Compliance Required of U.S. Persons Concerning Foreign Financial Accounts

June 1, 2017 / Stephen J. Dunn

Posted on : June 1, 2017|Stephen J. Dunn|Delinquent FBAR Submission Procedures, FBARs, Foreign Accounts Compliance, OVDP, Streamlined Procedures

U.S. persons are subject to compliance obligations concerning foreign financial accounts under two statutes, the Internal Revenue Code and the Bank Secrecy Act. A prior article explores who is a “U.S. person.”

Internal Revenue Code

A U.S. person is subject to compliance obligations under the Internal Revenue Code only with respect to foreign financial accounts which the U.S. person beneficially owns. Beneficial ownership means who really owns the funds in the account, as opposed to mere legal title, which concerns whose name is on the account. For example, it is possible for A to holds funds for the benefit of B in an account titled to A. The concept of beneficial ownership is unique to U.S. law. I will examine beneficial ownership in a future article.

Under the Internal Revenue Code, a U.S. person must report interest income realized on foreign financial accounts on Schedule B, Interest and Ordinary Dividends, Part I. The U.S. person must also answer questions about foreign financial accounts on Part III of Schedule B.

The Internal Revenue Code also requires a U.S. person meeting the threshold of Form 8938, Statement of Specified Foreign Financial Assets, to file Form 8938 with his, her, or its U.S. income tax return reporting his, her, or its beneficial ownership in foreign financial accounts. For a taxpayer who is single or married filing separately, the filing threshold is one or more foreign financial accounts with an aggregate balance exceeding $75,000 at any time during the year, or $50,000 on the last day of the year. These amounts double for married taxpayers filing a joint return. The amounts are higher yet for U.S. persons living abroad.

The Internal Revenue Code also requires a U.S. person with a qualifying interest in a foreign corporation to report that interest on Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, filed with his, her, or its U.S. income tax return. The qualifying interests include:

1. A U.S. citizen or resident who is an officer or director of a foreign corporation in which a U.S. person has acquired, in one of more transactions, stock meeting the 10% of the total voting power or total value of the foreign corporation’s outstanding stock, or an additional 10% (in voting power or value) of the foreign corporation’s outstanding stock.

2. A U.S. person who acquires stock in a foreign corporation which, when added to any stock owned on the date of acquisition, vests the U.S. person with 10% of the total voting power or total value of the foreign corporation’s outstanding stock.

3. A U.S. person who acquires stock which, without regard to stock already owned on the acquisition date, represents 10% or more of the total voting power or total value of the foreign corporation’s outstanding stock.

4. A U.S. person who had control of a foreign corporation for an uninterrupted period of at least 30 days during the tax year. “Control” for this purpose means ownership of more than 50% of—

1. The total combined voting power of all classes of the foreign corporation’s stock entitled to vote, or

2. The total value of shares of all classes of stock of the foreign corporation.

5. A U.S. shareholder who owns stock in a foreign corporation that is a controlled foreign corporation for an uninterrupted period of 30 days or more during the tax year of the foreign corporation, and who owned that stock on the last day of that year. A controlled foreign corporation is a foreign corporation that has U.S. shareholders owning, directly, indirectly, or constructively, on any day of the tax year of the foreign corporation, more than 50% of—

1. The total combined voting power of all classes of the foreign corporation’s stock entitled to vote, or

2. The total value of shares of all classes of stock of the foreign corporation.

One of the principal purposes of Form 5471 is to identify a U.S. person’s ownership of stock in a foreign corporation through a shell corporation.

A U.S. person reports all of his, her, or its foreign financial accounts on one Form 8938 for a given tax year. A U.S. person is subject to a $10,000 penalty for each year for which he, she, or it fails to file a Form 8938.A U.S. person files a Form 5471 for each foreign corporation in which he, she, or it has a qualifying interest for the tax year. A U.S. person is subject to a $10,000 penalty for each Form 5471 which he, she, or it fails to file.

A U.S. person is also subject to being assessed U.S. income tax on unreported income from foreign financial accounts, interest on such tax, and an accuracy-related penalty equal to 20% of such tax.

Bank Secrecy Act

The Bank Secrecy Act provides that if a U.S. person has signature authority over, or a financial interest in, foreign financial accounts with an aggregate balance exceeding $10,000 at any time during the calendar year, the U.S. person must file a FinCEN Form 114, Report of Foreign Bank and Financial Accounts, (“FBAR”) for that year.

A U.S. person is subject to a $10,000 penalty for failing to file an FBAR. But if the failure to file an FBAR is willful, the penalty is the greater of $100,000 or 50% of the high aggregate balance of the U.S. person’s foreign financial accounts for the calendar year. There is no penalty if the failure to file is due to reasonable cause.

Congress enacted the FBAR filing requirement, and the draconian penalty for failure to file an FBAR, to curb the evasion of U.S. income tax by the use of foreign financial accounts.

Voluntary Compliance Programs

Programs are available for U.S. persons who have failed to comply with U.S. laws concerning foreign financial accounts to voluntarily comply with such laws while minimizing or avoiding the penalties for noncompliance. Such voluntary compliance programs will be the subject of a later article.