Today we published a new video discussing the new FBAR (FinCEN Form 114). The video is embedded below.
UPDATE: See our video at: FBAR Video
The I.R.S. indicates on its website that electronic filing for FBAR Forms will be “MANDATORY” beginning July 1, 2013. The full quote is as follows:
Electronic Filing for FBAR Forms – MANDATORY Beginning July 1, 2013
On June 29, 2011, FinCEN announced that all FinCEN forms must be filed electronically with certain exceptions. The FBAR was granted a general exemption from mandatory electronic filing through June 30, 2013. E-filing is a quick and secure way for individuals to file FBARs. Filers will receive an acknowledgement of each submission. For more information about FBAR e-filing, read the FinCEN news release.
Interestingly, the FinCEN news release linked to says nothing about electronic FBAR filings being mandatory. On the contrary, the news release is titled “FinCEN Offers Optional Electronic Filing for FBAR Forms.” Emphasis added. The FinCEN news release explicitly states that “Paper FBAR forms will still be accepted until further notice is given by FinCEN.”
In addition, the instructions to the FBAR have no reference to electronic filing. The instructions provide two mailing addresses and also indicate that the FBAR may be hand delivered to any local office of the Internal Revenue Service or to the Internal Revenue Service’s tax attaches located in United States embassies and consulates for forwarding to the Department of the Treasury, Detroit, MI. No mention is made of electronic filing.
Additional investigation, however, supports the I.R.S.’s website that FBAR filings will be mandatory after June 30, 2013. FinCEN’s “Mandatory E-Filing FAQs” website indicates that “[w]ith limited exceptions, E-Filing is mandatory effective July 1, 2012” and that “FinCEN granted a general exemption for mandatory E-Filing for the FBAR until June 30, 2013.”
Thus, it would appear that electronic filing of the FBAR will be mandatory in less than three weeks. In fact, FinCEN states that it may impose a $500 penalty for failing to comply with its regulations if a form is required to be electronically filed but is filed on paper.
Although FinCEN states that it is working to allow tax preparation software to create and file an FBAR, this capability is not yet in existence. Consequently, after June 30, 2013, tax preparers will be unable to assist their clients in the preparation of FBARs. Clients will need to prepare and submit the FBARs on their own computers.
Many individuals file late FBARs. However, unless FinCEN provides an additional extension to exempt mandatory E-Filing of the FBAR, I wouldn’t be surprised if the number of late FBARs drops off precipitously after June 30, 2013. The combined $500 penalty for paper filing and the inability for tax advisors to assist in the preparation of the FBAR is likely sufficient to significantly impede the flow of FBARs being filed with FinCEN.
And, of course, as the I.R.S. likes to highlight, the FBAR must be received by the Department of the Treasury in Detroit, MI, on or before June 30th. An FBAR that is mailed on June 30th but that is received by FinCEN after June 30th is a late FBAR.
So let’s say you are a wealthy U.S. citizen living in Singapore (I am not an advisor of Eduardo Saverin and I have no information about his situation). You have $100,000 to invest over the next two years. You want to keep your life as simple as possible, so you decide that you will invest the funds in a single Singapore mutual fund. The mutual fund invests in stocks and securities in the Southeast Asian region, an area that is familiar to you.
On January 1, 2011 you invest the $100,000 in the Singapore mutual fund. It pays dividends at an annual rate of 4%. Thus, you receive dividends in 2011 of $4,000 and dividends in 2012 of $4,000. On December 31, 2012 you sell the shares in the Singapore mutual fund for $110,000.
You file your U.S. tax returns for 2011 and 2012 and pay tax on the $4,000 of dividends for each year. You are not really sure if the dividends qualify for the maximum 15% tax rate so you conservatively include them on your tax returns as non-qualified dividend income, paying tax at ordinary income rates.
You include the $10,000 gain on the sale of the Singapore mutual funds shares on your 2012 and pay long-term capital gains tax at a U.S. federal rate of 15%.
