Introduction
In today’s advanced world of globalization, executing business activities outside one’s own country has become easy, especially after the advancement of smart devices such as smartphones and the Internet. If a person or an entity has business outside their own country, it is very likely they would have a foreign bank account or even their financial assets in such another country.
In this report, an analysis is done on the laws and tax regulations surrounding the requirement of reporting such foreign accounts and foreign assets while filing the tax returns in the United States.
Reporting requirements on foreign assets and accounts in U.S. Tax return
The government of the United States has strict rules about reporting foreign assets and accounts to the Internal Revenue Service while filing tax returns. The IRS normally requires United States persons owning foreign assets, foreign financial accounts, investments, and income to report to the United States government every year under various forms.
The Internal Revenue Service has created multiple forms for such reporting such as FBAR (Foreign Bank and Financial accounts report), Form 8938 (FATCA), and so on.
Persons required to report the foreign assets and accounts
United States persons are required to report foreign assets and accounts. The definition of the United States persons includes the following;
United States Persons
United States persons for the purpose of foreign assets and accounts reporting includes following[i]:
- A citizen of the United States
- A resident of the United States
- A partnership firm incorporated in the United States
- A domestic corporation
- Any estate class/type, other than the foreign estate
- A trust, where one or more of the United States persons have a majority of the decision-making power or control over all the substantial choices of the trust
- A trust, where the United States government has the power to supervise the overall administration of the trust
- Any other person, who is not considered to be a foreign person as per the United States Law
Foreign persons
A foreign person for the purpose of foreign assets and accounts reporting includes the following:
- Any non-resident alien individual
- A Corporation incorporated outside the United States
- A Partnership firm formed outside the United States
- A trust started outside the United States
- Any Foreign estate
- Any other person who is not a United States persons
How to report
The rules relating to the reporting of such offshore assets and accounts of the Internal Revenue Service are complex. There are multiple thresholds relating to reporting these accounts and assets based on various factors such as the category of the filer, i.e., U.S. person, U.S. resident, and the category of assets that are reported.
List of foreign assets to be reported
Following is the list of foreign assets that are required to be reported
- Stock holdings
- Stock accounts
- Financial Accounts
- Mutual funds
- Life insurances
- Pension fund
- Retirement fund
- Bank accounts
Various forms required for foreign assets reporting
Following are various forms required for reporting the foreign assets
Foreign Accounts (FBAR) – FinCEN Form 114
FBAR requires a U.S person to report offshore bank accounts, financial accounts, retirement accounts, pension funds, and so on. However, a threshold has been defined by Internal Revenue Services for reporting such accounts. In cases where the total of the balances in these accounts exceed $10,000, a U.S person is required to report and disclose these accounts, in a detailed manner, in an FBAR form.
Failing to report these accounts when the threshold is met or crossed will result in a civil penalty, for willingly failing to file the report. The penalty amount will be equal to 50% of the total balances in these foreign accounts or a maximum of $100,000.
Internal Revenue Service’s Form 3520
This form is required to be filed in case a U.S. person receives a gift or inheritance from a foreign person. Reporting is required to be done when the amount of the gift or inheritance received exceeds $100,000.
This threshold shall be calculated as a yearly threshold. Hence, reporting is also required when a series of transactions, which are less than $100,000, but in aggregate exceed the threshold over the period of a tax year.
If a person fails to report the gift or inheritance exceeding $100,000 or files an incomplete return, under the IRS Form 3520, the penalty charged would amount to over $10,000 or a maximum of 35% of the gross amount of gift or inheritance[ii].
Internal Revenue Service’s Form 8865 or 5471
A partner, who is a U.S person, of a partnership firm formed in a foreign country and controlled by such a U.S. partner, is required to report various aspects under form 8865. An individual U.S person is said to be in control when he has 10% or more interest in a partnership firm. Form 8865 is used to report the financial position and overall income of such an offshore partnership firm. This form is required to be filed with the partner’s tax return.
A United States investor who owns, directly, indirectly, or in aggregate 10% or more than 10% of the voting power from all classes of voting stock combined, is required to report varying levels of information relating to the foreign company. The reporting is required to be done in Form 5471, where detailed information has to be submitted, such as Assets, Liabilities, Income statements, and so on.
Both the above-mentioned forms have to be filed every year by the U.S person, even when there is no requirement of filing tax returns otherwise. Failure to file this form would result in a penalty of $10,000. IRS would notify the delinquency to the assessee, where a 90 days’ time limit would be provided to file the return with a penalty. If the assessee fails to do so, a monthly penalty of $10,000 would be levied up to a maximum of $50,000. [iii]
Real Estate Income from Offshore property
In cases where a U.S Tax person sells the offshore property or even if they earn a rental income from such offshore property, the income needs to be reported in the U.S tax returns on their U.S taxes. Such income is required to be reported, even in cases where such income is exempt in the foreign country where the property is situated. A U.S person owning such offshore property can claim the depreciation in the U.S tax returns, even if the foreign country doesn’t allow such depreciation.
Depending on the type of the property, various deductions and expenses allowed as per the U.S Taxation laws can be taken as a benefit, even if such benefits cannot be taken as per the foreign taxation laws where the property is situated.
Internal Revenue Service’s Form 8938 (FATCA)
FATCA is an abbreviation for Foreign Account Tax Compliance Act. Reporting under this Act is required by U.S Individuals having financial accounts or specified foreign assets (such as Life insurances, ownership in the offshore business, etc.). A foreign financial asset would majorly include the following[iv],
- Any financial accounts operated or maintained by such foreign financial institution
- Stocks or securities
- Any interest held in a foreign entity
- Financial instrument or contract
For the purpose of reporting under this form, there are various thresholds for various categories of U.S person,
The unmarried individual taxpayer (living in the United States) or married individual taxpayer (who files a separate tax return and lives in the United States)
The total value of the offshore financial asset held as on the last day of the taxation year shall be more than $50,000 or greater than $75,000 at any point in time during such taxation year.
The married individual taxpayer (who files a joint tax return and lives in the United States)
The total value of the offshore financial asset held as on the last day of the taxation year shall be more than $100,000 or greater than $150,000 at any point in time during such taxation year.
Taxpayers who live outside the United States and file a separate tax return
The total value of the offshore financial asset held as on the last day of the taxation year shall be more than $200,000 or greater than $300,000 at any point in time during such taxation year.
Taxpayers who live outside the United States and file a joint tax return
The total value of the offshore financial asset held as on the last day of the taxation year shall be more than $400,000 or greater than $600,000 at any point in time during such taxation year
Entities formed/incorporated in the United States
The total value of the offshore financial asset held as on the last day of the taxation year shall be more than $50,000 or greater than $75,000 at any point in time during such taxation year
[I] https://www.irs.gov/individuals/international-taxpayers/classification-of-taxpayers-for-us-tax-purposes
[ii] https://www.irs.gov/forms-pubs/about-form-3520
[iii] https://www.irs.gov/instructions/i5471
[iv] https://www.irs.gov/businesses/corporations/do-i-need-to-file-form-8938-statement-of-specified-foreign-financial-assets