In 2010, in response to the discovery of the widespread use of undisclosed foreign bank accounts by U.S. taxpayers, Congress enacted the Foreign Account Tax Compliance Act (FATCA). Among other things, FATCA requires foreign financial institutions (i.e., foreign banks) and certain other nonfinancial foreign entities to report on the foreign assets held by their U.S. account holders or be subject to withholding on certain types of payments.
FATCA also created a new information reporting requirement for U.S. taxpayers with respect to their foreign assets, a requirement set forth in IRC section 6038D. FATCA’s information reporting requirement was implemented via new Form 8938, a form that was first required to be filed in 2012 (with returns for the 2011 tax year).
Reporting Differences between the FBAR and Form 8938
U.S. persons with foreign accounts should be aware that there are numerous differences between the FBAR and Form 8938. First and foremost are the different reporting thresholds. The FBAR must be filed when a U.S. person has foreign bank accounts with an aggregate high balance of $10,000 at any point during the tax year. Form 8938, by contrast, has different monetary thresholds depending upon the tax filing status and location of the taxpayer. An unmarried taxpayer residing in the United States must file Form 8938 if her specified foreign assets exceed $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Those thresholds increase to $200,000 and $300,000, respectively, for an unmarried taxpayer residing outside the United States. Married taxpayers residing in the United States and filing joint tax returns must file Form 8938 if their specified foreign assets exceed $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year (but just $50,000 and $75,000, respectively, if filing separate tax returns). For married taxpayers residing outside the United States and filing joint tax returns, the Form 8938 reporting threshold is $400,000 in specified foreign assets on the last day of the tax year, or more than $600,000 at any time during the tax year (but just $200,000 and $300,000, respectively, if filing separately).
Second, the type of interest in a foreign account that will trigger an obligation to file an FBAR is different than the type of interest that will trigger an obligation to file Form 8938. For FBAR purposes, ownership interest in an account, power of attorney over an account, or even just signature authority are each sufficient for purposes of reporting the account. In addition, foreign accounts in which an individual has an indirect but sufficient beneficial ownership interest (e.g., a greater than 50% ownership interest in the entity that directly owns the foreign account) must be directly reported on that individual’s FBAR. For Form 8938 purposes, by contrast, only foreign accounts in which the taxpayer has a direct ownership interest must be reported. Accounts in which the taxpayer solely has a power of attorney or merely has signature authority do not need to be reported on Form 8938. In addition, accounts in which the taxpayer has only an indirect interest (e.g., through an entity) do not need to be reported on Form 8938.
Third, there are significant differences between the FBAR and Form 8938 in terms of applicability to residents of U.S. territories or possessions. The FBAR filing obligation applies to all “U.S. persons,” and for FBAR purposes a U.S. person includes a bona fide resident of any U.S. territory or possession. Thus, residents of Puerto Rico, American Samoa, Guam, the U.S. Virgin Islands, and the Northern Mariana Islands must all file FBARs if their foreign accounts exceed $10,000 in value. For purposes of Form 8938, however, the issue is more complicated. An individual must file Form 8938 if they are deemed a “specified individual” whose specified foreign assets meet certain monetary thresholds. “Specified individual” includes residents of just two U.S. territories: Puerto Rico and American Samoa. But it does not include individuals who are residents of other U.S. territories, such as Guam, the U.S. Virgin Islands, or the Northern Mariana Islands.
Fourth, there are meaningful differences in what qualifies as a “foreign” account for purposes of the FBAR versus Form 8938. For FBAR purposes, an account in a U.S. territory or possession is treated as a U.S. account, and therefore does not need to be reported on the FBAR. For Form 8938 purposes, however, an account in a U.S. territory or possession is considered a foreign account and must be reported. Another example of a difference between the two forms is a financial account held at a foreign branch of a U.S. financial institution (e.g., a Chase account at a branch in London). For FBAR purposes, such an account is considered foreign and must be reported. But Form 8938 does not treat such an account as foreign, and it does not need to be reported on that form.
