Dana M. Trachtenberg, Esq. contributed to this post.
Prior to this year, if you owned foreign financial assets totaling at least $10,000, you had to meet one set of reporting requirements, mandating disclosure of any account in which you had a financial interest or as to which you had signatory or other authority on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (the “FBAR”). The FBAR is a separate information return and not part of the income tax return.
On March 18, 2010, the Hiring Incentives to Restore Employment Act (the “Hire Act”) was signed into law. The Hire Act imposes a new reporting requirement for foreign financial assets in addition to the FBAR reporting requirements.
New Reporting Requirement
Section 6038D of the Tax Code applies to tax years beginning after March 18, 2010. If the aggregate value of your interests in “specified foreign financial assets” exceeds $50,000 at any time during the tax year, then you must disclose certain information in your income tax return concerning the type of foreign asset, its value and where it is located.
A “specified foreign financial asset” includes any depository, custodial, or other financial account maintained by a foreign financial institution and any stock or security or financial instrument or contract issued by a person other than a U.S. person, or any interest in a foreign entity not held in an institutional account. A beneficiary of a trust holding specified foreign financial assets may be required to disclose his or her interest in such trust on his or her tax return if the value of the interest in the trust, together with the value of his or her other specified foreign financial assets, exceeds $50,000.
The initial penalty for failing to comply with the new requirement is $10,000. If the failure to disclose the required information continues for more than 90 days after notification from the IRS, an additional penalty of $10,000 is assessed for each additional 30-day period during which the failure continues. The maximum penalty may not exceed $50,000. A penalty may be avoided only by showing that the failure is due to reasonable cause. Avoiding civil or criminal penalties that may be imposed by a foreign jurisdiction for the disclosure of the required information is not reasonable cause to avoid U.S. penalties.
Additionally, Tax Code §6662 now lists “undisclosed foreign financial asset understatement” as an activity subjecting a taxpayer to a 40% accuracy-related penalty on underpayments attributable to any transaction involving an undisclosed foreign financial asset. As with Tax Code §6038D, the only way you can avoid this penalty is by showing reasonable cause for the underpayment and that you acted in good faith.
Statute of Limitations
As a new exception to the general three (3) year limitations period, if you omit more than $5,000 from gross income and such amount is attributable to a foreign financial asset with respect to which (i) information reporting is required under Tax Code §6038D or (ii) information reporting would be required if Tax Code §6038D were applied without regard to the $50,000 aggregate value threshold, then the limitations period is extended to six (6) years. Applying the extended statute of limitations even when you do not have to report under Tax Code §6038D because the value of the foreign assets is less than $50,000 provides an incentive to everyone with foreign assets to report income from foreign financial assets.
The new limitations exception applies to returns filed after March 18, 2010 and to returns filed on or before such date if the three (3) year limitations period has not expired as of such date.
These provisions significantly change the reporting requirements for those who own foreign financial assets. If you have specified foreign financial assets, now is a good time to review them to determine if you meet the new filing rules.