New foreign asset reporting rules enacted in 2010 may add some challenges to the 2011 filing season. Taxpayers will be required to provide more information with respect to assets maintained offshore and failure to do so can lead to substantial penalties. This article highlights the new rules and discusses what those rules mean for HR directors and taxpayers on international assignment from Japan.
The Foreign Account Tax Compliance Act ("FATCA") provisions were enacted in March 2010 as part of the Hiring Incentives to Restore Employment Act ("HIRE Act"). The FATCA provisions are in response to tax policy concerns that some U.S. persons have avoided paying taxes by sheltering assets offshore in foreign bank accounts, trusts, or corporations. To reduce tax evasion and promote transparency, a number of measures were enacted that impose significant reporting and information collection obligations on individual taxpayers and third parties.
The reporting obligations directed at individual taxpayers - the focus of this article - promise to increase both the complexity of income tax returns and the time it takes to prepare them.
Starting in 2011, U.S. taxpayers are required to report ownership of specified foreign financial assets to the extent the total value of those assets exceeds certain thresholds. The instructions to the recently released Form 8938 provide that specified individuals with specified foreign financial assets in excess of $50,000 on the last day of tax year or $75,000 at any time during the tax year for unmarried and married filing separate taxpayers ($100,000 and $150,000, respectively for married filing joint taxpayers) are required to file the Form 8938. Other thresholds apply for taxpayers living in foreign countries. The form instructions provide insight on the filing complexities of the new reporting requirements. Although the majority of the required information may be duplicative, when compared to Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts ("FBAR"), the new Form 8938 does not replace the FBAR, and requires the reporting of several additional items of information. It is also important to keep in mind that the new form is required to be included with the individual's tax return by the due date of the tax return (including extensions), while the FBAR is filed separately from the tax return by June 30 of the year following the reporting year.
In general, U.S. citizens, U.S. resident aliens for any part of the year, nonresident aliens who make an election to be treated as residents for joint filing purposes, and individuals who qualify as U.S. resident aliens but elect to be treated as nonresidents pursuant to the residency tie-breaker provisions of a treaty will be required to file as long as they meet the filing thresholds mentioned above.
The definition of a "specified foreign financial asset" is quite broad, and is one of the reasons for the increased complexity of the tax return. The term "specified foreign financial asset" includes any depository, custodial, or other financial account maintained by a foreign financial institution as well as, (a) any stock or security issued by foreign persons, (b) any financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and (c) any interest in a foreign entity.
Investment vehicles such as foreign mutual funds, foreign hedge funds, and foreign private equity funds are obvious examples of what is reportable on Form 8938. However, reporting is also required with respect to foreign trusts, passive foreign investment companies ("PFICs"), deferred compensation plans, and foreign pension plans.
A foreign pension plan which is "funded" and in which the assignee is "vested", is identified as a "specified foreign financial asset". This is just one example of the additional holdings that are not reported in the FBAR but are required to be reported on the new Form 8938. According to the requirement, the assignee is required to determine the fair market value of his interest in the pension plan as of last day of the tax year and report it on Form 8938. However, if the assignee does not know or have reason to know, based on readily accessible information, the fair market value at the end of the tax year (e.g., an interest in a defined benefit plan such as "corporate pension plan" in Japan) and does not receive any distribution, he/she may use a value of zero as the maximum value of the asset.
"Due to the inclusion of foreign pension plans in the definition of foreign financial assets and the relatively low filing threshold for individuals living in the U.S., many Japanese assignees participating in defined contribution pension plans (e.g., "Japan 401k" plan) will be required to file Form 8938. Therefore, it will be necessary to gather information regarding the year-end fair market value of an assignee’s interest in a foreign defined contribution pension plan in advance."
Non-compliance with the new reporting requirements can result in substantial penalties. Failure to properly report foreign financial assets can result in a penalty of $10,000 with additional penalties of up to $50,000 for continued failure to disclose after receiving a request from the IRS. Additional penalties can be assessed if there is unpaid tax on unreported income related to foreign financial assets. A six-year statute of limitations could apply to assess unpaid tax and applicable penalties if more than $5,000 of income is omitted from the taxpayer’s return and such income is attributable to foreign financial assets regardless of whether the individual met the dollar thresholds for filing Form 8938.
These new information reporting rules introduce another level of complexity to the income tax return. Individually more detailed analysis will be needed to determine whether an assignee is subject to these new reporting rules and what foreign assets he/she is required to report. Because the rules are new and Japanese assignees are not familiar with the U.S. tax filing requirements, additional time will be required to coordinate the collection of necessary information, such as foreign pension plan documents or features of a deferred compensation arrangement. Also, more time may be required to explain the new provisions to Japanese assignees who may be uncomfortable sharing private information they were not previously required to disclose. The consequences of not meeting tax obligations can result in significant penalties for failure to file and/or disclose. Therefore, it is very important that international assignment program managers send regular communications to assignees to educate them with respect to these new rules before the year end.
If you have any questions or need more information on Form 8938, please consult with KPMG.
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The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG LLP. All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.