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A Guide to Navigating International Reporting Obligations for US Taxpayers with Foreign Financial Investments

Understand the essential aspects of reporting obligations faced by US taxpayers with foreign financial assets. Explore the required forms, thresholds, implications, and penalties, so you can ensure compliance and the efficient management of your mobility program.

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Reporting Obligations for US Taxpayers with Foreign Financial Investments

Ensuring a seamless transition for employees as they move across international borders is a measure of success in the realm of global mobility. However, amidst the intricacies of international relocations, a critical yet often overlooked aspect demands attention: the nuanced and ever-evolving landscape of reporting obligations for US taxpayers with international financial investments.

In this guide, we'll outline the essential aspects of reporting obligations faced by US taxpayers with foreign financial assets. Exploring the required forms, thresholds, implications, and penalties to equip you with the necessary insights to ensure both compliance and the efficient management of your mobility program.

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US Taxation at a Glance Guides

Chapter 1

FinCEN 114 – Report of Foreign Bank and Financial Accounts

Purpose of the Form: The form, also referred to as FBAR, is used to report a financial interest in or signature authority over a foreign financial account.

Filing Requirement: Any US person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate maximum value of the foreign financial accounts exceeds $10,000 at any time during the calendar year.

Examples of foreign reportable accounts (not an all-inclusive list): Deposit and custodial accounts, accounts held at a foreign branch of a US financial institution, signature authority accounts, stock or securities held at a financial institution (report the account but not the individual stocks), indirect interest in financial assets held through an entity (if greater than 50%), mutual funds, accounts or non-account investment assets held by a grantor trust for which the taxpayer is the grantor, and life insurance or annuity contracts with cash value.

FBAR Reportable Accounts

Tax Implications: There is no tax associated with filing of the FBAR; however, any income generated by or within the foreign financial account must be reported on the individual income tax return.

Due Date and How to File: The FBAR must be filed on or before April 15 of the year immediately following the calendar year being reported with an automatic extension available to October 15 each year. The report must be e-filed at the BSA E-Filing website.

Penalties: Taxpayers who fail to timely file a complete and correct FBAR may be subject to civil monetary penalties, criminal penalties, or both. FBAR penalties vary, depending on whether the failure to file was willful or non-willful. Willful failure to file means that a person knew, or reasonably should have known, that they were required to file an FBAR and chose not to do so.

  • Civil monetary penalties for non-willful violations start at $10,000 and are adjusted for inflation. The current inflation adjusted penalty is $16,117, if assessed on or after January 25, 2024.
  • Civil monetary penalties for willful violations start at $100,000 and are adjusted for inflation. The current inflation adjusted penalty is $161,166, if assessed on or after January 25, 2024.
  • Criminal penalties for willful failure to file an FBAR is limited to $250,000 and/or 5 years of imprisonment. If violating another law of the United States, this penalty increases to $500,000 and/or 10 years of imprisonment.

 

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Chapter 2

Form 8938 – Statement of Specified Foreign Financial Assets

Purpose of the Form: Form 8938 is used to report foreign financial assets of a US taxpayer. This form reports similar information to the FBAR, but there are a few differences.

Filing Requirement: Any US person whose total value of all foreign financial assets exceeds a certain threshold must file Form 8938. The threshold depends on the taxpayer’s marital status, whether they file a joint return, and whether they live inside or outside the United States. Exhibit 1 provides a summary of filing thresholds.

Examples of foreign reportable accounts (not an all-inclusive list): Deposit and custodial accounts, stock/securities (report the account not the individual securities), individual stock/securities not held in an account, partnership interests, mutual funds, account and non-account investments held by a grantor trust where taxpayer is the grantor, hedge funds, and private equity funds.

Form 8938 Reportable Accounts

Tax Implications: There is no tax associated with filing Form 8938; however, any income generated by or within the foreign financial asset must be reported on the individual income tax return.

Due Date and How to File: Form 8938 is filed with the individual income tax return and must be filed by the due date of that return, including extensions.

