Foreign Accounts Compliance
Foreign Accounts Compliance: When it comes to foreign account compliance, there are many hurdles for taxpayers with offshore accounts, assets, investments, or income to overcome. Unfortunately, most taxpayers are blindsided by their recording requirements, if for no other reason than they do not learn about the reporting until many years have passed and they are already out of compliance. Foreign accounts compliance comes in several shapes and sizes, and it ranges from the relatively straightforward (ie FBAR) to the unnecessarily complicated (ie PFIC Form 8621). The following is a list of 10 of the more common foreign account compliance reporting forms.
FBAR (FinCEN Form 114)
When it comes to international tax, the FBAR is one of the most commonly referred-to forms. What is interesting (at least to us Tax Geeks) is that the FBAR is not a tax form and is not used to report anything associated with the filer’s income. Rather, it is a Title 31 form (Money and Finance) and refers specifically to the reporting of maximum account values for the filer’s foreign bank and financial accounts. While the form is not a tax form, the IRS is tasked with enforcing compliance — and unfortunately, the failure to be in compliance for FBAR filing may lead to significant fines and penalties.
The Form 3520 is primarily used for the reporting of large gifts from either a foreign individual or foreign entity. It is also used to report certain transactions involving foreign trusts. The form is due at the same time the tax return is due. While the form is not necessarily difficult, the biggest issue with this form is that if it is not filed timely, it may lead to automatic assessed penalties. For taxpayers who received gifts from overseas, the penalty is 5% per month up to a 25% penalty on the value of the gift. Since most people do not realize they missed the reporting until many months have already passed, the 25% penalty is standard. So, in the common example of a US person receiving a $1,000,000 gift or inheritance from a foreign relative, they will get hit with a $250,000 penalty.
Remember, this is not a penalty for non payment of tax since there is no income issue. Rather, this is merely for not filing a form timely.
Form 3520-A is a more complicated form. It is used to report certain ownership and transactions of foreign trusts. Especially in situations in which there are both US beneficiaries and foreign beneficiaries, it is not uncommon for a trustee of a foreign trust to not be aware that anything must be filed with the IRS — and this leads to significant penalties for the US owner of the trust/beneficiary of the trust. Generally, the form is due March 15 and if the applicant wants to apply for an extension, they file it on Form 7004 and not Form 4868.
The Form 5471 is used to report ownership in certain foreign corporations. This form can be very complicated, especially if it is a Controlled Foreign Corporation and therefore may be subject to issues such as Internal Revenue Code section 965, Subpart F income, and GILTI. What makes the form more complicated in other forms is because it requires the taxpayer to balance the finances of the company, which can be extremely difficult for taxpayers with no financial or accounting background.
Form 5472 is used by foreign persons to report ownership in a US company or disregarded entity and/or foreign companies operating in the United States (subject to permanent establishment exceptions under certain treaties). Part four of Form 5472 has a significant amount of transactions that requires reporting. The reporting is done by the foreign corporation on behalf of the foreign person.
While most types of distributions are reportable, it is important to note that dividend distributions do not qualify as reportable transactions.
Form 5472 is one of the most feared international information reporting forms because the penalty starts at $25,000 per violation (compared to $10,000 for Form 5471).
Form 8621 is used to report an ownership or interest in a passive foreign investment company. The rules involving PFIC are some of the most complicated international tax rules around. Issues involving excess distributions, QEF, and MTM elections make the form more complex than it otherwise should be. Unfortunately, many US taxpayers get stuck in PFIC territory simply because they own foreign mutual funds.
The Form 8865 is a counterpart to Form 5471. While Form 5471 is used to report foreign corporations, the Form 8865 is used to report foreign partnerships. The form is very similar to the Form 5471 but is less common due to the simple fact that most people prefer to establish foreign corporations as opposed to foreign partnerships due to the enormous headache in preparing the books for a partnership.
Form 8938 was developed in accordance with FATCA. FATCA is the Foreign Account Tax Compliance Act. It is used to report taxpayer’s interest in foreign financial assets. The form is very similar to the FBAR but they are not mutually exclusive and unlike the FBAR, the Form 8938 has a tax component. Not only does it require the taxpayer to include maximum account values and asset values, but the taxpayer must also parse out different types of income attributed to the asset as well as other reporting requirements.
The Schedule B is used to report an ownership, interest, or signature authority in a foreign account. It requires a taxpayer to identify which country(ies) the accounts are located; whether or not the taxpayer has to also file the FBAR — and whether or not the taxpayer has to report any foreign trusts .
*Beware of the ridiculous fear mongering you find online. If you accidentally marked “no” or you use a software program in which the default position is “no,” then you are not automatically willful if you made a mistake and marked “no” — it does not ignite a life sentence in prison.
We include Schedule E because this seems to be a very common mistake for taxpayers. If a person has a foreign rental property then that rental property is included on Schedule E, just like US rental property. In addition, even if the foreign property nets out a loss, it still needs to be included on the Schedule E to both report the income as well as the expenses associated with the property.
International Tax Law Is Complicated
When a US taxpayer has foreign accounts, they may have various international information reporting form requirements depending on the type and category of their foreign accounts and foreign assets. Many taxpayers do not become aware of the reporting requirements until they are already out of compliance and if that is the case, there are several amnesty programs to safely get back into compliance.
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