Finally, there is a difference in how the two forms are submitted and to whom. Although the FBAR form is now filed at the same time as Form 1040, it is not filed with the tax return, nor is it even filed with the IRS. Instead, it is filed with the Financial Crimes Enforcement Network (FinCen). Form 8938, by contrast, is attached to, and considered a part of, an individual’s Form 1040; thus, it is necessarily filed both at the same time as the tax return and directly with the IRS. Although both FinCen and the IRS are bureaus within the U.S. Department of Treasury, there are practical consequence to the fact that the FBAR is filed with FinCen and Form 8938 is filed with the IRS. In an audit or examination, an IRS agent will presumably always have access to a properly filed Form 8938 for the year under audit, as it is attached to and a part of the tax return. By contrast, the agent will not necessarily start with access to the filed FBAR. Thus, the Internal Revenue Manual (IRM) expressly provides that income tax examiners are not required to check FBARs in an income tax audit, but they are required to check Form 8938. One should not assume, however, that this means that IRS examiners will ignore the FBAR reporting obligation when they observe that Form 8938 was filed. Instead, per IRM 188.8.131.52 (“Required Filing Checks,” Nov. 4, 2015), the IRS is looking out for incorrectly prepared Form 8938s, because they believe this may also indicate possible FBAR violations.
Reporting Similarities between the FBAR and Form 8938
Despite the aforementioned differences, there are several similarities between the FBAR and Form 8938. Chief among them is the fact that both the FBAR and Form 8938 use essentially the same valuation criteria. Both the FBAR and Form 8938 require that the taxpayer set forth for each reported foreign account the “maximum” value in the account for the calendar year based on periodic statements. Both forms require that those values be converted to U.S. dollars using end-of-year calendar exchange rates, and that the maximum value be reported in U.S. dollars. Given the foregoing, it appears that the value assigned to reported foreign accounts should match on both forms. As a practical matter, to do otherwise may raise red flags with an IRS examiner who has examined both Form 8938 and the FBAR.
Traps to Avoid
The following are just some examples of pitfalls to be mindful of when dealing with foreign accounts, the FBAR, and Form 8938.
Failing to separately list on Form 8938 foreign accounts reported on the FBAR.
Although Form 8938 provides that information reported on certain other foreign asset reporting forms—such as Form 3520 (for reporting interests in foreign trusts, gifts, and estates) and Form 5471 (for reporting interests in foreign corporations)—does not need to be repeated on Form 8938, there is no such exception for the FBAR. A taxpayer must separately list on Form 8938 all qualifying foreign accounts and the maximum value of those accounts, even if that repeats information that was separately reported on the FBAR.
Not reporting small foreign accounts when there is a Form 8938 filing obligation but no FBAR obligation.
If the reporting threshold for Form 8938 is met because of other foreign financial assets (such as an interest in a foreign trust or corporation), then the taxpayer must list every foreign bank account in which she has a direct ownership interest, no matter how small. For example, if the taxpayer has three small foreign bank accounts holding $3,000 each—and the Form 8938 reporting obligation is triggered because of the value of the taxpayer’s other foreign assets—then the taxpayer must report each of these small foreign accounts on Form 8938, even if the taxpayer does not have to file the FBAR because the taxpayer’s foreign accounts combined are below the $10,000 FBAR reporting threshold. The taxpayer’s tax advisors should carefully perform a separate analysis for Form 8938 and for the FBAR, rather than simply assuming that accounts do not need to be reported on one form if they are not reported on the other.
Only reporting foreign accounts on Form 8938.
Form 8938 is broader than the FBAR because it requires reporting on not just foreign bank accounts, but all manner of foreign assets. Thus Form 8938 requires the reporting, inter alia, of interests in foreign trusts; foreign corporations; foreign stocks, notes, or bonds; a contract with a foreign person to buy or sell assets held for investment; gold certificates issued by a foreign person; foreign pensions; foreign mutual funds; and foreign hedge funds and foreign private equity funds. Simply reporting on Form 8938 the same foreign accounts reported on the FBAR—without considering other potentially reportable foreign assets (or inquiring into them if one is a tax professional)—may lead to a materially incorrect Form 8938 that may, in turn, result in penalties or issues with the statute of limitations for the entire tax return. With respect to penalties for an incorrect Form 8938, if the failure to disclose a specified foreign financial asset results in an underpayment of tax, then there is a 40% accuracy-related penalty on the underpayment per IRC section 6662(j).