You know that there are some U.S. forms to file to report / disclose your interest in the Singapore mutual fund, but you want to keep your life simple and you decide you don’t want to deal with any of these additional reporting requirements --- you have paid your U.S. tax --- what else could the I.R.S. want?
Is your tax situation really as simple as you hoped? Absolutely not!
You unwittingly invested in a “passive foreign investment company.” Okay, the name sounds a bit ominous, but is it really that bad? Passive foreign investment companies (“PFICs”) were created by Congress in 1986. The Internal Revenue Code sections dealing with PFICs are 20 or so pages long and if you look in the regulations you will only see about 40 pages of regulations.
However, you need to look further. In 1991, twenty-one years ago, the I.R.S. published proposed regulations on PFICs which have never been finalized. The proposed regulations are not binding on taxpayers. They are considered a body of informed judgment but accorded no more weight than the I.R.S.’s litigation position. The proposed regulations are where the bulk of the rules related to PFICs are located.
Forty pages of proposed regulations doesn’t sound that bad. The proposed regulations begin with the following:
A U.S. person that is a shareholder (within the meaning of paragraph (b)(7) of this section) of a section 1291 fund (as defined in paragraph (b)(2)(v) of this section) is subject to the special rules under section 1291 and these regulations with respect to gain recognized on direct and indirect dispositions of stock of the section 1291 fund and upon certain direct and indirect distributions by the section 1291 fund.
Maybe a little dense. What is a section 1291 fund? Are there various types of PFICs? Why, yes. Some of the types include “QEFs,” “pedigreed QEFs,” and “unpedigreed QEFs” (I am not joking --- see Prop. Treas. Reg. §1.1291-1(b)(2)).
Some of the other arcane terminology includes “nonqualified funds,” “prePFIC years and days,” “prior PFIC years and days,” “excess distributions,” “nonexcess distributions,” “deferred tax amounts,” and much more. Just paging through the proposed regulations I see sexy tax things like “section 304 transactions,” “nonrecognition transfers,” and all sorts of good stuff for a tax advisor.
You correctly reported the dividend income as ordinary income on your U.S. tax return. The one mistake in computing your U.S. tax liability for 2012 is that the gain on the sale of the shares of the Singapore mutual fund did not qualify for long-term capital gains treatment. Instead, put simply, the gain must be spread over the years in which you held the shares (god forbid that you owned the shares for 15 years), you must calculate a hypothetical tax at the U.S. highest ordinary income tax rate for the applicable year, and then compute an interest charge (using variable interest rates), and complete a separate I.R.S. form regardless of whether these special rules apply to you.
So you started with $100,000, received earnings and gains from the Singapore mutual fund of $18,000, paid U.S. tax of say $6,000 (approximately 35% of $18,000), for next cash remaining of $112,000.
Enough with the complexity. You live outside the U.S., You paid your U.S. tax. What can the I.R.S. do?
This post does not discuss the potential criminal penalties for not telling the I.R.S. about your Singapore mutual fund.
On the civil side, the I.R.S. can impose monetary penalties. First and foremost, for choosing not to file the FBAR (i.e., Form TD F 90-22.1), the IRS can impose a penalty of half of the account balance per year. Thus, the penalty for 2011 would be $50,000 and the penalty for 2012 would be $50,000. [The penalty may be less if you did not intentionally fail to file.]
Also, starting in 2011, there is a new I.R.S. form, Form 8938, that imposes a penalty of $10,000 (and can be greater) for failing to tell the I.R.S. about the foreign financial asset.
Thus, the penalties for the two years add up to $120,000.
In summary, the $112,000 of cash remaining from the Singapore mutual fund goes to the I.R.S. and you still owe the I.R.S. $8,000. You have been a loyal U.S. citizen all of your life and you want to remain a U.S. citizen and pay your U.S. taxes. But when you begin to understand the complexity of the rules (the PFIC rules mentioned above are merely one of many complex tax situations for U.S. citizens living abroad) backstopped with the potentially bankrupting penalties, you start to wonder whether your life might be better off not being a U.S. citizen.
