Another Offshore Assets Reporting Requirement

Jenny C. Lin

In recent years, as governments all over the world face their own budget crises, their attention has increasingly shifted to ensuring that taxpayers properly report and pay taxes related to their offshore assets to fill the revenue gap. As the carrot to encourage taxpayers to come forward and disclose any past noncompliance, many governments, such as United Kingdom, Italy, and Spain, initiated tax amnesty programs promising no criminal prosecution and/or reduced penalties. The United States itself launched three tax amnesty programs in 2009, 2011 and now 2012 for U.S. taxpayers who have not properly reported or paid taxes related to their offshore assets and/ or activities.

By all accounts, the tax amnesty programs seem to have been very successful in bringing in much needed revenue for their respective governments. The Internal Revenue Service (“IRS”), for example, announced that the first two tax amnesty programs in 2009 and 2011 generated more than $4.4 billion in collections as of January 9, 2012. IR- 2012-5.

Lawmakers and tax enforcement agencies see the success of the tax amnesty programs as confirmation that many taxpayers are using offshore jurisdictions to avoid compliance with its tax laws. Whether such perception is justified or not, lawmakers seem to agree among themselves that more transparency is needed to combat offshore abuses. As a result, Congress enacted the Foreign Account Tax Compliance Act (“FATCA”) in 2010.

In part, FATCA increases transparency by imposing an additional disclosure requirement on individuals and certain domestic entities.

Under FATCA, an individual who is a: (i) U.S. citizen; (ii) resident alien for any part of the taxable year; (iii) nonresident alien married to a U.S. citizen or resident with an election in effect to be treated as a U.S. resident for income tax and wage withholding purposes; and (iv) nonresident aliens of certain U.S. possessions are required to file Form 8938 with their annual tax return for the taxable year if the aggregate value of the individual’s interest in specified foreign financial assets reach the required threshold. Treas. Reg. §1.6038D-2T(a)(1). Those who are not required to file an annual return for the taxable year are excepted from filing a Form 8938 with the IRS. Treas. Reg. §1.6038D-2T(a)(7).

In general, Form 8938 is required to be filed if the thresholds to the right are met. Treas. Reg. §1.6038D-2T(a)(1)-(4).

There are various specified foreign financial assets subject to reporting under FATCA. These include:

• ŠŠany financial account maintained by a foreign financial institution; and ŠŠ
• the following which are held for investment and not held in an account maintained by a foreign financial institution –
• stock or securities issued by a non-U.S. person; ŠŠ
• a financial instrument or contract that has an issuer or counterparty which is a non-U.S. person; and ŠŠ
• an interest in a foreign entity, such as foreign corporations, foreign partnerships, foreign trusts and foreign estates.

IRC §6038D(b); Treas. Reg. §1.6038D-3T(a), -3T(b).

Many of the foreign assets subject to reporting under FATCA are actually already subject to reporting under existing laws, albeit some have slightly different criteria for triggering a reporting requirement. Some of the existing reporting requirements which overlap with FATCA include:

• ŠŠForm 3520 used for reporting transactions with foreign trusts and receipt of large gifts or bequests from foreign persons or foreign estates;
• ŠŠForm 5471 for reporting with respect to certain foreign corporations;
• ŠŠForm 8865 for reporting with respect to certain foreign partnerships; and
• ŠŠT.D. Form 90-22.1 (also known as the “Report of Foreign Bank and Financial Accounts” or “FBAR”) for reporting with respect to foreign financial accounts.

The regulations acknowledge the redundancy of FATCA’s reporting requirement by providing that assets reported on certain forms need not be included on Form 8938 again if the filing of the form on which the asset is reported is indicated on Form 8938. Treas. Reg. §1.6038D- 7T(a)(1). However, the regulations do not specifically exempt financial accounts reported on the FBAR from reporting under FATCA. As such, U.S. taxpayers must file both Form 8938 and FBAR if the threshold requirements for each are met.

There are also other lingering ambiguities that are either not addressed in the regulations or created in the instructions of Form 8938. For example, the instructions for Form 8938 provide that a person filing Form 3520 need not include the asset reported on Form 3520 on Form 8938 again. Form 3520 is used to report the receipt of large gifts or bequests from foreign persons or foreign estates and transactions with foreign trusts. However, the regulations only exempt such asset from reporting on Form 8938 if Form 3520 was filed as a result of being a beneficiary of the foreign trust. Treas. Reg. §1.6038-7T(a)(1)(A). Thus, the regulation does not appear to exempt all assets reported on Form 3520 from reporting on Form 8938.

