Unveiling the Hidden Costs: How Non-Compliance in Foreign Asset Reporting Could Lead to Substantial Penalties

Article Highlights

 

• The Report of Foreign Bank and Financial Accounts
• Statement of Specified Foreign Financial Assets
• Foreign Rental Property
• Foreign Pensions
• Reporting Receipt of Foreign Gifts or Bequests
• Reporting Ownership or Transactions with Foreign Trusts
• Annual Information Return for Foreign Trust with U.S. Owner
• Ownership or Voting Power in Foreign Corporation
• Tax on Non-Resident Alien Gifts of Property Located in the U.S.
• Unrecognized Foreign Accounts

In an increasingly globalized world, many U.S. taxpayers find themselves with financial interests or assets located outside the United States. Whether through inheritance, investment, or business ventures, these foreign assets come with specific reporting requirements mandated by the Internal Revenue Service (IRS) and the Financial Crimes Enforcement Network (FinCEN). Understanding these requirements is crucial to avoid severe penalties. This article explores the various forms and thresholds involved in foreign asset reporting, including the FBAR (FinCEN Form 114), Form 8938, and others, while also highlighting common scenarios where individuals might unknowingly hold foreign accounts.

FBAR (FinCEN Form 114) – The Report of Foreign Bank and Financial Accounts (FBAR) is a critical component of foreign asset reporting. U.S. persons, including citizens, residents, and entities, must file an FBAR if they have a financial interest in or signature authority over foreign financial accounts exceeding $10,000 at any time during the calendar year. The purpose of the FBAR is to provide the U.S. government with information to combat financial crimes such as money laundering and tax evasion.

The due date for filing the FBAR is April 15, with an automatic extension to October 15 if the initial deadline is missed. The FBAR is filed directly with FinCEN and not as part of any income tax return. Penalties for failing to file the FBAR can be severe, ranging from $10,000 for non-willful violations to the greater of $100,000 or 50% of the account balance for willful violations. These amounts are indexed for inflation annually, and as of January 25, 2024 they are $16,117 and $161,166, respectively.

Form 8938 – Statement of Specified Foreign Financial Assets – Form 8938 is required under the Foreign Account Tax Compliance Act (FATCA) and must be filed by U.S. taxpayers holding specified foreign financial assets exceeding certain thresholds. For individuals living in the U.S., the threshold is $50,000 on the last day of the tax year or $75,000 at any time during the year. For married couples filing jointly, these thresholds double.

The types of reportable foreign financial assets include financial accounts held at a foreign financial institution, a stock or security issued by a foreign corporation. and an interest in a foreign corporation, partnership, or trust.

The Form 8938 is included with the taxpayer’s income tax return and the due date is the same as the taxpayer’s income tax return, including extensions. Failure to file can result in a $10,000 penalty, plus possibly a 40% accuracy-related penalty, with additional penalties for continued non-compliance and potential criminal charges. In some cases it may be necessary to file both a FBAR and Form 8938.

Foreign Rental Property – While foreign rental properties themselves are not reported on the FBAR or Form 8938, any income generated must be reported on the taxpayer’s U.S. tax return. Additionally, if the property is held through a foreign financial account, that account may need to be reported on the FBAR and Form 8938 if it meets the respective thresholds.

Foreign Pensions – Foreign pensions can be complex, as they may be subject to different reporting requirements depending on their structure. Generally, foreign pensions are reported on Form 8938 if they meet the asset threshold. Additionally, distributions from foreign pensions are typically taxable and must be reported on the taxpayer’s income tax return.

Form 3520 – Reporting Receipt of Foreign Gifts or Bequests – Form 3520 is used to report the receipt of certain foreign gifts or bequests. U.S. persons must file this form if they receive gifts or bequests from foreign individuals exceeding $100,000 or gifts from foreign corporations or partnerships exceeding $20,116 as of 2025 ($19,570 in 2024). The due date for Form 3520 is the same as the taxpayer’s income tax return, including extensions. It is filed separately from the income tax return.

Failure to file Form 3520 can result in a penalty of 5% of the gift or bequest amount for each month the form is late, up to a maximum of 25%.

Form 3520 – Reporting Ownership or Transactions with Foreign Trusts – In addition to reporting foreign gifts, Form 3520 is also used to report ownership or transactions with foreign trusts. U.S. persons who create, transfer assets to, or receive distributions from a foreign trust must file this form. The penalties for failing to file are similar to those for foreign gifts, with additional penalties for failing to report distributions.

Form 3520-A – Annual Information Return for Foreign Trust with U.S. Owner – Form 3520-A is required for foreign trusts with U.S. owners. The trust must file this form annually to provide information about its activities and financial status. The due date is March 15, with an extension available until September 15. Failure to file can result in a penalty of 5% of the trust’s gross value.

Form 5471 – Ownership or Voting Power in Foreign Corporation – U.S. persons with certain levels of ownership or voting power in a foreign corporation must file Form 5471. This form provides information about the corporation’s financial activities and the taxpayer’s involvement. The due date is the same as the taxpayer’s income tax return, including extensions, and is included as part of the income tax return filing. Penalties for failing to file can be substantial, starting at $10,000 per year.

Form 709 – Tax on Non-Resident Alien Gifts of Property Located in the U.S. – Form 709 is used to report gifts of property located in the U.S. made by non-resident aliens. While this form is not specifically for foreign assets, it is relevant for U.S. persons receiving such gifts. The due date is April 15, and failure to file can result in penalties based on the value of the gift.

Unrecognized Foreign Accounts – Many individuals may unknowingly hold foreign accounts, such as online gambling accounts or family accounts in foreign countries. These accounts may still be subject to reporting requirements if they meet the thresholds for the FBAR or Form 8938. It is crucial for taxpayers to review all potential foreign financial interests to ensure compliance.

Navigating the complex landscape of foreign asset reporting can be daunting, but understanding the requirements and deadlines is essential to avoid significant penalties. U.S. taxpayers with foreign financial interests should consult with tax professionals to ensure compliance with all reporting obligations. By staying informed and proactive, taxpayers can effectively manage their foreign assets and avoid the pitfalls of non-compliance.

Contact this office with questions and assistance in complying with foreign reporting requirements.  Don’t expose yourself to unnecessary penalties.