Tax Alert

June 2010

Foreign Financial Assets: Transparency is the Word

The new 2010 Health Care and HIRE Tax Act, in addition to bringing new deductions and credits, also provides for increased reporting requirements for offshore assets. With these increased reporting requirements, also come new penalties. Below is a short summary of the new offshore asset reporting requirements and penalties effective for tax years beginning after March 18, 2010.

The new penalty will be 40% of the underpayment that is attributable to any transaction involving an "undisclosed foreign financial asset." The general underpayment penalty is 20%, but Congress increased foreign financial underpayment penalties to encourage more transparency from taxpayers. This penalty is separate from the non-reporting penalty on information returns which usually runs from $10,000 to $50,000.

Individuals and businesses are both subject to this new underpayment rule.

Individuals: If the correct income tax liability exceeds what is reported by the taxpayer by the greater of 10% of the correct tax or $5,000, then a substantial understatement exists.

Example: Reported tax due = $100,000. Actual tax due = $120,000 (due to unreported foreign financial asset income). $20,000 x 40% Penalty = $8,000 penalty. This excludes regular interest and penalties on underpaid taxes.

Corporations: If the correct income tax liability exceeds what is reported by the taxpayer by the lesser of (1) 10% of the correct tax (or, if greater, $10,000) or (2) $10 million, then a substantial understatement exists.

Example: Reported tax due = $120,000. Actual tax due = $150,000 (due to unreported foreign financial asset income). $30,000 x 40% Penalty = $12,000 penalty. This excludes regular interest and penalties on underpaid taxes.

You are probably familiar with the foreign bank account reporting requirements ("FBAR"). This takes it a step further. Undisclosed foreign financial assets are any assets required to be reported under a series of rules, but not reported for that year, such as

• Ownership interest in Foreign corporations, partnerships, and trusts. Example: Form 5471, for Controlled Foreign Corporations.
• Reporting transfers to Foreign persons. Example: Form 1042, U.S. Source Income Reporting for Foreign Persons.
• NEW: For tax years beginning after March 18, 2010, individuals holding more than $50,000 in aggregated foreign assets must report the assets on their income tax return. This is more inclusive than the FBAR rules and includes:
• Foreign Bank Accounts held that are maintained in a foreign financial institution;
• Stock or Security issued by a non-U.S. person;
• Financial instrument or contract held for investment that has an issuer other than a U.S. person; and
• Any interest in a foreign entity (any non-U.S. person).

The federal statute of limitations will not start until correct reports and returns are filed. You will be subject to a non-reporting penalty on information returns of $10,000 plus an additional $10,000 per each 30 days of failure to disclose up to a maximum of $50,000.

Start now to take inventory of all foreign assets that you own or are deemed to own. Talk to your family members and business partners, as you may be a deemed owner of foreign accounts of which you are not aware. It will then make your filings less cumbersome when the actual deadlines arrive!

 

For questions relating to this article or for assistance with developing an effective tax plan, please call or email Andrea R. Bains, CPA, MBT, at 310.432.7404 or abains@sjaccounting.com, or your principal contact at Stonefield Josephson.

 

The information in this document is not intended or written to be used as, and cannot be used as or considered to be a "covered opinion" or other written tax advice, and should not be relied on for the purpose of (1) avoiding tax-related penalties under the Internal Revenue Code, or (2) promoting, marketing, or recommending to another party any transaction or tax-related matter(s) addressed herein, for IRS audit, tax dispute, or other purpose.

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