An individual who relies on the instructions of Form 8938 may be taking the risk that a penalty may be imposed for failing to properly include an asset on Form 8938 despite following the instructions on Form 8938. Cases litigated before the courts have held that instructions on a form are not dispositive, especially if such instructions are contradictory to other authorities given greater weight. See e.g., Wilkes v. U.S., 50 F.Supp. 2d, 1281, 1287 (M.D. Fla. 1999), aff’d 210 F.3d 394 (11th Cir. 2000).

Civil penalties for failing to file Form 8938 in the time and manner required can be substantial. In general, the penalty for failing to file Form 8938 is $10,000. IRC §6038D(d) (1); Treas. Reg. §1.6038D-8T(a). If the failure to comply continues for more than 90 days after the IRS mails a notice of the failure to comply to the individual required to file Form 8938, an additional penalty of $10,000 is imposed for each 30-day period (or a fraction thereof) that the failure continues, up to a maximum of $50,000 for each failure. IRC §6038D(d)(2); Treas. Reg. §1.6038D- 8T(c). Therefore, the maximum penalty for each failure is potentially $60,000.

Although the reporting under FATCA may be duplicative of existing reporting requirements and overbroad, taxpayers should not take the matter lightly if they have offshore assets and/or activities. This is especially imperative given that the IRS has greatly increased enforcement with respect to a U.S. taxpayer’s reporting of worldwide income and offshore assets and activities.

There are other related consequences that may result from the failure to file Form 8938 in the time and manner required. First, underpayments attributable to any transactions involving an undisclosed foreign financial asset, including assets required to be disclosed pursuant to FATCA, is subject to an increased 40% penalty rather than the 20% penalty that generally applies. IRC §6662(j); Treas. Reg. §1.6038D-8T(f)(1). Second, the statute of limitations for assessment and collection may be extended to three years after the information required to be reported pursuant to FATCA is furnished to the IRS. §6501(c)(8).

The civil penalties are in addition to any criminal penalties that may apply for failing to file Form 8938 or failing to supply the information accurately and completely. Although the reporting under FATCA may be duplicative of existing reporting requirements and overbroad, taxpayers should not take the matter lightly if they have offshore assets and/or activities. This is especially imperative given that the IRS has greatly increased enforcement with respect to a U.S. taxpayer’s reporting of worldwide income and offshore assets and activities. This effort includes the issuance of a John Doe Summons to Swiss banking giant UBS AG in 2008 seeking the turnover of banking information relating to U.S. taxpayers and adding hundreds of agents to work on these international issues. The IRS, working with the U.S. Department of Justice, is also diligently pursuing the prosecution of recalcitrant taxpayers who did not enter the voluntary compliance programs and foreign banks and foreign bankers who assist and/or counsel U.S. taxpayers to violate U.S. tax law.

Taxpayers should not think that their small foreign account and/or foreign asset will not attract IRS interest or that criminal charges will not be brought if the taxpayer quietly amends or files the necessary returns. On May 19, 2011, the U.S. Department of Justice charged Michael F. Schiavo with willfully failing to disclose his foreign bank account for the 2006 year even though he quietly (without going through the tax amnesty program) mailed in FBARs for the 2003 to 2008 years and amended his income tax returns in 2009 after the tax amnesty program began. The balance in the foreign bank account from 2003 to 2008 was between $65,000 to $150,000 at all times. In all, Mr. Schiavo was alleged to have deprived the government of $40,624 in taxes.

Nor should taxpayers take comfort in thinking that they will not be discovered. As the issuance of a John Doe Summons to UBS shows, the IRS has a number of tools at its disposal. There are also tax treaties with many countries that require foreign governments to cooperate with the U.S. government in its tax investigation. Foreign governments are also recognizing that they have a common interest in ensuring offshore compliance. For instance, Germany, France, Britain, Italy and Spain have all agreed to share data with the United States in assisting the United States to implement FATCA.

The IRS’s position is clear that offshore compliance and enforcement is a high priority. Taxpayers should likewise treat offshore compliance with the same priority and not take the matter lightly.

Jenny C. Lin practices in Walnut Creek specializing in tax law with an emphasis in the international issues. She is certified specialist in tax law by the State Bar of California Board of Legal Specialization. She may be reached at (925) 202-2922.