In last month’s column, I talked about the Report of Foreign Bank and Financial Accounts, or “FBAR”, which requires taxpayers to disclose their interests in foreign financial accounts that exceeded $10,000 in value at any time during the previous calendar year. While the FBAR filing requirement is by far the most common foreign financial reporting burden taxpayers with assets overseas must bear, it is not the only disclosure fling of which to be aware.
[dropcap]T[/dropcap]he other disclosure-oriented filing the IRS has been putting particular emphasis on in recent years with increased enforcement measures is Form 8938, Statement of Specified Foreign Financial Assets. While more taxpayers are aware of Form 8938, as it is filed each year with your individual income tax return, many taxpayers do not fully understand the breadth of its applicability.
A few months ago, I ran into a friend of mine from St. Louis, where I attended law school. We had not seen each other in quite some time, and in catching up on the events of the past few years, he said something that particularly piqued my interest. He mentioned that he and his siblings had gone in on purchasing a house together just outside of the city of Edinburgh, in Scotland. One of his brothers lives over there, and came home last summer with the idea of the three of them going in on the property together, with the three families all taking turns using it for vacation, renting the property out during the rest of the year, and hopefully selling it as the area continues to develop and property values rise. My friend, being a big (putting it mildly) golf fan, was ecstatic about having a place to stay so close to St. Andrews and other famous Scottish courses. Given the recent explosion in short-term vacation rentals through websites such as VRBO.com and AirBnB.com, their interest in earning a little income with the property as it appreciates was not all that surprising. What was more interesting to me was that they chose to purchase the property with a limited liability partnership, in which each of them held a one-third interest. By holding the property in a partnership, rather than outright as individuals, my friend and his siblings had taken an otherwise non-reportable foreign asset and brought it under the purview of Form 8938.
The types of assets covered Statement of Specified Foreign Financial Assets overlap significantly with those covered by the FBAR. However, there are some notable differences. For example, the FBAR does not require disclosure of ownership of foreign securities if you do not hold those securities in an account with a foreign financial institution. Form 8938 does require disclosure of such assets. Similarly, Form 8938 requires the disclosure of interests in foreign hedge funds and private equity funds, while the FBAR does not. Finally, and most importantly for my friend, interests in foreign partnerships, including those holding real estate for investment purposes, must be disclosed on Form 8938, while they can be left off of an FBAR filing, in many cases.
The good news, if my friend’s situation is strikingly similar to your own and you are wondering what a Form 8938 even looks like, is that the failure to file Form 8938 is not always as risky as the failure to file an FBAR. For one thing, the disclosures on the Form 8938 are often also found on other filings you may already be making with the IRS on an annual basis. Forms 3520, 5471, 8621, and 8865 (relating to foreign partnership interests) all cover some of the same foreign financial interests and assets that are covered by Form 8938. If you are filing any one or more of these, you do not have to duplicate those disclosures when filing Form 8938.
The second big difference in the FBAR and Form 8938 filings is their respective reporting thresholds. As you may recall from my last column, if the total of your foreign assets covered by the FBAR exceeds $10,000 at any time during the year, you are required to disclose them. With Form 8938, the bar is much higher: you are only required to disclose if the total value of your reportable assets is greater than $50,000 at the end of the tax year, or eclipsed $75,000 at some point during the tax year (these numbers are even higher for individuals actually living abroad, or married individuals who are filing jointly). In my friend’s case, he came in just under the threshold for 2014, but he will need to watch the value of his interest closely as the years go by, especially if his increased presence in the United Kingdom leads to new bank accounts or other investments in the area.
[quote float=”left”]By holding the property in a partnership, rather than outright as individuals, my friend and his siblings had taken an otherwise non-reportable foreign asset and brought it under the purview of Form 8938.[/quote] Finally, the consequences of not filing your Form 8938, though still significant, do not quite measure up to those of an FBAR violation. While the failure to file a single FBAR can carry civil penalties in the six digits, the penalty for failure to file a Statement of Specified Foreign Financial Assets with your tax return is capped at $60,000, and in most cases will not come close to approaching that figure.
Of course, all penalties are bad penalties, regardless of the amount. This is why the takeaway from these two installments on foreign asset reporting requirements should be clearly stated: if you or your spouse have any assets resting outside the borders of the United States, you need to directly address your reporting responsibilities with your tax adviser or return preparer. Even if you are already reporting any income you generate from these assets, you may still have unfulfilled disclosure requirements. With foreign financial institutions being required to turn over more and more information on their US account holders, taxpayers should not wait to deal with any outstanding FBAR or Form 8938 issues. The benefits of the IRS’s many disclosure programs (such as decreased civil penalties and immunity from criminal prosecution) are only available to those who step forward voluntarily.
Ryan Coffield is a member of The Van Winkle Law Firm’s Business and Tax Groups, working primarily out of their Asheville office.