The IRS continues to rigorously enforce failures to report foreign financial assets and accounts. The minimum penalty is $10,000 for each year the reporting is not made. In the case of foreign bank and financial accounts, if the failure to report is willful, the penalty is increased to 50% of the highest balance in the account for each year the account was not reported. In addition, criminal penalties (including imprisonment) are also possible. The following will help assist you in identifying potential reporting and withholding obligations.
Report of Foreign Bank and Financial Accounts (FBAR):
U.S. individuals and entities are required to electronically file Form 114, Report of Foreign Bank and Financial Accounts (FBAR), by April 15th each year if the aggregate highest balance in all of the accounts is more than $10,000 at any time during the year. The FBAR is filed separately from your tax return.
Any account in which you have a financial interest or signature authority over is required to be reported. Entities required to report include U.S. corporations, LLCs, partnerships, and trusts or estates. Disregarded legal entities are required to separately report in addition to the owner of the entity.
Multiple parties may have to report the same account. For instance if an account is jointly owned with your parents, both you and your parents are required to report the full balance in the account. If an account is owned through an entity which you control, both you and the entity will be required to report the account.
A foreign financial account is any account located outside of the U.S. that is a bank account, securities account, or any other account with a business that accepts deposits as a financial agency. This would include:
- Foreign checking or savings accounts or certificates of deposit
- A foreign securities account holding stocks, bonds or other investments
- A foreign mutual fund or similar pooled fund
- A foreign retirement or deferred compensation account
- A foreign annuity account or insurance policy with a cash value
- A foreign account with a broker/dealer holding options, futures or commodities
- Any foreign account of a U.S. bank, financial institution, or brokerage, if located outside of the U.S.
Statement of Foreign Financial Assets (Form 8938):
In addition to the FBAR, individuals and specified domestic entities must disclose any foreign financial assets in their tax return using Form 8938. Married taxpayers filing a joint return are required to file this form if the aggregate value of the foreign assets exceeds $100,000 at the end of the year or $150,000 at any time during the year. For single filers and specified domestic entities, the filing thresholds are $50,000 and $75,000 respectively. A specified domestic entity is any closely held corporate or partnership entity that has gross income consisting primarily of passive (investment) income or primarily holds assets that produce such income. A domestic trust may also be considered a specified domestic entity if its current income beneficiary is an individual or other specified domestic entity subject to certain exceptions.
Foreign financial assets that are required to be reported are the same as are required to be reported on the FBAR except that:
- Foreign real estate if owned in any type of entity (including a disregarded entity) is also included
- Derivative investments are also included
- Foreign accounts of a U.S. bank, financial institution or brokerage are not included
Other Foreign Reporting (Forms 926, 3520, 5471, 5472, 8865):
Business entities and individuals have certain other foreign reporting requirements. Generally, the same $10,000 penalty may be imposed for failure to include any of the following forms with your tax return:
- Contributions of capital to a foreign corporation (Form 926)
- Transactions with a foreign trust and gifts from foreigners (Form 3520)
- Foreign trusts with a U.S. owner (Form 3520-A)
- Foreign corporations controlled by U.S. persons (Form 5471)
- U.S. corporations with 25% or more foreign owners (Form 5472)
- Foreign partnerships with U.S. partners (Form 8865)
Withholding on Payments and Pass-through Income to Foreign Individuals and Entities (Forms 1042 and 8804):
Payments to foreign entities or persons are subject to U.S. tax withholding:
- Withholding at 30% is required for fixed and determinable annual or periodic (FDAP) income paid to a foreign individual or entity. FDAP income includes dividends, interest, royalties, management fees, and similar income payments.The withholding is paid to the IRS periodically depending on the amount of the withholding and is annually reported to the IRS on Form 1042 and to the recipient on Form 1042S.
- Withholding is also required on a foreign partner’s share of business income of a U.S. partnership at the highest federal tax rate applicable to the partner. Estimated tax payments are made quarterly for the withholding by the partnership and are annually reported on Form 8804 to the IRS and on Form 8805 to the partner.
Failure to withhold under either of the above two requirements can result in the IRS assessing the withholding to the U.S. payer or partnership. A Form W8-BEN should be obtained to establish county of residence and potential treaty benefits.
In light of the continued rigorous enforcement of these reporting requirements and substantial penalties, please be sure to let your SVA professional know of any foreign assets or bank accounts you may have as well as any affiliations or transactions with foreign entities or persons. Please contact us if you have any questions.