Jane Chang, International Tax Principal and Michele Carter, International Tax Partner

August 9, 2024

If you're a U.S. individual with international investments, foreign bank accounts, or retirement plans, it's crucial to understand your IRS reporting obligations.

What do we mean by “U.S. Individual?” That includes:

• U.S. citizens,
• Legal permanent residents (or “green-card holders”) and
• Non-U.S. persons who meet the substantial presence test (aka the “183-day” test).

Many U.S. foreign filings are purely for informational purposes, but gifts from foreign persons, transactions or ownership in a foreign trust, or ownership in certain foreign corporations may require disclosure with the IRS. Failure to properly report foreign assets can lead to substantial penalties.

Here are some commonly missed foreign filings that may apply to you:

• Statement of Specified Foreign Financial Assets - Form 8938
  • Form 8938 is required if your specified foreign financial assets exceed certain thresholds. For example, single taxpayers must file if their foreign financial assets exceed $50,000 at year-end or $75,000 at any time during the year. The thresholds are higher for married couples and those living abroad.
  • If you own interests in foreign corporations, rental contracts with foreign entities, or hold foreign pension accounts, this form is critical. Once the filing threshold is met, then all foreign financial assets need to be reported even if they are small.
  • Generally, foreign rental real estate does not itself need to be reported. However, contracts with foreign counterparties and related bank accounts are required to be reported.

    • For example: A single taxpayer with a rental property outside the United States who receives annual rent in excess of $50,000 into a foreign bank account, may need to report both the foreign bank account and the value of the foreign rental contract on Form 8938.

  • Form 5471 and other reports required for foreign entities does not alleviate the Form 8938 filing requirement.
  • Form 8938 is filed with the U.S. individual income tax return and does not require a separate extension form.
  • Penalties for failing to file can be as high as $10,000.
• Foreign Bank Account Report (FBAR) (Form FinCen 114)
  • If the total value of your foreign financial accounts exceeds $10,000 at any time during the year, you must file an FBAR.
  • This form is often overlooked, especially when reporting accounts held indirectly through entities owned >50% or when you have signatory authority over foreign accounts.

    • For example: If a U.S. individual owns 75% of a foreign corporation and the corporation has a Swiss bank account with $12,000, then the U.S. individual is required to file a FBAR form to report ownership in the Swiss bank account of $12,000.
      
      If a U.S. individual owns less than 50% of a foreign corporation, but has the ability to direct funds in its Swiss bank account with $12,000, then the U.S. individual is required to file a FBAR form to report his or her signatory authority in the Swiss bank account of $12,000 unless an exception applies. 

  • The FBAR form is due April 15 following the calendar year reported with no separate extension form required for the automatic extension to October 15.
  • Failure to file can result in penalties up to $10,000 per year.
• Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts (Form 3520)
  • Form 3520 is used to report foreign gifts and foreign trust information, and is required if you:
    • Receive gifts from foreign persons exceeding $100,000,
    • Have transactions with foreign trusts, or
    • Received an inheritance from foreign individuals.
  • While the gifts from foreign persons are not taxable, they must be reported. Form 3520 is commonly missed to report gifts from foreign individuals that exceed $100,000 (cash or non-cash) in a calendar year.
  • Form 3520 is due April 15, but is automatically extended if the Taxpayer’s individual return is extended, not requiring a separate extension form, even though Form 3520 is separately filed from the U.S. individual return.
  • The penalties for failing to report can be severe, potentially reaching 25% of the gift's value. Form 3520 penalties related to foreign trust transactions may apply if the form is not timely filed or if the information provided is incomplete or incorrect. Penalties for foreign trust transactions are the greater of $10,000 or 35% of the transaction.
• Annual Information Return of Foreign Trust With a U.S. Owner (Form 3520-A)
  • U.S. owners of foreign trusts must file Form 3520-A. This includes foreign pension plans that may be treated as foreign trusts under U.S. tax law.
  • Forms 3520 and 3520-A are still required for foreign retirement plans unless it is determined the exemption requirements in Rev Proc 2020-17 are satisfied.

    • Exemptions may apply to tax-favored retirement trusts and tax-favored foreign nonretirement savings trusts that are established and operated to provide pension or retirement benefits, or to provide medical, disability, or educational benefits.

    • Exemptions may not apply if trust contributions exceed limits provided in the revenue procedure when converted into U.S. dollars.

  • Form 3520-A is due March 15 of the year following the calendar year for which the U.S. person grantor is reporting. Form 3520-A requires a separate extension to be filed, and the return can be extended to September 15 by filing Form 7004.
  • The penalties for not filing can be the greater of $10,000 or 5% of the trust’s assets owned by the U.S. person.
• Information Return by a Shareholder of a Passive Foreign Investment Company (PFIC) or Qualified Electing Fund (Form 8621)
  • If you hold shares in a PFIC, such as foreign mutual funds, you must file Form 8621.
  • A foreign corporation is treated as a PFIC if:
    • (1) at least 75% if its gross income for the year is passive; or
    • (2) at least 50% of the assets it held during the year produce passive income or are held for the production of passive income (e.g., rent, royalties, dividends, and interest).

  • The tax rules for PFICs are complex and often punitive, making proper reporting essential. Form 8621 (PFIC reporting) is often missed by individuals who have investments in foreign mutual funds or own PFICs though investment partnerships.

  • Absent certain elections, a U.S. person who sells PFIC shares at a gain is generally taxed at ordinary rates instead of capital gain rates. Distributions received from a PFIC do not benefit from qualified dividend rates. An interest surcharge may also apply on the tax related to PFIC income spread to the years of the PFIC holding period.   

  • Form 8621 is filed with the U.S. individual income tax return including the extended deadline, not requiring a separate extension form.
  • While there’s no direct penalty for failing to file, not doing so can indefinitely extend the statute of limitations on your entire tax return.

A U.S. taxpayer with cross border investments or transactions should ensure they are in compliance with all applicable U.S. tax reporting and record-keeping obligations to avoid significant penalties. If you have any questions please contact Jane Chang (jane.chang@hcvt.com or 714-361-7628) or Michele Carter (michele.carter@hcvt.com or 714-361-7627) for a consultation.