Maybe, just maybe, if the I.R.S. agent that you are dealing with is having a good day, you won’t owe all the penalties. Of course, it is not the I.R.S.’ fault. They didn’t make these rules --- Congress did. Congress should really make it less onerous for U.S. citizens living outside the U.S.
Mitt Romney’s 2010 tax return had a number of international related items. First, he has an interest in, or signature authority over, one or more financial accounts in Switzerland. See Question 7 on Schedule B. Presumably, he also filed an FBAR for the Swiss account(s).
Second, he had passive gross foreign source income of $1,525,982, with current year foreign income taxes paid on this income of $67,173. He also had $81,461 of a carryforward of passive foreign taxes from prior years, and he will carry forward $18,397 of passive foreign tax credits to 2011. He had an alternative minimum tax credit in the passive basket of of $77,565. See Forms 1116.
Although he had no general category foreign source income for 2010, he paid $690 of foreign taxes in the general category for 2010, and he carried forward $100,010 of foreign tax credits in the general category to 2010. His carry forward of general category foreign tax credits to 2011 will be $100,700.
Third, he filed Forms 8621 for seventeen passive foreign investment companies ("PFICs"). Four of these forms he made mark-to-market elections. Ten of the forms made qualified electing fund (“QEF”) elections. For one of the forms he appears to have made a QEF election in a prior year. Lastly, two of the forms related to Code §1291 funds.
Fourth, he filed a Form 8865 to reflect that he had contributed $172,109 to a Cayman Islands limited partnership.
Fifth, he filed Form 5471 to disclose his wholly owned Bermuda investment holding company. The company had a nominal deficit in current earnings during 2010 and reflected previously taxed income from prior Subpart F Income inclusions of $13,366.
Sixth, he filed two Forms 926 to disclose cash contributions to two Irish corporations. One of the transfers was for $1,523,419 and the other was for $139,625. Both contributions were non-taxable Code §351 exchanges.
U.S. citizens that live and work outside the U.S. often participate in foreign retirement plans. Similarly, non-U.S. citizens that move to the U.S. and become U.S. tax residents, after working outside the U.S., have often participated in foreign retirement plans.
A question that sometimes arises is whether the income accruing annually in the foreign retirement plans must be included on the individual's U.S. tax return. The rule for this situation was concisely stated in Rev. Proc 2002-23:
Under the domestic law of the United States, an individual who is a citizen or resident of the United States and a beneficiary of a [foreign] retirement plan will be subject to current United States income taxation on income accrued in the [foreign retirement] plan even though the income is not currently distributed to the beneficiary, unless the plan is an employees’ trust within the meaning of section 402(b) of the Internal Revenue Code and the individual is not a highly compensated employee subject to the rule of section 402(b)(4)(A).
Thus, as long as the foreign retirement plan is an employees’ trust and the individual is not a highly compensated employee, then no inclusion is required. On the other hand, if the foreign retirement plan is not an employees’ trust or if the individual is a highly compensated employee, then the annual increase in value of the foreign retirement plan is required to be included on the U.S. individual’s U.S. tax return.
There are often special rules in U.S. tax treaties that modify the taxation of pensions or retirement plans. Consequently, the applicable treaty should always be reviewed to determine whether U.S. domestic law is overridden by treaty.
Forms 3520 and 3520-A are generally not required to be filed by a U.S. individual who is the beneficiary of a foreign retirement that is an employees’ trust. However, U.S. individuals who are beneficiaries of other types of foreign retirement plans that are characterized as trusts for U.S. tax purposes may need to file Forms 3520 and 3520-A.
In addition, it is important to note that an FBAR and a Form 8938 may be required with respect to an interest in a foreign retirement plan.
The Treasury Department issued a new FBAR in January 2012. This is the third revision of the form in less than one year.
The instructions to the FBAR (TD F 90-22.1, Report of Foreign Bank and Financial Accounts) were substantially revised in March 2011. In November 2011, according to Willem Perez, there were two changes to the instructions (relating to the estimated time to complete the form and relating to amended forms).
