Tuesday, May 8, 2012

Information Reporting Requirements for Individuals with Foreign Financial Assets in 2011

As part of Congress’s expanded effort to ensure that foreign financial assets are reported to the IRS, individual taxpayers (including U.S. citizens, resident aliens (even if electing to be taxed as a resident of a foreign country under provisions of a U.S. income tax treaty), and certain nonresident aliens) must report the ownership of foreign financial accounts, securities, and other foreign financial assets if the total value of those assets during the year was more than the applicable threshold (generally, more than $50,000 end-of-year balance or more than $75,000 at any time during the year). Individual taxpayers reporting foreign financial assets must complete Form 8938, attach it to their annual income tax return, and file by the due date (including extensions) for that return. This new reporting requirement applies independently of, and in addition to, any required FBARs which are not filed with tax returns but rather filed separately by mail to Detroit, Michigan. Failure to file a complete and correct Form 8938 may result in significant penalties.

The information required by Form 8938 is extensive unlike an FBAR, which only requires summary information. In particular, assuming the applicable threshold is satisfied, Form 8938 requires taxpayers to (1) identify all foreign depositary, foreign security, and foreign custodial accounts, as well as other foreign financial assets not in a financial account reported on Form 8938 (including foreign stock and securities issued by foreign persons), owned during the year; (2) provide the maximum account balance or value of each asset during the year; and (3) list the amount of U.S. tax return items (for example, interest, dividends, gains, losses, deductions, and credits) attributable to these assets. In most cases, the maximum account balance or value of the asset will be its fair market value. A third-party appraisal of such maximum fair market value is not required, though taxpayers should be aware of specific rules that apply when translating the value of assets denominated in foreign currency into U.S. dollars for purposes of Form 8938. In addition, contrary to suggestions made by others, Form 8938 does not require any detailed reporting on activity in an account.

To address some of the confusion caused by the parallel FBAR and foreign financial asset (FATCA) reporting regimes applicable to individuals, we include the following comparison chart:

Collect information re foreign financial accounts
Collect taxes
IRS auditor does not have FBAR
Auditor has both Form 8938 and tax return
Threshold Amounts
Aggregate $10,000 or more
Aggregate $50,000 or more
$50,000 is presumed met if insufficient information given
Reporting Form
TD F 90-22.1, filed in
Form 8938, to be attached to Form 1040
Foreign hedge funds, private equity funds, etc.
Issue reserved
Statute of Limitations (“S/L”) on penalty
6 years
3 years after entire return and Form 8938 are filed. Effective for returns filed for 2011.
Filing Deadline
June 30
When tax return is due (including any extensions)
Nonwillful -$10,000
per year
Willful – Greater of $100,000 or 50% of account balance for each non-complaint year + possibly criminal penalties
$10,000/30 days; max = $50,000
40% on any understatement of gross income derived from an undisclosed foreign financial asset


Unique 2012 Estate and Gift Tax Opportunities

The current U.S. estate and gift tax exclusion amounts (“exclusions”) are as high as they ever have been. In 2012, a U.S. individual can give away $5,120,000 without paying any U.S. gift tax. For a married couple, the aggregate amount is $10,240,000. Currently, the maximum U.S. estate and gift tax rates are 35%. New York levies no gift tax but imposes a graduated estate tax up to 16% on New York taxable estates over $1,000,000.

Unless federal legislation is enacted before December 31, 2012, the $5,120,000 tax exclusions will revert to $1,000,000 in 2013, and the maximum U.S. estate and gift tax rate will increase to 55%. The President’s 2013 budget proposes that the gift tax exclusion be reduced to $1,000,000 per person, whereas the estate and GST tax exclusions would be lowered to $3,500,000. While no one can predict with any confidence what the new transfer tax exclusions and rates will be, we encourage clients to consider the unique planning opportunities in 2012.

If a person makes a $5,120,000 gift today, there would be no U.S. gift tax.[1] In addition, the post-gift income from and any future appreciation on the gift would escape U. S. estate tax. For persons resident in states such as New York, the gift would not be subject to state gift tax and would also escape state estate tax. Set forth below are some illustrations of the possible benefits of 2012 gifts.

If a New York person dies in 2012 with a taxable estate of $11 million, his or her U.S. estate tax would be $1,628,600 and New York estate tax would be $1,226,800, for total estate taxes of $2,855,420, passing $8,144,580 to the family.[2]

If the same person (having not made any prior taxable gifts) makes a $5,000,000 gift in 2012, his total estate (U.S. and New York State) taxes (assuming 2012 rates) would be $2,390,020, for a net family benefit of $8,609,980 or a tax savings of $465,400. If the person dies in 2013, assuming no new legislation, we estimate the total estate taxes would be $3,350,000 for a net benefit of $7,650,000 or a tax savings of $2,045,000.

In addition, future estate tax on a gift made to descendants in trust can be deferred for many years through a “Dynasty Trust.” While transfers in trust for more than one generation may incur a generation-skipping tax (“GST”), in 2012 there is also a $5,120,000 exemption from GST. Like the estate and gift tax, the GST exemption is scheduled to revert to $1,000,000 in 2013.[3]

Gifts can be outright or in trust. They can consist of cash, securities, real property or tangible personal property. There are myriad ways to structure gifts, including techniques to leverage the potential estate and gift tax savings, such as valuation discounts or sales to a grantor trust and techniques in which the donor retains an interest in the gift, such as a grantor retained annuity trust (“GRAT”) or a qualified personal residence trust (“QPRT”).[4] The recommended structure will depend on the individual’s circumstances.

Please contact us if you would like to discuss how you might take advantage of this opportunity.

Robert W. Sheehan, Partner
E-mail:  rsheehan@curtis.com
Tel.:  212 696-6176

Alan S. Berlin, Partner
E-mail:  aberlin@curtis.com
Tel.:  212 696-6038

Tina E. Albright, Partner
E-mail:  talbright@curtis.com
Tel.:  212 696-6150

William L. Bricker, Jr., Partner
E-mail:  wbricker@curtis.com
Tel.:  212 696-6039

J. Dinsmore Adams, Jr., Counsel
E-mail:  dadams@curtis.com
Tel.:  212 696-6940

Marco A. Blanco, Partner
E-mail:  mblanco@curtis.com
Tel.:  212 696-6113

Eduardo A. Cukier, Partner
E-mail:  ecukier@curtis.com
Tel.:  212 696-6107

1. The basic exclusion for 2012 is $5 million which when indexed for inflation becomes $5,120,000. This figure assumes U.S. citizenship and does not account for previous taxable gifts.

2. Assuming death after 2012 and using 2001 rates which will be in effect in 2013 until legislation passes, the total estate taxes would be $5,395,000 for a net benefit of $5,605,000.

3. Indexed for inflation.

4. The donor must survive the term of the GRAT or QPRT to achieve the potential estate tax savings.