Changes written into the US tax code in recent legislation impact this year more so than any in recent memory and present many important and financially significant modifications to the compliance reporting. Some of the rules had been deferred, but several new compliance reports are in effect with the tax filings for the year just ended, 2011. As a result, these new regulations will likely also lead to a spate of revised estate and family succession plans too.
Two areas that affect tax year 2011 are the new report of foreign financial assets, a broadly defined term, and increased requirements for paid preparers of US taxes.
· Principal among the new forms and rules is Form 8938 “Statement of Specified Foreign Financial Assets” which must be attached to US tax returns by US citizens and dual nationals who have financial assets outside the USA.
o Foreign financial accounts are defined as any financial account maintained by a foreign financial institution and any stock or security issued by any person other than a US person, any financial instrument or contract held for investment that has an issuer or counterpart that is not a US person, and any interest in a foreign entity.
o Fortunately there are special rules for US taxpayers who actually live outside the US. The threshold for the fair value of all foreign financial assets requiring the reporting those assets are significantly higher than the $50,000 reporting requirements for US taxpayers who live in the USA. If you are a bona fide resident of a foreign country, the aggregate value of all the foreign financial assets has to exceed $200,000 on the last day of the tax year, or more than $300,000 at any time during the year to trigger the compliance documentation. These amounts are doubled if you file a joint return.
· Most exPats understand the requirements for filing the FBAR and comply. The real dangerous exposure is to the thousands of dual nationals who have US passports but have been ignoring the US tax rules. They appear to be an active target of the regional IRS agents along with any shell companies with bank accounts in excess of $50,000.
· Also, the IRS implemented a paid preparer program a few years ago. As is customary with the US government those initial requirements were merely to register and have grown in complexity each year. Last year they began to charge paid preparers an annual fee and added continuing education requirements to maintain that license, and any paid preparer of more than 100 returns had to electronically file the returns. For 2011 they increased the preparer license fee and now require any paid return preparer with more than 10 clients to submit all returns electronically or submit a statement justifying the reason for not doing so.
o If you use a non US CPA or tax attorney to prepare your returns, be sure to verify that they are currently licensed and have completed the required CPE. This may be problematic for many overseas preparers who work seasonally for companies preparing returns. The barrage of new rules and filing requirements in the past two years are substantial, and you need to know that your paid preparer has kept up to date with his or her professional skills.
The impact of each of these is explained in more detail below.
Foreign Financial Assets, Form 8938:
This filing disclosure is in addition to the long-standing rules requiring filing of the foreign bank account information (TD 90-22.1 the FBAR is filed separately with the Treasury Department in Detroit by 30 June of each year), and the controlled foreign corporation information return (Form 5471), or the series 3520/3520A forms for foreign trusts – none of which create any income tax but all of which carry substantial financial penalties if you fail to submit them to the Treasury Department. Of course the new regulations also subject those who fail to properly file the new form 8938 with a minimum $10,000 penalty.
The 61 pages of new regulations, published 21 December 2011, acknowledge that there is overlap in the reporting among these various forms but rather than eliminate duplicate full disclosure of value information on the new form 8938 provides a cross-reference to the related 5471 or 3520 forms also being filed by the taxpayer, some of which will be attached to the same return.
The new rules regarding the form 8938 require identifying any financial assets held offshore not just active business entities. Foreign financial accounts are broadly defined as any financial account maintained by a foreign financial institution and any stock or security issued by any person other than a US person, any financial instrument or contract held for investment that has an issuer or counterpart that is not a US person, and any interest in a foreign entity.
So, any interest in a foreign entity would include stock issued by a foreign corporation to a US person and would require that asset to be reported now on the new form 8938 without regard to whether any taxable income was derived from it or not.
The current issue is likely to affect many expats who own a retirement home or have filed for the Person of Means resident visa. The good news is that your property has realized some increase in value over the past few years in Panamá, and it may well be that the retirement home you acquired is now is worth more than $300k. If you placed that asset in a Panamanian SA, then you will have to disclose the ownership of that foreign entity (the SA) and report the value of the corporation to the IRS. If you placed the cash into a government bond program, that financial asset will be have to be shown on both the TD90-22.1 and the new Form 8938.