The latest version of the form appears to only change who to contact if you have questions (page 7). The old form (from two months ago) indicated that questions should be directed to the Detroit Computing Center Hotline at an 800 number. Now the form specifies to call 866-270-0733 number for domestic callers and 313-234-6146 for international callers.
The new instructions also include an email address for questions: FBARquestions@irs.gov. With taxpayers so concerned about FBAR penalties, providing an email address for questions is a step in the right direction.
New Brunswick’s Premier (a premier is a province's head of government, much like a governor of a state in the U.S.), David Alward, recently announced that he is filing U.S. tax returns back to 2003. Alward is a dual U.S./Canadian citizen. He was born in Massachusetts, but has not resided in the U.S. since he was quite young.
An article by the Telegraph-Journal mistakenly attributes Alward’s current need to file U.S. tax returns with the Foreign Account Tax Compliance Act (FATCA), enacted in 2010 as part of the Hiring Incentives to Restore Employment. The Premier, as a U.S. citizen, is obligated to file U.S. tax returns just as any other U.S. citizen.
Sometimes taxpayers living outside the U.S. are under the impression that they only need to file U.S. tax returns if they reside in the U.S. or if they have U.S. source income. Although this would be correct for most other countries (most other countries tax based on residency), the U.S. is an exception. All U.S. citizens, regardless of where they live and regardless of whether they may also be citizens of other countries, are subject to U.S. tax on their worldwide income.
Double taxation can typically be avoided through foreign tax credits and/or income tax treaties. However, in some instances, double taxation can result.
Foreign Financial Assets
Under recently enacted Code §6038D(a), any individual who during the taxable year holds an interest in any specified foreign financial asset is required to attach to his or her income tax return for the taxable year certain required information with respect to each specified foreign financial asset if the aggregate value of all of the individual’s specified foreign financial assets exceeds $50,000. Code §6038D applies to taxable years beginning after March 18, 2010. The I.R.S. intends to, but has not yet, released Form 8938, Statement of Specified Foreign Financial Assets. Notice 2011-55 suspends the requirement to attach Form 8938 to income tax returns that are filed before the release of Form 8938.
Under recently enacted Code §1298(f), U.S. persons who are shareholders of a passive foreign investment company (P.F.I.C.) are required to file an annual report with the I.R.S. Prior to the enactment of Code §1298(f), P.F.I.C. shareholders were required to file Form 8621 in certain circumstances (but not annually). Code §1298(f) was effective on March 18, 2010. However, Notice 2010-34 provided that shareholders of a P.F.I.C. that were not otherwise required to file Form 8621 annually prior to the enactment of Code §1298(f) would not be required to file an annual report as a result of the addition of Code §1298(f) for taxable years beginning before March 18, 2010. Pending the release of a revised Form 8621, Notice 2011-55 further suspends the Code §1298(f) reporting requirement for taxable years beginning on or after March 18, 2010, for P.F.I.C. shareholders that are not otherwise required to file Form 8621 as provided in the current instructions to Form 8621. P.F.I.C. shareholders with Form 8621 reporting obligations as provided in the current instructions to Form 8621 must continue to file the current Form 8621 with an income tax or information return filed prior to the release of a revised Form 8621.
This notice does not relieve a person of the responsibility to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, (“FBAR”) if the FBAR is otherwise required to be filed.
In Notice 2011-54, the I.R.S. has provided an additional extension for persons having signature authority over, but no financial interest in, a foreign financial account in 2009 or earlier calendar years for which the reporting deadline was extended by Notice 2009-62 or Notice 2010-23. These persons now have until November 1, 2011, to file FBARs with respect to those accounts. The deadline for reporting signature authority over, or a financial interest in, foreign financial accounts for the 2010 calendar year remains June 30, 2011.
If a U.S. citizen lives in a foreign country and purchases a prepaid electronic toll card (a “PETC Card” --- similar to an EZ Pass), does the U.S. citizen need to report this card on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBAR”)?
[The short answer is that you probably do not need to include the account on your FBAR, but you might want to spend the extra two minutes to include it in any case, just to be extra cautious.]
