It’s a common misconception that if you have income or assets offshore and it never touches U.S. soil, then you don’t have to report it. That belief is proved wrong with a new tax form, Form 8938, which seeks information on individuals’ foreign financial assets, with substantial penalties for failure to report. In future years, entities also will be required to fill out the form.
“This area is just ripe for people to misstep, and the penalties for noncompliance in this area are incredibly steep, starting at $10,000,” says Henry J. Grzes, CPA, director, international tax, at SS&G, Inc. “Many tax practitioners, as well as taxpayers, are unaware of these new rules.”
Smart Business spoke with Grzes about Form 8938, why it was created and some the challenges taxpayers may face in staying on the right side of the law.
What is tax Form 8938, Statement of Specified Foreign Financial Assets?
Form 8938 requires individuals — if they meet certain filing thresholds — to disclose the existence of foreign financial assets they have an ownership interest in, which can be individually or jointly owned. The form was first required to be filed with 2011 tax returns. The law that requires disclosure of assets is complex, so the IRS initially decided only individuals would be required to file, but once it finalizes regulations and provides additional guidance, corporations, trusts and partnerships will also have to comply.
Why did the IRS create Form 8938?
It was created to make sure taxpayers are properly reporting the existence of and any income from a bank account, ownership in a foreign corporation, whether public or private, and other offshore assets. The IRS has been focusing on taxpayers with offshore activities, especially if those activities aren’t being properly reported on their tax returns.
The recent U.S. pursuit of UBS, a global financial institution, brought the issue to the forefront. UBS employees allegedly attended high-profile events such as the Super Bowl and solicited people to invest money with them by saying they wouldn’t disclose the existence of the investment to other parties..
What are the penalties for failing to properly file Form 8938?
There’s an initial penalty of $10,000 for failure to file, which applies to both spouses if you file jointly, even if only one spouse has foreign financial assets. Failure to file or failure to disclose an asset will also extend the statute of limitations for a return. For example, if you don’t file Form 8938 for the 2011 return until tax year 2013, the statute may remain open for all or part of your income tax return until three years after the date in which the 2011 Form 8938 is filed. If there is unreported income from the assets included on the 2011 filing, the statute of limitations is extended even further.
What advice would you give individuals who aren’t sure if they qualify for Form 8938?
Seek qualified help and inquire whether your tax preparer has experience in international reporting. Some tax practitioners might not want to take on such a filing burden because they aren’t familiar with the area and could be liable for potential preparer penalties.
The form can be confusing because whether you have to file depends on whether you file separately or jointly and whether you live in the United States or abroad. In each circumstance, there is a different filing threshold. In addition, a specified foreign financial asset may not be what you think. For example, holding precious metals directly doesn’t need to be reported on Form 8938, but if you hold precious metals in an account in a foreign financial institution, the account must be reported. When in doubt, report it.
It’s also hard to determine the fair market value of some assets, such as ownership in a closely held business. The IRS requests that you use readily accessible information to determine the maximum value of the foreign asset. If you can’t determine the value, put it down on the form as a value of zero. This is often the case where a taxpayer is a beneficiary to a foreign estate and no distributions were received by the taxpayer in the reporting year.
If individuals have to file the Foreign Bank Account Report (FBAR), why do they need to fill out Form 8938?
The rules for filing the FBAR and Form 8938 are promulgated under different titles of the U.S. code. Form 8938 is part of the Income Tax Act, so only certain individuals can access the information without a subpoena or legal reason. FBAR is part of the Bank Secrecy Act and is a law enforcement tool used to detect money laundering or terrorism.
Filing and reporting requirements for the FBAR and Form 8938 requirements are different; if you file either Form 8938 or FBAR, it doesn’t mean you have to file the other, but you may have to file both.
What happens if someone failed to file the form for the 2011 tax year?
The IRS is playing hardball. There is a reasonable cause provision that allows a taxpayer to avoid any late filing penalties if the failure to file or to disclose an asset is due to reasonable cause and not due to willful neglect. If you have a reasonable argument to put forth, it’s still going to involve time and money. You may not end up having to pay any penalties that might be assessed, but to get to that point, you will have to affirmatively show to the IRS that the facts support a reasonable cause claim.
For taxpayers who determine they need to file this form and did not include it with their 2011 returns, it would be wise to address this failure as soon as possible. Such a voluntary admission of noncompliance and taking corrective action to immediately cure this filing deficiency will generally be to an individual’s benefit when attempting to negotiate any penalty abatements with the IRS as a way to demonstrate a good faith effort to be in compliance with these new filing obligations.
Henry J. Grzes, CPA, is a director, international tax, at SS&G, Inc. Reach him at (919) 651-1616 or [email protected].
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