What to Do with an Estate with Foreign Assets (Even that “Little” Bank Account in Europe)

This article regards estates of decedents who owned foreign assets and the tax and reporting requirements.  Many people are quite shocked to learn about the reporting requirements for foreign bank accounts, in particular.  After all, tax is typically being paid in the foreign jurisdiction, or perhaps the foreign bank accounts generate little to no income that is taxable anyway.  There are, however, two categories to be concerned with, first, of course is taxation.  Second is reporting in and of itself.  How does this all relate to estates?  Well, if the estate has foreign assets and the proper reports are not made, then the personal representative of the estate could be liable.

One of the main reporting obligations is actually not an IRS form at all, it’s a treasury department Form FinCen 114, commonly called an FBAR (Foreign Bank Account Report). It’s part of the financial crime enforcement network, and if the foreign bank accounts in the aggregate exceed $10,000 at any point during the year (even very briefly) then this report must be electronically filed.  The penalties for failure to file can be quite draconian, including willful penalties of 50% or more of what is not reported.  Again, note that this filing has nothing to do with the amount of tax owed, if any.  If a person has signature authority of foreign financial accounts then there can also be a reporting requirement, even if there is no financial interest in the account.  As such, one should be careful about the accounts that a person has signature authority over.  Similarly, one should be careful about having a power of attorney over one’s parents who have a foreign account, as there could be a reporting requirement.

As for tax reporting, several years ago an act of Congress commonly called FATCA added Form 8938, Statement of Specified Foreign Financial Assets.  It is very important that this form is filed, since the statute of limitations never runs if it is not – meaning that there could be a potential tax problem forever.  The IRS recently released regulations requiring this form to be filed by certain domestic entities as well.

Foreign mutual funds held in an estate of a United States citizen or resident are particularly problematic. A United States citizen or resident should never own foreign mutual funds due to the extensive reporting under Form 8621, PFIC shareholder filings and the often very unfavorable tax treatment and the difficulties in obtaining information from often very reluctant foreign financial institutions (FATCA and PFICs are two of the main reasons it’s often hard for United States citizens and residents to open accounts overseas). Although there may be some elections available to alleviate some of the tax burden, foreign financial companies often refuse to supply the needed information.

Of course, some will wonder how the IRS would ever know about these accounts.  Well, FATCA requires foreign financial institutions to identify and report US holders of non-US financial accounts.  The US already has agreements with most countries for this reporting.

The major forms to be concerned with are set forth in the list below.  This is not an exhaustive list and not every form is needed in every circumstance.  The form number is listed with its title in parenthesis:

• FinCen 114 (Foreign Bank Account Report),
• Form 926 (Transfers to Foreign Corporations),
• Form 1042 (Payments to Foreign Taxpayers),
• Form 3520, 3520A (Foreign Trusts),
• Form 5471 (US Owned Foreign Companies),
• Form 5472 (Foreign Owned US Companies),
• Form 8233 (Independent Personal Services by Nonresident),
• Form 8621 (Passive Foreign Investment Corporations),
• Form 8833 (Treaty Based Disclosure Form),
• Form 8840 (Closer Connections Form),
• Form 8858 (Foreign Disregarded Entities),
• Form 8865 (Foreign Partnerships),
• Form 8938 (Specified Foreign Financial Assets),
• Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding).

Now, back to the subject of personal representative liability.  Pursuant to Title 31 U.S.C.§3713(b) any personal representative who pays “any part of a debt of the . . . estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.” Therefore, the personal representative may be liable for taxes, interest and penalties if the distribution leaves the estate unable to pay the government and the personal representative had notice of the government’s claim.  In terms of notice “the executor must have knowledge of the debt owed by the estate to the United States or notice of facts that would lead a reasonably prudent person to inquire as to the existence of the debt owed before making the challenged distribution or payment.” United States v. Coppola, 85 F.3d 1015, 1020 (2d Cir.1996). Therefore, there is a duty of inquiry regarding the existence of these obligations, and as such important that the proper reporting is done and taxes paid.

