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Janice Eiseman
 

Reporting Requirements for Foreign Assets

What you should know about the new Code Section 6038D.

September 20, 2010
by Janice Eiseman, JD, LLM

The 2009 Internal Revenue Service (IRS) amnesty program for failure to file Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts,” (the FBAR), heightened our awareness of the importance of filing information returns disclosing foreign bank accounts. We all reviewed the various IRS pronouncements and notices on FBAR filing requirements. Now we have to learn a whole new filing regime the purpose of which is similar to the purpose of the FBAR.

Section 6038D

The new section, Section 6038D, was added to the Code by the Hiring Incentives to Restore Employment (HIRE) Act (P.L. 111-147), effective for tax years beginning after March 18, 2010. Under new Code Section 6038D, an individual must attach to his or her tax return certain information about “foreign financial assets” if the aggregate value of all the assets exceeds $50,000 (or such higher dollar amount as the Secretary may prescribe). “Foreign financial assets” include any depository, custodial or other financial account maintained by a foreign financial institution and to the extent not held in an account maintained by a financial institution:

  1. Any stock or security issued by a person other than a U.S. person,
  2. Any financial instrument or contract held for investment that has an issuer or counterparty other than a U.S. person and
  3. Any interest in a foreign entity. It is clear that there is overlap between the filing requirements for the FBAR and the information requirements under new Code Section 6038D.

The Joint Committee on Taxation in its report (Report No. JCX-4-10) recognized the overlap; however, it also pointed out one example in which an FBAR would not be required, but reporting under Code Section 6038D may be required. That example was the beneficiary of a foreign trust, who is not within the scope of FBAR reporting because their interest in the trust is less than 50 percent, but may be within the scope of Section 6038D if the value of their interest in the trust together with the value of other specified foreign financial assets exceeds the aggregate value threshold. There was much discussion last year regarding whether a foreign hedge fund was a foreign financial account under the FBAR regulations. In Proposed Regulations on FBAR, reporting promulgated in February 2010 that issue was reserved because of pending legislative proposals. Surely new Code Section 6038D was the reason for the reservation.

The consequences of not filing the required information with the tax return are onerous:

  1. There is a $10,000 penalty set forth in Code Section 6038D(d)(1). This penalty may be increased if the taxpayer is notified about the failure and does not respond within 90 days after the day the notice is mailed. The increase is $10,000 for each 30-day period (or fraction thereof) during which the failure continues after the expiration of the 90-day period. The penalty cannot exceed $50,000. I.R.C. § 6038D(d)(2). The penalty is subject to abatement provided the failure is due to reasonable cause and not willful neglect. I.R.C. §6038D(g).
  2. Code Sections 6662(b)(7) and (j) were added under HIRE, which provisions impose a 40-percent accuracy-related penalty for underpayment of tax that is attributable to an “undisclosed foreign financial asset understatement.” A “foreign financial asset understatement” for any tax year is the portion of the understatement for the year that is attributable to any transaction involving an undisclosed foreign financial asset that should have been disclosed under information reporting sections listed in Section 6662(j)(2), on which list Section 6038D is included.
  3. Section 6501(c)(8), a provision suspending the Statute of Limitations from running, was amended under HIRE to include Section 6038D and to add “ tax return.” As originally enacted in March 2010, this change prevented the general three-year period for assessment from beginning to run for any item on a tax return until the IRS is provided information required under listed information reporting provisions, including new Section 6038D, even though the item is unrelated to income adjustments associated with missing information requirements. In other words, the Statute of Limitations was kept open for all issues on a taxpayer’s return if it fails to report under the listed information reporting Code sections. Fortunately, Section 6501(c)(8) was amended in legislation signed by the President on August 10, 2010 by adding a new provision, Section 6501(c)(8)(B), which provision provides that the failure to attach an information return will only keep the statute open for items on the return relating to the failure provided the taxpayer acted with reasonable cause and not with willful neglect.
  4. The substantial omission provision extending the Statute of Limitations from three years to six years, Section 6501(e), was amended to provide that the six-year period applies if there is an omission of gross income in excess of $5,000 and the omitted gross income is attributable to a foreign financial asset with respect to which:

    1. InformInformation reporting is required under Code Section 6038D or ation reporting is required under Code Section 6038D or
    2. Would be required if Code Section 6038D were applied without regard to the $50,000 aggregate asset value threshold amount and any other exceptions provided by regulations permitted under Section 6038D(h)(1) involving duplicative disclosure of assets.

Code Section 6038D Accomplishments

What has been accomplished by the enactment of Code Section 6038D when compared to the FBAR reporting provisions?

When reading the Joint Committee on Taxation Report (JCX-4-10), it is clear that Congress was frustrated by the fact that the FBAR reporting requirements originate in the Bank Secrecy Act, which is part of Title 31 of the United States Code, versus Title 26, which is the Internal Revenue Code. Although the FBAR is received and processed by the IRS, it is neither part of the income tax return filed with the IRS nor filed in the same office as the return. Accordingly, under Title 26, the FBAR is not considered “return information,” and its distribution to other law enforcement agencies is not limited by the nondisclosure rules of Title 26. Also, the collection and enforcement powers available to enforce the Internal Revenue Code under Title 26 are not available to the IRS in the enforcement of the FBAR civil penalties, which remain collectible only in accord with the procedures for non-tax collections. The only connection between the FBAR and Form 1040 is the question on Schedule B asking the taxpayer about interests in foreign financial accounts and reference to page B-2 for exceptions and filing requirements for Form TD F 90-22.1. Information reported on Schedule B is not readily available to those within the IRS, who are administering FBAR compliance, despite the fact that the Federal return may be the best source of information for this purpose. Furthermore, the FBAR civil penalties are limited to willful failure to comply with FBAR reporting requirements and a reduced penalty for a non-willful, but negligent, failure to file. In contrast, there are various sanctions allowed by the Code for failure to file required information, including suspension of the applicable statute of limitations and penalties based upon underpayment of tax resulting from failure to disclose. The Code penalties impose a lesser burden of proof and threshold for imposition of the penalty than the willful FBAR penalty.

Conclusion

It is very important for tax professionals to become knowledgeable about information reporting with respect to foreign assets. To not know the rules will be dangerous because clients will be exposed to statute of limitation issues and myriad of penalties.

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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.