Code section 6038D, effective for tax years beginning after March 18, 2010, requires new filing requirements for “specified persons” having an interest in “specified foreign financial accounts.” (SFFAs). On December 19, 2011, Temporary Regulations were published in the Federal Register outlining these new filing requirements. Treasury Decision (T.D.) 9567,
76 F.R. 78594-01. The Internal Revenue Service (IRS) also issued Form 8938 (PDF), the form designed under section 6038D, along with instructions. Filing Form 8938, if applicable, is required for tax years ending after December 19, 2011. Consequently, clients meeting the filing requirements must file Form 8938 with their 2011 tax returns. The instructions provide a detailed summary of the Temporary Regulations. This article provides citations to the temporary regulations and its preamble to help you find information that may not be provided in the instructions.

Note: Filing Form 8938 does not eliminate Report of Foreign Bank and Financial Accounts (FBAR) filing. SFFAs reported on Form 8938 must be reported on an FBAR if required on the FBAR (Preamble, section 6D)). However, duplicative reporting of an SFFA is not required:

1. If a taxpayer completes information required in Part IV, Form 8938 and
2. Reports an SFFA on timely filed Forms 3520 (PDF), 3520-A (PDF), 8621 (PDF), 5471 (PDF), 8865 (PDF) or 8891 (PDF). Temp. Reg. §1.6038D-7T. This exclusion does not eliminate filing Form 8938; it simply eliminates listing SFFAs on Form 8938. These excluded SFFAs are still counted for purposes of calculating threshold reporting amounts. Temp.
   Reg. §1.6038-2T(a)(6).

Specified Persons

Which clients may have to file Form 8938 with their 2011 returns? The 2011 filing requirement does not apply to domestic entities. Proposed Regulations also published December 19, 2011, contain rules on which domestic partnerships, corporations and trusts will be required to file Form 8938. (Proposed Reg. §1.6038D-6, REG-130302-10, 76 F.R. 78594-01.) Until Proposed Regulation § 1.6038D-6 is issued as a final regulation, no domestic entity is required to file Form 8938. (Preamble, section 5.)

Generally, individual clients who are U.S. citizens and resident aliens, are subject to the filing requirement provided they hold interests in SFFAs meeting the threshold amounts. The list of “specified individuals,” who may have to file Form 8938, is set forth at Temp. Reg. §1.6038D-1T(a)(2). However, specified individuals are not required to file Form 8938 if they are not required to file a return with respect to such taxable year. Temp. Reg. § 1.6038-2T(a)(7).

Specified Foreign Financial Assets

SSFAs are composed of two classes distinguished by whether a foreign financial institution (as defined in code section 1471(d)(4)) is involved:

1. Financial accounts (defined in code section 1471(d)(2)) maintained by a foreign financial institution are reported on Part I, Form 8938 and,
2. Other foreign financial assets (defined in Temp. Reg. §1.6038D-3T(b)) held for investment and not held in a foreign financial institution account are reported on Part II, Form 8938.

Financial assets held in a financial account maintained at a foreign financial institution are not required to be separately listed. Temp. Reg. § 1.6038D-3T(a)(1).

Financial accounts maintained by U.S. payors, defined in Treasury Regulation § 1.6049-5(c)(5)(i), are excluded from the definition of SFFAs. Temp. Reg. §1.6038D-3T(a)(3)(i). Such payors include U.S. branches of foreign financial institutions and foreign branches of U.S. financial institutions. Also excluded are financial accounts for which the specified person uses mark-to-market accounting under section 475 for all of the holdings in the account. Temp. Reg.
§1.6038D-3T(a)(3)(ii).

“Other foreign financial assets” listed in Temp. Reg. §1.6038D-3T(b)(1) come within one or more of the following three categories:

1. Stock or securities issued by a non-US person,
2. A financial instrument or contract that has an issuer or counterparty, which is a non-US person and
3. An interest in a foreign entity with special rules for foreign trusts and estates. A U.S. person is defined in section 7701(a)(30).

To be an SFFA, the asset must fit under one of these categories and it must also be held for investment. If an asset is used in a trade or business, it is not an SFFA. Temporary Regulation §§ 1.6038D-3T(b)(4) and (5) set forth rules on determining whether an asset is used in a trade or business. They state that stock can never be considered as used in a trade or business. In Preamble section 2B, the IRS asks for comments on the trade or business provisions and the treatment of stock.

Financial assets are excluded if the specified individual uses mark-to-market accounting under section 475 for the asset. Temp. Treas. Reg. §1.6038B-3T(b)(2). Beneficial interest in a foreign trust or estate is not an SFFA unless the specified person knows or has reason to know based on readily accessible information of the interest. Receipt of a distribution from the foreign trust or estate constitutes actual knowledge. Temp. Reg. §1.6038D-3T(c).

Threshold Levels for Reporting

Your clients are not required to file Form 8938 unless they meet threshold levels set forth in Temp. Reg. §1.6038D-2T(a). Different types of taxpayers have different levels. For example, married taxpayers filing jointly living in the U.S. must file if the aggregate value of all SFFAs in which either individual holds an interest that exceeds $100,000 on the last day of the taxable year or more than $150,000 at any time during the taxable year. Individuals are considered to hold an interest in the SFFAs owned by their disregarded entity. They are considered to hold an interest in the SFFAs held by their grantor trust, except for domestic investment or bankruptcy trusts. They do not hold an interest in SSFAs owned by a partnership, corporation, trust (except for grantor trust rule set forth in prior sentence) or an estate solely because they are a partner, shareholder or beneficiary. Temp. Reg. § 1.6038D-2T(b)(3).

Detailed rules on how to value an SFFA are set forth in Proposed Treasury Regulation § 1.6038D-5T. If the SFFA is valued in a foreign currency, then the currency must be converted to U.S. dollars using the currency exchange rate on the last day of the taxable year even if the asset has been disposed of prior to the last day of the taxable year. Temp. Reg. 
§1.6038D-5T(c).

Consequences of Not Filing Form 8938

Failure to file can result in a penalty of $10,000, which can be increased up to $50,000 for failure to file after IRS notification. No penalty will be imposed if the specified person can show the failure is due to reasonable cause and not due to willful neglect. (Temp. Reg. §1.6038D-8T.) There is a 40-percent penalty on an understatement of tax attributable to any undisclosed foreign financial asset, which includes assets with respect to which information is required under section 6038D. I.R.C. § 6662(j).

Failure to file extends the statute of limitations for the tax year until the taxpayer provides the required information. If the failure is due to reasonable cause and not willful neglect, then the statute is extended only with regard to the items relating to the failure rather than the entire tax year (I.R.C. § 6501(c)(8)). Furthermore, the statute is extended to six years after the return is filed if the taxpayer omits $5,000 from gross income attributable to an SFFA without regard to the reporting threshold or any reporting exceptions under section 6038D(h)(1)
(I.R.C. § 6501(e)(1)).

Janice Eiseman, JD, LLM, is a principal at Cummings & Lockwood in Stamford, Conn. office where she focuses on the taxation of closely held businesses and tax planning for owners and investors. Eiseman has broad-based experience counseling clients on the formation, ownership and structuring of various business entities, as well as drafting and negotiating tax-based and transactional documentation for both individual and business clients. She has also done controversy work before the Internal Revenue Service and the New York State Department of Taxation and Finance. Prior to joining Cummings & Lockwood, she served as senior tax and benefits counsel at the New York City-based law firm Morrison & Cohen LLP.