The world of US tax surrounding foreign income and asset reporting is complex. Unfortunately, many domestic CPAs and those taxpayers who take a “do it yourself” approach do not understand the full set of requirements behind the US’s international tax reporting requirements.
The team here at Evolution Tax & Legal has serviced the likes of large fortune 500 companies, to small solely owned businesses, and individual investors with their annual tax compliance and reporting needs.
We’ve put together this article to help you understand your United States tax reporting obligations if you or your business hold assets or earn income outside of the US.
US Tax Reporting Requirements if You or Your Business Owns Foreign Assets
So what are the general IRS forms and foreign assets they require to be reported? Well, they are FinCen 114 (better known as a Foreign Bank and Account Report, or FBAR), Form 8938, Form 3520, and Form 3520-A. We will take turns exploring each one of these IRS forms and what they require.
1. FinCen Form 114, Foreign Bank and Account Report (“FBAR”)
To put it simply, an FBAR requires a US person to report their interest in foreign financial accounts in which they have a financial interest or signatory authority, so long as the aggregate max values of the accounts are in excess of $10,000 at any point in the year. For example, if a taxpayer has three foreign bank accounts, each of which have a corresponding max value of $4,000, $5,000, and $6,000 through the year, the taxpayer will be required to file an FBAR and report their interest in such accounts. This is because the aggregate max value of the accounts in the year, $15,000, exceeds the $10,000 filing threshold.
The test for filing an FBAR can be broken down into three basic tests—(1) your must be a US person; (2) you must have a financial interest or signatory authority over foreign financial accounts; and (3) the max value of the foreign financial accounts must be in excess of $10,000.
2. Form 8938, Statement of Specified Foreign Financial Assets
Form 8938 requires similar reporting to that required on an FBAR and requires US citizens and residents to report their interest in foreign assets. Generally, Form 8938 must be filed if you are a US citizen or resident, you have an interest in specified foreign financial assets, and either the max or ending value of those assets is more than the reporting threshold set out for your filing status.
Sounds very similar to an FBAR, right? Generally, the assets you report on an FBAR will also be reported on your Form 8938, but the opposite cannot be said. Form 8938 has broader reporting requirements for foreign assets. Additionally, a lot of people assume that if they file an FBAR, they are relieved from filing Form 8938—please be careful because that is not true.
So what are the assets that must be reported on Form 8938? Once again, this is a definitional term that requires some fleshing out. The instructions for Form 8938 state that a taxpayer’s “interest in specified foreign financial assets” are to be reported.
A “specified foreign financial asset” includes—
(1) Financial accounts maintained by a foreign financial institution.
(2) The following financial assets if they are held for investment and not held in an account maintained by a financial institution:
a. Stock or securities issued by a non-US entity;
b. Any interest in a foreign entity; and
c. A financial instrument or contract issued by a counterpart that is not a US person.
Once you know you are a US citizen or resident who holds an interest in a foreign financial asset, the last item to determine is whether the max or ending values of such assets exceeds the reporting threshold set out by the IRS. This reporting threshold depends on your filing status and where you resided during the tax year.
For a full breakdown of this reporting threshold, you can visit Series 102: People Who Are Required to File US Taxes. To break it down generally for you, if you are a US citizen or resident who resided in the US for the tax year, use the Single filing status, and either (1) the max value of your foreign assets is greater than $75,000 at any time in the year; or (2) the ending value of your foreign assets is greater than $50,000 at the end of the year, then you meet the filing threshold.
For those with the status of Married Filing Jointly, these reporting thresholds are increased to $150,000 for max valuation and $100,000 for end of the year value.
3. Form 3520
The final form we will talk about in this article is Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. If the formal name of this IRS form didn’t give it away, Form 3520 is used to report a US person’s transactions with foreign trusts, ownership interests in foreign trusts, and the receipt of gifts of foreign property or inheritances in excess of a specified threshold amount.
Specifically, there are four situations where a Form 3520 should be prepared and filed for a given tax year—
(1) You are the responsible party for reporting a reportable event that occurred during the current tax year, or you are a U.S. person who transferred property (including cash) to a related foreign trust (or a person related to the trust) in exchange for an obligation or you hold a qualified obligation from that trust that is currently outstanding.
(2) You are a U.S. person who, during the current tax year, is treated as the owner of any part of the assets of a foreign trust under the rules of Internal Revenue Code 671 through 679.
(3) You are a U.S. person or an executor of the estate of a U.S. person who received a distribution from a foreign trust during the current tax year; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year, you or a U.S. person related to you received (1) a loan of cash or marketable securities (including an extension of credit) directly or indirectly from such foreign trust, or (2) the uncompensated use of trust property; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year such foreign trust holds an outstanding qualified obligation of yours or a U.S. person related to you.
