Recently created rules outlining IRS reporting requirements for entities with foreign asset holdings or transactions are in effect this tax season – and failing to follow the new rules can result in significant penalties.
The rules will require covered domestic corporations, partnerships and trusts – which are considered formed or availed of for the purpose of holding, directly or indirectly, specified foreign financial assets (specified domestic entities) – to file Form 8938 Statement of Specified Foreign Financial Assets if the total value of those assets exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year. The requirements apply to covered U.S. entities for tax years beginning after Dec. 31, 2015.
The regulations were issued in 2016 under tax code Section 6038D, which itself was enacted as part of the 2010 HIRE Act that outlined certain measures for U.S. taxpayers to report foreign assets to the IRS. They also come at a time when federal regulators – including the IRS, Department of Justice and the Securities and Exchange Commission – are increasing their overall focus on foreign-held assets in order to prevent and deter a range of activities, from tax avoidance to money laundering and corrupt practices.
Whether or not an entity qualifies as a “specified domestic entity” is determined annually, and they must report foreign financial assets even if none of the assets affects their tax liability for the year. For the purposes of the Form 8938 requirements, a covered specified domestic entity is defined as: a closely held domestic corporation or partnership in which either at least 50% of its gross income comes from passive income or at least 50% of its assets produce or are held for the production of passive income, or a domestic trust that has one or more specified individuals or domestic entities as a current beneficiary.
A corporation is considered “closely held” if a specified individual directly, indirectly or constructively owns at least 80% of the corporation (by vote or by value), on the last day of the corporation’s tax year. Similarly, a partnership is considered “closely held” if a specified individual holds directly, indirectly or constructively, at least 80% of the partnership’s capital or profits interest on the last day of the partnership’s tax year.
Failure to file Form 8938 as part of an annual tax return can bring a penalty of $10,000, with an additional $10,000 for each 30 days of non-filing after the IRS becomes aware of your failure to disclose, up to a maximum penalty of $60,000. Therefore, as tax season approaches, it’s important to take stock of your firm’s foreign holdings and determine which reporting requirements apply to you – and which you can exclude. As the IRS continues to expand its focus on offshore holdings, and as foreign financial institutions continue to increase their disclosure of U.S. taxpayer holdings, it’s important to not let this slip under the radar.