Form 8938 is broader than the FBAR because it requires reporting on not just foreign bank accounts, but all manner of foreign assets.
Ignoring the ‘presumption’ baked into Form 8938.
There is a presumption expressly set forth in IRC section 6038D—the statute that resulted in the creation of Form 8938—that if the IRS determines that a taxpayer had an ownership interest in a foreign asset, then the reporting threshold for Form 8938 was met and the taxpayer was required to report the asset. As such, the burden is on the taxpayer to demonstrate that the reporting threshold was not met. Because of this presumption built into the statute—as well as the harsh penalties that may be applied and the statute of limitations issues that may arise if foreign assets are omitted from Form 8938—the over-inclusion of assets on Form 8938 may be a preferable way for taxpayers and their tax professionals to deal with the form.
Assuming that foreign accounts held in the name of a foreign entity do not need to be reported on Form 8938.
Form 8938 includes a rule regarding indirect interests that is often misinterpreted. If the foreign account is held in the name of a foreign trust, a foreign entity, or a fictitious entity, it will still get reported on Form 8938 in one form or another. For example, if the account is in the name of a foreign trust, then the taxpayer would likely need to file Form 3520, and then file a Form 8938 that separately lists the filing of Form 3520. If the foreign account is held by a foreign corporation in which the taxpayer has an ownership interest, then the taxpayer would likely need to file Form 5471 as well as a Form 8938 that separately lists the filing of Form 5471. If the foreign account is held in the name of a disregarded entity or fictitious entity, or is simply a numbered account, then it will probably need to be reported on Form 8938 as a directly held asset of the taxpayer.
Failing to properly consider a child’s foreign assets.
For FBAR purposes, when a child has foreign accounts, those accounts must be reported on an FBAR filed for that child if the $10,000 reporting threshold is satisfied. But for Form 8938, the question is more complicated. Assuming that the reporting thresholds are met, if the parents file Form 1040 on behalf of the child to report unearned income, then they must include Form 8938 with that tax return to report any specified foreign financial assets owned by the child. Alternatively, if the parents file Form 8814 (Parents’ Election to Report Child’s Interest and Dividends) with the parents’ income tax return and thereby elect to include in their gross income certain unearned income of their child (i.e., the “kiddie tax” election), then the parents must report on the parents’ Form 8938 any specified foreign financial asset that the child owns.
If, however, the child does not have to file an income tax return for the tax year (e.g., not enough unearned income), then, per the instructions to Form 8938, there is no obligation to file Form 8938, even if the value of the child’s specified foreign financial assets is more than the reporting threshold for Form 8938.
Failing to consider the interplay between Form 8938 and the statute of limitations.
As reflected in the Instructions to Form 8938, the IRS takes the position that there is no running statute of limitations for the entire Form 1040 tax return if the taxpayer fails to file the required Form 8938 with that tax return. Even more important, the IRS appears to be taking the position, as reflected in the instructions to Form 8938, that filing a materially incomplete Form 8938 (i.e., one that “fail[s] to report a specified foreign financial asset that you are required to report”) is deemed to be a failure to file Form 8938 for purposes of keeping open the statute of limitations on the entire tax return. The statute of limitations will not start to run until the taxpayer files the required “complete” Form 8938. Further, even if a specified foreign asset is reported on Form 8938, if as little as $5,000 in income from that asset is omitted from the tax return, then the statute of limitations for the entire return is extended from three years to six years.
The foregoing are just some of the pitfalls that taxpayers should be aware of when dealing with foreign bank accounts, the FBAR, and Form 8938. Taxpayers should consult tax professionals knowledgeable in this area to help them navigate such issues.