(4) You are a U.S. person who, during the current tax year, received either:
a) More than $100,000 from a nonresident alien individual or a foreign estate that you treated as gifts or bequests; or
b) More than $16,388 from foreign corporations or foreign partnerships that you treated as gifts.
If you made a transaction that would also qualify you to report an FBAR or Form 8938, you will have to separately report it on Form 3520. However, some Form 3520 filing you are exempt you from reporting certain “specified foreign financial assets” on your Form 8938.
Essentially, if you are required to report the value of a foreign trust, estate, or another bank account on Form 3520, you are exempt from having to report the value of this “specified foreign financial asset” again. In order to do this, you will have to notate on Page 1 of Form 8938, Part IV the amount of Form 3520s you report the “specified foreign financial asset”.
US Income Tax Reporting Requirements for Foreign Businesses
Have you wondered how you should report your interest in foreign businesses? Well, there are many types of foreign businesses and related forms to report. We will cover reporting for foreign corporations, partnerships, and disregarded entities.
1. Foreign Corporations – Form 5471
Foreign corporations are reported in multiple ways for US tax purposes. Generally, the level of reporting and associated IRS forms depends on various factors, such as percentage of total ownership, your relation to the foreign corporation as a shareholder, director, officer, or other executives, and the corporation’s own activities. Generally, if you meet the applicable reporting threshold, a Form 5471 will have to be filed with your individual or business return to report the ownership of a foreign corporation.
Form 5471 is used by US persons who are officers, directors, or shareholders in certain foreign corporations to report their ownership interest in said corporations or specified transactions with said corporations. There are 5 categories of US persons who must file Form 5471. If an individual meets any one of these 5 categories, they must file Form 5471 along with their individual return for the year. As a note, a separate Form 5471 must be filed for each different foreign corporation a US person meets one of the 5 categories of filers for Form 5471.
Each category of filer for Form 5471 has its own specific information and schedules they must include with their filing. Generally, the more involvement you have with a foreign corporation, the more information you will have to file with your 5471.
If you are an owner, officer, or director of a foreign corporation, please contact our team to make a determination if you are required to file Form 5471. We can help make that determination for you, and help you prepare and file the proper Form 5471.
2. Foreign Partnerships – Form 8865
Similar to the treatment of foreign corporations, foreign partnerships are reported in various ways to the US government. The amount of information required to be filed depends on your overall ownership of the partnership, the type and amount of property contributed to the foreign partnership, and the acquisition or disposition of the partnership’s ownership in the given tax year.
Once a proper determination is made that the entity owned is a foreign partnership, then a determination as to what category of filer one falls in must be made to properly report their ownership interest in such entity on IRS Form 8865.
Form 8865 is used by US persons who own, make transfers to or from, or acquire or dispose of foreign partnerships in a given tax year. There are a total of 4 categories of filers, each of which has its own required reporting with respect to the ultimate filer. If a US person meets one of the four categories provided, they must include Form 8865 with individual tax return for the year and include the required information and schedules as prescribed by the category of filer they meet.
Similar to the requirements of filing Form 5471, each Category of filer for Form 8865 is required to include a different set of information and schedules. The information and schedules required are outlined below.
Generally, the more involved someone is with a foreign corporation, the more information they will be required to file. Additionally, if a US person meets more than one category of filer, they will be required to fill out all information for all such category of filer they meet. As noted above, there are certain exceptions to this rule.
3. Foreign Disregarded Entities – Form 8858
Unlike the previous forms discussed which are only used to report the activity of a single type of foreign entity, Form 8858 is used to report the activity of two separate types of entities – a foreign disregarded entity and a foreign branch.
Foreign Disregarded Entities. Unlike the normal principles of US tax law, foreign disregarded entities are required to have their activity reported on a specific form to the IRS. This is Form 8858. If not for extra reporting requirements with respect to foreign disregarded entities, the activity would only be reported directly on the return of the disregarded entity’s owner. For example, a domestic disregarded entity’s activity is reported directly on Schedule C for an individual without any further reporting requirements for federal purposes (i.e. sometimes States will require independent reporting of a disregarded entity).
Similar to the analysis for foreign corporations and partnerships, in order to be required to file Form 8858, a person must own a foreign entity treated as a disregarded entity. Foreign entities formed are, by default, treated as a disregarded entity if there is a single owner of a foreign entity and they are not afforded limited liability protection through their entity. Additionally, a foreign entity that is by default treated as a corporation, can make an election to be treated as a disregarded entity if it only has a single owner.
Once a proper determination has been made that the foreign entity you own is treated as a foreign disregarded entity, Form 8858 will have to be filed with your annual federal tax filings.
Foreign Branches. A foreign branch is defined as an integral business operation carried on by a U.S. person outside the United States. Facts indicating the existence of a foreign branch include a separate set of books and an office or other fixed place of business used by employees in carrying out business activities outside the United States. A permanent establishment under a treaty is deemed to be a foreign branch. Any U.S. person, including an individual, may have a foreign branch.