At first glance, one might say:
“Isn’t the FBAR only for accounts in excess of $10,000? If the PETC Card account balance never even comes close to $10,000, why do I care?”
The FBAR instructions provide that the form must be filed for foreign financial accounts “if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year.” If one or more accounts push the aggregate value in excess of $10,000, then all foreign financial accounts must be reported.
The PETC Card is an account, and the account is with a foreign person. It is therefore a “foreign account.” The question is whether it is a “financial” account. The FBAR instructions define a financial account as follows:
Financial Account. This term includes any bank, securities, securities derivatives or other financial instruments accounts. Such accounts generally also encompass any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund (including mutual funds). The term also means any savings, demand, checking, deposit, time deposit, or any other account (including debit card and prepaid credit card accounts) maintained with a financial institution or other person engaged in the business of a financial institution. Individual bonds, notes, or stock certificates held by the filer are not a financial account nor is an unsecured loan to a foreign trade or business that is not a financial institution.
The first two sentences in the definition define a financial account by example:
The third sentence provides that a financial account includes “any . . . account maintained with”:
In parenthesis, the third sentence specifically refers to prepaid cards. The PETC Card is a prepaid card.
An analysis must be performed of the government agency (or the outsourced company) that administers the PETC Card to determine whether it is either a financial institution or a person engaged in the business of a financial institution. If yes, the PETC Card must be reported on the FBAR. The FBAR instructions do not include a definition of a financial institution or what is required for a person to be engaged in the business of a financial institution.
The Treasury Department recently issued proposed regulations regarding the FBAR. These proposed instructions slightly modify the definition of an “other financial account.” Under these proposed regulations (which are not yet binding), the term ‘‘other financial account’’ means:
One might wonder whether the agency or company that administers the PETC Card is “accepting deposits” each time a credit card is charged to replenish the account. Also, what is a “financial agency”? Is it the same as a “financial institution”?
This blog posting is long enough. As indicated at the beginning of this post, if you are a U.S. citizen with a foreign PETC Card, the short answer is that you probably do not need to include the PETC Card account on your FBAR. It seems likely that the agency or company that administers the PETC Card would likely not be considered a financial institution or financial agency. However, rather than performing an investigation into the activities of the government agency or the outsourced company, it is likely much more expedient to spend the extra two minutes to include the account on the FBAR.
Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (hereinafter referred to as the “FBAR”), generally must be filed by June 30th of each year to report financial interests in, or signature authority over, foreign financial accounts held during the prior calendar year.
In October 2008, the I.R.S. revised the FBAR and its accompanying instructions. The instructions were modified in several controversial ways. This blog posting only discusses the changes with respect to U.S. citizens or U.S. residents that own interests in foreign commingled funds, including foreign mutual funds.
Both the old and the new instructions to the FBAR provide that a financial account includes “any bank, securities, securities derivatives, or other financial instruments account.” The revised FBAR instructions, however, add an embellishment to the definition of financial account. The revised instructions provide that financial accounts:
generally also encompass any accounts in which the assets are held in a commingled fund and the account owner holds an equity interest in the fund (including mutual funds).
On its face, the instructions would now appear to require every U.S. citizen and U.S. resident with an interest in a foreign mutual fund, or commingled fund, to file the FBAR. Given the potential civil penalty of $10,000 per year for nonwillful failure to file the FBAR, this is an important change to the instructions.
Unfortunately, the instructions do not provide a definition of an “account.” Further, there does not appear to be any other authority to provide additional guidance as to what is meant by an account.
If a U.S. person directly acquires stock in a foreign corporation, it is difficult to see how the shares of stock themselves constitute an “account.” Clearly, if the shares are in a foreign brokerage account, then the foreign brokerage account could trigger the FBAR filing requirement. However, not all shares in foreign corporations are acquired through foreign brokerage accounts. The following discussion assumes that a U.S. person’s direct ownership of shares of a typical foreign corporation that has active business operations does not rise to the level of an “account” for purposes of the FBAR.