The PTIN program – Preparer Tax Identification Number
The continuing education requirements are met if the preparer is a US licensed CPA, attorney, Enrolled Agent of Enrolled Actuary. Other paid preparers now have to meet minimum CPE of 20 hours annually, which is a good thing. As a US licensed CPA my bi-annual CPE requirements are at least 80 hours with a minimum of 20 hours each year.
Since our client base is almost exclusively expats, many of whom own small business and rental property which is held for convenience in local corporations and sometimes in private family foundations, we know that many of our clients are going to be affected by these new requirements. To adapt to these new regulations, we have added another professional tax software program to the one we have been using; a sister-product that includes both the 5471 and 8938 forms which can be e-filed.
In the past the 5471 forms we have prepared for clients with active offshore businesses had to be physically mailed to the IRS, which is further complicated by the fact that the IRS doesn’t use street addresses for mail which precludes using the common international courier services. This added program costs more to prepare the return, but overall will save our clients money. We can now e-file these more complex returns and it simplifies delivery and speeds up any refund to the taxpayer. An added benefit to our clients, this saves the taxpayer the time and effort to carry the documents to an authorized courier service center and incurring the added cost to mail them.
Here’s an editorial with some background for those who have labored this far without getting cross-eyed or angry. What follows is a summary of some of the previously written editorials on these topics and my take on the potential problems with the new compliance reporting.
Most of you are familiar by now with the facts that the US Congress passed what was touted as a jobs bill with the pleasant sounding name “H.I.R.E” Act. Any of you who read my occasional editorials know that what it did was to substantially revise the US tax laws as they affect any US citizen living and working outside the continental US of A. It created an entire new section of the Internal Revenue Code and a companion subset called FATCA – Foreign Account Tax Compliance Act. And nearly all of the effects are negative and for otherwise law abiding citizens, expensive to abide by and even more expensive to ignore.
Yes, there are some folks who have hidden their wealth off shore, but most of them don’t actually live outside the US of A; those individuals have used the past laws and international agreements to put their wealth outside the reach of the US Treasury Department. However, in Congress’s zeal to confiscate what the US government alleges are illegally hidden funds the legislation has created burdens that may be difficult and/or costly to comply with by law-biding US citizens who live outside the US of A.
The politicians justified their action and claimed in systematic overstatements the scope of those hidden assets. Worse they continue to brag about unsubstantiated amounts collected by a relatively small number of additional FBAR filings. Citing these great returns to the Treasury they now offer another ‘voluntary disclosure program’ but with increased penalties to be levied on the maximum value in previously unreported financial accounts at any time in the past eight years!
The US Congress has created a series of rules which within its own language state that the sovereign laws of other nations are irrelevant when it comes to the US governments power to investigate and secure compliance with its tax code. I have written previously of the potential impact on otherwise law-abiding US Citizens who choose to live outside the walls of the US of A. Unfortunately, many of those predictions are coming true: Banks are beginning to refuse new business from any US Citizens and some are even asking their existing US clients to close their accounts and take their business elsewhere.
Counter arguments from major trading partners, most notably Canada, have fallen on deaf ears. Remember, that expats are a diluted voting force. We are all forced to vote in the last US precinct we lived in prior to moving overseas. Our real voice is diffused as a result. I’ve written previously on the fact that about 14 states have populations smaller than the overall expat community, and each of them has at least two senators and one congressional representative. ExPats have no representative voice in Congress.
But it is not just the expats and dual nationals who are being adversely affected. The Treasury Department’s own collection agent – the IRS – is struggling to keep up with the tax law changes and the required modifications to the regulations and the forms the US taxpayers are now being required to append to their returns if they happen to have any assets outside the reach of the Treasury Department computers. The new forms are not ready for filing. The new e-filing system is not ready to accept returns yet. And the real question becomes one of if the IRS can’t even get the regulations written until the last minute, how are they going to get the computer programs that scan these new documents operating properly without creating a whole mess of inconsistencies and erroneous reports challenging the filings? I suspect many taxpayers will receive computer generated letters with threatening language and fines that will ultimately be found to be mistakes by the government.