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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.
audit rules for partnerships. Normally one would not think that a change to “audit rules” would impact estate planning. However, many estates have LLCs taxed as partnerships, or even limited partnerships or limited liability partnerships, which are used as family limited partnerships in order to obtain valuation discounts through lack of control and lack of marketability (provided that all of the proper procedures and documentation is followed). Moreover, many estates have revocable trusts that own limited liability companies, which is a common way to avoid the often lengthy process of probate for business assets. Again, these techniques are quite common..png)