For the tax year 2011, U.S individuals (including resident aliens and certain nonresident aliens) who owned certain foreign assets, may have been required to file a Statement of Specified Foreign Financial Assets (Form 8938) when certain reporting thresholds were met. So what changed? For fiscal years beginning in 2016, entities –such as certain domestic corporations, partnerships, and trusts – may now be required to also file Form 8938.
If a taxpayer is a specified person (either a specified individual or a “specified domestic entity”) and has an interest in specified foreign financial assets (financial accounts maintained by a foreign financial institution, foreign security, foreign entity, foreign instrument, or foreign contract), and the value of those assets is more than the applicable reporting threshold, Statement of Specified Foreign Financial Assets (Form 8938) must be filed.
Section 6038D created a new annual filing for U.S. taxpayers on Form 8938 beginning in tax year 2011. However, the IRS did not define the term “specified domestic entity”. They deferred providing the definition of “specified domestic entity” pending the issuance of regulations, which left the filing requirement only affecting individuals. The IRS finally defined this term by issuing final regulations in February 2016. An entity that meets the definition of “specified domestic entity”, discussed below, and which meets the reporting threshold amounts, will now be required to file Form 8938
What is a Specified Domestic Entity?
Under the final regulations, a “specified domestic entity” is a domestic corporation, or a domestic partnership:
- if such domestic entities are owned at least 80% directly, indirectly, or constructively (by voting or value of corporation, or capital or profit interest of partnership) by a specified individual (that is a U.S. Citizen, a resident alien, and certain nonresident aliens) on the last day of the tax year; and
- at least 50 percent of the domestic entities’ gross income or assets are passive.
In addition, if a trust is formed for purposes of holding (directly or indirectly) specified foreign financial assets by having one of more specified persons (a specified individual or a specified domestic entity) as a current beneficiary, it would be also considered a specified domestic entity.
For the purpose of Form 8938, passive income is defined as the portion of gross income from passive types of income such as interest, dividends, rents, royalties, annuities, gains from futures, forwards and similar transactions in commodities, and net income from notional principal contracts.
Combined Assets for Passive Income or Assets of Related Corporations and Partnerships
If a domestic corporation and domestic partnership are held by the same specified individual with at least 80 percent ownership, such a domestic corporation and domestic partnership are treated as owning the combined assets and receiving the combined income of all members of that group for the purpose of determining whether a domestic corporation or domestic partnership meets the 50% passive income or asset test discussed above.
For example, if A, a specified individual, owns 100% of DC 1, a domestic corporation, and DC 1 owns 80% of DC 2, another domestic corporation, DC 1 and DC 2 are considered as owning their combined assets and receiving the combined income for the purpose of determining passive income or assets, since A owns 100% of DC 1 and constructively owns 80% of DC 2.
Constructive ownership analysis should be performed for the determination of whether a specified individual owns at least 80% of a domestic corporation or partnership under Section 267(c) and (e)(3).
For example, if A, a specified individual, owns 60% of DC 1, a domestic corporation and B, a member of A’s family, also owns 30% of DC 1, A is considered to own 90% of DC 1 for the purpose of the 80% test, discussed above.
For fiscal year entities beginning in 2016, if a specified domestic entity has a total value of foreign assets that exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year, such specified domestic entity must file the Form 8938.
As discussed above, there is a potential new filing obligation for certain domestic corporations, partnerships or trusts on Form 8938. Proper analysis should be performed to determine the proper filing requirement. Failure to file a Statement of Specified Foreign Financial Assets (Form 8938) may subject you to a failure to file penalty of $10,000.
If you’re uncertain whether or not you need to file Form 8938 or have questions, please contact your Untracht Early advisor.