Many, if not most, foreign mutual funds would be treated as corporations for U.S. tax purposes. In fact, the passive foreign investment company (“P.F.I.C.”) rules are specifically targeted at foreign mutual funds. In order to be a passive foreign investment company, the foreign entity must be a corporation under U.S. tax principles. If the FBAR instructions apply to foreign corporations that are treated as mutual funds, each time a U.S. person acquires shares of stock in a foreign corporation (a mutual fund or otherwise), a determination would need to be made as to whether the foreign corporation was a “commingled fund,” such as a mutual fund.
The instructions to the FBAR do not provide a definition of a commingled fund or of a mutual fund, and it is unclear what these terms are intended to mean. For instance, if a foreign holding company has one wholly owned subsidiary and no other assets, presumably the holding company would not be a commingled fund. On the other hand, if the foreign holding company owns a small percentage of many different companies (just like a mutual fund), the holding company may be a commingled fund. It is unclear where on this spectrum a non-commingled fund becomes a commingled fund (and therefore causes the shares to become an “account”).
After receiving comments from U.S. tax practitioners, the Treasury Department last month (August 2009) issued Notice 2009-62. This notice provides an extension to file an FBAR until June 30, 2010 for the 2008 year and earlier years with respect to foreign commingled funds. In the interim, the Treasury Department is expected to provide additional guidance.
Interestingly, if the forthcoming definition of a commingled fund is not simple and clear, it may be easier (read less expensive) to file protective FBARs for all foreign shareholdings. If U.S. tax return preparers must investigate the activities of each foreign corporation in which their client owns shares (to determine the entity’s status as a commingled fund or not), it may be easier, cheaper, and safer (penalty wise) to complete the FBAR for all foreign shareholdings.
Andrew Mitchel is a U.S. international tax attorney who advises businesses and individuals with cross-border activities.
On June 24, 2009 the I.R.S. published an update to its frequently asked questions (FAQs) regarding the filing of FBARs (Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts) and other cross-border tax forms under the offshore account and entity voluntary disclosure program announced on March 23, 2009.
There are now 51 FAQs.
FAQ # 46 asks:
A taxpayer moved to the U.S. in 2007 and is now a permanent resident of the U.S. The taxpayer had a requirement to file an FBAR for one year but failed to do so. Is the taxpayer subject to a penalty equal to 20 percent of the account?
The answer to this FAQ is quite interesting ---
First, the taxpayer should confirm that the taxpayer had an FBAR filing requirement. Assuming that the taxpayer was required to report the interest earned on the account during the year the taxpayer was in the U.S. and failed to do so, the taxpayer is subject to a penalty based on the high account balance during the year. The penalty may be limited to five percent if the taxpayer did not avoid U.S. tax with respect to the deposits and if the account was passively held during the year the taxpayer was in the U.S. If there was no unreported taxable income related to the unreported foreign accounts that would have been reported on the FBAR, the taxpayer will not be subject to the 20 percent offshore penalty. In that case, the taxpayer should file delinquent FBARs attaching a statement explaining why the FBAR was not timely filed. For more information, see FAQ 9.
As mentioned in FAQ #50,
Taxpayers and practitioners trying to decide whether to simply file an amended return . . . or to make a formal voluntary disclosure . . . should consider the nature of the error they are trying to correct.
As mentioned in FAQ #15, the civil penalty for non-willfully failing to file the FBAR cannot exceed $10,000. If the failure to file is non-willful and the bank account balance is greater than $50,000, the voluntary disclosure program would not seem to make sense. Further, the I.R.S. has been lenient in assessing the $10,000 penalty for non-willful failures, especially under circumstances such as those described in FAQ #46. If the taxpayer described in FAQ #46 did not willfully fail to file the FBAR, the taxpayer should consider whether filing the FBAR as part of the voluntary disclosure program is the best course of action.
Andrew Mitchel is an international tax attorney who advises businesses and individuals with cross-border activities.
Subscribe to International Tax Blog using web-based news readers or Email using Feedburner or Feedblitzsubscribe to our feed