Foreign Financial Assets, Form 8938 Instructions

At the beginning of 2011, we posted about the new reporting requirement for certain individuals who own foreign assets over a certain threshold. For tax years beginning after March 18, 2010, citizens, resident aliens and certain nonresident aliens with specified foreign assets with an aggregate value exceeding the threshold must file the new Form 8938 in addition to Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (the “FBAR”). As most individuals use a calendar tax year, the 2011 calendar tax year is the first year this will be an issue. The IRS released the final Form 8938 and accompanying Instructions at the end of last year.

Form 8938 must be filed with an individual’s income tax return. If an individual need not file an income tax return, that individual is not required to file Form 8938, regardless of the value of his or her foreign financial assets. The Instructions confirm that, for now, only individuals must file. It is worth noting, however, that the draft Instructions previously issued specified that the Service anticipates eventually issuing regulations and guidance which will require domestic entities holding specified foreign financial assets exceeding the threshold to file.

The Instructions provide several interesting insights into how the new reporting requirement is to be applied, including some new information on the reporting threshold, for which there are several categories not clear on the face of the statute. An unmarried taxpayer (or married filing separately) living in the United States satisfies the reporting threshold if the aggregate value of his or her specified foreign financial assets exceeds $50,000 on the last day of the tax year or exceeds $75,000 at any point during the tax year. Married taxpayers filing jointly and living in the United States satisfy the reporting threshold if the aggregate value of their specified foreign financial assets exceeds $100,000 on the last day of the tax year or exceeds $150,000 at any point during the tax year. A taxpayer who is a resident of a foreign country or present in a foreign country at least 330 full days out of 12 consecutive months satisfies the reporting threshold if the aggregate value of his or her specified foreign financial assets exceeds $200,000 on the last day of the tax year or exceeds $300,000 at any point during the tax year. If such a taxpayer living abroad is married filing jointly, he or she satisfies the reporting threshold if the aggregate value of his or her specified foreign financial assets (jointly with those of his or her spouse) exceeds $400,000 on the last day of the tax year or exceeds $600,000 at any point during the tax year. Those who reviewed the draft Instructions should take careful note of these reporting thresholds, as several vary from those issued with the draft Instructions.

Additionally, the Instructions contain detailed instructions on determining value of foreign assets, including several examples. A big issue covered by this section is joint ownership, as the appropriate value depends upon whether the co-owner is your spouse, whether that spouse would have a reporting requirement, and whether you file jointly. When joint owners are not spouses or are spouses, but one spouse is not a specified individual, and therefore does not need to file Form 8938, each must include the full value of the asset in question. When joint owners are spouses filing separately and each is a specified individual, each spouse only includes half the value of the asset each. Joint owner spouses filing jointly should include the full value of the asset only once.

Form 8938 requires that the taxpayer disclose the maximum value of each foreign asset during the year. The Instructions state that for foreign financial accounts it is acceptable to rely on periodic statements and, for other assets, the value on the last day of the tax year, unless the taxpayer has reason to believe that is not a reasonable estimate of maximum value. With regard to valuing a beneficiary’s interest in a foreign trust, however, there is a specific valuation method based on the standard for distributions. If distributions are discretionary, the maximum value is all cash or other property received by that beneficiary in distributions for the year. If distributions are mandatory, the maximum value of the beneficiary’s interest is determined under section 7520 of the Internal Revenue Code.

There are several exceptions to reporting in the draft Instructions meant to eliminate duplicative reporting, one notably concerning interests in foreign grantor trusts. The owner or beneficiary of a foreign grantor trust need not report the specified foreign assets within the trust or that person’s interest in the trust on Form 8938 if that person reports the trust on Form 3520 and the trust files Form 3520-A. The taxpayer must still include the value of any excepted asset in determining whether the reporting threshold is met, however, and must identify the forms on which the specified foreign financial asset is reported in Part IV, Excepted Specified Foreign Financial Assets of Form 8938.

The Instructions provide a lot of information and details even beyond what is discussed here. As this is the first year for this reporting requirement, some extra attention to these Instructions is certainly worth the time.