts deposits in the ordinary course of a banking or similar business.
• As a substantial part of its business, it holds financial assets for the account of others.

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

Other specified foreign financial assets.   

Examples of other specified foreign financial assets include the following, if they are held for investment.

Foreign financial institution.   

In most cases, a foreign financial institution is any financial institution that is not a U.S. entity and satisfies one or more of the following.

• It is engaged (or holds itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities.
• 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 foreign estate.
• An interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty.
• An option or other derivative instrument with respect to any of these examples or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer.

Assets held for investment.   

You hold an asset, including stock or a partnership interest, for investment if you do not use it in, or hold it for use in, the conduct of any trade or business.

Specified Foreign Financial Assets Required to be Reported

If you have an interest in a specified foreign financial asset and the total value of all of your specified foreign financial assets exceeds the reporting threshold applicable to you, report the asset on Form 8938 unless an exception to reporting applies.

You have an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross proceeds, or distributions from holding or disposing of the asset are or would be required to be reported, included, or otherwise reflected on your income tax return.

You have an interest in a specified foreign financial asset even if there are no income, gains, losses, deductions, credits, gross proceeds, or distributions from holding or disposing of the asset included or reflected on your income tax return for this tax year.

Interests in assets held by disregarded entities.   

If you are the owner of a disregarded entity, you have an interest in any specified foreign financial assets owned by the disregarded entity.

Interests in jointly owned assets.

A joint owner of an asset has an interest in the entire asset.

Interests in assets held in financial accounts.   

If you report your interest in a financial account, you do not need to report an interest in the assets held in the financial account.

Interests in assets generating certain unearned income of children.   

If you file Form 8814, Parents’ Election To Report Child’s Interest and Dividends, with your income tax return to elect to include in your gross income certain unearned income of your child (the “kiddie tax” election), you have an interest in any specified foreign financial asset held by the child.

Interests in assets held by entities that are not disregarded entities.

In most cases, you do not own an interest in any specified foreign financial asset held by a partnership, corporation, trust, or estate solely as a result of your status as a partner, shareholder, or beneficiary.

Interests in assets held by grantor trust.   

If you own any part of a grantor trust, other than a domestic bankruptcy liquidating trust or a domestic widely held fixed investment trust, you own an interest in any specified foreign financial assets held by that part of the trust.

Interests in foreign estates and foreign trusts.   

An interest in a foreign trust or a foreign estate is not a specified foreign financial asset unless you know or should have known of the interest. If you receive a distribution from the foreign trust or foreign estate, you are considered to know of the interest.

Reporting Period

Unless an exception applies, the reporting period for Form 8938 is your tax year.

Figuring Maximum Value

You must provide the maximum value during the tax year of each specified foreign financial asset reported on Form 8938. In most cases, the value of a specified foreign financial asset is its fair market value. In most cases, you can make a reasonable estimate of the asset’s maximum fair market value during the tax year. An appraisal by a third party is not necessary to estimate the maximum fair market value during the year.

Assets with no positive value.   

If the fair market value of a specified foreign financial asset is less than zero, use a value of zero both to determine if the total value of all of your specified foreign financial assets is more than the appropriate reporting threshold and to report the maximum value of the asset on Form 8938.

Foreign currency conversion.   

If your specified foreign financial asset is denominated in a foreign currency during the tax year, the maximum value of the asset must be determined in the foreign currency and then converted to U.S. dollars. In most cases, you must use the U.S. Treasury Department’s Financial Management Service foreign currency exchange rate for purchasing U.S. dollars. If no Financial Management Service exchange rate is available, you must use another publicly available foreign currency exchange rate for purchasing U.S. dollars and disclose the rate on Form 8938.

Currency determination date.

Use the currency exchange rate on the last day of the tax year to figure the maximum value of a specified foreign financial asset or the value of a specified foreign financial asset for the purpose of determining the total value of your specified foreign financial assets to see whether you have met the reporting threshold. Use this rate even if you sold or otherwise disposed of the specified foreign financial asset before the last day of the tax year.

Reporting the value of jointly owned assets. If you own an asset jointly with one or more persons, you must report the asset’s value as follows.

Married specified individuals filing a joint income tax return.   

If you are married and you and your spouse file a joint income tax return, report any specified foreign financial asset that you jointly own only once and include the maximum value of the entire asset (and not just the maximum value of your interest in the asset). Also, you must report any specified foreign financial asset that either you or your spouse separately owns and include the maximum value of the entire asset. If you file Form 8814, you must report any specified foreign financial asset your child owns only once and include the entire value of the asset.

Married specified individuals filing separate income tax returns.

If you are married, and you and your spouse are specified individuals who file separate income tax returns, both you and your spouse report any specified foreign financial asset that you jointly own on your separate Forms 8938, and both you and your spouse must include the maximum value of the entire asset on your separate Forms 8938. You also must report any specified foreign financial asset that you own individually on your separate Form 8938 and include the maximum value of the entire asset. If you file Form 8814, you must report any specified foreign financial asset your child owns and include the maximum value of the entire asset.

Other joint ownership.   

If you are a joint owner of a specified foreign financial asset and you cannot use one of the special rules for married individuals, you must report the specified foreign financial asset and include the maximum value of the entire asset.


Valuing interests in trusts. If you are a beneficiary of a foreign trust, the maximum value of your interest in the trust is the sum of the following amounts.

• If you receive distributions at the discretion of the trustee, the value of all of the cash or other property distributed during the tax year from the trust to you as a beneficiary, and • If you receive mandatory distributions, the value using the valuation tables under section 7520.

CONCLUSION:

As you can clearly see from the above discussion, there are so many landmines based on existing and new laws that you need to retain an expert…immediately.  Time is running out and any changes you may need to make are fast becoming a fleeting luxury.  If you have any question, please contact the author for a confidential discussion.