Penalties: Failure to file a complete and accurate Form 8938 by the due date is $10,000. The IRS may also assess a continuation penalty if Form 8938 is not filed within 90 days after the IRS mails a notice. The additional penalty applies for each 30-day period (or part of a period) during which Form 8938 is not filed, up to $50,000. Taxpayers may also be subject to criminal penalties and accuracy-related penalties if tax is underpaid as a result of a transaction involving an undisclosed Specified Foreign Financial Asset (SFFA).

Additionally, failure to file the form keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 8938 but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever.

Exhibit 1

 

Chapter 3

Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund

Purpose of the Form: Form 8621 is required to be filed annually if a US taxpayer is a shareholder of a Passive Foreign Investment Company (PFIC) and meets certain requirements.

What is a PFIC? A PFIC is a foreign corporation that has one of the following attributes:

  • At least 75% of its income is considered “passive” (e.g., interest, dividends, royalties); or
  • At least 50% of its assets are passive income producing assets.

Examples of PFICs: Generally, most foreign mutual funds (or other similar pooled investments) fall within the definition of a PFIC. This can be the case even if such funds are held through a tax-deferred savings account such as a UK Individual Savings Account (ISA) and Canadian Tax-Free Savings Account (TFSA) or through a non-qualified pension / retirement account that is treated as a foreign trust for US tax purposes.

Filing Requirement: Generally, a US person that is a direct or indirect shareholder of a PFIC must file Form 8621 each tax year the US person receives direct or indirect distributions from a PFIC, recognizes gain on a direct or indirect disposition of PFIC stock, is reporting information with respect to a Qualified Electing Fund (QEF) or IRC Section 1296 mark-to-market election, is making an election that is reportable in Part II of Form 8621, or is required to file an annual report pursuant to IRC Section 1298(f).

Tax Implications: The form is used to make an election to pay taxes on the current income of the PFIC (assuming that tax is required to be paid by the US shareholder). If an election is not made to pay taxes on the current income of the PFIC, then any future distributions may be subject to punitive taxes on excess distributions. Form 8621 tracks distributions and income from PFICs that otherwise may not be part of taxable income and assesses a tax with interest on those amounts (referred to as excess distributions) from the current year.

Due Date and How to File: Form 8621 is filed with the individual income tax return and must be filed by the due date of that return, including extensions.

Penalties: The failure to file the form does not directly result in a monetary penalty. Rather, it keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 8621 but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever. Additionally, failure to file Form 8621 could lead to criminal investigation and potential FBAR and Form 8938 penalties which we discussed above.

 

Chapter 4

Form 5471 – Information Return of US Persons with Respect to Certain Foreign Corporations

Purpose of the Form: This form is used 1) by certain US persons who are shareholders of foreign corporations and/or 2) by certain US citizens and residents who are officers and/or directors in foreign corporations in which a US person acquires stock.

Common Definitions:

  • US shareholder is a US person that owns at least 10% directly, indirectly, or constructively of the foreign corporation.
  • Controlled Foreign Corporation (CFC) is a foreign corporation that is controlled by US shareholders who collectively own greater than 50%.
  • Section 965 Specified Foreign Corporation (SFC) includes 1) any CFC and 2) any foreign corporation with a domestic corporation as a US shareholder.
  • Control means ownership of more than 50% (directly, indirectly, or constructively).

Form 5471 reporting is not determined by whether any income was generated or if the business generated a profit during the year.

Filing Requirement: A US person is required to file Form 5471 if they meet the requirements of at least one of five categories. There are five different categories of Form 5471 filers—and some of the categories can be further broken down into sub-categories, depending on the specific type of ownership.

