Specified Domestic Entities Now Required to Disclose Foreign Assets on Form 8938
Author: Chris Clifton
On February 23, 2016, the IRS issued final regulations under Internal Revenue Code Section 6038D that require certain domestic entities to report their foreign financial assets on Form 8938, Statement of Specified Foreign Financial Assets, beginning with their 2016 income tax returns.
Since 2011, certain individuals have been required to disclose their directly held foreign financial assets on Form 8938, which is filed with Form 1040. Domestic entities weren’t required to file Form 8938 prior to the final domestic entity regulations.
The new Form 8938 filing requirements apply to domestic closely held investment entities, including domestic C corporations, S corporations, limited liability companies (LLC), partnerships and nongrantor trusts. The Form 8938 filing requirements rarely should apply to domestic entities that operate an active trade or business and are more likely to apply to entities such as family limited partnerships and trusts.
A domestic partnership, LLC or corporation must file Form 8938 with Form 1065, 1120 or 1120S for taxable years that begin in 2016 or later if all of the following are true:
- The partnership, LLC or corporation directly holds specified foreign financial assets having an aggregate value exceeding $50,000 on the last day of the entity’s taxable year or $75,000 at any time during the entity’s taxable year.
- The partnership, LLC or corporation is closely held—at least 80 percent owned—by one U.S. citizen or U.S. resident alien on the last day of the entity’s taxable year.
- Constructive ownership rules of §267(c) and (e)(3) apply for determining the ownership of a domestic individual with a special caveat that family attribution includes spouses of family members.
- At least 50 percent of the partnership, LLC or corporation’s gross income for the taxable year is passive income, or at least 50 percent of the assets held by the partnership, LLC or corporation at any time during the taxable year are assets that produce or are held for producing passive income.
- Passive income primarily includes investment-type income such as dividends, interest, rents, royalties, annuities and gains from the sale of assets that produce investment income. Passive income for Form 8938 purposes doesn’t include income from §469 (Form 8582) passive activity.
- For the asset test, the passive asset percentage is determined based on a weighted average approach. Partnerships, LLCs and corporations may use either fair market or book value to determine the value of their assets.
A domestic nongrantor trust must file Form 8938 with Form 1041 for years that begin in 2016 or later if both of the following are true:
- The trust directly holds specified foreign financial assets having an aggregate value exceeding $50,000 on the last day of the entity’s taxable year or $75,000 at any time during the entity’s taxable year.
- The trust has at least one current beneficiary who is a U.S. citizen or U.S. resident alien.
- A current beneficiary is any person who at any time during the taxable year is entitled to, or at any person’s discretion may receive, a distribution from the trust’s principal or income, determined without regard to any power of appointment to the extent such power remains unexercised at the taxable year’s end.
- A current beneficiary also includes any holder of a general power of appointment, whether or not exercised, that was exercisable at any time during the taxable year, but doesn’t include any holding of a general power of appointment that’s only exercisable on the holder’s death.
However, if the trustee of the domestic nongrantor trust meets all of the following provisions, the trust is exempt from Form 8938 reporting for any foreign financial assets under supervisory authority or fiduciary obligation by such trustee, even if the trust has a U.S. current beneficiary and holds specified foreign financial assets that would otherwise meet the filing threshold:
- The trustee has supervisory authority or fiduciary obligations with regard to the specified foreign financial assets held by the trust.
- The trustee timely files—including extensions—annual income tax and information tax returns, e.g., Form 1041, on the trust’s behalf.
- The trustee is a federally regulated or examined bank or financial institution or a publicly traded corporation or its affiliate.
Failure to file Form 8938 when required will result in a $10,000 penalty unless—based on an affirmative showing of the facts and circumstances—the failure was due to reasonable cause and not willful neglect. A 40 percent underpayment penalty may apply to any tax underpayment relating to an undisclosed specified foreign financial asset. Failure to timely file Form 8938 also leaves the statute of limitations open for the entity’s entire income tax return unless the failure is due to reasonable cause and not willful neglect, in which case the statute of limitations only remains open for items not properly reported on Form 8938.
For a list of the types of foreign assets reportable (and not reportable) on Form 8938, see the IRS Comparison of Form 8938 and Report of Foreign Bank and Financial Accounts Requirements chart.
Closely held investment entities such as family limited partnerships and domestic nongrantor trusts should evaluate whether they’re required to file Form 8938 to report specified foreign financial assets. Your advisor can help determine whether a filing obligation exists and assist with compliance.
For further information and assistance, contact your BKD advisor.