The good news, however, is that much of the reporting, aside from the PFIC reporting of course, is actually not very difficult.  Moreover, there are generally tax credits that can be used due to foreign tax paid, meaning that the US tax liability is often quite small.  If there are past years that have not been reported, the government currently offers several different programs to settle the tax and reporting obligations for reduced penalties (provided that a person comes forward prior to receiving IRS notice).  Considering the severity of the penalties, proper reporting is obviously very advisable.

Do you have foreign assets or accounts? Then read this post.....

US citizens and residents who have assets and/or accounts in foreign countries, beware.  You have reporting requirements with harsh penalties for failure to comply.

According to the IRS:

United States persons are required to file an FBAR if:

1. The United States person had a financial interest in or signature authority over at least one financial account located outside of the United States; and
2. The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.

An FBAR is required for "financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account."  The FBAR filing requirement exists "to help the United States government identify persons who may be using foreign financial accounts to circumvent United States law. Investigators use FBARs to help identify or trace funds used for illicit purposes or to identify unreported income maintained or generated abroad."

Moreover, and interest, gains, etc. from these accounts must be reported on the tax return.  US Citizens and US residents should file tax returns every year, even if all of their income is earned in a foreign country. 

According to the IRS:

Depending on a taxpayer’s particular facts and circumstances, the following penalties could apply: A penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”). United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year. Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation. A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048.This return also reports the receipt of gifts from foreign entities under section 6039F.The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift. A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b).The penalty for failing to file each one of these information returns or for filing an incomplete return, is five percent of the gross value of trust assets determined to be owned by the United States person. A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046.The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return. A penalty for failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency. A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional. A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit. Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax. A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent. A penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent. An accuracy-related penalty on underpayments imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.

Therefore, it is imperative that one keep up with all of the proper filings.

If this wasn't enough, there are now additional filings under FATCA:

You must file the new Form 8938 if:

• You are a US Citizen or Tax resident; and
• You have "[a]ny financial account maintained by a foreign financial institution," "[s]tock or securities issued by someone other than a U.S. person," "[a]ny interest in a foreign entity," and/or "[a]ny financial instrument or contract that has as an issuer or counterparty that is other than a U.S. person."  The types of assets that may be ensnared by this provison is quite broad, so it is strongly recommended to consult a tax professional; and
• "The aggregate value of your specified foreign financial assets is more than the reporting thresholds that applies to you: Unmarried taxpayers living in the US: The total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.  Married taxpayers filing a joint income tax return and living in the US: The total value of your specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.  Married taxpayers filing separate income tax returns and living in the US: The total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year." 
• "For Taxpayers living abroad (You are a U.S. citizen whose tax home is in a foreign country and you are either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year, or [y]ou are a US citizen or resident, who during a period of 12 consecutive months ending in the tax year is physically present in a foreign country or countries at least 330 days.) If you are a taxpayer living abroad you must file if . . . [y]ou are filing a return other than a joint return and the total value of your specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year; or [y]ou are filing a joint return and the value of your specified foreign asset is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year."

This form will need to be filed with the 2011 tax return (generally filed in 2012 for most people).  Therefore, this is a new form, released November 2011.

So what are the penalties for failing to file this new form you might ask?  It's at least $10,000, and up to $50,000 for a continued failure to file after the IRS notifies you of your failure to report. For most taxpayers this will be filed with the 2011 tax return they file during the 2012 tax filing season.  Worse,  "underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40 percent."  40%!!!!

Just in case I have failed to emphasize how serious the US government is taking this reporting, remember that it can be a crime not to report and US government agencies such as the Financial Crimes Enforcement Network have issued warnings to dissuade people from failure to file.

Oh, and there is nowhere to hide: "FATCA will also require foreign financial institutions . . . to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest."

Sources:IRS.gov, fincen.gov

Foreign Bank Accounts

Very important for those with foreign bank accounts to do all of the reporting.  Very severe penalties if you fail to do so.  Remember that green card holders and citizens are subject to worldwide taxation.