  • Category 1 filer: A US shareholder of a foreign corporation that is a Section 965 SFC at any time during the tax year and who owned that stock on the last day of the tax year.
    • Example: A US individual who owns at least 10% directly, indirectly, or constructively of the CFC is considered a Category 1 filer.
  • Category 2 filer: A US officer or director of a foreign corporation where a US person acquired stock that meets a 10% threshold.
    • Example: A US person is an officer or director of a foreign corporation in which a US person obtains 10% stock. The US officer or director is required to file Form 5471 to report the transaction to the IRS. This filing obligation applies even if the US officer or director does not own any stock.
  • Category 3 filer: A US person who became or stopped being a US shareholder during the year, or an individual who became a US person while holding at least 10% of the foreign corporation’s stock by vote or value. Examples:
    • US person who—when they acquire stock or additional stock—has 10% stock ownership in the foreign corporation.
    • US person who disposed of foreign corporation stock bringing their ownership to less than 10%.
    • A nonresident alien who has 10% or more stock ownership in the foreign corporation and then becomes a US tax resident in that year.
  • Category 4 filer: A US person who controlled a foreign corporation during the year.
    • Example: US person who owns greater than 50% of the foreign corporation (directly, indirectly, or constructively) is a Category 4 filer.
  • Category 5 filer: A US shareholder of a CFC who owned the stock at any time during the tax year and who owned that stock on the last day of the tax year.

Tax Implications: US shareholders of CFCs are taxed on their pro-rata share of the foreign corporation’s current income whether or not distributed. Such income is reportable as either Global Intangible Low-Taxed Income (GILTI) or Subpart F income on the individual’s tax return. Certain elections are available to reduce or eliminate the tax on the CFC earnings at the US shareholder level.

Additional tax implications may apply if an individual is employed by the company, receives dividends/distributions, has a shareholder loan, transfers appreciated property, or sells company stock.

Due Date and How to File: Form 5471 is filed with the individual income tax return and must be filed by the due date of that return, including extensions.

Penalties: Taxpayers who fail to timely file a complete and correct Form 5471 may be subject to civil monetary penalties, criminal penalties, or both. Form 5471 penalties vary depending on the filer categories. Civil monetary penalties generally start at $10,000 and could increase after failure notification. Additional penalties for failure to report required information on Schedule M are limited to a maximum of $50,000 per foreign corporation, for a total of $60,000. Similarly, additional penalties for failure to report required information on Schedule O are limited to a maximum of $50,000 for each failure per reportable transaction, for a total of $60,000. The IRS may also reduce foreign taxes available for credit by 10% with escalation after failure notification. Additional penalties may be imposed for undisclosed foreign financial asset understatements.

Additionally, failure to file Form 5471 keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 5471 but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever.

 

Chapter 5

Form 926 – Return by a US Transfer of Property to a Foreign Corporation

Purpose of the Form: This form is used to report certain transfers of tangible or intangible property to a foreign corporation.

Filing Requirement: US persons must file Form 926 if they:

  • Transfer more than $100,000 in cash or property during the preceding 12-month period ending on the date of transfer to a foreign corporation; or
  • Own at least 10% of the voting power or total value of the corporation immediately after the transfer (regardless of the amount transferred)

Tax Implications: Generally, there is no income or loss flowing onto an individual’s income tax return. US taxpayers may be required to recognize a gain if they transfer appreciated property to the foreign corporation.

Due Date and How to File: Form 926 is filed with the individual income tax return and must be filed by the due date of that return, including extensions.

Penalties: Failure to file Form 926 carries a penalty of 10% of the value of property transferred, up to $100,000 per return. If the failure to file Form 926 was due to intentional disregard, the penalty is unlimited.

Additionally, failure to file Form 926 keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 926 but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever.

 

Chapter 6

Form 8858 – Information Return of US Persons With Respect to Foreign Disregarded Entities and Foreign Branches

Purpose of the Form: This form is used by US persons that own Foreign Disregarded Entities (FDEs) or operate a Foreign Branch (FB).

Filing Requirement: US persons that are tax owners of FDEs, operate a FB, or that own interest in a Controlled Foreign Corporation (CFC) or Controlled Foreign Partnership (CFP) that is a tax owner of FDE or FB are required to file Form 8858 annually.

Tax Implications: Operating results of an FDE or FB are reported on the owner’s income tax return.

Due Date and How to File: Form 8858 is filed with the individual income tax return and must be filed by the due date of that return, including extensions.

Penalties: Taxpayers who fail to timely file a complete and correct Form 8858 may be subject to civil monetary penalties, criminal penalties, or both. A $10,000 penalty is imposed on a US person where the CFC or CFP fails to timely file a correct Form 8858 (with escalation after failure notification) up to $60,000 per violation per year. The IRS may also reduce foreign taxes available for credit by 10% with escalation after failure notification. Additional penalties may be imposed for undisclosed foreign financial asset understatements.

Additionally, failure to file Form 8858 keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 8858 but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever.

 

Chapter 7

Form 8865 – Return of US Persons With Respect to Certain Foreign Partnerships

Purpose of the Form: This form is used by certain US persons who are owners of a foreign partnership.

Filing Requirement: A US person is required to file Form 8865 if they meet the requirements of at least one of the four categories.

  • Category 1 filer: A US person who controlled a Foreign Partnership (FP) at any time during the partnership’s tax year.
    • Example: A US individual who owns more than 50% directly, indirectly, or constructively of the Controlled Foreign Partnership (CFP) is considered a Category 1 filer.
  • Category 2 filer: A US person who owned at least 10% of the FP while the FP was controlled by US persons each owning at least a 10% interest.
  • Category 3 filer: A US person who contributed property to a foreign partnership:
    • While they owned at least 10% of the FP immediately after contribution (regardless of the amount contributed); or
    • If they owned less than 10%, the value of property contributed (during the 12-month period ending on the date of transfer) exceeded $100,000.
  • Category 4 filer: A 1) US person who acquired or disposed of an interest during the year resulting in this person falling below the 10% ownership threshold; or 2) a US person’s direct proportional interest has changed by +/- 10%.

Tax Implications: Operating results of the partnership are reported on the owner’s income tax return.

Due Date and How to File: Form 8865 is filed with the individual income tax return and must be filed by the due date of that return, including extensions.

Penalties: Taxpayers who fail to timely file a complete and correct Form 8865 may be subject to civil monetary penalties, criminal penalties, or both. Form 8865 penalties vary depending on filer categories as follows:

  • Category 1 and 2 filer. Civil monetary penalties generally start at $10,000, which can increase after failure notification. Any additional penalties for failure to furnish timely information are limited to a maximum of $50,000 per foreign partnership, for a total of $60,000. The IRS may also reduce foreign taxes available for credit by 10% with escalation after failure notification.
  • Category 3 filers. Filers who fail to properly report a contribution to a foreign partnership, are subject to a penalty equal to 10% of the fair market value of the property at the time of the contribution, up to $100,000 limit, unless the failure is due to intentional disregard. In addition, the transferor must recognize gain on the contribution as if the contributed property had been sold for its fair market value.
  • Category 4 filers. Failure to properly report information for this category results in a $10,000 penalty. In addition, criminal penalties can apply unless it is shown that such failure is due to reasonable cause. Additional penalties for failure to furnish timely information are limited to a maximum of $50,000, for a total of $60,000.

Additional penalties may be imposed for undisclosed foreign financial asset understatements.

Additionally, failure to file Form 8865 keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 8865 but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever.

 

Chapter 8

Form 3520 – Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts

Purpose of the Form: This form is used by US persons (and executors of US decedents’ estates) to report transactions with foreign trusts, ownership of foreign trusts, and receipt of gifts from foreign persons.

Filing Requirement: A US person (or executor of a US decedent) is required to file Form 3520 if they meet any of the requirements listed below:

  • A US person completed a transaction with a foreign trust, such as, but not limited to:
    • they transferred money or other property to a foreign trust
    • they received a distribution from a foreign trust
    • they held a qualified obligation from the trust that is currently outstanding
    • the foreign trust holds an outstanding qualified obligation of a US person who is a US owner or beneficiary.
  • An executor of the estate of a US decedent where:
    • the decedent made a transfer to a foreign trust by reason of death
    • the decedent was treated as the owner of any portion of a foreign trust immediately prior to death
    • the decedent’s estate included any portion of the assets of a foreign trust
    • an executor of the estate of a US person who received a distribution from a foreign trust
  • A US person is an owner of all or any portion of a foreign trust at any time during the tax year.
  • A US person received large gifts or bequests from foreign persons.

Tax Implications: The US income taxation of a foreign trust depends on whether the trust is a grantor or nongrantor trust.

  • Income from a foreign grantor trust is generally taxed to the trust’s grantor, rather than to the trust itself or to the trust’s beneficiaries.
  • Income from a foreign nongrantor trust is generally taxed when distributed to US beneficiaries, except to the extent US source or effectively connected income is earned and retained by the trust, in which case the nongrantor trust would pay US income tax for the year such income is earned.

Gifts or bequests from foreign partnerships or corporations may be taxable to the recipient.

Due Date and How to File: Form 3520 is due at the same time as individual income tax return, including extensions. However, it must be mailed to a specialized processing center separate from the individual income tax return.

Penalties: Taxpayers who fail to timely file a complete and correct Form 3520 may be subject to civil monetary penalties, criminal penalties, or both. Form 3520 penalties vary depending on filer categories. Civil monetary penalties generally start at the greater of $10,000 or the following:

  • 35% of the gross value of any property transferred to a foreign trust for failure to report the creation of or transfer to the foreign trust
  • 35% of the gross value of distributions received from a foreign trust for failure to report receipt of the distributions
  • 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a US person

Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting.

Penalties on unreported gifts start from 5% of the gift per month, up to maximum penalty of 25% of the gift.

Additional penalties may be imposed for undisclosed foreign financial asset understatements.

Finally, failure to file Form 3520 keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 3520 but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever.

 

Chapter 9

Form 3520-A – Annual Information Return of Foreign Trust with a US Owner

Purpose of the Form: This form is used by a foreign trust with at least one US owner to provide information about the trust, its US beneficiaries, and any US person who is treated as an owner of any portion of the foreign trust.

Filing Requirement: A foreign trust with a US owner must file Form 3520-A for the US owner to satisfy its annual information reporting requirements under IRC Section 6048(b). Each US person treated as an owner of any portion of a foreign trust under the grantor trust rules is responsible for ensuring that the foreign trust files Form 3520-A and provides the required annual statements to its US owners and US beneficiaries. If a foreign trust fails to file Form 3520-A, the US owner must complete a substitute Form 3520-A and attach to the owner’s Form 3520.

Tax Implications: The US income taxation of a foreign trust depends on whether the trust is a grantor or nongrantor trust.

  • Income from a foreign grantor trust is generally taxed to the trust’s grantor, rather than to the trust itself or to the trust’s beneficiaries.
  • Income from a foreign nongrantor trust is generally taxed when distributed to US beneficiaries, except to the extent US source or effectively connected income is earned and retained by the trust, in which case the nongrantor trust would pay US income tax for the year such income is earned.

Due Date and How to File: Form 3520-A is due by the 15th day of the 3rd month after the end of the trust's tax year (e.g., due March 15 if the trust’s tax year is the calendar year) and can be extended an additional six months with Form 7004. Form 3520-A must be mailed to a specialized processing center separate from the individual income tax return.

Penalties: A US owner of a foreign trust that fails to timely file a complete and correct Form 3520-A may be subject to civil monetary penalties, criminal penalties, or both. Civil monetary penalties generally start at the greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the US person and may increase after failure notification. Additional penalties may be imposed for undisclosed foreign financial asset understatements.

Additionally, failure to file Form 3520-A keeps the tax return open indefinitely. Generally, the statute of limitations for the IRS to audit a tax return is three years. However, if a taxpayer is required to file Form 3520-A but fails to do so, the statute of limitation for the tax year never starts, so the IRS can go back and audit the entire tax return forever.

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